EVOLUTIONARY CHANGE: THE INVISIBLE HAND AND MONEY

Instead of being designed by men, civilization has evolved, according to one view. Social institutions [government, the rule of law, the social division of labor connoting production activities, markets (credit, labor, commodities, etc.), money, languages, mores (morals and values), et. al.] are determined not simply by preceding causes but as part of a process of unconscious self-organization of a structure or a pattern. These social institutions spontaneously come into existence. They are complex and self-maintaining mass phenomena. Reinforcing this point, Adam Smith wrote in The Theory of Moral Sentiments that men aiming at the “gratification of their own vain and insatiable desires” are “led by an invisible hand” in such a way that they “without intending it, without knowing it, advance the interest of society and afford means for the multiplication of the species.” The Origin of Money Theory, formulated by economist Carl Menger, in 1871, provides an account of the evolution of the social institution of money. Money, according to the Theory, is not a creation of the state as many think it is today. Rather it came into existence spontaneously through an unconscious, self-organizing, self-maintaining, evolutionary process. An outline of the theory is presented below. A. The Seven Steps of Carl Menger’s Origin of Money Theory: * The seven (7) steps below explain the emergence of a commodity money like gold or silver in the fifteenth through the early twentieth centuries and of the fiat moneys that predominate today like the U.S. Dollar, the Swiss Franc, the Euro, the British Pound, the Swedish Krona, and more. 1. Primitive indirect exchange becomes an alternative to direct exchange. 2. The evolution of a set of more marketable goods into commonly-used media of exchange. 3. The contraction of the number of media of exchange. 4. The emergence of sophisticated indirect exchange: money. 5. The evolution of fully-backed money substitutes. 6. The evolution of partially-backed money substitutes (otherwise known as the evolution of fractional reserve banking). 7. The emergence of fiat money.

B.

The Case in which Direct Exchange is Impossible: 1. Individual A is the holder of commodity p but desires only commodity r. 2. Individual B is the holder of commodity q but desires only commodity p. 3. Individual C is the holder of commodity r but desires only commodity q.

C.

Necessary Conditions for Indirect Exchange to Occur: 1. The unequal valuations of the participants in exchange. 2. There must be more than two individuals and more than two kinds of commodities in the market. 3. There must be a difference in the marketability of the goods. 4. Indirect exchange must be beneficial to the exchanging participants.

D.

Indirect exchange is distinguished from direct exchange according as a medium of exchange is interposed or not. Specification of the concepts of indirect exchange and monied exchange according to the Origin of Money Theory. Knowledge of the lay concept of monied exchange. Concept of Money: According to the Origin of Money Theory, money is the most marketable good. It is the commonly-used and generally accepted medium of exchange in an economy.

E.

“The first view [change by design versus change by evolution] holds that human institutions will serve human purposes only if they have been deliberately designed for these purposes, often also that the fact that an institution exists is evidence of it having been created for a purpose, and always that we should re-design society and its institutions that all our actions will be wholly guided by known purposes.... Yet the belief underlying them, that we owe all beneficial institutions to design, and that only such design has made or can make them useful for our purposes, is largely false.” -- Friedrich A. Hayek from Law, Legislation and Liberty

The fatal conceit as identified by Friedrich A. Hayek in a 1988 book by the same name is the belief “that man is able to shape the world around him according to his wishes.” It is the fatal conceit which has facilitated the prevalent twentieth [and now twenty-first] century perspective that civilization is by design rather than having evolved. Evolutionary economics and the fatal conceit are part of the economist’s critique of the socialist form of economic organization.

2

FUNCTION OF MONEY

ORIGIN OF MONEY The case is not essentially different when supply and demand do not coincide quantitatively, e.g. when one indivisible good has to be exchanged for various goods in the possession of several persons. Indirect exchange becomes more necessary as division of labour increases and wants become more refined. In the present stage of economic development, the occasions when direct exchange is both possible and actually effected have already become very exceptional. Nevertheless, even nowadays, they sometimes arise. Take, for instance, the payment of wages in kind, which is a case of direct exchange so long on the one hand as the employer uses the labour for the immediate satisfaction of his own needs and does not have to procure through exchange the goods in which the wages are paid, and so long on the other hand as the employee consumes the goods he receives and does not sell them. Such payment of wages in kind is still widely prevalent in agriculture, although even in this sphere its importance is being continually diminished by the extension of capitalistic methods of management and the development of division of labour. 1 Thus along with the demand in a market for goods for direct consumption there is a demand for goods that the purchaser does not wish to consume but to dispose of by further exchange. It is clear that not all goods are subject to this sort of demand. An individual obviously has no motive for an indirect exchange if he does not expect that it will bring him nearer to his ultimate objective, the acquisition of goods for his own use. The mere fact that there would be no exchanging unless it was indirect could not induce individuals to engage in indirect exchange if they secured no immediate personal advantage from it. Direct exchange being impossible, and indirect exchange being purposeless from the individual point ofview, no exchange would take place at all. Individuals have recourse to indirect exchange only when they profit by it; i.e. only when the goods
1 The conclusion that indirect exchange is necessary in the majority of cases is extremely obvious. As we should expect, it is among the earliest discoveries of economics. We find it clearly expressed in the famous fragment of the Pandects of Paulus: 'quia non semper nee facile concurrebat, ut, cum tu haberas, quod ego desiderarem, invicem haberem, quod tu accipere velles' (Paulus lib. 33 ad edictum I.L pr. D. de contr. empt. 18, 1). Schumpeter is surely mistaken in thinking that the necessity for money can be proved solely from the assumption of indirect exchange (see his Wesen und Hauptinhalt der theoretischen Nationalokonomie, Leipzig 1908, pp. 273 ff.). On this point, cp. Weiss, Die moderne Tmdenz in der Lehre vom Geldwert, Zeitschriftfiir Volkswirtschaft, Sozialpolitik und Verwaltung, Bd. XIX, pp. sx8 ff.

