Utilitarian Considerations on the Production of Money

1. The Sufficiency of Natural Money Production

So far we have described how a commodity money system would work in a free market and how this system appears from an ethical point of view. We have also argued that our present paper currencies and electronic currencies could not survive in a truly free market against the competition of commodity monies. They continue to be used because they enjoy the privilege of special legal protection against their natural competitors, gold and silver. At no time in history has paper money been produced in a competitive market setting. Whenever and wherever it came into being, it existed only because the courts and the police suppressed the natural alternatives.

In other words, to have a paper money means to allow the government to significantly curtail the personal liberties of its citizens. It means to curtail the freedom of association and the freedom of contract in a way that affects the citizens on a daily basis and on a massive scale. It means send in the police and to use the courts to combat human cooperation involving “natural monies” such as gold and silver, monies in use since biblical times.

These circumstances weigh heavily against paper money. Using the armed forces of the state to put an entire nation before the stark choice of either using the government’s money, or renouncing the benefits of monetary exchanges altogether—this is certainly not a light matter, but one that requires a compelling and unassailable rationale. To make a moral case for paper money or electronic money, one has to demonstrate that they convey significant advantages for the community of their users (the “nation”), advantages that might compensate for their severe moral shortcomings. The question, then, is whether such advantages exist. Can paper money and electronic money be justified on utilitarian grounds? To this question we now turn.

It is a significant fact that, before the time when paper money first came into being, no philosopher of money ever criticized the then-existing commodity monies on utilitarian grounds. It is true that Plato proposed to outlaw private ownership of natural monies—gold and silver—on political grounds, namely, to ensure that each individual was economically dependent on government.^[1] But even Plato did not claim that gold and silver were somehow inadequate as monies, or that monies imposed by the government could render greater monetary services. And neither do we find any such thought in Aristotle or in the writings of the Church fathers and the scholastics. Quite to the contrary! Bishop Nicholas Oresme argued that the money supply was irrelevant for monetary exchanges per se. Changes of the nominal money supply—the “alteration of names”—did not make money more suitable to be used in indirect exchanges, nor less; such changes merely affected the terms of deferred payments (credit contracts), which was also why Oresme opposed them.^[2]

Thus before the sixteenth century there was apparently no problem of hoarding, or of sticky prices, and apparently no need to stabilize the price level, the purchasing power, or aggregate demand. But the champions of paper money are far from seeing any significance in this fact. Gold and silver, they argue, were sufficient for the primitive economies prevailing until the High Middle Ages. But the capitalist economies that emerged in the Renaissance required a different type of money. And the new theories explaining this need arose along with the new paper currencies. So what do we make of these new theories? We have to examine them one by one, even though in the present work we can only address the major ones, trusting that the reader will rely for everything else on other works.

But before we explain the fallacies involved in the most widespread justifications of paper money, let us point out that post-1500 monetary writings not only swamped the world with such justifications, but also provided the rejoinders. We have already mentioned that Oresme argued that the money supply was irrelevant, in the sense that the services derived from monetary exchange did not depend on the quantity of money used. The intellectuals of the Renaissance and of the mercantilist period could never quite get around this fundamental insight. Even those who otherwise justified various inflationist schemes had to acknowledge it.^[3] Then the classical economists stated very clearly that, in principle, any quantity of money would do; even though they qualified this proposition in the light of various false doctrines they had inherited from their mercantilist predecessors.^[4] The first economist who had a clear scientific grasp of the issue was John Wheatley, the brilliant critic of the monetary thought of Hume, Steuart, and Smith.^[5] But Wheatley never presented a systematic doctrine in print. In the twentieth century, Ludwig von Mises and Murray Rothbard filled this gap. The practical offshoot of their monetary analysis is that no social benefits can be derived from government control over the money supply. In Rothbard’s words:

We conclude, therefore, that determining the supply of money, like all other goods, is best left to the free market. Aside from the general moral and economic advantages of freedom over coercion, no dictated quantity of money will do the work better, and the free market will set the production of gold in accordance with its relative ability to satisfy the needs of consumers, as compared with all other productive goods.^[6]

