What Is Money
-- Posted Tuesday, 8 September 2009 | Digg This Article
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By: Trace Mayer, J.D.
The first section of the first chapter in The Great Credit Contraction addresses the conflicting definitions of money and currency. If one does not have a correct understanding of money and currency then they will have flawed conclusions regarding inflation or deflation. This will lead to inaccuracies when performing mental calculations of value and result in poorly allocated capital.
WHAT IS MONEY
The terms money, money substitutes, illusions and currency are often used interchangeably. Since they do not mean the same thing this misuse can be confusing. Even many of the leading experts in this subject have difficulty agreeing on definitions. The conflation of these terms causes great problems in understanding monetary science. Therefore, we will separate and distinguish each.
EXPERTS DO NOT AGREE
Money must have intrinsic value by being a tangible asset. This is because when A gives B the pizza, the pizza has intrinsic value. For the transaction to be extinguished, A must receive from B an asset with intrinsic value. If B exchanges a 1oz. American Silver Eagle $1 coin for the pizza, then at the time of the transaction, a pizza and a silver coin would exchange hands. Value would be exchanged for value at the time of settlement, and the transaction would be extinguished.
A money substitute, on the other hand, is a negotiable instrument that promises the payment of money. An example would be a silver certificate that reads: ”This certifies that there have/has been deposited in the Treasury of the United States of America (number) silver dollar(s) payable to the bearer on demand.”
Chartalism, the State theory of money, asserts the government gives money or currency its value. This theory completely opposes basic economic law. In reality, the backing of government-issued money substitutes with bullion gives the currency value.
If A exchanged the pizza with B for a silver certificate, then the transaction would be settled but not extinguished until A passed on the silver certificate for value. While A holds the silver certificate, its value could change and it could become worthless. This happened on June 24, 1968 when the Treasury of the United States of America declared it would no longer honor redemption of silver certificates.
The use of a money substitute introduces risk to A in the transaction with B because A relinquishes value when he tenders the pizza to B but does not receive an asset with intrinsic value in exchange at settlement. Instead, A must use the instrument in another transaction to receive value.
An illusion is a negotiable that promises nothing and has no intrinsic value. It is like a silver certificate that promises the bearer no silver. It has value only because individuals are willing to bear the payment risk and other risks of the illusion. The bearer usually tolerates the risks because their cost is lower than the value placed on the utility derived from the service the currency provides to the market participants.
In conclusion, currency is primarily used to settle transactions. When money, such as gold, silver or platinum, is used to settle a transaction, then the transaction is extinguished. However, if either illusions or money substitutes are used, then the transaction is not extinguished and one or more parties to the contract are left to bear the risk of extinguishing the transaction. This risk often leads to errors in accurately assessing the value and utility from the underlying consideration in determining the price for the transaction. This is one of the largest risks with using fiat currency. As the illusions evaporate during The Great Credit Contraction, here is a free sample, it will be real tangible assets the remain and increase in purchasing power.
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Trace Mayer, J.D.
What Is Money?
By: Gary North
-- Posted Tuesday, 29 September 2009 | Digg This Article
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This question divides economists even more than it divides voters. Voters do not think much about this question. Economists think about it throughout their careers. They do not agree with each other regarding the answer.
The problem is, about half of American economists who specialize in monetary theory and banking policy are either on the payroll of the Federal Reserve System or sell their services to the FED on a piece-rate basis.
Most of the others are trying to get in on the deal. Through the FED, economists set policy for American banking, and, through banking, just about everything else.
The economists are not agreed. Federal Reserve policy is therefore not consistent. It is mostly a system of trial and error – these days, very large errors. Through the influence of the FED among foreign central banks, and through the influence of the top dozen American graduate schools, the confusion over what money is has spread to the entire world.
In the area of monetary policy more than any other area of modern life, the self-certified, self-policed, and self-confident experts are making it up as they go along. Then the rest of us have to go along.
In my forthcoming series of articles, you will learn the following:
1. The experts do not know horse apples from apple butter about monetary theory.
2. Monetary theory should be an integrated part of a general economic theory of how the world works.
3. Whenever an economic theory of how the world works makes an exception for monetary theory, the proposed monetary theory is incorrect, or the general theory is incorrect, or both are incorrect.
