​2. What is value? (url) AUDIO >

 

Something has value to someone if they are willing to voluntarily exchange their property for it.

Therefore, value resides in individuals, not in things. It is derived from the importance (or utility) that things hold for the individual, rather than the cost of producing those things.

In other words, value is subjective, not objective. Nothing has inherent value; everything has value only to someone.

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In the past, influential economists held that the value of goods was objective and determined by their cost of production. According to this view, the higher the production cost of an item, the greater its value. While this notion might seem reasonable, it is fundamentally flawed. The shift away from this concept in the 1860s heralds the start of modern economic theory.

If the value of an item were truly tied to its production cost, then repeatedly digging a hole and filling it in would be considered highly valuable, which is clearly not the case.

Consider a sculptor who works 12 hours a day for a year, spending considerable sums on tools and materials to create a massive sculpture that no one wishes to purchase at any price. In this scenario, the sculpture's value could be considered negative, as costs for storage or disposal would accrue.

Furthermore, if the cost to produce a table is $100 and the seller needs to sell it urgently but finds no buyer willing to pay more than $50, it would be rational for the seller to accept $50. Attempting to sell it at or above the cost of production would likely result in the table not being sold at all.

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Being subjective, value cannot be measured, but only ranked: an individual can state that one thing holds more or less value for him compared to another, but he cannot specify how much. He can express a maximum price he is willing to pay, but as we will explore in the next chapter, prices differ from value.

Moreover, interpersonal comparisons of value (i.e., utility) are logically impossible: the value Alice places on spending time with her children cannot be compared to the value Bob places on doing it.

Value is the foundation of economic science. Understanding economics largely involves grasping the implications of value's subjectivity.

The first implication is that what holds value for an individual are not goods and services in their entirety (i.e. classes of goods and services: eg. 'health', whatever that is), but units of these goods and services.

If goods and services themselves (not just units of them) held value for Alice, she would spend all her money on what she values most. However, this is not what people do. Alice will spend her first dollars on items at the top of her priority list (imagine a column in a spreadsheet). Once she has acquired a certain quantity, she will then spend on her next highest priority, and so forth.

The more units of a good or service Alice acquires, the less value the last unit (the marginal unit) holds for her. This principle is known as the law of diminishing marginal utility. Its discovery resolved the 'water-diamond paradox' that puzzled economists for centuries: if water is more essential than diamonds, why are diamonds more expensive? Because typically, people have ample access to water. On the Titanic's life raft, however, a small bottle of water might be traded for many diamonds.

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Today, the law of diminishing marginal utility is often misinterpreted, even by professional economists. This principle is frequently misrepresented by asserting that $1,000 holds more significance for someone with $10,000 than for someone with $100,000,000. However, this is not what the law of diminishing marginal utility implies. Instead, it posits that $1,000 would have more significance for an individual when he/she owns $10,000 compared to if the same individual owned $100,000,000. This must be the case without exception. Indeed, with $100,000,000, one could afford items much further down their priority list. Given that interpersonal comparisons of utility are logically impossible, it's simply wrong to state that $1,000 is necessarily (or even can be) more important to someone with $10,000 than to someone with $100,000,000. Such a common misinterpretation of the law of diminishing marginal utility is logically inconsistent.

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A logical consequence of the theory of marginal, subjective value is that concepts like 'public interest', 'common good' and similar terms, are logically nonsense. These concepts imply that value can be objective, not merely subjective. The arbitrariness of these concepts is also evident in how 'public interest' abruptly changes with each new political regime. What is called 'public interest' is just a respectable name for the arbitrary will of the current political regime and a justification for the violence needed to impose it.

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3. What is the relation between value and price? (url) AUDIO >

The price of something is the measure of what is given in exchange for it.

Today, we are accustomed to monetary prices, but the concept of price also applies to barter (direct exchange). If Alice exchanges n cows for m acres of land with Bob, then the price of that land for Alice is n/m cows per acre, and for Bob, the price of those cows is m/n acres of land per cow.