§2
The Origin of Money. Indirect exchange is distinguished from direct exchange according as a medium is involved or not. Suppose that A and B exchange with each other a number of units of the commodities m and n. A acquires the commodity n because of the use-value that it has for him. He intends to consume it. The same is true of B, who acquires the commodity m for his immediate use. This is a case of direct exchange. If there are more than two individuals and more than two kinds of commodity in the market, indirect exchange also is possible. A may then acquire a commodity p, not because he desires to consume but in order to exchange it for a second commodity q which he does desire to consume. Let us suppose that A brings to the market two units of the commodity m, B two units of the commodity n, and C two units of the commodity o, and that A wishes to acquire one unit of each of the commodities n and o, B one unit of each of the commodities o and m, and C one unit of each of the commodities m and n. Even in this case a direct exchange is possible if the subjective valuations of the three commodities permit the exchange of each unit of m, n, and o for a unit of one of the others. But if this or a similar hypothesis does not hold good, and in by far the greater number of all exchange transactions it does not hold good, then indirect exchange becomes necessary, and the demand for goods for immediate wants is supplemented by a demand for goods to be exchanged for others.1 Let us take, for example, the simple case in which the commodity p is desired only by the holders of the commodity q, while the commodity q is not desired by the holders of the commodity p but by those, say, of a third commodity r, which in its turn is desired only the possessors of p. No direct exchange between these persons can possibly take place. If exchanges occur at all, they must be indirect; as, for instance, if the possessors of the commodity p exchange it for the commodity q and then exchange this for the commodity r which is the one they desire for their own consumption.
1

Cp. \Vicksell,

Wert, Kapital und Rente, Jena 1893, repr. London 1933, p.

so f.

:30

31

,I

l

FUNCTION OF MONEY they acquire are more marketable than those which they surrender. Now all goods are not equally marketable. While there is only a limited and occasional demand for certain goods, that for others is more general and constant. Consequently, those who bring goods of the first kind to market in order to exchange them for goods that they need themselves have as a rule a smaller prospect of success than those who offer goods of the second kind. If, however, they exchange their relatively unmarketable goods for such as are more marketable, they will get a step nearer to their goal and may hope to reach it more surely and economically than if they had restricted themselves to direct exchange. It was in this way that those goods that were originally the most marketable became common media of exchange, i.e. goods into which all sellers of other goods first converted their wares and which it paid every would-be buyer of any other commodity to acquire first. And as soon as those commodities that were relatively most marketable had become common media of exchange, there was an increase in the difference between their marketability and that of all other commodities, and this in its turn further strengthened and broadened their position as media of exchange. 1 Thus the requirements of the market have gradually led to the selection of certain commodities as common media of exchange. The group of commodities from which these were drawn was originally large, and differed from country to country; but it has more and more contracted. Whenever a direct exchange seemed out of the question, each of the parties to a transaction would naturally endeavour to exchange his superfluous commodities, not merely for more marketable commodities in general, but for the most marketable commodities; and among these again he would naturally prefer whichever particular commodity was the most marketable of all. The greater the marketability of the goods first acquired in indirect exchange, the greater would be the prospect of being able to reach the ultimate objective without further manceuvring. Thus there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected
1 Cp. Menger, Untersuchungm ilber die Methode dt?T Sozialrcissenschaften und der t>olitischen Okonomie insbesondere, Leipzig 1883, pp. 172 ff.; Grundsiitze der Volkswirtrchaftslehre, Zweite Aufi., Vienna 1923, pp. 2.p fL

J

ORIGIN OF MONEY until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money. This stage of development in the use of media of exchange, the exclusive employment of a single economic good, is not yet completely attained. In quite early times, sooner in some places than in others, the extension of indirect exchange led to the employment of the two precious metals gold and silver as common media of exchange. But then there was a long interruption in the steady contraction of the group of goods employed for that purpose. For hundreds, even thousands, of years the choice of mankind has wavered undecided between gold and silver. The chief cause of this remarkable phenomenon is to be found in the natural qualities of the two metals. Being physically and chemically very similar, they are almost equally serviceable for the satisfaction of human wants. For the manufacture of ornaments and jewellery of all kinds the one has proved as good as the other. (It is only in recent times that technological discoveries have been made which have considerably extended the range of uses of the precious metals and may have differentiated their utility more sharply). In isolated communities, the employment of one or other metal as sole common medium of exchange has occasionally been achieved, but this shortlived unity has always been lost again as soon as the isolation of the community has succumbed to participation in international trade. Economic history is the story of the gradual extension of the economic community beyond its original limits of the single household to embrace the nation and then the world. But every increase in its size has led to a fresh duality of the medium of exchange whenever the two amalgamating communities have not had the same sort of money. It would not be possible for the final verdict to be pronounced· until all the chief parts of the inhabited earth formed a single commercial area, for not until then would it be impossible for other nations with different monetary systems to join in and modify the international organization. Of course, if two or more economic goods had exactly the same marketability, so that none of them was superior to the others as a medium of exchange, this would limit the development towards a unified monetary system. We shall not attempt to decide whether this assumption holds good of the two precious metals gold and silver. c J

32

33