4. Fiat money is always a form of counterfeiting.
5. Counterfeiting produces bad results for almost everyone except the counterfeiters.
6. Fractional reserve banking is legalized counterfeiting.
7. Government fiat money is counterfeit.
8. Those who trust government money will lose wealth more surely than those who do not trust it.
9. There are ways to escape bad monetary policy.
10. The worse the policy, the fewer the avenues of escape.
If you stick with me through this series of articles on monetary theory and policy, you will have a much better idea about where modern society has gone wrong. You will also have a better idea of how to protect yourself against the inevitable consequences, all of which are negative, of the government's violations of sound money principles.
It boils down to this question: If you don't know what money is, how will you obtain more of it? This is another way of saying that if you don't understand the modern violations of monetary theory, you will not understand the extent to which you are vulnerable to bad policies which are going to produce disastrous consequences, just as they have in the past.
THE DEBATE OVER MONEY
What is money? These three words introduce one of the most baffling areas of economic thought. I can think of no other area of economics in which there is greater confusion, leading to greater economic disruptions, than this one.
A characteristic feature of all systems of economic thought except the Austrian School is a failure to integrate monetary theory with general economic theory. With the exception of the Austrian School, all schools of thought create exceptions to the laws of economics that they say apply in all of the other areas of the economy. They insist that the government is necessary to intervene into the free market in order to bring order to monetary affairs.
They argue that money is not part of a system of economic practice and theory. They also imply that monetary theory is not part of an integrated system of economic cause-and-effect. The explanations given for economic causation in every other area of the economy are not accepted as valid in the realm of money.
Monetary theory, when coupled with an explanation of how banking works, provides a case study of the unwillingness of economists to pursue the logic of economic causation. This should be a tip-off to the fact that there is something fundamentally wrong with either their theory of money or their general economic theory.
FOUR AREAS OF CONFUSION
The confusion regarding monetary theory and practice has several aspects. First, there is conceptual confusion. There is a lack of understanding of how the free market works. The two fundamental rules governing free-market pricing are these:
1. Supply and demand
2. High bid wins
When you apply these two principles to any area of the economy, you have the conceptual tools necessary to understand the basics of economic causation. All deviations from free-market economic theory invariably involve the abandonment of one or both of these two principles of economic analysis. This certainly applies in the area of monetary theory and monetary policy.
Second, there is the confusion over the origin of money. How did money come into existence? What motivated people to make the decisions that led to the institution of money? What interference with people's motivation did the state imposes in order to gain certain advantages for itself? How do these interventions reduce economic liberty and the smooth functioning of the monetary system?
Third, there is the financial issue. That which individuals want for themselves personally, namely, more money, is bad for the economy when either the state or the banking system interferes with private contracts. What we want to achieve for ourselves individually we had better avoid corporately: more money. This is not understood by virtually all schools of economic opinion, with the exception of the Austrian School.
Fourth, there is the political issue. There is great confusion over the proper relationship between civil government and monetary policy. Economists insist that the monetary system should not be autonomous; civil government must interfere in some way to provide stability and predictability to the monetary order. In rare instances, this is limited simply to the enforcement of contracts. In most cases, the principle of necessary government regulation is extended to mandate broad intervention by political authorities.
IDEAS HAVE CONSEQUENCES
There is a familiar phrase in the American conservative movement: ideas have consequences. This phrase comes from the book title of a 1948 book by English professor Richard Weaver. This principle certainly applies to monetary theory. Mistaken ideas have disastrous consequences.
Mistaken ideas in the area of monetary policy have produced more disasters than mistaken ideas in any other area of economic thought. There is a reason for this. Money is at the heart of the modern economy. Mistaken policies in the realm of money and banking spread to the entire economy. There is a kind of multiplication effect. The worse the idea in economic theory, the more widespread and devastating its consequences when the idea is applied to the monetary system.
