Keynes and the efficient market hypothesis

Over at The Money Illusion, Scott Sumner has posted a number of blog entries about John Maynard Keynes as an investor and how it informs the debate about efficient markets:

Far from refuting the efficient markets hypothesis (EMH), the story of Keynes’ investments actually supports the buy and hold recommendations of those who adhere to the efficient markets view, “stocks for the long run.” He did best when he didn’t try to time the market, and did poorly when he engaged in fancy speculative gambles during 1928-29.

It seems to me that one of the errors that many people (including some academics) make when discussing market efficiency is to assume that the hypothesis requires that all participants in the market are rational. Since this postulate so obviously contradicts empirical reality, it is argued that economic approaches associated with market efficiency (such as New Classical Macroeconomics and Real Business Cycles) must be flawed as well. But does the efficient market hypothesis really require such a strong postulate? Is it not enough to propose that rational individuals take advantage of the profit opportunities created by those who make mistakes?

Another flaw in discussions about rationality and efficient markets is that little attention is being paid to the question whether it can be rational to be irrational. As Bryan Caplan has argued in his book The Myth of the Rational Voter: Why Democracies Choose Bad Policies, the average  voter in a mass democracy does not have a strong incentive to be rational because irrationality is basically costless. Thus Caplan writes “irrationality, like ignorance, is sensitive to price, and false beliefs about politics and religion are cheap.” Linking rationality to incentives in this fashion offers the prospect for a reformulation of classical economics that can lead to improved insights into the observation that we see so much variability in the applicability of the strong rationality postulate.

Of course, the case against efficient markets is of little practical interest unless it can be argued that something meaningful can be done about it. Government intervention seems to be of little use if the incentives that shape and maintain irrational behavior apply to collective choice as well; instead, we should expect them to be worse for reasons that are unique  to government (monopoly, the absence of price mechanisms, the prospects of redistribution etc.)

Animal spirits in public policy

In the Summer 2009 issue of the Independent Review, Arnold Kling reviews George A. Akerlof and Robert J. Shiller’s new book Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Reading his review, one wonders how it is still possible for a serious scholar to make a case for more government intervention by simply documenting all the ways in which actual human behavior differs from the (strong) rationality postulates of classical economics. As Arnold Kling points out, and this must be getting quite tiresome, why assume that these same “animal spirits” do not inform and shape public policy as well? It is not hard to imagine a book that uses politics and government policies as illustrations of irrationality, conformity, and unfair decision making. As a matter of fact, current government responses to the financial crisis should provide a wealth of examples for numerous volumes about “politicians in panic.”

What might be more illuminating from a scholarly perspective is to investigate how different incentives and institutional environments produce lesser and greater diversions from the postulates of rational choice. A focused contribution to investigating these topics has been made by the economist Bryan Caplan, culminating in his excellent, and courageous, book, The Myth of the Rational Voter: Why Democracies Choose Bad Policies.

Of course, purists will rightly argue that the case of Akerlof and Shiller is dead on arrival because no prescriptive statements can be derived from their detailed descriptions of irrational behavior without accepting the authors’ own outlook, in their case expressed in the metaphor of society as a family in which the government behaves as the parents. The use of this metaphor sheds an interesting light on how some modern liberals view society as an extended family.

Macroeconomics in politics

Steve Chapman writes:

If the economy improves and unemployment drops, Obama can take credit. If it fails to improve and unemployment rises, though, he can say he averted an even worse showing. Republicans will take the opposite tack — attributing any improvement to the natural resilience of the economy and blaming the administration if things get worse. And neither side will really know who’s right.

A scientifically trained politician (or journalist) often has good reasons to simply say, “I do not know.” But in politics, or especially in politics, such statements are considered a sign of weakness, and therefore, political suicide. To be a successful politician you need to signal strength, not epistemological sophistication. To a lesser extent this applies to (partisan) journalists who write about macroeconomic matters as well. If Paul Krugman would just confine himself to sketching a number of different scenarios without taking sides, many people would find his columns boring and would look for ammunition to engage in political debate elsewhere. The addiction to politics is so strong that we are prepared to throw everything we have been taught about valid reasoning and how science operates out of the window.

