THE MICROFOUNDATIONS OF MONEY 251

…were equally saleable, there would be no raison d’être for money, and gold would have only the value that comes from its commodity functions.

(Anderson 1917, pp. 477–8)

As markets develop in a monetized economy, money loses its special position in the economy. More and more acceptable substitutes arise, and an ever growing number of transactions in the economy occur without money as we know it. Various assets—perhaps interest-paying bearer bonds and equity instruments— are used to settle accounts. Many of the ‘exchange media’ will thus no longer be fixed in terms of the unit of account. The holding of these assets does not entail the forgoing of interest and earnings as the holding of money does. Without legal restrictions on the media, these instruments will ‘portfolio-dominate’ money (that is, people will no longer wish to hold any non-interest bearing claims fixed in terms of the unit of account).25 The monetary functions can become partially or totally separated as acceptable and ‘portfolio-dominant’ assets displace the money we use today in the settlement of transactions. The value of the accounting unit, which persists as the new media of exchange arise, can be traced back to its origin in the interaction of individuals in the market-place in the same way that the purchasing power of money was traced back to its commodity origin in Mises’ (1971 [1912]) ‘regression theorem’. Drawing on this analogy with Mises’ account, we might characterize this explanation of the further evolution towards separation and refined barter as a ‘progression theorem’.26 Thus, a decentralized decision-making process can explain, first, the emergence of a ‘money’ combining both the unit of account and medium of exchange to overcome the inconveniences of ‘crude’ barter, and, second, the separation of functions as ‘money’ enhances the saleability of other goods.

SUMMARY AND CONCLUDING REMARKS

The application of some of the ideas and arguments developed by Richard Rorty on foundationalism have helped to illuminate a number of foundationalist issues within economic theory. The purposes and limits of the Walrasian generalequilibrium (GE) model were clarified, and the desire to ground monetary theory —or any other aspect of economics—in this construct was brought into question. The moneyless and institutionless GE world may provide a valuable foil as a reference point against which to sharpen other theories, even if those theories are populated by money and institutions and are directed toward achieving different goals.

Economists need not feel uneasy with incompatibilities among the branches of the discipline since much can be learned from studying the differences. Different vocabularies and models fulfil different purposes. Playing them off against each other rather than having them do battle in a winner-takes-all game helps to highlight their strengths and weaknesses. In our application, a relatively neglected but important aspect of Menger’s monetary economics—that is, the

252 HERMENEUTICAL REASON

organization of markets—was emphasized by way of contrast with the GE model in which markets are perfectly organized. In addition, the pitfalls of an essentialist approach to monetary theory were shown through the limits that were placed on the interpretation of Menger’s ideas on the marketability of the monetary asset. Rather than demand that a theory explain money in a very narrow sense, or that money is a necessary component of all discussion about macroeconomics, one can consider a broader model that accounts for money’s rise and its possible fall. By being willing to entertain alternative classification schemes and ways of organizing our thought, we can raise new questions and extend our understanding into areas that our theories could not and did not attempt to address. After opening the discourse to include such alternatives, we can then explore the merits of the various theories, sharpening our understanding through their interplay.

ACKNOWLEDGEMENTS

My thanks are due to Tyler Cowen, Daniel Klein, Don Lavoie, Mario Rizzo, Jeremy Shearmur, and seminar participants at Duke University for helpful suggestions.

NOTES

1See Madison (1987) and Bernstein (1983) for a more complete explication of hermeneutics and the ‘critique of foundationalism’.

2Friedrich von Hayek, has also condemned this narrow view of inquiry under the label of ‘scientism’ which he describes as ‘a very prejudiced approach which, before it has considered its subject, claims to know what is the most appropriate way of investigating it’ (Hayek 1979, p. 24).

3When asked by Arjo Klamer to comment on the contrast between new classical economics and monetarism, the eminent monetarist Karl Brunner replied that much of the new classical economics suffers from the Cartesian fallacy:

This idea has had a strong influence on philosophy but also upon the program of the new classical economics best represented by Neil Wallace [see, e.g., Kareken and Wallace 1980]… You are not allowed to talk about money if you have not derived from ‘first principles’ a specification of all the items which are money… Adherence to the Cartesian principle would condemn science to stagnation.

(Klamer 1983, p. 195)

4Consequences of policies have been effectively analysed and assumptions ferreted out using, for example, process and order analysis (Marget 1966, vol. II, and Hayek 1941) as well as public-choice theory (Buchanan and Tollison 1984).

5In order to address the empirical relevance issues, ‘computable GE’ models have been developed which permit ‘simulations’ to be done measuring the impact of

THE MICROFOUNDATIONS OF MONEY 253

these effects (Shoven and Whalley 1972). The results, however, are highly sensitive to both the calibration of the initial parameters and the specific structure (e.g., number of sectors) of the model.

6More on how the dominance of tools in economists’ thinking narrows discourse in the discipline in the following section.

7See Weintraub (1983) for a history of the solution of the GE existence problem.

