The confusion about the regression theorem multiplies. Once again, that hoary chestnut, that the reg. thm. only applies to a barter economy, is getting popular.
Time for Smiling Dave to clear things up. We begin by quoting Mises, then, since it is written in very stilted English, to translate it.
In Human Action, Mises begins his study of the regression theorem by noting that “…the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange.”
Let’s translate this into simple language to make sure we know what it’s saying.
“…the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange…”
Translation: Why does Smith want and accept a dollar, or a bitcoin, or any other unit of any kind of money, as worth a pound of apples?”
“…depends on its value in exchange.”
Translation: Because plenty of other people also want the dollar or the bitcoin in their pockets, and also accept it as worth a pound of apples.
He writes that this simple statement led people to reject the whole Austrian analysis of money.
Devil’s Advocate: And how right they were. Supposedly Smith only accepts it as money because Jones and Butler and Yeats, and thousands of other people do. But the same is true of Jones. He only accepts it because a thousand other people do. Same with every single one of those thousands. Each one accepts it only because everyone else does.
And of course, that can’t be. You have to start somewhere. When the world was created, nobody accepted anything as money, obviously. So let’s say that on January first, nobody accepts a silver coin as money. Why does Smith wake up on January second and agree to accept a silver coin as money from now on, when nobody else does? For him to accept it, you need thousand of other people to accept it. Otherwise he won’t be able to buy the many things he needs with silver coins. [Alternately, why do thousands of people wake up on January second and all decide to accept the silver coin as money?]
SD: Yes, that’s an excellent question. And that question has to be answered whether Smith is living in a barter economy or a money economy [meaning where people are using gold, say, and he suddenly accepts silver as money, too]. Why should he accept silver coins, or bitcoins, or any new candidate for money, that nobody else does?
Bottom line, the regression theorem’s question has to be answered in every economy, barter or money. How wrong it is to say that the reg. thm. only applies to a barter economy.
Praxeology and Psychology.
Some have argued that that there is no need at all to answer the above question. That we are barking up the wrong tree. Here is the gist of their argument:
We have left the field of praxeology [=economics] and have entered into psychology when we talk about why Smith will accept bitcoins, or anything else, as money. That is a question for psychology, not economics. People are funny. They do things for subjective [= often stupid] reasons, often egged on by wild, irrational, psychological impulses. It is not our task to delve into their minds, but to study their actions.
Thus, these people claim that asking why people accept or reject a bitcoin as money is not our job. Leave it to the shrinks. We are economists, and have a different job to do, namely, serious economics. Just for fun, let’s call the assumption that we need not understand why people choose the means they do the Shrink Hypothesis.
DA: You make it sound like they are wrong.
SD: Indeed they are. That whole argument confuses means and ends. The ends a man chooses are subjective, yes. Why he chooses them is not part of economics, that’s correct. But the study of the means he chooses to achieve his goals is the very heart of economics, and is not something to be left to the shrinks. As Mises writes in Human Action, “It [=praxeology] is a science of the means to be applied for the attainment of ends chosen…”
DA: So the shrinks study why people choose certain goals, and economists study why, given a goal, they choose certain means to achieve that goal.
DA: But Dave, maybe the Shrink Hypothesis is right. Maybe economics studies the means people use, but does not study why they use them.
SD: That cannot be so. To prove this, lets look at the laws of supply and demand. Every economist agrees that the higher the price of a product, the more people will be willing to supply the product, and the less they will be willing to buy the product.
Now for a thought experiment. Let’s assume that one day all mankind decides they want to buy high and sell low, always. The higher the price of anything, the more people start buying it. And this happens for everything, universally contradicting the laws of supply and demand. And that happens from today until the end of time, for all goods and services. When asked, they will all say that their goals remain the same as they ever were. Since this is a thought experiment, let’s add that we know they are telling the truth.
DA: But that implies they have all decided that wasting money is a means to get rich. They have sized upon a new means.
SD: Would such a reality contradict all we know about the laws of supply and demand?
DA: Yes it would. It is exactly the opposite of what all the textbooks say.