Again, as we have pointed out, this is anything but a novelty in the history of thought. Oresme clearly saw that increases of the nominal money supply would enrich the princes at the expense of the community. But except for very rare and exceptional emergency situations, this was not the price to be paid for some benefit that could not otherwise be obtained. Nominal increases of the money supply were unnecessary from the point of view of the entire commonwealth. The nominal alteration of the coinage, said Oresme,

… does not avoid scandal, but begets it… and it has many awkward consequences, some of which have already been mentioned, while others will appear later, nor is there any necessity or convenience in doing it, nor can it advantage the commonwealth.^[7]

The truth is often deceptively simple. It is the errors that are manifold and complicated. So it is at any rate in the case of money. The simple truth is that there is no need for political intervention to impose monies different from the ones that the market participants would have chosen anyway. But many doctrines have been concocted to justify precisely such intervention.^[8] It is not necessary for us to refute all of them in the present work. In what follows we will discuss only the seven most widespread errors.

2. Economic Growth and the Money Supply

The most widespread monetary fallacy is probably the naïve belief that economic growth is possible only to the extent that it is accompanied by a corresponding growth of the money supply.^[9] Suppose the economy growths at an annual rate of 5 percent. Then according to that fallacy it is necessary to increase the money supply also by 5 percent because otherwise the additional goods and services could not be sold. The champions of this fallacy then point out that such growth rates of the money supply are rather exceptional for precious metals. Gold and silver are therefore unsuitable to serve as the money of a dynamic modern economy. We better replace them with paper money, which can be flexibly increased at extremely low costs to accommodate any growth rates of the economy.

This argument is wrong because any quantity of goods and services can be exchanged with virtually any money supply. Suppose the money supply in our example does not change. If 5 percent more goods and services are offered on the market, then all that happens is that the money prices of these goods and services will decrease. The same mechanism would allow economic growth even when the quantity of money shrinks. Any rate of growth can therefore be accommodated by virtually any supply of natural monies such as gold and silver.

The qualification “virtually” takes account of the fact that there are certain technological limitations on the use of the precious metals. Suppose there are high growth rates over an extended period of time. In this case, it might be necessary to reduce coin sizes to such an extent that producing and using these coins becomes unpractical. This problem is very real in the case of gold. It has never existed in the case of silver—which is also why many informed writers consider silver to be the money par excellence. In any case, such technological problems pose no problem. As Bishop Oresme explained more than 700 years ago, the thing to do in such cases is simply to abandon the use of the unpractical coins, say gold coins, and switch to another precious metal, say silver.^[10] And, we may add, on the free market there are strong incentives to bring about such switching promptly and efficiently. No political intervention is necessary to support this process.

A more sophisticated variant of the growth-requires-more-money doctrine grants that any quantities of goods and services could be traded at virtually any money supply. But these advocates argue that, if entrepreneurs are forced to sell their products at lower prices, these prices might be too low in comparison to cost expenditure. Selling product inventories at bargain prices entails bankruptcy for the entrepreneurs.

But this variant is equally untenable, because it is premised on a mechanistic image of entrepreneurship. Fact is that entrepreneurs can anticipate any future reductions of the selling prices of their products. In the light of such anticipations they can cut offering prices on their own cost expenditure and thus thrive in times of declining prices. This is not a mere theoretical possibility but the normal state of affairs in periods of a stable or falling price level. For example, in the last three decades of the nineteenth century, both Germany and the U.S. experienced high growth rates at stable and declining consumer-price levels.^[11] The same thing is observed more recently in the market for computers and information technology, the most vibrant market since the 1980s, which has combined rapid growth with constantly falling product prices.

3. Hoarding

The foregoing considerations also apply to the phenomenon of hoarding. It is impossible to use money without holding a certain amount of it; thus every participant in a monetary economy hoards money. The reason why the pejorative term “hoarding” is sometimes used in lieu of the more neutral “holding” is that, in the mind of the commentator, the amounts of money held by this or that person are excessive. The crucial question is of course: by which standard?

