All Commentary
Wednesday, May 2, 2012

Cavemen, Money, and Spontaneous Orders

Some things are the product of human action but not human design.

Who invented money? Who invented market prices? Who invented cities? What about language? The answer is: no one.

But wait! Don’t people spend money, set prices, build cities, and speak language? Yes, they do, but that doesn’t mean that they were originally the result of conscious human design or deliberate planning.

One of the most important discoveries of social philosophy is that the world is not divided into just two categories: Things that are natural and things that are manmade. That dichotomy sounds superficially reasonable. After all, we see a cloud floating in the sky, which is clearly natural; and we see a clock sitting on our desk, which is clearly the result of rational human design. But what about money, markets, cities, and language?

Well, if the only (mutually exclusive) categories we have are the “natural” and “manmade,” then whatever is not natural must be manmade. So money, markets, cities, and language must all be manmade, right?

Historically, social science—economics in particular—really was born with the realization that in addition to the natural and the manmade there is a third category. We refer to it today as “spontaneous order,” which is, to use a phrase that F.A. Hayek culled from Adam Ferguson (a contemporary of Adam Smith): “the result of human action but not of human design.”

Spontaneous Order: The Case of Money

Take money, for example. Money is an incredibly useful thing. It greatly facilitates trade—I can’t imagine maintaining my current lifestyle by engaging only in barter: “I’ll trade somebody a one-hour lecture on economics in exchange for one week of housing.” Good luck with that! But if no one invented money, how did it come into being?

Money is a peculiar good. First, it is involved in at least one side, and often both sides, of every exchange in a developed economy. So what happens to the value of money has an immediate and significant impact on the entire economic system, unlike say the market for iPads. That’s why in the history of economics monetary theory was the genesis of macroeconomics. But money has a unique aspect that makes it challenging to explain how it even exists: It has no direct value in use.

People who tried to barter their labor for things they wanted to consume soon discovered that it would be easier to trade their labor for something that, even if they didn’t want it for themselves, they knew others would want in trade. That’s how cows, sea shells, wampum, and eventually precious metals came to be used as media of exchange. When a particular medium of exchange becomes so popular that you’re sure that anyone would accept it in exchange, it becomes money—in technical terms, a good primarily valued for direct use that evolves into a good primarily valued for its indirect use as a medium of exchange.

(In his seminal book, Principles of Economics [1871], Carl Menger, founder of the Austrian school of economics, was the first to distinguish between a good’s use value and its exchange value.)

The thing to notice about this story is that at no point did anyone invent money. Rather, there was a long, step-by-step process that involved human action—trading goods for something that gradually (and unintentionally) became more and more marketable because others were using them that way. And from that process, over time, money emerged.

No one could have planned a money economy from scratch. If you lived in a world of barter and you suddenly had a flash of insight and realized how useful money could be, and even if you could make everyone else understand how much better things could be with money compared to barter, you still couldn’t launch the system.

Could a Genius Caveman Do It?

It’s as if a genius caveman were to realize one day how wonderful it would be to have an iPad and could convince all the other cavemen how wonderful it would be. They still couldn’t make one.  Where would the plastic, the metal, know-how, the music, and so on come from? The iPad, like money, is the result of a long evolutionary process that began, well, with the caveman. Some say Steve Jobs invented the iPad—and in a real sense he did—but he could never have actually produced it on his own, without the support of all that historical infrastructure, developed over a long process of exchange.

Likewise, money exists and continues to be used today because of an enormous historical infrastructure. But the case of money is even more complicated because money, as we’ve seen has no direct use value. The infrastructure that supports money is made up entirely of mutually reinforcing expectations: I will accept money in exchange only if I’m confident that others will accept money in exchange, and they will do so only if they expect still others to accept it, and so on.  That makes money unique among goods, and also problematic.

Money Is Even More Peculiar

For most people an iPad has value because it is itself very useful.  Same with carrots. That makes it relatively easy to form an expectation of how many carrots you would trade for an iPad—perhaps 500 pounds of carrots for one iPad or one pound of carrots for one-five-hundredth of an iPad. To paraphrase Ludwig von Mises in his Theory of Money and Credit, if overnight everyone completely forgot the value an iPad had for them yesterday, it wouldn’t be terribly hard to reestablish it because the value is chiefly use value. That means you could quickly decide how many carrots or whatever you’d be willing to trade for an iPad, despite your sudden amnesia.

Not so with money.

That’s because the value of money is, again, virtually all exchange value. Your estimate of the value of a dollar to you today is entirely dependent on what a dollar bought yesterday. If you and everyone else forgot what that exchange value was, no one person could reestablish a dollar’s value. Remember, you would be willing to accept dollars in exchange for something of use value only because you are reasonably sure that others would accept it in exchange. Reestablishing the value of money—its purchasing power—if it were collectively forgotten, or if its value lost through hyperinflation, or if the economy reverted to pure barter, would be a long and intricate process.

Most Spontaneous Orders Share These Characteristics

These peculiarities of money make it a particularly interesting example of a spontaneous order, but the other social phenomena I mentioned earlier have the same essential qualities. Thus it’s no more possible to build a living city or create a living language or construct a real market process than it is to design and implement money where it didn’t exist before. Indeed this is probably true of all complex social phenomena. And it defines the limits of human reason in shaping and directing social orders.

  • Sanford Ikeda is a Professor and the Coordinator of the Economics Program at Purchase College of the State University of New York and a Visiting Scholar and Research Associate at New York University. He is a member of the FEE Faculty Network.