Related reading: Looking at the world through politically-colored glasses

On economic forecasting: A positive-sum game against nature

Undercover at Wal-Mart

The New York Post recently posted an interesting personal account of writer and cryonics activist Charles Platt about working conditions and company policies at Wal-Mart. In Platt’s own words:

Some people, usually community activists, loath Wal-Mart. Others, like the family of four struggling to make ends meet, are in love with the chain. I, meanwhile, am in awe of it.

Platt does not found much ground for the negative treatment of Wal-Mart by progressives and singles out labor unions as one of the major sources of misinformation about Wal-Mart:

You have to wonder, then, why the store has such a terrible reputation, and I have to tell you that so far as I can determine, trade unions have done most of the mudslinging. Web sites that serve as a source for negative stories are often affiliated with unions.

But as he points out in his intelligent discussion of labor unions, the reason that people are paid low wages at Wal-Mart and other large retailers simply reflects supply and demand and not any deliberate attempt to keep wages low:

In our free-enterprise system, employees are valued largely in terms of what they can do. This is why teenagers fresh out of high school often go to vocational training institutes to become auto mechanics or electricians. They understand a basic principle that seems to elude social commentators, politicians and union organizers. If you want better pay, you need to learn skills that are in demand.

The blunt tools of legislation or union power can force a corporation to pay higher wages, but if employees don’t create an equal amount of additional value, there’s no net gain. All other factors remaining equal, the store will have to charge higher prices for its merchandise, and its competitive position will suffer.

This is Economics 101, but no one wants to believe it, because it tells us that a legislative or unionized quick-fix is not going to work in the long term. If you want people to be wealthier, they have to create additional wealth.

Although there is less support for labor unions in the United States than in other modern Western countries, the mystery remains why these organizations are taken seriously at all. Labor unions are labor cartels that do not create wealth but can only redistribute existing wealth at the expense of others. In reality, labor unions are often detrimental to increased productivity and creation of wealth because their policies produce unemployment, social unrest, and contribute to an entitlement culture in which people are discouraged from seeking individual solutions to better their economic conditions. As such, labor unions represent a harmful combination of tribalism and economic ignorance.

The writer also draws attention to the issue that small “mom and pop” stores are not necessarily better than large corporations. Many of them simply go bankrupt because they are unimaginative, wasteful, and rude to their customers. There is one caveat to this perspective, however, and that is that government regulation and labor union policies often favor bigger companies over smaller companies. Economies in countries like the Netherlands are heavily regulated by the government and the result has not been more diversity in retail but the depressing development of (designated) urban “shopping streets” that feature the same stores wherever one goes.

Despite their rhetoric about representing the little guy against corporate interests, in reality labor unions feel a lot more comfortable with large scale negation between the government, big corporations, and union representatives than the prospect of a healthy competition between unruly, impenetrable small companies. This (unintended) bias of government and unions for large corporations has recently been made official policy as a result of the “Too Big to Fail” doctrine which shelters failed companies from bankruptcy and socializes losses (corporate welfare).

Perhaps the most telling sign of the times is the influence of government employee labor unions. As an opinion piece in the Wall Street Journal notes:

When the movement among public-sector workers to unionize began gathering momentum in the 1950s, some critics, including private-sector labor leaders such as George Meany, observed that government is a monopoly not subject to the discipline of the marketplace. Allowing these workers — many already protected by civil-service law — to organize and bargain collectively might ultimately give them the power to hold politicians and taxpayers hostage.

There is a great taboo on individuals selling their votes but what to think of a President that rewards labor union voters in the public sector (the new privileged class) with more projects, higher wages, and increased job security while people  who work in the private sector cannot escape the consequences of the current financial crisis?

Further reading: Public Sector Unions Are Killing United States

Understanding business cycles

In his book Recessions and Depressions: Understanding Business Cycles, Todd A. Knoop points out that a Rational Expectations perspective does not necessarily require that all segments of society are rational or use all available information:

Those who are rational will take advantage of the profit opportunities created by those who are consistently making mistakes.

