Enters the State: Fiat Inflation through Legal Privileges

1. Treacherous Clerks

It is well known that the history of institutions cannot be adequately understood without considering the economic constraints and incentives of the protagonists. This holds true especially in the case of monetary institutions. The emergence of our present-day institutions in this field—central banks, paper money, and so on—must be seen in the context of government finance. Governments at nearly all times and places have been the main beneficiaries of inflation. Rather than protecting society from it, therefore, all of them have sooner or later given in to the temptation of using inflation for their own purposes. First they stopped combating it. Then they facilitated it, encouraged it, and finally promoted it with all their powers. They have obstructed and suppressed the production of money on the free market, set up institutions that were designed for perennial inflation, and constantly remodeled these institutions to increase their inflationary potential.^[1] In all such cases, in which governments create inflation or increase it beyond the level it would otherwise have reached, there is fiat inflation.

Governments inflate the money supply because they gain revenue from inflation. As we have pointed out, additional money benefits the first owners at the expense of all other money owners. Therefore, if government or its agents are the ones who bring about the extension of the money supply, they stand ready to gain from it, and they gain at the expense of the other citizens. In the fourteenth century, Nicholas Oresme argued that this fact was at the root of the frequent monetary interventions of the princes:

I am of the opinion that the main and final cause why the prince pretends to the power of altering the coinage is the profit or gain which he can get from it; it would otherwise be vain to make so many and so great changes. …Besides, the amount of the prince’s profit is necessarily that of the community’s loss.^[2]

The times have changed and the techniques of inflation have changed with them. But governments still intervene in the production of money and money certificates in order to obtain additional income. The difference between our time and the age of Oresme is that present-day governments have received absolution from the scientific authorities of our day. Many princes blushed when they were caught debasing the currency of the country. But modern presidents, prime ministers, and chancellors can keep a straight face and justify inflation with the alleged need to stabilize the price level and to finance growth. All the recognized experts say so.^[3] And it betrays a lack of courtesy to point out that “recognition” of an expert means that he is on the government’s payroll.

Inflation can certainly also exist in a hypothetical society in which the government does not in the slightest way interfere with the production of money. The crucial point is that in such a case there are no legitimized institutions of inflation. Being a criminal activity, inflation has to flee the light of day and lingers only at the edges of such a society. As long as the citizens are free to produce and use the best money available, therefore, sound money prevails, whereas debased money and fractional reserves lead a fringe existence. Inflation can then cause occasional harm for individuals, but it cannot spread far and last long. Only the government has the power to make inflation a widespread, large-scale, and permanent phenomenon, because only the government has the power to systematically prevent the citizens from spontaneously adopting the best possible monies and money certificates. Unfortunately, as we shall see, this is exactly what governments have done in the past. The resulting damage has been immense, not only in terms of material wealth, but also in terms of the moral and spiritual development of the western world. We will therefore analyze the inflation that springs from government fiat in some detail.

Notice at present that the gain that the government and its allies derive from fiat inflation can most adequately be called “institutional usury,” as Dempsey has pointed out.

2. Fiat Money and Fiat Money Certificates

According to a widely held opinion, government has the power to impose money on its citizens. This is of course the premise of the so-called state theory of money, which we have criticized above, and according to which money is by its very nature fiat money—a creation of the state. As we have argued, the state theory of money is untenable on grounds of both theoretical reasons and historical experience.

But the scope of fiat money has also been explained in a more realistic version. These advocates do not claim that all kinds of money need the backing of the state. They merely contend that, in some cases, the power of the official apparatus of compulsion and coercion can establish money. In other words, there is here no dispute of the fact that free enterprise can produce natural monies. The point is that governments too can produce money, not by becoming entrepreneurs, but by forcing the citizens to use some money of the government’s choice.

This version is correct, provided one does not subscribe to an exaggerated notion of what “forcing” and “imposing” means. The government cannot for example bring its citizens to abandon their traditional monies and to replace them henceforth with armchairs or with stones that weigh three tons each. Neither can it bring its citizens to use a paper money that loses 90 percent of its value per hour. Such a policy, even if it were pursued with utmost determination, would not establish money of the government’s liking; it would merely destroy the entire network of indirect exchanges. Rather than using the inadequate money, the citizens would refuse to exchange at all. The result would be misery and death for millions, as well as chaos and overthrow of the government.

Similarly, the government cannot just print paper tickets and command their citizens to use them. As we have seen, a new kind of money can only be introduced into the market if it has some known value that exists prior to its monetary use. The government therefore has to somehow connect its paper money to the existing price system. So far, two ways of doing this have been tried out. One, the government can issue paper tickets that bear the same names as the units of the already existing monies, and oblige all citizens through legal tender laws to accept the paper as if it were natural money. This was how the American Union government introduced “greenbacks” in 1862.^[4] Two, the government can grant legal privileges to some of the already existing monies or money certificates, and thereby turn them into fiat monies and fiat money certificates.

3. Fiat Inflation and Fiat Deflation

Privileged monies and certificates have a wider circulation than they would have attained on the free market. They are therefore inherently inflationary. Notice however that fiat inflation is not just any inflation initiated by a government. When governments secretly counterfeit money certificates, as they have often done in the Middle Ages, they do not create fiat inflation. Rather in these cases they are “private” counterfeiters just as any other counterfeiter outside of government. The characteristic feature of fiat inflation is that it is done openly and legally. As we shall see, however, official approval does not diminish the pernicious effects of inflation; and it is far from removing its ethical offensiveness.

The reverse side of the increased circulation of the privileged coins and banknotes is a decreased circulation of alternative media of exchange. The very meaning of monetary privilege is that it creates a competitive disadvantage for the monies and money certificates that would have been used if the privilege had not been established. Thus the fiat inflation of privileged coins and banknotes always and everywhere goes hand in hand with a fiat deflation of the other monies and money certificates.

The legal privileges that governments use to create fiat money and fiat money certificates fall into four large groups: legalized falsifications, legal monopolies, legal tender laws, and legalized suspensions of payments. Usually these privileges are not granted in separation from one another, but in some combination; for example, the late nineteenth century notes of the Bank of England were legal tender and had a monopoly. Still it is true that theoretically those four privileges could be granted independent of one another. For the sake of analytical clarity, we will therefore do both: study the independent impact of each of them, and discuss how they combine with one another. This will be our subject in the next four chapters. We will then conclude our analysis of inflation with a chapter on paper money, which has come into existence as a consequence of those four privileges, and another chapter on the cultural and spiritual consequences of fiat inflation.