Henceforth, we'll consider indirect exchange and monetary prices.

Unlike value, price is, by definition, measurable and objective.

Price and value are interconnected. Specifically:
 

• Price can never exceed value: The value to someone of what they are buying cannot be less than the value of what else they could purchase with the same money at that moment. If it were, they would not make the exchange. No one engages in an exchange to end up worse off;

• Nor can price equal value: No one participates in an exchange to remain in the same position as before.

It follows logically that the price paid in an exchange is always less than the value: without exception.

This implies that, as long as it's free (i.e., voluntary), an exchange generates additional value for both parties; it's inherently win-win.

This does not suggest that after a voluntary exchange, both parties are as happy as they could potentially be; rather, given their specific circumstances at the moment of exchange, a free exchange leaves them both better off than before, producing the best peaceful outcome possible for both in those circumstances. Without free exchange, improvement for one party can only come at the expense of the other through coercion (a win-lose scenario).

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4. Why can only free exchange produce a continuous increase of prosperity? (url) AUDIO >

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Given the link between value and price, the price paid in a free market conveys information about the value an item holds for buyers. If many value an item, its price typically increases, and vice versa.

It's crucial to emphasize that only free market prices carry this information about value; arbitrary or distorted prices do not.

This value information embedded in free market prices enables successful production, fostering prosperity. Without it, producers would find it impossible to determine what to produce profitably or how. Using Ludwig von Mises's analogy, navigating without free market prices is akin to sailing in the dark, mid-ocean, without a compass, under cloudy skies, and without GPS: there's no way of knowing your direction.

Free-market prices effectively coordinate production and consumption by conveying continuously changing, private, and intimate information about value. This information, inherently decentralized across billions of individuals, is by definition inaccessible to any central entity (e.g. an authority). Prosperity hinges on utilizing this information about value, achievable only through the free market process.
 

There are two types of social orders:
 

• Positive orders: result from both human action and design, like a business producing pencils. Employees act under the design of management, adhering to a unified hierarchy of ends.

• Spontaneous orders: Arise from human action but not from human design. The free market exemplifies this, where prices emerge from voluntary exchanges without a central planner or a unified goal, allowing individuals freedom to pursue their own ends within non-arbitrary rules.

These orders are not mutually exclusive but complementary; spontaneous orders (for example, the free market) include multiple positive orders (for example, businesses).

It isn't possible to declare in general that one is superior to the other economically. Which is better depends on the nature of the knowledge that is needed to produce success: the relevant knowledge:

 

• When the relevant knowledge is centralized (e.g. pencil production), then only the positive order can be successful: without it, pencils cannot be produced.

• When the relevant knowledge is decentralized (as it is in the case of value), then only the spontaneous order can be successful: without it, prices cannot convey information about value, there's no coordination between production and consumption; the ship navigates in the dark; prosperity cannot be attained.

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The problems arise when, in the face of relevant knowledge that is decentralized (as in the case of value), one recurs to positive order: e.g. State interventionism. In this case, the economic system fails to produce prosperity (or produces less prosperity than it could have produced otherwise) because the relevant knowledge is wasted. Metaphorically, it's like using a boat on a road.

 

Secondly, but not for importance, in this case people lose their freedom: when society as a whole is managed (as if it was an organization), people must act (in one way or another, in one measure or another) towards goals not of their own choosing but imposed from above through coercion—collectivist goals. In essence, treating society as an organization (i.e. State interventionism) substitutes freedom with authoritarianism.

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The reason most people equate the absence of State interventionism (and even existence) with chaos is due to their unfamiliarity with the concept of spontaneous order. Accustomed only to the positive orders they are familiar with, they equate a successful society with a successful organization. Since the absence of management in an organization would lead to chaos, they infer that the absence of management in society at large would similarly result in chaos. However, as we have shown, the opposite holds true. In an economy as a whole, it is the very presence of centralized management (and thus a single hierarchy of goals) that, by preventing the use of decentralized knowledge about value, leads to economic impoverishment and the erosion of freedom.