It is possible to give a meaningful definition of hoarding in moral terms. Some people have a neurotic propensity to keep their wealth in cash. They are misers who hoard their money even when spending it would be in their personal interest. They neglect clothing, housing, education, charity, and so on; and thus they deprive themselves of their full human potential, and in turn deprive others of the benefits that come from social bonds with a developed human being. Notice that this definition of hoarding as pathological behavior does not refer to absolute amounts of money held. Rather it concerns the amounts of money held relative to alternative ways of investing one’s wealth. There are indeed many situations in which it is advisable—both for an individual person and for groups—to hold large sums of cash. For centuries, holding large numbers of gold and silver coins was an important way for people to save their own private pension funds, and in many times and places it was the only way to provide for old age and emergency situations. Similarly, in times of stock market and real-estate booms, it is generally prudent to keep a large amount of one’s wealth in cash. It is true that there are other situations in which even very small sums of money held might be excessive. The point is that the question whether one’s cash balances are just “money held” or whether they are pathological “money hoards” must be determined for each individual case.

The right way to deal with excessive money hoarding is to talk to the persons in question and persuade them to change their behavior. What if these persons remain stubborn? Is it then advisable to apply political means such as expropriation or an artificial increase of the money supply? The answer to these questions is in the negative. Hoarding per se might be pathological, but it does not deprive other people of what is rightfully theirs. And in particular it does not prevent the efficient operation of the economy.

As we have stated above, the absolute money supply of an economy is virtually irrelevant. The economy can work, and work well, with virtually any quantity of money. Hoarding merely entails a reduction of money prices; hoarding on a mass scale merely entails a large reduction of money prices. Consider the (completely unrealistic) scenario of a nation hoarding so much silver that the remaining silver would have to be coined in microscopically small quantities to be used in the exchanges.^[12] In a free society, the market participants would then simply switch to other monies. Rather than paying with silver coins they would start using gold coins and copper coins.

Now suppose that, despite the foregoing considerations, a government bent on fighting money hoards would set out to artificially increase the money supply anyway. Would this policy reach its goal? Not necessarily. There is at least an equal likelihood that the policy would actually promote hoarding. The increased money supply would raise the money prices being paid on the market above the level they would otherwise have reached. And this makes it necessary for people to hold larger cash balances. Now it is true that the increase in individual cash balances is not necessarily in strict proportion to the increase of the price level. Thus it is possible that people will, relatively speaking, reduce their demand for money as a consequence of the policy. But it is just as likely that the policy will have no such effect, or that it actually produces the opposite effect.

Thus we conclude that hoarding cannot serve as a pretext for the artificial extension of the money supply. In some extreme cases it might merit the attention of spiritual leaders and psychologists. But it is never a monetary problem.

4. Fighting Deflation

Still another variant of the same basic fallacy that we just discussed is the alleged need to fight deflation.

The word “deflation” can be defined in various ways. According to the most widely accepted definition today, deflation is a sustained decrease of the price level. Older authors have often used the expression “deflation” to denote a decreasing money supply, and some contemporary authors use it to characterize a decrease of the inflation rate. All of these definitions are acceptable, depending on the purpose of the analysis. None of them, however, lends itself to justifying an artificial increase of the money supply.

The harmful character of deflation is today one of the sacred dogmas of monetary policy.^[13] The champions of the fight against deflation usually present six arguments to make their case.^[14] One, in their eyes it is a matter of historical experience that deflation has negative repercussions on aggregate production and, therefore, on the standard of living. To explain this presumed historical record, they hold, two, that deflation incites the market participants to postpone buying because they speculate on ever lower prices. Furthermore, they consider, three, that a declining price level makes it more difficult to service debts contracted at a higher price level in the past. These difficulties threaten to entail, four, a crisis within the banking industry and thus a dramatic curtailment of credit. Five, they claim that deflation in conjunction with “sticky prices” results in unemployment. And finally, six, they consider that deflation might reduce nominal interest rates to such an extent that a monetary policy of “cheap money,” to stimulate employment and production, would no longer be possible, because the interest rate cannot be decreased below zero.