In other words, the failure of some individuals to act on the future effects of policies  will create profit opportunities for people who do anticipate such effects.  This is an important observation because it highlights how public policies can be rendered ineffective without having to assume that all people are forward-looking, rational individuals.

The book also contains a useful observation about the effect of random shocks on business cycles:

It might seem strange that random shocks to productivity can create business cycle swings. Shouldn’t every negative shock be quickly offset by some positive shock? The answer is, no. Economists and statisticians have long known that if you flip a coin 20 times, cyclical patterns will emerge. There will be series of heads that follow each other just as there will be series of tails. If productivity is a random variable, then it is not surprising that economies exhibit cyclical patterns. Persistent business cycles can come about as a result of the luck that is inherent in any random process.

The existence of business cycles as such in unregulated economies does not necessarily constitute “market failure.”  In its most simplistic form, such a view of market failure would be akin to saying that free markets fail because they are not immune to meteorite attacks.

But at the end of his chapter on Rational Expectations Knoop states that

rational expectations in an imperfectly competitive model of the economy can have much different implications….It is not necessarily rational expectations but the Rational Expectations model of perfectly flexible markets that generates what many economists consider to be implausible results.

Any model that assumes competitive markets will lead to implausible results if it is used to predict how individuals behave in an economy where government policies adversely affect the operation of markets. This does not invalidate models of perfect competition but highlights the need for models that reconcile the postulate of rationality with imperfect markets, provided such models do not claim to be actual descriptions of laissez-faire economics.

One troubling implication of Rational Expectations is that government can only influence real variables in the economy if its policies are secret and unpredictable.  Even if one does not agree with the strong postulates of Rational Expectations, public stabilization policies that assume that people will repeatedly ignore their future tax burden or neglect profit opportunities that are generated by these policies, do not even pass the test of common sense. Government can, of course, respond in turn by preventing markets to refect these new realities, but this can only produce  a perpetual cycle to disturb the operation of the price mechanism.

Knoop’s book on understanding business cycles is a useful introduction to the subject although his chapter on Real Business Cycles Models could benefit from a more balanced perspective. The conjecture that business cycles could be the most efficient response to  exogenous changes given the structure of the economy is an important insight and reconciles microeconomics and macroeconomics.  Although the New Keynesian economists also provide microfoundations for their views, it is sometimes hard to tell whether these views are refinements of classical economics or departures from it. If New Keynesian Economics is just a “hodge podge of reasons for this or that market failure” it runs the risk of being able to explain any kind of empirical observations.

New Keynesian Economics seems to be less confident about public policy recommendations. It will be interesting to observe what the fate of this school of economics will be if recent work on the microfoundations of political failure will be given more attention in macroeconomics.

Market fundamentalism

A recent trend in progressive thinking is to accuse opponents of “market fundamentalism.” That seems to be a smart rhetorical tactic because a) it rides on the wave of concerns about any kind of fundamentalism, and b) the phrase appeals to people’s reasonableness. After all, if two ways of “organizing society” are available, only a complete fanatic would advocate markets over government in all cases.

A major problem with the phrase market fundamentalism is that it simply assumes that to be reasonable one cannot advocate the most extreme position on an issue. But as many historians can point out, views that would have been considered extreme or fundamentalist hundreds of years ago have become mainstream in contemporary society. Furthermore, with some creativity any position can be phrased to be a middle of the road view. “Surely you agree that shooting political opponents is the moderate policy between not prosecuting them at all and torturing them.” Finally, the pejorative use of fundamentalism can backfire  at progressives. With similar arguments, conservatives can argue that liberals hold fundamentalist views on other issues such as human nature and society (all nurture, no nature).

But perhaps the biggest problem with the accusation of market fundamentalism is that facts or arguments have been made irrelevant in favor of appeals to reasonableness. Does it even matter if there are logical, empirical, or moral arguments to prefer markets over government? One argument to generally prefer markets over government is that for a voter the cost of being irrational is close to zero. Another argument (and observation) is that we should get better results from competition than from monopoly, even if both mechanisms are not perfect. And last, but not least, logical and epistemological arguments favor the presumption of liberty, and thus markets over government.