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The reason why only free exchange can produce lasting, continuous and peaceful prosperity is that the creation of such prosperity depends on the use of knowledge about value, and that only the spontaneous order of the free market has access to and can use that knowledge.​

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5. What is money? (url) AUDIO >

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The typical answer to this question is: "money is a medium of exchange." Indeed, this is one of the three functions of money, alongside its roles as a unit of account and a store of value. However, defining money as a medium of exchange is insufficient. Both gold and contemporary fiat money (money created out of thin air by the modern banking system) serve as mediums of exchange, yet they are fundamentally different, and actually opposite concepts. Equating money with a medium of exchange is akin to describing an airplane as a means of transport; while not incorrect, it fails to capture the essence of what an airplane is (also a bicycle is a means of transport).

There exists a deeper, more precise definition of money. Understanding this opens new avenues of thought. To grasp it, one must briefly examine the origins of money.

Before money, there was barter, or direct exchange. The challenge with barter lies in the necessity for a double coincidence of wants: for instance, if Alice wishes to exchange eggs for shoes, she must find someone not only possessing shoes but also desiring eggs in return.

This requirement for a double coincidence severely restricted trade and, consequently, the creation of value.

Naturally, people began to notice that certain goods were particularly liquid, always in demand. They started acquiring these goods not to consume them but to use them for trade as this would increase their possibilities. Over time, goods better suited for exchange were selected based on specific characteristics, without which a commodity could not be a good medium of exchange:

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• scarcity;

• durability;

• transportability;

• divisibility;

• homogeneity;

• easy verifiability of quality;

• finality (capability of allowing for a final settlement with no strings attached).

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Given the available technology, gold (and to a lesser extent, silver) emerged as the preferred medium of exchange based on these criteria.

Thus, money is, fundamentally, the most liquid good or commodity. The crucial term here is "good" or "commodity". In fact, because money is a good, or a commodity, it cannot be created out of thin air.

However, in recent history, with various fluctuations, money was replaced with fiat money: money created out of thin air by the banking system. In other words, States have abolished by law the first characteristic of money: scarcity. This replacement was a process. This process started in 1914 to finance the first World War. The Great War was so expensive that the political burden of financing it via taxes would have been too high. So the political power financed it via inflation by legally abolishing gold as money, replacing it with fiat, and printing the latter at will. In other words, instead of financing the war by taking money from people, the ruling class financed it by taking the purchasing power of the money that remained in people's pockets. The process was completed in 1971 when the last remaining links to gold (provided by the gold exchange standard) were definitively abandoned.

 

Since the State wants to have the legal monopoly of money, this had the effect of adding two new characteristics without which a commodity could not be a good medium of exchange:

 

• privacy;

• censorship resistance.

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Bitcoin is the reaction of the free market against the suppression of non-arbitrary money by the State. As we shall see, this reaction produced a form of non-arbitrary money (or quasi-money) that is superior to the previous form of non-arbitrary money (gold) in relation to all characteristics, not only scarcity.

Just as there are two types of law:

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• arbitrary law: legal positivism or fiat law (coercive rules arbitrary decided by an authority);

• non-arbitrary law: natural law (coercive rules logically deduced:- cannot be created out of thin air);

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so there are two different kinds of money:

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• arbitrary money: fiat money (money created out of thin air by the banking system);

• non-arbitrary money: the most liquid good (cannot be created out of thin air).

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These categories are interconnected: arbitrary law gives rise to arbitrary money, while non-arbitrary law supports non-arbitrary money.

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It's important to understand that, even though fiat money and gold are opposite, fiat money could not have become money if gold hadn't previously been spontaneously emerged as non-arbitrary money. This is the essence of Ludwig von Mises' famous Regression theorem, which I'll discuss separately.

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Mises' regression theorem is at the center of the question whether Bitcoin is or can become money.

