Monies

1. The Division of Labor Without Money

To understand the origin and nature of money, one must first consider how human beings would cooperate in a world without money—in a barter world. Exchanging goods and services in such a barter world confronts the members of society with certain problems. They then turn to monetary exchanges as a means for alleviating these problems. In short, money is a (partial) solution for problems of barter exchanges. But let us look at this in just a little more detail.

The fundamental law of production is that joint production yields a greater return than isolated production. Two individuals working in isolation from one another produce less physical goods and services than if they coordinated their efforts. This is probably the most momentous fact of social life. Economists such as David Ricardo and Ludwig von Mises have stressed its implication: even if there are no other reasons for human beings to cooperate, the greater productivity of joint efforts tends to draw them together. The higher productivity of the division of labor, as compared to isolated production, is therefore the basis of a general “law of association.”^[1]

Without money, people would exchange their products in barter; for example, Jones would barter his apple against two eggs from Brown. In such a world, the volume of exchanges—in other words, the extent of social cooperation—is limited through technological constraints and through the problem of the double coincidence of wants. Barter exchanges take place only if each trading partner has a direct personal need for the good he receives in the exchange. But even in those cases in which the double coincidence of wants is given, the goods are often too bulky and cannot be subdivided to accommodate them to the needs. Imagine a carpenter trying to buy ten pounds of flour with a chair. The chair is far more valuable than the flour, so how can an exchange be arranged? Cutting the chair into, say, twenty pieces would not provide him with objects that are worth just one twentieth of the value of a chair; rather such a “division” of the chair would destroy its entire value. The exchange would therefore not take place.

2. The Origin and Nature of Money

These problems can be reduced through what has been called “indirect exchange.” In our example, the carpenter could exchange his chair against 20 ounces of silver, and then buy the ten pounds of flour in exchange for a quarter ounce of silver. The result is that the carpenter’s need for flour, which otherwise would have remained unsatisfied, is now satisfied through an additional exchange and the use of a “medium of exchange” (here: silver). Thus indirect exchange provides our carpenter with additional opportunities for cooperation with other human beings. It extends the division of labor. And it thereby contributes to the material, intellectual, and spiritual advancement of each person.

In the history of mankind, a great variety of commodities—cattle, shells, nails, tobacco, cotton, copper, silver, gold, and so on—have been used as media of exchange. In the most developed societies, the precious metals have eventually been preferred to all other goods because their physical characteristics (scarcity, durability, divisibility, distinct look and sound, homogeneity through space and time, malleability, and beauty) make them particularly suitable to serve in this function.

When a medium of exchange is generally accepted in society, it is called “money.” How does a commodity such as gold or silver turn into money? This happens through a gradual process, in the course of which more and more market participants, each for himself, decide to use gold and silver rather than other commodities in their indirect exchanges. Thus the historical selection of gold, silver, and copper was not made through some sort of a social contract or convention. Rather, it resulted from the spontaneous convergence of many individual choices, a convergence that was prompted through the objective physical characteristics of the precious metals.

To be spontaneously adopted as a medium of exchange, a commodity must be desired for its nonmonetary services (for its own sake) and be marketable, that is, it must be widely bought and sold. The prices that are initially being paid for its nonmonetary services enable prospective buyers to estimate the future prices at which one can reasonably expect to resell it. The prices paid for its nonmonetary use are, so to speak, the empirical basis for its use in indirect exchange. It would be extremely risky to buy a commodity for indirect exchange without knowing its past prices; as a consequence, the spontaneous emergence of a medium of exchange is virtually impossible whenever such knowledge is lacking. On the other hand, when it exists, then there can arise a monetary demand for the commodity in question. The monetary demand then adds to the original nonmonetary demand, so that the price of the money-commodity contains a monetary component and a nonmonetary component. Although in a developed economy the former is likely to outweigh the latter quite substantially, it is important to keep in mind that the monetary use of a commodity ultimately depends on its nonmonetary use. The medieval scholastics called money a res fungibilis et primo usu consumptibilis.^[2] It was in the very nature of money to be a marketable thing that had its primary use in consumption.

3. Natural Monies

We may call any kind of money that comes into use by the voluntary cooperation of acting persons “natural money.”^[3] To cooperate voluntarily in our definition means to provide mutual support without any violation of other people’s property, and to enjoy the inviolability of one’s own property.^[4]

The role of private property as a fundamental institution of human society is of course a staple of historical experience and social science. It is also a staple of Christian social thought, rooted in the Sixth and Ninth Commandments. Within the Catholic Church, the popes emphasized that private property must be held inviolable, not out of any juridical dogmatism in favor of the well-to-do, but because they perceived such inviolability to be the first condition to improve the living standards of the masses.^[5] They upheld this notion knowing full well that property owners are often bad stewards of their assets. They upheld it even in the cases in which the owners do not, as a matter of fact, use their private means to promote the good of all of society. And they upheld it in those cases in which the owners did not even have the slightest intention to pursue the common good. In short, the popes championed the distinction between justice and morals—between the right to own property and the moral obligation to make good use of this property.^[6] A violation of one’s moral obligation could not possibly justify the slightest infringement of property rights. Private property is sacred even if it is abused or not used:

That justice called commutative commands sacred respect for the division of possessions and forbids invasion of others’ rights through the exceeding of the limits of one’s own property; but the duty of owners to use their property only in a right way does not come under this type of justice, but under other virtues, obligations of which ‘cannot be enforced by legal action.’ Therefore, they are in error who assert that ownership and its right use are limited by the same boundaries; and it is much farther still from the truth to hold that a right to property is destroyed or lost by reason of abuse or non-use.^[7]

In the case of a society in which private property is inviolable, we may speak of a “completely free society” and its economic aspect may then be called a “free market” or a “free economy.” Such an economy, if perfected by charity, truly promotes “economic and civil progress.”^[8] The monetary corollary of such a society is, as we have said, natural money—or rather all the different natural monies that would exist in such a society, for there are good reasons to assume that a free society would harbor a variety of different monies, which would all be natural monies in our sense. Notice that natural money is an eminently social institution. This is so not only in the sense that it is used in interpersonal exchanges (all monies are so used), but also in the sense that they owe their existence exclusively to the fact that they satisfy human needs better than any other medium of exchange. As soon as this is no longer the case, the market participants will choose to discard them and adopt other monies. This freedom of choice assures, so to speak, a grass-roots democratic selection of the best available monies—the natural monies.

Where property rights are violated, especially where they are violated in a systematic manner, we may no longer speak of a completely free society. It is possible that natural monies would still be used in such societies, namely, to the extent that the violations of property rights do not concern the choice of money. But wherever people are not free to choose the best available monies, a different type of money comes into existence—”forced money.” Its characteristic feature is that it owes its existence to violations of property rights. It is used, at least to some extent, because superior alternative monies cannot be used without exposing the user to violence. It follows that such monies are tainted from a moral point of view. They may still be beneficial and used in indirect exchanges, but they are in any case less beneficial than natural monies, because they owe their existence to violations of private property, rather than to their relative superiority in satisfying human needs alone.

Gold, silver, and copper have been natural monies for several thousand years in many human societies. The reason is, as we have said, that their physical characteristics make them more suitable to serve as money than any other commodities. Still we call them natural monies, not because of their physical characteristics, but because free human beings have spontaneously selected them for that use. In short, one cannot tell on a priori grounds what the natural money of a society is. The only way to find this out is to let people freely associate and choose the best means of exchange out of the available alternatives. Looking at the historical record we notice that, at most times and most places, people have chosen silver. Gold and copper too have been used as monies, though to a lesser extent.

4. Credit Money

Natural money must possess two qualities. It must first of all be valuable prior to its monetary use, and it must furthermore be physically suitable to be used as a medium of exchange (at any rate more suitable than the alternatives). The historical monies we have mentioned so far derive their prior value from their use in consumption. Even in the case of the precious metals this is so. It is true that they are not destroyed in consumption, as for example tobacco and cotton, but they are nevertheless consumed as jewelry, ornament, and in a variety of industrial applications.

Now there are other monies that do not derive their prior value from consumption. The most important cases are paper money and electronic money, to which we will turn below. But there is also credit money, the subject of the current section. As the name says, credit money comes into being when financial instruments are being used in indirect exchanges. Suppose Ben lends 10 oz. of silver to Mike for one year, and that in exchange Mike gives him an IOU (I owe you). Suppose further that this IOU is a paper note with the inscription “I owe to the bearer of this note the sum of 10 oz., payable on January 1, 2010 (signature).” Then Ben could try to use this note as a medium of exchange. This might work if the prospective buyers of the note will also trust Mike’s declaration to pay back the credit as promised. If Mike’s reputation is good with certain people, then it is likely that these people will accept his note as payment for their goods and services. Mike’s IOU then turns into credit money.

Credit money can never have a circulation that matches the circulation of the natural monies. The reason is that it carries the risk of default. Cash exchanges provide immediate control over the physical money. But the issuer of an IOU might go bankrupt, in which case the IOU would be just a slip of paper.

Not surprisingly, therefore, credit money has reached wider circulation only when the credit was denominated in terms of some commodity money, when the reputation of the issuer was beyond doubt, and when it was the only way to quickly provide the government with the funds needed to conduct large-scale war. This was for example the case with the American Continentals that financed the War of Independence and with the French assignats that financed the wars of the French revolutionaries against the rest of Europe. In the early days, credit money had also been issued in other forms than paper. In particular, IOUs made out of leather have been repeatedly used as money starting in the ninth century.^[9]

Credit money is only a derived kind of money. It receives its value from an expected future redemption into some commodity. In this respect it crucially differs from paper money, which is valued for its own sake. And this brings us to the next topic.