One effective response to the accusation of market fundamentalism is to ask why the only alternative to government is a free market. For most people who have been accused of market fundamentalism the crucial distinction is not between government and market but between voluntary and coerced acts.

The lure of accusing someone of market fundamentalism is so strong that it does not even seem to matter anymore if someone is a market fundamentalist in order to be called one. As Bryan Caplan notes in his book The Myth of the Rational Voter: Why Democracies Choose Bad Policies, “a standard rhetorical tactic is to equate modest reductions in the role of government with the elimination of government regulation altogether.” If the accusation of market fundamentalism is supposed to have any meaning at all, only a handful of economists or political thinkers could be labeled as true market fundamentalists. But the frequent use of the phrase would suggest that individuals like Murray Rothbard and Anthony de Jasay are dominating public thinking about markets.

But what about “democratic fundamentalism?” In the chapter on market fundamentalism Caplan writes:

A person who said, “All the ills of markets can be cured by more markets” would be lampooned as the worst sort of market fundamentalist. Why the double standard? Because unlike market fundamentalism, democratic fundamentalism is widespread. In polite company, you can make fun of the worshipers of Zeus, but not Christians or Jews. Similarly, it is socially acceptable to make fun of market fundamentalism, but not democratic fundamentalism, because market fundamentalists are scarce, and democratic fundamentalists are all around us.

The Myth of the Rational Voter is a major antidote to such democratic fundamentalism. Although a small minority of people object to democratic politics because all government is coercive and redistributive, the economic verdict that democracy fails because voters not do not face strong incentives to correct bias is likely to be more credible to most people, including economists.

The addiction to politics

“As the leader of a think tank dedicated to public policy, I would love it if Americans were as obsessed with policy as I am.”
(Arthur C. Brooks, president of the American Enterprise Institute)

Can politics become an addiction? A more realistic question is to ask why politics is an addiction for so many people. The most straightforward answer would be that a compulsive interest in politics just reflects a natural preoccupation with advancing one’s interest (or that of others). But as was discussed in the previous installment, The Calculus of Voting, as general rule, politics is not a very effective means to advance one’s interests. Could it be that the identification of advancing one’s interests and engagement with politics reflects tribal instincts? As Hal Finney writes on the blog Overcoming Bias:

We have this instinct that choosing our Leader is as important to our lives as it was when we were a tribe of two dozen, and that we have similar influence over the result. Following elections and participating in politics activates these vestigial tribal instincts in much the same was as sports, with similarly futile results.

Such an explanation helps in reconciling the mysterious discrepancy between the empowerment voters  experience when engaging in politics and the actual power it confers to them. If during most of mankind’s existence there was a strong relationship between participation in small-scale decision making and individual consequences, it should not be surprising that we have evolved to be “political animals” and that such instincts are even triggered in elections where millions of people vote and where most individual goals can be more easily gained by non-political individual acts.

It is interesting to note that the changed scale in human interaction does not produce similar effects in markets. Being a consumer of a product or service does not become more futile when more people consume  the good. A company can grow to serve millions of individuals in different nations and supply and demand generally ensures that one gets what one chooses. In his book Social Contract, Free Ride:A Study of the Public Goods Problem, Anthony de Jasay even argues that the absolute size of a group is not directly relevant to the rationality of voluntary contribution to public goods.

Although much ink has been spilled over political bias in the media, one rarely encounters the opinion that the media devotes too much attention to politics as such. Most people who shape public opinion and write for a living seem to share the Aristotelian vision of political participation as salvation. As William C. Mitchell and Randy T. Simmons write in their book Beyond Politics:

Participating in the political process is seen as a way of lifting oneself above the crass self-interest many believe characterize market transactions. In this essentially Aristotelian vision people are not able to reach their highest potential unless they participate in the political process. In fact, such participation is deemed necessary for human moral development.

But as public choice scholars have pointed out, the nature of man does not change as soon as he enters the political arena or takes office. Perhaps it even brings out his worst traits or selects for the people that have them. The short-term and divisive nature of everyday politics seems to be a very fertile ground for fanaticism and biased reasoning.