However, theoretical and empirical evidence substantiating these claims is either weak or lacking altogether.^[15]

First, in historical fact, deflation has had no clear negative impact on aggregate production. Long-term decreases of the price level did not systematically correlate with lower growth rates than those that prevailed in comparable periods and/or countries with increasing price levels. Even if we focus on deflationary shocks emanating from the financial system, empirical evidence does not seem to warrant the general claim that deflation impairs long-run growth.^[16]

Second, it is true that unexpectedly strong deflation can incite people to postpone purchase decisions. However, this does not by any sort of necessity slow down aggregate production. Notice that, in the presence of deflationary tendencies, purchase decisions in general, and consumption in particular, does not come to a halt. For one thing, human beings act under the “constraint of the stomach.” Even the most neurotic misers, who cherish saving a penny above anything else, must make a minimum of purchases just to survive the next day. And all others—that is, the great majority of the population—will by and large buy just as many consumers’ goods as they would have bought in a nondeflationary environment. Even though they expect prices to decline ever further, they will buy goods and services at some point because they prefer enjoying these goods and services sooner rather than later (economists call this “time preference”). In actual fact, then, consumption will slow down only marginally in a deflationary environment. And this marginal reduction of consumer spending, far from impairing aggregate production, will rather tend to increase it. The simple fact is that all resources that are not used for consumption are saved; that is, they are available for investment and thus help to extend production in those areas that previously were not profitable enough to warrant investment.

Third, it is correct that deflation—especially unanticipated deflation—makes it more difficult to service debts contracted at a higher price level in the past. In the case of a massive deflation shock, widespread bankruptcy might result. Such consequences are certainly deplorable from the standpoint of the individual entrepreneurs and capitalists who own the firms, factories, and other productive assets when the deflationary shock hits. However, from the aggregate (social) point of view, it does not matter who controls the existing resources. What matters from this overall point of view is that resources remain intact and be used. Now the important point is that deflation does not destroy these resources physically. It merely diminishes their monetary value, which is why their present owners go bankrupt. Thus deflation by and large boils down to a redistribution of productive assets from old owners to new owners. The net impact on production is likely to be zero.^[17]

Fourth, it is true that deflation more or less directly threatens the banking industry, because deflation makes it more difficult for bank customers to repay their debts and because widespread business failures are likely to have a direct negative impact on the liquidity of banks. However, for the same reasons that we just discussed, while this might be devastating for some banks, it is not so for society as a whole. The crucial point is that bank credit does not create resources; it channels existing resources into other businesses than those which would have used them if these credits had not existed. It follows that a curtailment of bank credit does not destroy any resources; it simply entails a different employment of human beings and of the available land, factories, streets, and so on.

In the light of the preceding considerations it appears that the problems entailed by deflation are much less formidable than they are in the opinion of present-day monetary authorities. Deflation certainly has much disruptive potential. However, as will become even more obvious in the following chapters, it mainly threatens institutions that are responsible for inflationary increases of the money supply. It reduces the wealth of fractional-reserve banks, and their customers—debt-ridden governments, entrepreneurs, and consumers. But as we have argued, such destruction liberates the underlying physical resources for new employment. The destruction entailed by deflation is therefore often “creative destruction” in the Schumpeterian sense.^[18]

Finally, we still need to deal with the aforementioned fifth argument—deflation in conjunction with sticky prices results in unemployment—and with the sixth argument—deflation makes a policy of cheap money impossible. Because these arguments are of a more general nature, we will deal with them separately in the next two sections.

5. Sticky Prices

In the past eighty years, the sticky-prices argument has played an important role in monetary debates. According to this argument, the manipulation of the money supply might be a suitable instrument to re-establish a lost equilibrium on certain markets, most notably on the labor market. Suppose that powerful labor unions push up nominal wage rates in all industries to such an extent that entrepreneurs can no longer profitably employ a great part of the workforce at these wages. The result is mass unemployment. But if it were possible to substantially increase the money supply, then the selling prices of the entrepreneurs might rise enough to allow for the re-integration of the unemployed workers into the division of labor. Now, the argument goes, under a gold or silver standard, this kind of policy is impossible for purely technical reasons because the money supply is inflexible. Only a paper money provides the technical wherewithal to implement pro-employment policies. Thus we have here a prima facie justification for suppressing the natural commodity monies and supporting a paper money standard.