5. Paper Money and the Free Market

So far we have singled out the precious metals to illustrate our discussion because, historically, the precious metals have been the money of the free market, and also because to the present day no other commodities seem to be more suitable to be used as media of exchange. But the contention that gold, silver, and copper are the best available monies seems to be contradicted by the fact that, today, there is virtually no country in the world that uses precious metals as monies. Rather, all countries use paper monies.^[10] This universal practice seems to have a ready explanation in the observation that paper money is even more advantageous than the precious metals, for at least three reasons: (1) its costs of production are far lower; (2) its quantity can be easily modified to suit the needs of trade; and (3) its quantity can be easily modified to stabilize the value of the money unit.

Before we turn to analyzing these alleged advantages in more detail, we have to deal with the even more fundamental question of whether paper money is a market phenomenon in the first place. Does it owe its existence to the free choice of the money users, or to legal privileges? If the former is the case, there seems to be no fault with paper money—quite to the contrary. But if it exists only due to compulsion and coercion; that is, due to violations of property rights—its alleged advantages must be examined very carefully.

Now if we turn to the empirical record, we confront the stark fact that, in no period of human history, has paper money spontaneously emerged on the free market.^[11] No Western writer before the eighteenth century seems to have even considered that the existence of paper money was possible. The idea arose only when paper certificates for gold and silver gained a larger circulation, especially in the context of large-scale government finance.^[12] In the eighteenth, nineteenth, and twentieth centuries, various experiments with paper money have taken place in the West.^[13] Governments have issued paper money along with the legal obligation for each citizen to accept it as legal tender. They overrode the stipulations made in private contracts and forced creditors, say, to accept payments in paper “greenbacks” rather than in gold or silver. In most cases, however, governments have transformed previously existing paper certificates for gold and silver into paper money by outlawing the use of gold and silver, and of all other suitable commodities and certificates. The experience of other cultures and times tells the same story. Paper money had been introduced in China in the twelfth century, equally through compulsion and coercion by the ruler.^[14] In all known historical cases, paper money has come into existence through government-sponsored breach of contract and other violations of private-property rights. It has never been a creature of the free market.

The historical record does not of course provide a decisive verdict on the question whether paper money can spontaneously emerge on a free market. Can we settle the issue on theoretical grounds? Here the following consideration comes into play. By its very nature, paper money provides only monetary services, whereas commodity money provides two kinds of services: monetary and commodity services. It follows that the prices paid for paper money can shrink to zero, whereas the price of commodity money, will always be positive as long as it attracts a nonmonetary demand. If the prices paid for a paper money fall to zero, then this money can never be re-monetized again, because short of an already-existing price system the market participants could not evaluate the money unit. Thus the use of paper money carries the risk of total and permanent value annihilation. This risk does not exist in the case of commodity money, which always carries a positive price and which can therefore always be re-monetized.

It does not take much fantasy to predict the practical implications of this fact. In a truly free market, paper money could not withstand the competition of commodity monies. The more farsighted and prudent market participants would get rid of their paper money first, and the others would follow in due course. At the end of this process, which could be consummated in but a few seconds, but which could conceivably also last a few years, the paper currency would be completely eradicated.^[15]

The preceding analysis leads to the conclusion that no money can remain in circulation only because it has been in circulation up to now. The ultimate source of its value—the rock bottom of its value—must be something else than the mere fact that, so far, people have been willing to accept it.^[16] All kinds of psychological motivations might provide such a source for a while, but they will all collapse under the pressure of a substitution process of the kind we have described above. What then? Can the armed power of the government keep money in circulation? The government’s fiat can indeed confer value on paper money—the value of not getting into trouble with the police.^[17] But this observation only confirms our point that paper money is not a market phenomenon. It cannot flourish in the fresh air of a free society. It is used only when police power suppresses its competitors, so that the members of society are given the stark choice of either using the government’s paper money or forgoing the benefits of a monetary economy altogether.^[18]

6. Electronic Money

The preceding observations can be directly applied to the case of electronic money. An economic good that is defined entirely in terms of bits and bytes is unlikely ever to be produced spontaneously on a free market, for the very same reasons that we just discussed in the case of paper money. And despite the dedicated efforts of various individuals and associations, no such money has in fact ever been produced since the creation of the Internet made electronic payments possible. At present, only government money has been produced in electronic form; and as in the case of paper money, governments could do this only because they have the possibility to suppress competition.

On the free market, the new information technologies have been unable to create any new monies. They have been able to develop various new instruments to access and transfer money. These new electronic techniques of dealing with money are very efficient and beneficial, but they must not be confused with the creation of electronic money.