The desire to engage in political battle and to see one party as the enemy is so strong that, as Bryan Caplan speculates, people tend to ignore the absence of any real differences in public policy between the major parties for the  sake  of enjoying the illusion of a partisan rift:

So what is the “key difference” between the parties? Rhetoric. When Republicans advocate a small contraction of the welfare state, Democrats claim that Republicans totally oppose the welfare state. And many Republicans oblige them by standing up for “liberty” and “responsibility.” Similarly, when Democrats advocate a small expansion in the welfare state, Republican claim that Democrats oppose free markets. And many Democrats oblige them by saying things like “markets only benefit the rich.”

This rhetorical illusion is so powerful that when a Democrat like Clinton adopts many pro-market reforms, Republicans still hate him as a 60s radical. And when Bush II sharply expands the welfare state, Democrats still hate him as a billionaire’s lackey.

The observation that people can get so excited  about rhetoric despite minor differences in public policy does not bode well for the view of politics as salvation or as a source for wisdom or personal growth.

Although one would expect the views and temperament of people who advocate a de-politicized society to steer them away from a strong engagement with practical politics, a surprising number seem obsessed with everything political. It appears that the tribal instinct to engage in politics and strife does not necessarily exclude people who claim that society would be better off without it.

Some of the most remarkable examples of such libertarian obsession with electoral politics were displayed during the Ron Paul campaign. For example, self-identified libertarian anarchists were observed to continuously monitor the primary elections results and blog the latest results online. But when Ron Paul failed to win the primaries, many of his advocates returned to advocating non-voting instead.

Although campaigning to vote for a  politician on one occasion and advocating non-voting on another may reflect just pragmatic political strategy, such a mixed message risks leaving people profoundly confused. In some respects it is also incoherent. The orthodox economic argument that in large democracies  an individual vote has a very low probability of deciding the outcome does not change when Ron Paul runs for office.

But perhaps the most persuasive argument against resorting to politics is one of opportunity costs. All the time that has been spent in vain to political campaigning and producing handbooks to persuade politicians to  refrain from being politicians could have been spent on the creation of private alternatives for government, education of the general public, and legal assistance to people who are faced with government interference instead. One does not have to subscribe to the view that voting is an immoral act to agree that “if one takes care of the means, the end will take care of itself.”

Further reading: Carl Watner (ed.) & Wendy McElroy (ed.): Dissenting Electorate: Those Who Refuse to Vote and the Legitimacy of Their Opposition

This is part 2 in a 3 part series on voting, elections and politics.

Part 1: The calculus of voting
Part 3: Beyond politics

The calculus of voting

Is it rational to vote? For most people the question may seem absurd but quite a few economists and political scientists have made the claim that it is not. The reasoning is that in large elections the probability that your individual vote will decide the outcome is so small that voting is a futile exercise. A classic statement of the orthodox economic view of voting can be found in David Friedman’s Price Theory: An Intermediate Text:

“…consider someone making two decisions–what car to buy and what politician to vote for. In either case, the person can improve his decision (make it more likely that he acts in his own interest) by investing time and effort in studying the alternatives. In the case of the car, his decision determines with certainty which car he gets. In the case of the politician, his decision (whom to vote for) changes by one ten-millionth the probability that the candidate he votes for will win. If the candidate would be elected without his vote, he is wasting his time; if the candidate would lose even with his vote, he is also wasting his time.”

If the probability of affecting the outcome is negligible, there is no strong incentive to inform oneself of the  positions of the candidates. Contrary to respectable opinion, being ignorant about politics  can be rational. This  stands in stark contrast to the situation of a consumer in the marketplace who is going to get what  he chooses. Leaving aside the complicating issue of “public goods,” it might be argued that there is no tension between rationality and choice in the marketplace but there is a serious tension between rationality and participation in (large scale) democratic elections.

Strictly speaking, the negligible probability that one’s vote will decide the outcome of an election itself does not render voting irrational. A voter may place an extremely high value on a particular outcome of  the election. So even if the probability of deciding the outcome is very low,  a voter may still be motivated to vote. To use an interesting example, if one believes that the probability of resuscitation of cryonics patients is very low, one can still justify the decision to make cryonics arrangements because of the high value placed on being alive. But a contrary position is possible as well. If one does not care about the outcome of an election, the low probability of affecting that outcome will even further undermine the reason to go out and vote.