There are five analytical categories in which mistaken ideas lead to bad economic policy. I summarize them as follows: sovereignty, authority, law, sanctions, and continuity. These five categories are crucial for economic analysis. They are exceptionally crucial in the realm of monetary policy, as I will demonstrate. They are violated constantly in modern society. They have been violated constantly ever since 1914: the outbreak of World War I. National governments and private banking came close to honoring the truth in these five categories for a century: 1815 to 1914. During that century, there was considerable monetary stability for Western Europe, leading to greater economic growth than any other period in the history of man.
Because of the violation of nineteenth-century monetary policy, we have seen the rise of world wars, hyperinflation, and depression. None of these would have been likely apart from fiat money, which is a violation of the law of property. This violation leads to terrible consequences in the real world.
WHAT IS MONEY?
Let us return to the original question: What is money? The best answer to this continual question was provided in 1912 by the Austrian economist, Ludwig von Mises. In his book, "The Theory of Money and Credit," he provided an answer in six words: money is the most marketable commodity. He had in mind gold and silver coins, but his theory encompassed any commodity that can or has served as money in history.
By defining money as the most marketable commodity, Mises integrated monetary theory with general economic theory. His theory of money was an extension of his theory of the free market. He rested his case for the free market on the right of private ownership.
I have said that there are five analytical categories in which mistaken ideas lead to bad economic policy: sovereignty, authority, law, sanctions, and continuity. Now I must explain what I mean.
1. SOVEREIGNTY. Property rights are the foundation of money, Mises argued. Property rights provide the legal setting for voluntary exchange. He argued that the development of money was an unplanned outcome of the decisions of individuals who sought to increase their wealth by increasing their productivity.
Individuals have always sought to specialize in those areas of production in which they have a competitive advantage. This advantage may be due to personal skills. It may be due to geographical location. Whatever the origin of the advantage, the individual seeks to exploit this advantage. He specializes in one area of economic production, so that he will have an increased quantity of goods and services to exchange with other individuals, who specialize in those areas in which they have a competitive advantage. Mises argued that out of the barter system came money. A monetary commodity was originally valued for something other than exchange. It may have been sought because it was beautiful. It may have been sought because it had religious significance. Whatever the reasons that people sought to accumulate a particular commodity, this led to the discovery that this particular commodity could be used to facilitate voluntary exchange.
Instead of having to find a buyer for the particular commodity or service that an individual produced, he could exchange his output for a commodity that was widely desired by other members of society. As these exchanges grew in number, this commodity began to attain value as a result of its ability to serve in the process of exchange. What had originally been a commodity valued for some other characteristic increasingly was valued for the purpose of facilitating exchange. In other words, this commodity became money.
As a free-market economist, Mises did not attribute the origin of money to the decision of a civil government. It was not that a particular king or group of nobles decided that it would be convenient if a particular commodity were adopted as money. On the contrary, governments began to extend their control over money because they recognized that they could increase their extraction of wealth from private citizens with greater efficiency if they taxed people's monetary income rather than taxing their individual output. It was easier to collect money and spend it for the purposes of civil government than it was to collect hundreds or even thousands of goods. It was not that the state was the origin of money; it was that money became a tool of the expansion of the state. The state claimed sovereignty over money because it was convenient for the state to gain control over this most central of economic assets.
In short, Mises argued that the free-market social order possesses original sovereignty over money. Any claim by the civil government that it exercises sovereignty over money is not grounded in economic theory or the law of contracts. It is grounded in the desire of civil rulers to extract greater wealth from those under their authority.
2. AUTHORITY. Mises argued that the authority over money originally came from the authority of individuals to exchange their goods and services voluntarily. There is a hierarchy of control that is based on individual ownership.
Civil government attempts to gain authority over monetary affairs because it is less expensive for the government to expand its authority over every other area of life when it controls the monetary system. In short, there are both competing sovereignty and competing authority – market vs. state – in the competitive arena of monetary policy.
3. LAW. There is a law of monetary affairs, but this law is not unique to money. The general law of contracts led to the creation of money. A legal order that enabled individuals to exercise control over their labor, their property, and the output of the combination of labor and property led to the establishment of a monetary system.