This argument grew into prominence during the 1920s in Austria, Germany, the United Kingdom, and other countries. After World War II, it became something like a dogma of economic policy. But this does not alter the fact that it is sheer fallacy, and it is not even difficult to see the root of the fallacy. The argument is in fact premised on the notion that monetary-policy makers can constantly outsmart the labor unions. The managers of the printing press can again and again surprise the labor-union leaders through another round of expansionist monetary policy. Clearly, this is a silly assumption and in retrospect it is very astonishing that responsible men could ever have taken it seriously. The labor unions were not fooled. Faced with the reality of expansionist monetary policy, they eventually increased their wage demands to compensate for the declining purchasing power of money. The result was stagflation—high unemployment plus inflation—a phenomenon that in the past thirty years has come to plague countries with strong labor unions such as France and Germany.

6. The Economics of Cheap Money

Another widespread fallacy is the idea that paper money could help to decrease the interest rate, thus promoting economic growth. If new paper tickets are printed and then first offered on the credit market, so the argument goes, the supply of credit is increased and as a consequence the price of credit—interest—declines. Cheap money is now available for businessmen all over the country. They will invest more than they otherwise would have invested, and therefore economic growth will be enhanced.

There are actually a good number of different fallacies involved in this argument, and it is impossible for us to deal with all of them here.^[19] Suffice it to say that capitalists invest their funds only if they can expect to earn a return on investment—interest—and that they do not seek merely nominal rates of return, but real returns. If they expect the “purchasing power” of the money unit (PPM) to decline in the future, they will make investments only in exchange for a higher nominal rate of return. Thus suppose Mrs. Myers plans to lend the sum of 100 oz. of silver for one year to a businessman in her neighborhood, but only in exchange for a future payment of 103 oz. Suppose further that she expects silver to lose some 5 percent of its purchasing power within the following year. Then Mrs. Myers will ask for another 5 oz. (making the total future payment 108 oz.), so as to compensate her for the loss of purchasing power.

Now the question is whether (1) printing new money tickets will in fact decrease the real interest rate and (2) whether, if it does decrease the real interest rate, this will be an economic boon.

To answer the first question, we have to bring anticipations back into the picture. If the capitalists realize that new paper notes are being printed, they can expect a decline of the PPM and thus they will ask for a higher price premium. If the price premium is an exact compensation for the decline of the PPM, the real interest will be unaffected. In this case, the artificial increase of the money supply would entail merely a different distribution of capital among businessmen, and thus a different array of consumer goods being produced. Some businessmen and their customers will win, whereas other businessmen and their customers will lose. But there will be no overall improvement.

Now suppose that the capitalists overestimate the future decline of the PPM. In this case, the real interest rate would actually increase and many businessmen would be deprived of credit they could otherwise have obtained. Again, the consequence would be a different distribution of capital among businessmen, and thus a different array of consumer goods being produced. But there would be no overall improvement or deterioration.

Yet it is also possible that the capitalists underestimate the future decline of the PPM. This might be the case, in particular, when they are unaware of the fact that more paper notes are being printed. It is this scenario that the advocates of cheap money commonly have in mind. But the hope that tricking capitalists into accepting lower real interest rates entails more economic growth is entirely unfounded. It is true that in the case under consideration the real interest rate would decline under the impact of new paper money being offered on the credit market. It is also true that this event is likely to incite businessmen to borrow more money and to start more investment projects than they otherwise would have started. Yet it would be a grave error to infer that this is tantamount to enhanced economic growth. The case is exactly the reverse.

