Legalized Falsifications

1. Legalizing Debasement and Fractional Reserves

Above we have discussed how inflation can be created independent of government, namely, through the “private” falsification of money certificates. Such inflation, albeit widespread, is negligible from a quantitative point of view when compared to fiat inflation. The reason, as we have argued above, is that there are powerful forces at work to contain private falsification within fairly narrow limits. First, falsifying money certificates is a tort, and counterfeiting (intentional falsification) is a criminal activity punishable by law. Second, once a falsification has been discovered, the market participants are likely to abandon the use of the false certificates and begin to use other ones. Third, in the worst of all cases, the market participants can demand payments in bullion and verify the fine content of metal by themselves.

The legalization of false certificates removes the first of these three limitations. “Legalization” can mean that the government declares a debased coin—or a fractional-reserve banknote—to be a means of payment that every creditor is legally obliged to accept at par; we will deal with this case in some detail.

But the legalization of false certificates can also come in a more elementary form, namely, when the government becomes agnostic about the language of the country and thus refuses to enforce the laws. For example, it might adopt the point of view that the expression “one ounce of gold” is really just a string of letters that can be given just about any contractually binding meaning. It would follow that a mint can legally issue coins that feature the imprint “one ounce of gold,” but which in fact contain just half an ounce, or no gold at all. The government could also adopt such an agnostic point of view vis-à-vis banknotes; or at least it could use ambiguous imprints such as the famous “promise to pay.”^[1] All such policies legalize false money certificates, if not in intention, then at least in fact. The present chapter deals with such cases.

First of all, let us observe that the government’s agnosticism in these matters has in all known cases been rather self-serving. The legalization of false certificates usually occurred after the government itself had already debased the currency or because it planned to debase it, or because it sought to obtain credit from fractional-reserve banks. The result is always the same: counterfeiting henceforth goes unpunished, and thus the material incentives of counterfeiting develop a greater inflationary potential.

However, as we have noticed above, on an otherwise free market such policies very quickly lead to some sort of a correction through the remaining liberty of action. The citizens, cautious of the widespread falsifications and weary of the constant inflation under their laws, would start using money certificates that are produced abroad. Rather than using, say, the “coronas” produced by their own prince, they might start using the “ducats” of the neighboring country, where the falsification of certificates is still a legal offense. In short, laws that legalize false money create more inflation than would otherwise have existed; but per se they do not open the floodgates. However harmful and morally offensive such legislation might be, it cannot create large-scale fiat inflation.

Quite to the contrary, we should rather expect such legislation to have some deflationary effect. The reason is that the production of debased coins, even though it is now legal, takes time. It is impossible for the government (or for that matter, for any other private agency) to replace the entire existing stock of coins in one stroke. It follows that the gradual introduction of the new debased coins makes the supply of these coins heterogeneous. Old sound coins circulate side by side with new debased coins. When the market participants realize what is happening, they will spend much more time distinguishing between old and new coins; or they might just as well hoard the old coins, or sell them abroad, and use only new coins for payments. But this means a more or less drastic reduction of the coin supply available for exchanges—fiat deflation. Again, this effect is likely to be dampened through the remaining liberty of action. As long as the competitive production of money certificates is still possible, the fiat deflation can be contained within fairly narrow limits.

One thing is sure, however: The legalization of false certificates permanently increases the risk of being cheated in monetary exchanges. Nicholas Oresme wrote: “And so there is no certainty in a thing in which certainty is of the highest importance, but rather uncertain and disordered confusion, to the prince’s reproach.”^[2] Substitute the word government for the word prince, and we have an accurate description of the fact.^[3] Oresme also noted that official debasement would invite foreign counterfeiters to seize the opportunity presented by the general confusion over the debased coinage “and thus rob the king of the profit which he thinks he is making.”^[4]

2. The Ethics of Legalizing Falsification

We have emphasized that the legalization of false money certificates, though harmful, is virtually insignificant from a quantitative point of view, at least in comparison to the inflationary impact of legal monopolies and legal tender laws. Nevertheless this privilege is fundamental because it is the foundation of all other monetary privileges. It would seem impossible, for example, to establish legal tender laws in favor of some debased coin, or of some fractional-reserve banknote, if the latter are per se illegal. And thus it follows that the moral case for all other monetary privileges depends on the morality of legalized falsifications.

Nicholas Oresme described the moral character of this practice in no uncertain terms. It was for him a matter of course that imprints on a coin should be truthful (according to the Ninth Commandment). To provide a justification for the practice of falsifying money certificates was impossible. The government could claim no exception. Quite to the contrary, Oresme thought that the falsification of money certificates was particularly offensive in this case. He said:

… it is exceedingly detestable and disgraceful in a prince to commit fraud, to debase his money, to call what is not gold, gold, and what is not a pound, a pound, and so forth. …Besides, it is his duty to condemn false coiners. How can he blush deep enough, if that be found in him which in another he ought to punish by a disgraceful death?^[5]

As a confessor of the powerful, Oresme knew only too well the temptation of inflation. He therefore did not limit his admonition to the case of falsification, but condemned any alteration of existing monies whatsoever. More precisely, Oresme charged that the government should never alter money, because the legitimacy of the alteration of money made a tyrannous government perfect. To be licit, alterations of coins needed the consent of the entire community of money users, and even in this case consent would not automatically provide legitimacy to the policy (for example, he argued that money should never be debased for regular revenue purposes). Only if the alteration provided the only means to deal with an emergency situation, such as a sudden attack by an overwhelming enemy, could it be licit, provided it had the consent of the entire community. Oresme also observed that the pope will never grant the privilege of altering money; and that, even if it were granted as an exception, it could always be revoked.^[6]