The law of pricing is no different from the law of any other asset. Again, there are two laws: first, supply and demand; second, high bid wins. As these two laws extend to the general society, the monetary order comes into existence.
Here is Mises' central point: the monetary system is the product of human action, but not human design. This is what is denied by all schools of economic opinion except the Austrian School. All the schools of opinion believe that, for the proper functioning of money, the civil government, because of its inherent sovereignty, must exercise control over money. So, it must have legal authority over money. This means that the law of money, as an extension of the law civil government, is different from the laws governing voluntary economic exchange.
4. SANCTIONS. Then there are sanctions. Government imposes sanctions for violating civil law. What are the comparable sanctions in the realm of monetary policy? The sanctions are simple: profit and loss. These two sanctions govern the realm of voluntary economic exchange. They therefore govern the realm of monetary policy. The sanctions of profit and loss, which apply to every other area of voluntary exchange, also apply in the realm of monetary policy, and therefore should apply in the realm of monetary theory. But, we find that this is not the case in any school of economic opinion except the Austrian School.
5. CONTINUITY. The fifth category of economic analysis that applies to money is the category of continuity. Continuity is the crucial factor in all ownership. Does an individual have the right to retain possession of his property through time? Do voluntary exchanges transfer ownership of property to other individuals? If the answer is yes, then the same degree of continuity must prevail in the realm of monetary policy. One of the central factors in all forms of money is continuity through time. If an individual does not believe that a particular asset will enable him to purchase scarce goods and services in the future, the value of the monetary unit will fall. It will fall to whatever value that consumers impute to it for their purposes. If gold or silver coins were expected to be abandoned by market participants who are seeking stability of purchasing power over time, the value of the two metals would fall to whatever they are worth in other areas of the economy.
It is more likely that pieces of paper with rulers' pictures on them will be subjected to doubts concerning their continuity of value than gold or silver coins that are used widely in exchange.
In summary, the original sovereignty over money was established by the free market, which is in turn was an extension of a particular legal order. Second, authority over money inheres in an individual's right to possess property. Third, the law of money is an extension of the law of private property. It is in no way different from the general legal order that governs ownership and exchange. Fourth, the sanctions of profit and loss apply to money, just as they apply to all the other areas of the free market economy. Finally, there is continuity of money over time because there is continuity of ownership over time.
Money is an extension of the free-market social order. To the extent that civil government interferes with money, it interferes with the operations of the free-market order. Interference in the area of money beyond the general application of laws governing contracts has more extensive consequences, all negative, than interference in any other area of the economy. This is because money is the universal facilitator of voluntary exchange. An error in policy in the realm of money extends to the entire society.
September 29, 2009
Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.
Copyright © 2009 Gary North
What Is Money?
By: Gary North
-- Posted Thursday, 1 October 2009 | Digg This Article
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Part 2: Precious Metal Coinage
The case for precious metal coinage as the best form of money arises from two things: first, an understanding of how money developed in the past; second, an understanding of economic theory.
The case for a precious metals coinage is the case for historical continuity. Individuals in the past voluntarily adopted gold and silver coins as the preferred commodities to facilitate economic exchange. They did not accept these two metals as the preferred monetary units because of their commitment to economic theory. They chose those metals because there are advantages offered by these metals that competing commodities do not possess to the same degree. The main advantage is continuity of value (price) over time.
Gold and silver became currencies throughout the world because they possess certain physical characteristics that facilitate their adoption as money. The most important aspect of both gold and silver is that they must be mined. It is expensive to dig these metals out of the ground. Silver is primarily a byproduct of the mining of other metals: lead, copper, and zinc. Mining firms must bear the costs of extracting these metals from the earth. This limits the production of these metals. They are comparatively scarce minerals, and it is expensive to dig them out of the ground. So, not much gold and silver come into the economy in any given year.
Because the two metals became desirable in the past primarily as monetary commodities, there is considerable demand from individuals to own these commodities whenever they become money. This is the issue of continuity over time. They were valuable in the past, so people expect them to be valuable in the future.