At any point of time, the available supplies of factors of production put a limit on the number of investment projects that can be successfully completed. What the artificial decrease of the real interest rate does is to increase the number of projects that are launched. But the total volume of investments that can be completed has not thereby increased, because this volume depends exclusively on the productive resources that are objectively available during the time needed for completion. The artificial decrease of the interest rate therefore lures the business community into all kinds of investments that cannot be completed. In terms of a biblical example, they could be said to start building all kinds of towers, only to discover after a while that they just had the resources to build the foundations, but not to finish the towers themselves (Luke 14:28–30). The labor and capital invested in the foundations are then lost, not only for the investor, but for the entire commonwealth. They could have been fruitfully invested in a smaller number of projects, but the artificial decrease of the interest rate prevented this. In short, economic growth is diminished below the level it could otherwise have reached.

To sum up, it is by no means sure that politically induced increases of the money supply will lead to a decrease of the interest rate below the level it would have reached in a free economy. The success of cheap-money policy is especially unlikely when the policy is not adopted on an ad-hoc basis, but turned into a guiding principle of economic policy. But the fundamental objection to this policy is that it is counterproductive even if it succeeds in decreasing the interest rate. The consequence would be more waste and thus less growth.

7. Monetary Stability

The second-most widespread monetary fallacy relates to the problem of monetary stability. The conviction that money should be an anchor of stability in the economic world is very old. But to understand this postulate in a proper way, it is necessary to distinguish two very different meanings of “monetary stability.”

The first meaning stresses the stability of the physical integrity of commodity money (in particular, the physical composition of coins made out of precious metals) through time. In this sense, monetary stability does have a precise meaning. From a purely formal point of view, it can therefore be a possible postulate of ethical monetary policy. It is a postulate relating to the production of money. No producer shall make coins bearing the same imprint but containing different quantities of precious metal. Monetary stability in this sense is not only unobjectionable, but truly a presupposition of a well-functioning economy. And it is this sense of monetary stability that was stressed in the Bible and in authoritative texts of the Middle Ages.^[20]

Notice that monetary stability in the sense of a stable physical integrity of commodity money results in a relatively stable “purchasing power” of the money unit (PPM). When mining is less profitable than other branches of industry—which tends to be the case when the price level is high—then less money will be produced and money prices will tend to decline. And when mining is more profitable—usually when the price level is low—then more money will be produced and money prices will therefore tend to rise. All of this is of no importance whatever for the benefits that can be derived from monetary exchanges. It is true that a great decrease of the PPM is conceivable when extremely rich and cost-efficient new mines are discovered. But notice two things. First, in a free economy, the market participants can very easily protect themselves against any unwanted eradication of the PPM by simply adopting other monies. Second, as a matter of fact, no such violent depreciations of the PPM have ever occurred in the case of precious metals. The famous “gold and silver inflation” of the sixteenth and seventeenth century increased Europe’s money stock according to certain estimates by not more than 50 percent^[21]; according to others by up to 500 percent.^[22] However, this happened over a period of some 150 years. Thus the average growth rate of the money supply lay somewhere between 0.3 and 3.3 percent per annum. By contrast, in our days of paper money, even the countries enjoying a “conservative” monetary policy experience far greater increases of the money supply. For example, in the U.S. and in the European Union, the stock of “base money” (paper notes plus accounts held at the central banks) has been increased by annual rates of between 5 and 10 percent during the past five years.

Now let us turn to the second meaning of monetary stability. It connotes the stability of the purchasing power of the money unit (the PPM). The first thinker to formulate the postulate of a stable PPM was Saint Thomas Aquinas in the thirteenth century. He argued:

The particular virtue of currency must be that when a man presents it he immediately receives what he needs. However, it is true that currency also suffers the same as other things, viz., that it does not always obtain for a man what he wants because it cannot always be equal or of the same value. Nevertheless it ought to be so established that it retains the same value more permanently than other things.^[23]

