Money, like any good or service, has a supply and a demand. Natural money, that is, commodity money selected by the market, is supplied by production of the monetary commodity. Its demand is determined by the cash balances (or, inversely, cash flows) which individuals prefer to hold. Increases in cash balances (decreases in cash flows) reflect an increase in the demand for money and vice-versa.
Guido Hulsmann explains all of this very nicely here along with a nice explanation of the interaction between the demand for money and the interest rate. He identifies the increased investment in production of the monetary commodity as the factor which leads to an increase in the interest rate as a result of increased demand for money (in a natural money economy). In the opening of the article, he defines the price of money, conventionally, as “the total array of goods and services that can be exchanged for one unit of money.” But this definition has the ugly problem that it makes the price of money purely subjective and admits to as many definitions of the “price of money” as there are ways to choose “baskets” of goods, witness the CPI. Mises observed this (I can’t remember where but I know he said it).
But this got me to thinking - can’t we just define the price of money as the profitability of production of the monetary commodity? This would give a single, objective measure of the price of money that reflects the supply and demand for money. As supply increases, the profitability of producing the monetary commodity goes down, and vice-versa. As demand increases, the profitability of producing the monetary commodity goes up, and vice-versa. In other words, the exchange rate of the raw commodity against money - seigniorage - correlates positively with the price of money. So, this eliminates any arbitrariness in the choice of CPI basket to measure the price of money… as seigniorage increases, the price of money increases, as seigniorage decreases, the price of money decreases. The price of money is seigniorage in a natural money market.
Prices/costs are subjective. Anyways, the TOTAL array of goods money can buy is not the CPI. It is something very difficult to measure, but CPI is certainly something you could choose, the PPI, the average of the two, the GDP deflator, or whatever. However, the price of money is indeed the value of things it can be traded for.
The problem is not necessarily the definition, but that it’s very difficult to measure.
But we do not say that the price of an apple is the “total array of goods that an apple could be traded for” - we say “the price of apples is 69 cents an apple”, or whatever. In other words, the price of everything except money is given in terms of a single good - money. What makes this measurement so useful is that everything else is also expressed in terms of money so that it is easy to calculate the price of any one thing in terms of any other thing simply by taking the ratio of their money prices. But, if we apply this procedure in the case of the price of money itself, we get back the meaningless constant ratio of 1:1, $1 = $1. So, that doesn’t tell us anything about the value of the dollar relative to all non-money goods and services. My hypothesis is that seigniorage, in a natural money economy, does indeed give us information about the relative value of money versus all non-money goods and services, namely, when seigniorage increases, the purchasing power of money, that is, the amount of things out of “the total array of goods and services that can be exchanged for one unit of money” also increases and vice-versa.
Let me add some more rationale for this. Hulsmann says, “An increased demand for silver will increase the ROI of silver production, because the factors of production needed to produce a given amount of silver now tend to become available at lower silver prices. This in turn will modify the spending on all other goods. In particular, capital will move from other industries into the silver industry, prompting the ROI of silver production to fall and the ROI of all other industries to rise, until the ROI of all lines of business is equal.” So, this establishes a direct correlation between the ROI of production of the money commodity and the demand for money - capital will flow into the money production industry in response to an increase in the demand for money which resulted in increased profits available in money production until the ROI has abated to the equilibrium level. Seigniorage, then, is what coordinates the demand for money with the production of money… it is the price of money.
Maybe I should email Hulsmann to see what he has to say and share his response here.
Secondly, yes, you CAN say that the price of an apple is the total array of things it can be traded for. If it can be traded for 69 cents, then that’s the price of the apple. If you can trade an apple for a certain model of a pair of shoes, then the price of the apple is a pair of shoes. See? That’s EXACTLY what a price is. In a monetary system, people tend to use money as a medium of exchange, thus making prices much easier to calculate because they because quantifiable.