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One of the reasons why the State could easily replace gold with fiat money is that it was believed (and by many economists it's still believed today) that money is something fundamentally different from ordinary economic goods: marginal subjective value theory does not apply to it. This erroneous belief was fostered by the idea that, if marginal subjective value theory applied to money, then there would be a logical circularity:

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a) on the one hand, money is demanded because it is a medium of exchange, and therefore for its purchasing power;

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b) on the other hand, given marginal subjective value theory, demand for money determines its purchasing power (the higher the demand for money, the higher its price in terms of other goods).

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In the words of Mises, "the purchasing power of money is explained by reference to the demand for money; on the other hand, demand for money by reference to its purchasing power”. This apparent circularity has induced the first modern economists to consider money "neutral": something different from ordinary goods; something to which marginal subjective value theory would not apply, like the value scale of a thermometer.

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In 1912 Ludwig von Mises discovers that the circularity is only apparent. Money is not different from other goods: marginal subjective value theory applies to it as well. This discovery completes the basic structure of modern economic science, which started with the discovery of the logically consistent theory of value by Carl Menger in 1861.

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Mises' logical demonstration happens in two steps:

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1) The first step can't be synthesized better than by Robert Murphy in this passage: "Today’s purchasing power is derived from individual expectations about tomorrow’s purchasing power, expectations that are themselves based on [the observation of] yesterday’s purchasing power. By introducing the time element, we have thus broken out the vicious cycle; we are not explaining the purchasing power of money by the purchasing power of money because the purchasing power at one time is explained by the purchasing power of an earlier time” (Robert Murphy) and these two purchasing powers are two distinct magnitudes.
 

This first step solves the problem of circularity. However, it appears to replace it with a problem of infinite regress: if you explain today’s purchasing power by reference to yesterday’s purchasing power, then how do you explain yesterday’s purchasing power?

 

2) In the second step, Mises shows that the regress is not infinite: “If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins” (Mises). In fact, when we discussed the origin of money, we saw that money is the most liquid good or commodity and, as such, before becoming money, was not a medium of exchange and was valued only for its industrial properties.

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It is thus demonstrated that fiat money could not have become money if gold hadn't previously been spontaneously emerged as non-arbitrary money, and therefore if gold had not been valued for its own industrial properties before it became money.

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Fiat money replacing fiat money (e.g. the euro) is perfectly compatible with Mises' regression theorem: the euro traces back to national currencies which in turn trace back to gold. If Bitcoin were to become money in the Eurozone, it would trace back to the Euro, then to national currencies, and ultimately to gold.

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However, the creation of fiat money from scratch, without any link to commodity money, would be impossible: this is the fundamental implication of Mises' Regression Theorem.

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6. What is the optimal money supply in an economy?​ (url) AUDIO >

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​Given that the entire focus of central banks and the lifelong work of many economists is dedicated to addressing this question, the scientifically accurate response is surprisingly straightforward and perhaps illustrates better than anything else the profound disconnect between economic science and mainstream economics.

Any supply of money is optimal for any economy as long as it is fixed and sufficiently divisible:

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 "The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do" (Ludwig von Mises);

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"We are now on the threshold of a great economic law, a truth that can hardly be overemphasised, considering the harm its neglect has caused throughout history. … Every supply of money is always utilised to its maximum extent, and hence no social utility can be conferred by increasing the supply of money" (Murray N. Rothbard).

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This fundamental economic laws derives directly from marginal subjective value theory.

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If the quantity of money is fixed, then the information about value conveyed by prices will be as comprehensive and accurate as possible. Changes in prices will reflect changes in scarcity to the greatest extent possible. For example, an increase in the price of a particular item will reflect higher scarcity of that item (due to an increase in demand, a decrease in supply, or both). This information will be accurate because, by definition, there are no distorting factors. Thanks to this correct information, the free-market process will be able to create prosperity by using the knowledge about value dispersed among the different individuals. In fact, the higher prices of that item create higher profits for the producers, thereby incentivizing them or others to produce more of it (or to develop better/cheaper alternatives).