Notice that Saint Thomas realized perfectly well that a stable PPM was not a natural outcome of the market process. It was in his eyes an ethical postulate. However, no major writer before him believed that a stable PPM was a meaningful policy objective. Aristotle had observed that the prices of all things are in a continuous flux, and that money was no exception.^[24] And that was it. Even after Aquinas, most scholastics sided on this issue with the Greek philosopher rather than with Saint Thomas. To the extent that late scholastics such as Martín de Azpilcueta, Tomás de Mercado, Pedro de Valencia, and others stressed a postulate of monetary stability at all, they meant the stable physical composition of coins.^[25] Only starting from the seventeenth century, did secular writers from John Locke to David Ricardo to Irving Fisher come to endorse the postulate of a stable PPM. Today, this postulate lies at the heart of most contemporary writings on the problem of monetary stability. It is also a widely accepted definition among contemporary Catholic writers on monetary affairs.^[26] However, despite its popularity it is fraught with ambiguities and is liable to lead to wrong policy conclusions.

It is a matter of course that a stable PPM is “a major consideration in the orderly development of the entire economic system.”^[27] The question is merely how to balance this consideration with other considerations of a moral and economic nature. On the free market, as we have seen, there is a tendency for the selection of the best monies, including in terms of PPM stability. As long as the citizens are free to choose their money, they can avoid exposure to any violent fluctuations of the PPM by simply switching to other monies. The question, then, is whether the stabilization of the purchasing power of money is such an overriding goal that it would justify the establishment of government control over the money supply, in order to “fine-tune” the purchasing power to an extent that would not spontaneously result from the market process. The ideal of such fine tuning inspired a great intellectual movement in the early twentieth century. Under the leadership of the American economist Irving Fisher and others, this movement paved the way for the complete triumph of paper money.^[28]

In practice, the Fisherian stabilization movement was an abject failure. Throughout the entire twentieth century, in all countries, the purchasing power of money managed by public authorities declined and oscillated as never before in the entire history of monetary institutions. However, despite this rather devastating empirical record, one could hold that, in theory at least, the case for monetary stabilization is still valid and that it simply needs to be applied much better than in the past. In order to assess this contention it is necessary to examine whether, in principle at least, one can fine-tune the PPM, and whether such fine-tuning could possibly be warranted in the first place. To these questions we now turn.

First of all notice that the notion of “purchasing power of money” (PPM) cannot be given an impartial definition. The PPM is in fact the total array of things for which a unit of money can be exchanged. If the price of telephones increases while the price of cars drops, it is impossible to say by any impartial standard whether the PPM has increased or decreased. One can of course make up some algorithm that “weighs” the prices of cars and telephones and so on, and brings them under a common mathematical expression or index. But such indices are not some sort of constant measuring stick of economic value. For one thing, the constituents of the price index are in need of incessant adaptation (they need to be changed) to take account of the changes in the array of goods and services offered on the market in exchange for money. Moreover, and most importantly, no such index conveys generally valid information. Different persons buy different goods; therefore, some of them might experience a rise of prices (of the prices they have to pay) while others experience a drop of (their) prices in the very same period. The quantitative statement of the index reflects just an average of very different concrete situations. But it is concrete circumstances, not some average, that count for human decision-making.

We cannot do more here than scratch the surface of these technical problems.^[29] Our point is that, from a purely formal point of view, monetary stability in the sense of a stable PPM cannot be easily translated into a clear-cut political postulate. The very concept of PPM is fraught with ambiguities that can only be overcome by more or less arbitrary decisions of those charged to apply it. The political implications are momentous. The PPM criterion gives great and arbitrary powers to those charged with making up the algorithm.

Now let us assume for the sake of argument that these very considerable problems did not exist. Let us assume that monetary stability in the sense of a stable PPM could in fact be unequivocally defined. Then the question is: Would it be expedient to postulate a stable PPM? As we have said, this question is answered affirmatively by a great number of contemporary writers on monetary economics. The basic rationale is that one of the chief functions of money is to serve as a standard of value. Businessmen and others use money prices in their economic calculations, and to make these calculations as accurate as possible it is necessary to have a stable standard of value.