People pay to purchase these commodities with the net output of their productivity. They bid for ownership of these coins just as they bid for ownership of any other commodity. They offer their goods and services for sale in exchange for gold or silver.
There is continuing demand for these metals. This encourages miners to search for better ways of discovering and refining gold and silver. The supply of money increases slowly and predictably. People can adjust their plans accordingly.
Because of the geological limitations on the production of gold and silver, individuals can more accurately predict price changes. If they are not good at forecasting, profit-seeking specialists will do this on behalf of consumers.
Specialists in forecasting have knowledge of the available supply of particular goods and services. They can rely on the fact that there will not be an extensive increase in the supply of gold or silver, precisely because it is so expensive to dig the two metals out of the ground. So, this creates an environment in which individuals can make fairly accurate forecasts about the production costs of whatever it is they produce.
The focus of concern for a forecaster is more on the supply of the nonmonetary side of any transaction than on the monetary side. The monetary side is stable. This increases predictability. This in turn decreases the likelihood of errors in forecasting. By reducing the likelihood of errors, everyone benefits.
This assumes that the state does not control the supply of money. If the state controls the supply of money, which means fiat money, then the predictability of prices is reduced. The supply factor of money becomes far more variable. Pricing therefore becomes far less predictable. This increases the cost of doing business.
People have to invest resources to protect themselves from errors in their forecasts. In other words, they must buy some form of insurance. If the state were not in control of the money supply, individuals would not have to set aside as many assets to protect themselves against variations in the money supply.
Gold and silver have been universally recognized by societies throughout the world as reliable forms of money. This has given an advantage to any society that restricted the use of money to gold and silver coins, or warehouse receipts to specific quantities of gold and silver. This is what the 19th century provided more than any society in modern times.
Historically, the only society that has maintained a gold coin standard for 1000 years was Byzantine society, from the fourth century until the 15th century. That was the longest period of monetary stability in the history of man. Eastern Rome was wealthier than Western Rome, and the most important single reason for this was the fact that Eastern Rome had a stable monetary order for 1000 years.
Deflation of the money supply is unlikely under gold and silver monetary standards. Most gold stays above ground and is in somebody's possession. This is less true of silver, which is more of an industrial commodity than gold is. But deflation as a policy is highly unlikely. There can be no vast increase of the money supply, because gold and silver are difficult to mine. There is therefore no subsequent monetary contraction, because individual gold and silver coins are held by individuals across the world. No society can vastly expand the quantity of gold and silver, and therefore we cannot have an economic collapse that is based on the breakdown of exchange because of the contraction of money.
When gold and silver coins are the primary form of money, increases the production of nonmonetary assets tends to lower prices. There is a steady increase in the output of goods and services other than money, and therefore we have a situation in which more goods and services are chasing essentially the same quantity of money. This leads to steadily lower prices.
Steadily lower prices are the correct economic goal. Whenever we view scarcity as a liability, then the increase in productivity steadily reduces the effect of this liability. If we want to see a decrease in scarcity, we want to see a decrease in the general price level. As greater productivity enters the society, the competition among sellers of goods and services in order to gain ownership of gold and silver will lead to a reduction of prices.
This is the whole point of competition. We want to see lower prices. Lower prices are an indication of increased wealth. So, deflation, in the sense of price deflation, is a social benefit and an individual benefit. Deflation in the sense of the contraction of the money supply is not a social benefit and not an individual benefit. Gold and silver produce the kind of price deflation that is good for individuals as well as social order. Fiat money produces the kind of economic crisis and monetary contraction that is bad for individuals and social order.
Those few economists who defend the use of gold and silver coins as the basis of the monetary system are dismissed as gold bugs. The reason why they are dismissed is that their opponents believe that the government should be sovereign over money, and that politicians and bureaucrats are the proper sources of economic policy. These critics of gold do not trust the free-market social order. They do not trust individual decision-making. They especially do not trust individual decision-making with respect to how much money an individual should possess. They have a fundamental hostility to individual responsibility, and this is manifested most obviously in their hostility to gold and silver coinage as the foundation of the monetary order.
