circularity and regression

The conversation with my Lovecraftian friend continues:

Another question. Why does gold have the value it does?

So what does it mean for something to have value? I try to address that in the Gilligan article and more specifically here:

http://www.bkmarcus.com/blog/2005/06/value.html

Gold has exchange value because people want it, and people want it for all the reasons it made such a good money: (1) its stable supply makes it a convenient store of wealth (i.e., hedge, in an inflationary context); (2) it's fungible, which means, for example, that a half an ounce of gold has approximately half the exchange value of an ounce of gold; (3) it's scarce enough that a little bit of weight represents a lot of wealth, compared to other metals (see comment on silver and platinum above); it's marketable and easily liquidated, meaning that people will acquire it from you readily.

I'm still not sure I understand "value", though. To me, value means that some item is good for some use. Gold's value, as you've described it, seems somewhat circular to me.

Excellent. You've identified the circularity paradox of monetary theory. I currently work for the Ludwig von Mises Institute as a "publications assistant". Ludwig von Mises was the man who solved the circularity paradox with his regression theorem.

I have a different concise definition of value than you do: an item has value if you are willing to take action to acquire it. I prefer this for two reasons: (1) it makes explicit the fact that value comes from the subjective preferences of the evaluator and not from any inherent characteristic of the object, and (2) economists distinguish between use value and exchange value, and I think my definition covers both.

When you say "To me, value means that some item is good for some use," you are defining use value. (Although you have to have a very open understanding of use: I use a piece of music to give myself pleasure or elicit a particular mood; the addict uses heroin to get high; etc.)

Brief digression: Among goods with use value, we need to distinguish between consumer goods, where the use is a direct satisfaction, and capital goods, where the use is the creation of other goods. Some capital goods help produce consumer goods and some capital goods produce other capital goods. Think of the ladder I use to pick the apple I want to eat, and then think of the hammer and nails that I use to build the ladder. Then think of the machine someone used to produce those nails, and on and on. This is called the structure of capital. Thus endeth the brief digression.

Some things are valued not for any direct use, but because we predict that someone else will exchange the goods we want for it. For instance, I see something on ebay that has been mislabeled or misidentified and I suspect I can get Jack [a collector and auction maven the Lovecraftian and I have in common] to pay me twice what I bid for it. That thing has exchange value for me because it has use value for Jack. (It might also have exchange value for Jack, but let's keep it simple.)

Different things can have use- or exchange value depending on the evaluator.

Money, uniquely, has only exchange value. This is what appears circular: money is valuable because other people value it, but other people value it because it has exchange value.

Mises broke the circle by introducing time into the description. I value a dollar today because I expect its exchange value tomorrow to be close to its exchange value yesterday. Its exchange value yesterday was based on its exchange value the day before. No circularity.

But then we have a new problem: infinite regress. Almost as bad as circularity.

No, said Mises. The exchange value of money originally arose out of the use value of a bartered commodity. In my "Pocket Tanks and value theory" post, I link to a famous article on the use of cigarettes as money in POW camps. This is a good microcosmic demonstration of how a commodity becomes money. All the prisoners get identical care packages from the Red Cross. I like the canned pineapple, but not the canned peas. You hate the sweet syrup that the pineapple comes in so we trade. This sort of thing goes on throughout the camp. I don't smoke so I'm willing to trade away my monthly carton of cigarettes from the Red Cross. I quickly notice that it's much easier to trade cigarettes than it is to trade the canned peas. Eventually everyone notices this. Cigarettes are the most marketable commodity in the POW camp. At this point, I'm less anxious to trade away my cigarettes because even though I don't smoke (i.e., they have no use value to me), I know that they are easy to trade for the things I want (i.e., they have exchange value). Smokers start smoking less because the cigarettes now have an additional use as money. Notice that the cigarettes had to start with a use value in this scenario, and that their exchange value is originally based on their use value. But over time, their exchange value goes up -- not because of an increase in their use value, but because of an increase in their exchange value. Sounds circular, but remember the regression theorem: today's exchange value is based on yesterday's exchange value ... back through time until we can link it to original use value.

(You might find it interesting to see how many of my 4 criteria for money apply to cigarettes in the POW context.)

So gold is so well known for its exchange value -- and has been for centuries and millennia -- that we forget it also has use value as a soft metal, especially for decorative purposes.

I hope I've explained the demand for gold. And I hope my previous email explained the relevance of the supply of gold. The combination of a relatively stable supply and a relatively stable demand are what make gold a good hedge. They're also what made and would make gold such a good money, but I've tried not to focus too much on that question here.