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However, if the quantity of money is not fixed (e.g., if it increases), then changes in prices will reflect changes in the money supply, not in scarcity. The information about value conveyed by prices (which are not anymore free-market prices) will thus be incorrect, increasingly so as the money supply grows. Based on this incorrect information conveyed by prices, the economic process will move in the wrong direction: a direction that is economically unsustainable. The spontaneous coordination between production and consumption which is made possible by the use of the decentralized information about value conveyed by free-market prices is lost. An economic crisis will inevitably ensue.

To fully grasp why and how this occurs, it is necessary to understand the concepts that will be explored in the following sections.

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7. What is inflation?​ (url) AUDIO >

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​Today, inflation is commonly seen as the increase of the 'price level'.

 

The concept of 'price level' is itself logically absurd. All goods have a single price in money: this is what makes economic calculation possible. However, money does not have a single price. It has as many prices as the goods it can buy. As M.N. Rothbard notes, "the purchasing power of money [PPM] is an array of the quantities of alternative goods and services that can be purchased for a unit of money. Since the array is heterogeneous and specific, it cannot be summed up in some unitary price-level figure."

More fundamentally, the scientific (and originary) definition of inflation refers not to a rise in prices, but to an increase in the quantity of money. The subsequent rise in prices, or the loss of purchasing power of money, is the consequence, not the cause. This distinction is more than semantic. If the root cause of a problem remains unnamed or if its name is mistakenly applied to its effect, addressing the issue becomes considerably (and perhaps intentionally) more difficult.

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Henceforth, I will refer to an increase in the quantity of money as inflation, and a rise in prices as loss of purchasing power of money.

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To understand how inflation is created and on what scale, one must examine how the modern monetary and banking system work. We will explore this in a subsequent chapter.

Here, we will outline the economic consequences of inflation.

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1. Loss of purchasing power of money. The first consequence is, as we have anticipated, a rise in prices. Assuming, for the sake of argument, that price indexes make sense, the stated objective of central banks is to raise prices by approximately 2.5% per year. This means that, if everything proceeds as planned, the purchasing power of money is halved within one generation, specifically over 28 years. The U.S. dollar lost 25% of its purchasing power just in the last decade, from 2013 to 2023."

2. Transfer of money from creditors to debtors. The loss of purchasing power due to inflation transfers wealth from creditors to debtors, and consequently, to the largest debtor of all: the State. Let's consider a scenario where Alice borrows $1,000 from Bob for one year. For simplicity, let's ignore the interest rate (this will be explored in a later chapter). After a year, Alice repays Bob $1,000. However, if during that year the purchasing power of money has decreased by 10%, then effectively, $100 has been transferred from Bob to Alice.

3. Negative incentives for saving (positive incentives for consuming). The greater the loss of purchasing power of money, the less incentive there is to save, and conversely, the greater the incentive to consume. Given that sustainable investments rely solely on savings (much like successful physical activity relies on training), a decrease in savings leads to fewer sustainable investments (see a later chapter).

4. Cantillon effect.  The new money created out of thin air by the central banks enters the economic system via the credit markets and it takes time for it to propagate in the economy and lose its purchasing power. Therefore, there is a tiny group of people who receive the new money first (before it has lost purchasing power) and a much larger group of people who receive it later, when its purchasing power decreased. In other words, there is a transfer of wealth from the productive class to the parasitic class that operates close to the bureaucratic centers of political/financial power.

5. Cyclical crises. By far greatest effect of inflation are cyclical, systemic crises. To understand why, it's necessary first to delve into the concept of the interest rate, which we'll do in the next section.

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8. What is the interest rate?​ (url) AUDIO >

 

The interest rate can be superficially defined as the cost of borrowing a sum of money. This cost is expressed as a percentage of the sum of money borrowed for 1 year.

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Just as money and law have both non-arbitrary and arbitrary (or fiat) forms, so does the interest rate. The fiat interest rate presupposes and implies fiat law and fiat money: without them, it could not exist.