They dismiss what they call the theology of gold. They dismiss it because they are great believers in the theology of state sovereignty. As high priests of civil government, they are contemptuous of defenders of individual responsibility regarding the quantity, quality, and physical form of the monetary unit. So, it is never a question of the theology of gold. It is always a question of whose theology of gold: pro-gold or anti-gold.
In the 20th century, the theologians of fiat money have predominated over the theologians of gold and silver coinage. This is another way of saying that the theology of state sovereignty has predominated over the theology of the free market.
FEATURES OF MONEY
There are certain features of the original commodities that have become money historically. These features gave the original money metals an advantage over all of the other commodities that might have served as money, and in some cases historically have served as money.
There are five of these characteristics: recognizability, divisibility, portability, high value in relation to weight and volume, and continuity of value over time. Any physical commodity that possesses these five characteristics is a candidate to become the monetary commodity of a particular social order.
Historically, gold and silver have possessed these five characteristics to a greater degree than any other commodity. There have been rivals. Salt has been a rival. Animals have served as money in history. Even women have served as money in certain societies. (The problem with women as money is the problem of divisibility. Half a woman is not much use as a monetary unit.)
All forms of money are marked by one characteristic above all other characteristics: liquidity. It is unfortunate that economists use the term "liquidity" to describe such an asset. This is a transfer of a physical characteristic to an economic characteristic.
There are three characteristic features of a liquid asset. First, you can get other people to exchange goods and services for this commodity on what is essentially an instant basis. Second, you can persuade them to make the exchange without offering a discount. Third, you do not have to spend any money to advertise the item to persuade other people to exchange their goods and services. These three features must be present in order for commodity to attain the status of money.
I will give an example. If I walk in to a store, pull out a dozen $100 bills, and ask, "Can I get anyone help me?" I will get someone to help me. I will not have to ask this twice. This may be a socially disapproved public display, but I will get help. If the salespeople are working on commission, I will get lots of help. I don't have to offer extra money to get the salesperson to sell me whatever that is offered for sale. I may even be offered a discount if I am willing to buy more than one costly item.
Third, the advertising procedure is really simple. I just say, "I've got his money here. Does somebody want to help me?" That is all the advertising I need.
Any item that cannot be exchanged for goods and services on this basis is not money. Somebody may want to call it money, but it is not money. In today's world, gold is not money. I cannot go into Wal-Mart and buy whatever I want for gold coins. Wal-Mart's barcode system is not set up to recognize gold coins.
The promoters of fiat money have been ingenious in finding ways to de-monetize gold. It was done in the United States by Franklin Roosevelt in 1933. He made it illegal for Americans or residents of the United States to own gold, either in the United States or outside its jurisdiction. That de-monetized gold. That made gold a nonmonetary commodity. Gold bugs may proclaim: "Gold is money." Gold is not money except for central banks.
The legal order of the United States and every other nation ought to be restructured so that the voluntary ownership of property can lead to the decision by individuals to hold one form of money or another. If they choose to hold gold or silver coins, then these should be a society's money.
Gold should not become money because of a decree by civil government. In the same sense that gold should not have been de-monetized by a decree of civil government, gold should not be re-monetized by civil government, except in one limited case. If a government is going to tell people that it will collect taxes, it has the legal authority to designate what the tax unit of account will be. I recommend that governments designate the unit of account for taxes as gold. That is the extent of what government should do to promote gold. Gold and silver became monetary commodities because of individual decisions of economic actors. This is the correct defense of a gold standard. The defense must rest on the right of individuals to own property. Gold does not have independent authority or independent sovereignty. Gold and silver as monetary units are dependent on a particular legal order. This legal order ought to be favorable to the private ownership of all commodities, including gold and silver.
This historically has been the position of Austrian School economics. That is because Ludwig von Mises defended his theory of the origin of money in terms of a specific logic of economics. He defended it in terms of the private property order. He did not defend it in terms of a government decree which made gold or silver a monetary commodity. He defended it in terms of the individual decisions of specific people who decided they would rather own gold or silver than some other commodity.