When is money a stable standard of value? Here we encounter a certain variety of opinions. For example, according to Locke and others, this was the case if the national money supply did not change. According to David Ricardo and others, it was the case if the money unit preserved its purchasing power. According to Hayek and others, it was the case if the total amount of money spending did not change.^[30] But it does not matter much which of the above definitions we adopt. The basic rationale for a stable standard of value is a spurious one in all cases.^[31]

The nature of business calculation is not to measure the absolute “value” of a firm’s assets, but to compare alternative courses of action. Suppose Jones has a capital of 1,000 ounces of gold and that he can use them to either set up a shoe factory or establish a bakery. He expects the shoe factory to yield 1,100 ounces or 10 percent gross return, and the bakery to yield 1,200 ounces or 20 percent gross return. This comparison is the essence of business calculation. Stability of the PPM does not at all come into play. Jones can calculate with equal success under a stable, a growing, or a declining PPM.^[32] His calculus can be exact when the national money supply increases, decreases, or remains frozen. And it can be exact irrespective of whether the total amount of money spending changes or remains the same as before.

In the light of these considerations, it appears that older writers such as Oresme were right all along to neglect the stable PPM criterion, and to keep their attention focused on monetary stability in the sense of the physical integrity of coinage.

8. The Costs of Commodity Money

One great disadvantage of natural monies such as gold and silver seems to be their relatively high cost of production. According to a widespread opinion that became popular through the writings of classical economists Adam Smith and David Ricardo, paper money could do the monetary job just as well, and at much lower production costs.

It is true that producing a 1-ounce silver coin, which we might call “one dollar,” entails much higher costs than producing a banknote that bears the same name. But it does not follow that this is necessarily a disadvantage. The natural costs that go in hand with producing gold and silver are in fact a supreme reason why these metals are better monies than paper. The fact that they are costly means that they cannot be multiplied at will; and this in turn means that commodity monies such as gold and silver feature a built-in natural insurance against an excessively depreciating purchasing power of money.^[33] In this crucial respect they are far superior to paper-money notes, which can be multiplied ad libitum and which, as universal experience shows, have been multiplied and are currently being multiplied in far greater proportions than gold and silver ever have.

Hence, the comparison between commodity monies and paper money should not be cast in too narrow terms. Relevant benefits do not just consist in some arbitrarily narrow “exchange service,” as we have just argued, but include things like guarantees against inflation. And the relevant costs are not just the cost of fabricating the different monetary objects, but total costs entailed by each system. Even the most ardent advocates of paper money have conceded that our current monetary regime is hardly a bargain. For example, consider that central banks and other monetary authorities have built up huge bureaucracies, and that the Fed-watching industry (people employed to interpret and forecast the policy of the monetary authorities) is similarly important.^[34] These two items alone add up to a significant payroll next to which the expenses for mining and minting look much less “costly” than the Ricardians portray. And notice the irony that mining and minting are still with us in the age of paper money!

There is of course nothing wrong with experimenting with cheaper alternatives to gold and silver coins. Nothing would preclude such experiments in a free society. All we can say is that in the past all such experiments have lamentably failed. And the advocates of paper money therefore hardly ever seriously considered establishing their pet scheme on a competitive basis. Ricardo and his followers advocate the coercive replacement of a more costly good by a cheaper one. Clearly, in all other spheres of life, we would reject any such proposal as extravagant and outrageous. We do not coerce all members of society into driving only the cheapest cars because they satisfy some arbitrarily conceived “transportation needs” at lowest cost. We do not impose rags and hovels on people who prefer clothes and houses. Neither is there a reason to impose paper money on those who prefer the monies of the ages.

Thus another standard justification for paper money does not hold water. And the same demonstration can be delivered for all other economic theories that purport to explain why it should be beneficial to suppress the natural commodity monies and to replace them with a political makeshift such as paper money. We could go into much length delivering these demonstrations. The point of the foregoing pages was to exemplify the general thesis that there is no utilitarian rationale for the institution of paper money, the money of our times. This thesis will serve as the starting point for the following discussion of the various abuses that can be made, and which unfortunately have been made, in the realm of the production of money.