The fiat interest rate is set arbitrarily by central banks, both directly through bureaucratic decisions and indirectly by injecting newly created money into the economy. Since this newly created money enters the economy via the credit markets, it results in an artificially lowered interest rate.

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To grasp the problems caused by inflation and fiat interest rate, it's crucial first to understand the non-arbitrary (or natural) interest rate and its function in the economic process.

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The non-arbitrary interest rate has three components:

 

• one primary (or fundamental): time preference, and

• two secondary (or accessory): compensation for risk and for the loss of purchasing power of money

 

Here we'll discuss only the primary component: time preference. The two secondary components are straight forward.

 

The reason why these are secondary (or accessory) components is that it is at least theoretically possible to imagine a situation without risk or loss of purchasing power of money. On the contrary, it is not possible to imagine (not even theoretically) a situation where individuals do not have preferences between present time and future time.

 

Since time has value, the marginal subjective value theory applies to it. Time preference refers to the value an individual places on time, essentially their preference for present versus future. Specifically, between consumption and saving.

 

• An individual with 'high' time preference values the present relatively more than the future, leading to higher consumption and less saving.

• Conversely, an individual with 'low' time preference prioritizes future over present, consuming less and saving more.

 

The lower the individual time preferences prevailing in a society, the larger the savings and therefore the amount of resources which are available for investments. For the law of supply and demand, the lower their price: the interest rate.

 

And vice-versa: the higher the individual time preferences prevailing in a society, the smaller the savings and therefore the amount of resources which are available for investments. For the law of supply and demand, the higher their price: the interest rate.

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The role of the interest rate is to coordinate savings and investments. It can do this because it uses a knowledge about the subjective value of time which (as the knowledge of the value of anything) is decentralized among billions of individuals and is unavailable to any directing mind.

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• If the interest rate is 'low', this means that there are many resources available for investments. This allows for the realization of more entrepreneurial projects, more ambitious, more complex, more long term.

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• On the contrary, a higher interest rate signals fewer resources available for investments. This allows for the realization of less entrepreneurial projects, less ambitious, less complex, more short term.

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A society with low time preferences (and thus high savings, abundant investment resources, and low interest rates) typically experiences significant structural growth and rising prosperity.

Conversely, societies with high time preferences (and thus high interest rates) tend to experience slower growth and reduced prosperity.

Metaphorically, the interest rate, reflecting savings, acts like a measure of training: the greater the training (the lower the non-arbitrary interest rate), the higher the peaks that can be achieved, and vice versa.

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There is no inherent problem with individuals having high time preferences, provided they understand and accept the consequences. The value of time is subjective and, therefore, not to be questioned.

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However, complications arise when monetary authorities use fiat interest rates and fiat money to create an illusion that people can enjoy both low interest rates and high time preferences simultaneously.

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We'll see this in the next section. Before we do it, it's useful to observe more in detail the process of structural growth. This allows to see in what way the interest rate coordinates savings and investments.

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On the one hand, lower time preferences (higher savings) produce, as we have seen, lower interest rates. These increase the present value of capital goods. As a result, stock prices rise.

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On the other hand, higher savings imply by definition lower demand of consumer goods. As a result, the prices of these goods decrease.

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It becomes less profitable to invest in the production of consumer goods (whose prices have decreased) and more profitable to invest in the production of capital goods (whose prices have risen).

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There is therefore a transfer of resources (including labour) from the stages of production closer to the final stage of consumption (the so-called late stages of production) to the stages further away from the final stage of consumption (the early stages).

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The higher demand for workers in the early stages of production does not imply higher nominal wages: in fact, it is compensated by lower demand for workers in the late stages.

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However, since prices of consumer goods have decreased, real wages have increased.

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When the dust settles: the structure of production is longer and more complex. Consumption has decreased in relation to capital goods; however, in the long term can be higher more in quantity and in value. The economy is richer, more advanced, more prosperous.

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An important takeaway of this spontaneous process of structural growth is that a continuous decrease in prices of consumer goods (the so-called 'deflation') is positive. It is a characteristic of a virtuous economic process.

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