SD: Would it behoove us as economists to try and figure out why they seized on this new means of doing things?
DA: It absolutely would. If we want to get to the bottom of things, and understand why reality contradicts our laws of economics, we certainly do.
SD: Not if you agree with the Shrink Hypothesis. Then you have to say that who cares why people have suddenly chosen a mad means of doing things. Economics has been proven wrong by the new reality, and that’s that.
DA: What would you say, Dave?
SD: I’d say that what is really going on is that the thought experiment has a missing piece. If the experiment wants to say people have chosen a new means, then it has to say why they have chosen that means. Because economics always has to know why a particular means was chosen. That’s what economics is, knowing all you can about the means.
DA: But the proposer of the thought experiment would be hard put to answer why everyone suddenly decided losing money is the best way to make money.
SD: Exactly. Thus, we have refuted the thought experiment, but the Shrink Hypothesis has to accept it. And it has no way of claiming our thought experiment is implausible. Remember, the Shrink Hypothesis considers all possible choices of means as equally valid, and thus equally likely, at least in theory. They see nothing odd about all mankind getting up one day and accepting bitcoin, or anything else, as money. Remember, people are funny.
DA: But wait a minute. Your argument assumes that bitcoin is a means. Is money a means or an end?
SD: Marx wrote that to a small group of people money is an end in itself. But surely even he was only talking about money that can be used to buy things. Even Marx would never claim that some capitalist runs his business solely for the purpose of accumulating Monopoly money. Come to think of it, he writes that they pursue “exchange value”, proving my point.
So that to almost everyone alive, money is a means of achieving their ends. You work to make money so you can buy stuff. You don’t work to make money because it looks pretty. You might buy a painting because it is pretty, because having a pretty painting is a goal you might have. But nobody has a goal of having pretty money. Money to people is a means. That’s why it’s called a “medium” of exchange. “Medium” means “means”. Money is a means, not an end. This cannot be emphasized enough.
Thus, Mises’s classic, The Theory of Money and Credit, is not a psychology book. It doesn’t say people are funny. It discusses which money people will choose as the preferred means of buying things they want, and which money will be outright rejected as a means of getting what they want.
DA: So an economist should indeed study if and why people will accept or reject bitcoins.
One Guy Does Not Solve the Problem.
DA: Moving on, some people are saying, yet again, that to be a medium of exchange all you need is one person using the bitcoin once to buy a pizza, and then the bitcoin is forever enshrined as a medium of exchange, from that moment to all eternity. Thus, all your arguments on this blog that bitcoin isn’t a medium of exchange are refuted by simple reality. A single slice of pizza, digested long ago, shows how wrong it is to claim bitcoin is not a medium of exchange.
SD: The fact that one guy bought a slice of pizza for ten thousand bitcoins five years ago doesn’t answer the question raised by the regression theorem. Say Mr Geek accepted those 10,000 bitcoins and gave a slice of pizza for them. Smith will still not say, nor will anyone else, “OK, you want to pay me in bitcoins instead of dollars? Sure.”
DA: Why not?
SD: Because once Smith accepts those bitcoins, he has to pay his rent and his phone bill and electric bill somehow. And he has to go shopping for food and clothing. And pay all kinds of people for all kinds of things, none of whom will take his bitcoins in payment. And he knows this. That slice of pizza did not change reality. Everyone he knows, except maybe for Mr Geek, wants to be paid in dollars, not bitcoin. And everyone they know wants the same thing.
Nor does Microsoft.
DA: But Dave, look at all the big box companies like Microsoft that accept payment in bitcoin nowadays. They consider it money.
SD: Oh no, they don’t. They won’t touch bitcoin with a ten foot pole. It never enters their wallets for a second. What happens is, there is a middle man, a bitcoin company, that accepts the bitcoins from the buyer, charges Microsoft a fee, and gives Microsoft cash dollars.
DA: And that middle man? What does he do with the money?
SD: He holds onto it, gambling that it will go up in price. Or else he sells it to other gamblers.
What is the Answer to Those Questions? How does a new Money Take Flight?
It’s in Human Action, or read Bitcoin Takes a Beating for a popular exposition.