8Technical flourish can come to replace economic insight. An analogous complaint has become a commonplace among music critics: the technical virtuosity of even second-rank pianists far exceeds that of the greats from the past, but the passion and originality is to a large extent absent—the interpretation lacks imagination and interest. See Hayek (1979) and Rorty (1980) on the general impact of scientism, and Lavoie (1986) for its influence specifically in economics.

9As Donald McCloskey (1986, p. 162) has expressed, this notion—restricting ourselves to formal techniques—‘is to imitate the drunk who looks for his wallet under the lamp post because the light is better there’.

10Rorty points to Thomas Kuhn’s (1970, 1977) work in the history and sociology of science to support his claim that: ‘What we mistook for the ennobling effects of obedience to methodological canons were merely the moral virtues which are encouraged by certain sorts of disciplinary matrices’ (Rorty 1980, p. 43). That is, although a mechanistic and formalistic approach and vocabulary has been rather ‘useful for purposes of prediction and control’ in the natural sciences, there is no reason to then conclude that this type of description is more ‘absolute’ or less ‘subject-related’ (i.e. ‘objective’) than alternative approaches.

11Geertz elaborates:

The uses of cultural diversity…lie…along the lines of defining the terrain reason must cross if its modest rewards are to be reached and realized. This terrain is uneven, full of sudden faults and dangerous passages where accidents can and do happen, and crossing it, or trying to, does little or nothing to smooth it out to a level, safe, unbroken plain, but simply makes visible its clefts and contours.’

(Geertz 1986, p. 270)

12Demands that any useful macroeconomic construct must contain ‘money’ are similarly misguided (e.g. Garrison 1984). The problems of demanding in advance specific structures of theories is precisely the foundationalist legislation of a discipline that Rorty (1979, esp. pp. 155–64) attacks. Also see Hayek (1979). More on the place of ‘money’ in macroeconomic theory below.

13A recent exception in the Austrian literature is O’Driscoll (1986a).

14Note that Keynes (1936) had a similar research agenda in mind, in that he did not argue that a ‘full employment equilibrium’ price vector could not exist, as some have interpreted him, but rather that he wished to understand the failure of the price mechanism to bring about equilibrium (see Weintraub 1979, pp. 115–8).

15Quine (1980 [1951], pp. 20–46) thinks of theories as lattices of interrelated propositions and concepts, with some more in the centre and others more on the edge of the web. What is at the heart of the Mengerian web is on the edge of the Walrasian web. In the terms of Lakatos’ (1970) development of Quine’s imagery, each of these economic ‘research programs’ has a different theoretical ‘hard core’.

254 HERMENEUTICAL REASON

16The non-Walrasian mechanism discussed here is also called the Hahn process, originating with Hahn and Negishi (1962). See Weintraub (1979, pp. 109–26), Negishi (1985), and Arrow and Hahn (1971) for more complete and formal expositions.

17Erich Streissler (1973, p. 169) has argued that this lack of the market price due to difficulties of co-ordinating traders: ‘is, I think, perhaps the most important part of Menger’s vision of the working of the economy’. See also Walsh and Grahm (1980) cited above.

18Hahn’s (1985, pp. 370, 377) recent evaluation of such models is not sanguine: ‘while no doubt something has been learned from the fixed-price model, it is high time to get on0133….Fix-price theory is a striking example of an attempt to take a short cut. Too much effort has gone into it.’

19Although this problem was raised earlier (see discussion of Anderson 1917 below), only recently has this possibility and its relation to Austrian monetary theory begun to receive attention again. See Cowen and Kroszner (1987 and 1989b), Greenfield and Yeager (1983), Wallace (1983), and Hall (1982). O’Driscoll (1985 and 1986b) and White (1984) provide critical views.

20Friedman explains:

there is a need for either some anchor to provide long-term price predictability, some substitute for convertibility into a commodity, or, alternatively, some device that would make predictability unnecessary. Many anchors and devices have been suggested, from monetary growth rules to tabular standards to the separation of the medium of exchange from the unit of account. As yet, no consensus has been reached among them

(Friedman 1986, p. 646)

21Cowen and Kroszner (1989a) and references therein provide historical examples of alternative and changing monetary institutions and the impact of the legal background on what takes on ‘moneyness’. In a formal setting, Chang et al. (1983) have shown that if money market instruments are introduced into the standard ‘money-bonds’ portfolio model, then a zero cash-balance equilibrium obtains.

22Keynes (1936, p. 239) was well aware that ‘liquidity’ must not be regarded as an absolute but did not develop the point further.

23See Williams (1986) and Telser (1981) on commodities futures markets as substitutes for money markets.

24Automobile and other durable goods ‘trade-ins’, real-estate swaps, stock ‘conversion’ provisions of bonds, and mergers through stock transfer and other ‘non-cash’ means may also be considered forms of barter, rendering a medium of exchange at least to some extent superfluous. Instruments—from the venerable bill of exchange to modern money-market mutual fund shares—can not only reduce the quantity of the exchange media required to sustain a given level of transactions at a given set of prices, but also act as a substitute for the medium in circulation (see, e.g., Greidanus 1932).

25See, for example, Wallace (1983). Considerations of risk-bearing and calculational inconveniences which may militate against the disappearance of money as we know it are discussed in Cowen and Kroszner (1989b).