In his 1971 book for new voters, Why Vote?, the author William C. Mitchell is making this very point.  He believes that people who do not care about the value of the outcome in an election where the probability of influencing it is perceived to be very low is a good reason to abstain from voting. In all other scenarios, he recommends voting.  He also mentions another reason to vote; voting may be intrinsically rewarding and can be seen as an expression of values, such as the support for democracy. But in 1994, the same William C. Mitchell co-authored a book with Randy T. Simmons called Beyond Politics: Markets, Welfare, and the Failure of Bureaucracy, an introduction to public choice (the economic study of politics) that displays a far more negative vision on government and politics as evidenced by sections such as “In Dispraise of Politics—Some Public Choices,” “The Anatomy of Public Failure,” “In Praise of Property, Profits, and Markets.” The authors revisit the issue of voting as follows:

Voting is a painfully limited way to express one’s values and preferences. It accomplishes its results only indirectly; the vote does not immediately call forth that which is voted for. In fact, if we vote for something but are in the minority we do not get it at all, if we vote against something and are in the minority, we get it and are compelled to pay for the unwanted goods or services.

The authors also address the issue that as more voters participate in an election the individual power of  a vote decreases. In light of this, it is hard to make something of campaigns to “get out the vote” that appeal to the power conferred by  voting. The more people are persuaded by such a message, the less their votes matter.  Perhaps the value of a vote would increase if voters would be able to sell it. But there is a great taboo on  selling votes. But this taboo may not be consistent if one considers the fact it only applies to one part of the electoral process. Politicians routinely “buy” votes by promising entitlements to specific groups.

The value one assigns to different election outcomes is informed by one’s views on the relationship between a specific candidate winning and the effects on policy. For example, if one believes that in terms of public policy (not just rhetoric), there is not enough difference between the parties, the value one attaches to a specific outcome will lessen. If one further believes that contemporary democratic politics will generate an endless cycle between slightly different policies (for example, mixed economies with a bias on markets versus mixed economies with a bias on government), and substantial deviations from this generate their own incentive for  substantial reversals, the combination of a low chance of affecting the outcome and a decreased interest in a specific outcome of the election, will tip the scales in favor of abstaining from voting again.

The only argument that does not appear to be so vulnerable to considerations about the expected benefits from voting is that which claims that by voting one is expressing support for political democracy and ensures a non-violent transition of power. But there is an important flip-side to this argument because it can also explain why people may decide not to vote. By not voting people can “signal” to others their disapproval of a system that allows one person (or group) to gain at the expense of another. Historically such a perspective has been rare because of the conviction that the existence of government is necessary to solve public goods and coordination problems. But economic and political arguments for the necessity of government have been subjected to increased (technical) scrutiny by  some economists and political philosophers, culminating in a school of thought that seeks to substitute markets and private institutions for government.

It may be true that voting is not just about self-interest but about expressing oneself, but so is not voting.

Further reading: Doug Casey – None of the Above

This is part I in a 3 part series on voting, elections and politics.

Part 2: The addiction to politics
Part 3: Beyond politics

Singularity economics and the future of money

On his website, Robin Hanson discusses an unfilled niche in economics which he calls the “economics of science fiction” or “economics of future technology.” Another modern phrase would be “Singularity economics.” Hanson describes the economics of science fiction as the:

“economic analysis of the sorts of assumptions typically explored in science fiction. It is distinguished from the typical hard science fiction analysis by using the tools of professional economics, rather than the intuitive social scientist of the typical engineer. And it is distinguished from most economics by taking seriously the idea that we can now envision the outlines of new technologies which may have dramatic impacts on our society.”

One interesting question is how future advances in science and human nature will impact the monetary system. Two developments that may have a substantial impact on the future of money are molecular nanotechnology and the stability of governments.