Let us now consider the question of counterfeiting. Counterfeiting is universally condemned by civil governments. Wherever we go, a national civil government has passed a law imposing serious sanctions against anybody who would counterfeit the national monetary unit. Why governments do this? Because they are all counterfeiters, and they deeply resent an invasion of their turf. Laws against counterfeiting in today's world are a form of gang warfare.
What are the economic reasons why counterfeiting of precious metals coins should be illegal? In a voluntary society, counterfeiting would be a violation of contract. It is a violation of contract because it uses fraud. The counterfeiter says that a particular coin or bar of metal contains a specific quantity and fineness of that metal. The counterfeiter has added base metals that are worth less money than the precious metal. He is trying to deceive the buyer of his coin regarding the value of the coin. Because fraud is involved, counterfeiting is a crime against the victim.
Counterfeiting is a threat to society because it enables the counterfeiter to increase the supply of the monetary unit at a cost that is less than mining precious metals out of the ground. This means that there will be a greater quantity of money in circulation as a result of counterfeiting than would have been the case had counterfeiting not taken place.
The problem with any increase in the money supply has to do with the disruption of prices and the communication of false information. Prices convey information. Prices distorted by counterfeiting convey distorted information. Counterfeiting decreases the value of the monetary unit generally. Almost everyone in society is hurt by the resulting price inflation. There is no equality of harm in the realm of counterfeiting. Some people win; most people lose. This is true whether the counterfeiter is a private individual acting on his own behalf, or whether he is a licensed agent of the Federal government.
There are evil effects of monetary inflation. The most obvious one is the falling value of the monetary unit. Individuals who own money are harmed because the value of the money they accumulated on the assumption of continuity of value is reduced. As more monetary units come into circulation, the value of the older monetary units falls. This benefits those people who gain early access to the newly counterfeited money, which is a limited group, and it does so at the expense of people who hold the currency as a way of gaining economic continuity.
Then there is the boom-bust cycle. This was described by Mises in his book, "The Theory of Money and Credit." The boom-bust cycle occurs because commercial banks increase the amount of money, which they then lend to entrepreneurs. The entrepreneurs use the newly created money to bid away capital goods and labor from their competitors. They extend the division of labor by adding new production processes. They do not do this on the basis of voluntary thrift on the part of investors. They do this on the basis that a bank has increased the money supply, and has lent this new money to them.
There is an initial expansion of economic activity. Businessmen increase their demand for labor and goods, because they possess an increased supply of money by which to increase that demand. It is a question, once again, of the two fundamental points, "supply and demand," and "high bid wins." Those who get access to the new money early are in a position to bid up the price of production goods.
Then, when the money supply doesn't continue to expand, the people who expanded their output of consumer goods find that consumers are unwilling to purchase the increased quantity of goods. This begins the bust phase of the cycle. Things looked promising in the boom phase, but they produce a disaster in the bust phase.
Another injurious effect of inflation is that it increases the cost of making economic plans. Because rising prices disrupt continuity, producers must hedge their investments and their plans against rising costs of production. The continuity that precious metals coinage would permit is lost. It becomes more expensive to make accurate plans regarding the future. This imposes an increased cost because of the counterfeiting is going on in society.
A fourth area of harm is theft of creditors. Creditors extended loans to individuals on the basis of an assumption. They assumed that the purchasing power of the monetary unit would be maintained. They may have believed that there might even be an appreciation of the currency unit, because increased productivity in society leads to reduced consumer prices. Creditors forfeited the use of their money on the basis of an assumption regarding the continuity of the money supply. This assumption is overturned when counterfeiters expand the money supply, thereby lowering the purchasing power of the monetary unit. The creditor is expropriated, because the debtor repays the loan with an asset that is worth less than it had been worth the time that the loan was made.
A gold coin standard or silver coin standard provides continuity that fiat money systems do not provide. Such a standard makes life difficult for counterfeiters. This is why governments do whatever it takes to substitute a fiat currency unit for a precious metals coinage. The government wants to benefit as the nation's monopolistic counterfeiter. It will share this only with commercial banks and the central bank. It does this only because the central bank promises to be the lender of last resort to the national Treasury.
October 1, 2009
Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.
Copyright © 2009 Gary North