Tangible forms of money may be greatly affected by advanced molecular technologies because it will enable individuals or organizations to duplicate money at low cost. As Robert Freitas notes in his paper “Tangible Nanomoney,” “any form of physical currency whose value depends solely upon the physical arrangement of common atoms” will fail to meet the traditional criteria that a physical currency needs to satisfy, such as possessing intrinsic value and immunity to counterfeiting. Although counterfeiting of money could remain illegal, the costs of enforcing this may be excessively high. As Tyler Cowen notes, “In the very long run, our monetary standard might be determined by what is least susceptible to counterfeiting or alchemy/nanotechnology.”

During the 20th century, government has acquired almost unlimited power over money. This coincided with a move from a commodity based currency to a fiat currency with no underlying intrinsic value. As humans evolve, it is questionable if such a currency will be sustainable. Most modern states derive their power, and therefore their power to issue and control money, from the mandate of voters. But as economic analysis of voting in large democracies has demonstrated, voting is hard to reconcile with economic rationality. Unlike voting in the marketplace (”buying”), the probability that an individual can affect the outcome of a (national) election is negligible. As David Friedman puts it in his textbook on price theory:

“consider someone making two decisions–what car to buy and what politician to vote for. In either case, the person can improve his decision (make it more likely that he acts in his own interest) by investing time and effort in studying the alternatives. In the case of the car, his decision determines with certainty which car he gets. In the case of the politician, his decision (whom to vote for) changes by one ten-millionth the probability that the candidate he votes for will win. If the candidate would be elected without his vote, he is wasting his time; if the candidate would lose even with his vote, he is also wasting his time.”

When people will come to recognize the tribal origins of voting and selecting “leaders,” and the desire to express individual choice as collective choice will decrease, the mechanisms of empowering a legal authority that issues and controls money will be affected as a result (as will other traditional functions of government).

As Freitas notes, a future currency “should be self-validating by its own physical form, and not rely upon any legalistic governmental imprimatur, easily-altered surface stamping, or monopoly minting authority to partake of value (e.g., no “fiat” specie).” The most obvious alternative for a government-controlled fiat currency is a commodity based currency. For such a commodity to be used as money it should be homogeneous, easy to subdivide, and have a high value to weight ratio. The most obvious candidate for such a currency is gold. Gold has a long historical track record as a commodity used for money and some economists, particularly advocates of the Austrian School of Economics such as Ludwig von Mises and Murray Rothbard, have been staunch advocates of the gold standard. Although gold has the clear advantage that its supply cannot be greatly inflated by government or advanced nanotechnology, the value of gold has historically shown considerable variability. For this reason the economist David Friedman proposes that the ideal commodity “would not be any single commodity, but a commodity bundle.”

A major advantage of using such a commodity bundle instead of a single commodity is that changes in monetary and non-monetary demand for a single commodity in the bundle (for example, gold) will only have a small effect on the bundle as a whole. In the context of advanced nanotechnology, commodities that can be produced by physical arrangement of common atoms may need to be excluded from such a commodity bundle to increase stability. Therefore, the most plausible candidate to be used as the standard for money would be a bundle of commodities that cannot be created by advanced molecular technology, i.e., a bundle of commodities reflecting chemical elements. In his paper, Robert Freitas discusses ideal candidates for tangible nanomoney such as the superheavy elements (SHE), which could become a part of a new standard, if not part of the physical money itself in case the standard for such a currency and the currency itself would coincide. Clearly, a mature nanotechnology will have effects on both the standard for future money as well as the physical forms of payment that are used in daily economic life.

There does not need to be a universal commodity (or bundle of commodities) and private firms can issue their own commodity-based money, which may or may not evolve into a universal standard. As David Friedman points out in his manuscript “Future Imperfect,” future (online) technologies can do conversions fast and invisible to the user, permitting multiple standards to coexist. Such a system can be a fractional reserve system, or not. The most important feature of a future money is that it should “not rely upon legalistic governmental imprimatur” and be immune to advanced molecular technologies.


Robert Freitas – Tangible Nanomoney
David Friedman – Gold, Paper, Or…Is There a Better Money?
David Friedman – Future Imperfect
Ludwig von Mises – Gold versus Paper
Murray Rothbard – What Has Government Done to Our Money?