Chapter 4: Utilitarian Considerations on the Production of Money
Having described the workings of a commodity money on a free market, and its ethics; Hülsmann takes up some of the utilitarian arguments against commodity money and in favor of paper money that have been suggested by many writers.The main ethical consideration against paper money is this:
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.
But the utilitarian arguments must also be addressed, to see whether there are “advantages that might compensate for [paper money schemes'] severe moral shortcomings.” It is interesting that before the time that paper money came into existence, no philosopher of money ever criticized commodity monies on utilitarian grounds. But as paper money became to be used, apologies for its use began to appear, as did the rejoinders to these writings. There are centuries worth of these writings, and it would take many books to fully address all relevant fallacies.
In lieu of a full exposition, Hülsmann briefly demolishes 7 common false doctrines that purport to explain the deficiencies of commodity money and advantages of paper money.
Economic Growth. Some claim that economic growth is possible only to the extent that the money supply grows. This is incorrect, since any quantity of goods can be exchanged with virtually any quantity of money.
Hoarding. Unlike other authors, Hülsmann concedes that there is indeed a moral category of “hoarding” which can be distinguished from merely “holding” money. Hoarding is a pathological behavior which harms the hoarder, and must be dealt with by persuasion. But neither holding nor hoarding have negative consequences on society at large, for increases in the amount of money held merely changes the demand for money, causing a rise in the purchasing power of money. Hülsmann does not point out the virtues of this as Rothbard does, but explains that even in the extreme case of mass holding, market participants can switch to another money.
Fighting deflation. The supposedly harmful character of deflation is a modern sacred dogma vociferously propounded by Federal Reserve Chairmen and Governors. The core claim is that a drop in the purchasing power of money will cause consumers to wait and wait, withholding their spending and thereby causing a decrease in economic activity, which will then spiral into a depression. Hülsmann points out that there are two constraints to countervail this tendency. The first is the “constraint of the stomach” — that households must eat, and pursue entertainment, and service their cars to go to work, etc. The second is the time preference of individuals: at some point, a consumer is willing to buy, say, a plasma TV now at a higher price than in 3 months at a lower price, so that he can enjoy the good during the 3 months that he would’ve waited.
Another argument: if the purchasing power of money drops, especially unexpectedly, widespread bankruptcy might result. This would be especially true for those who carry debt. This is bad from the point of view of those who go bankrupt, but is it bad for society at large? After all, the factors of production are not destroyed. They merely change hands, and can be once again profitably employed. Hülsmann states, “The net impact on production is likely to be zero.” Now, I am not initially persuaded by this, since it is clear that bankruptcies and business interruptions have real costs; but Hülsmann provides some insight about where his text is going that points us in an interesting direction:
Deflation certainly has much disruptive potential. However…it 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.
This is a very important point, I think. And not just because I value thrift.
Sticky Prices. As Keynes famously argued, if labor unions, with their government-granted privileges, succeed in forcing and keeping nominal wage rates up, and these wage rates cause institutional unemployment, then central bankers should be able to return the workers to full employment by expanding the money supply, driving the purchasing power of money down making the union-set wage rates once again market wage rates at which entrepreneurs can make money. But, as Hülsmann points out, this argument rests on a very dubious proposition: “that the managers of the printing press can again and again surprise the labor-union leaders”. Nonetheless, this has been the policy of many central banks for many years. The outcome?
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.
Cheap Money. Related to the first fallacy above, some have claimed that if cheap credit were liberally offered (in the form of paper money), then entrepreneurs would have the chance to start many worthwhile endeavors, and this would result in economic growth that is faster than otherwise could be obtained. But this is clearly false. The available factors of production — real things — are the true limit to economic growth, and all that the artificial explosion of paper money accomplishes is an increase in the number of entrepreneurial projects launched, and therefore a decrease in the percentage of entrepreneurial projects that can be successfully completed.
The use of cheap money puts the entire economy in the same position as the man who did not properly plan for his tower. The discussion in this section reminded me of the great powerpoint presentations on this topic by Roger Garrison.
Monetary Stability. There are two ways that “monetary stability” could be defined. The first way stresses the stability of the physical integrity of a commodity money (weight, fineness, etc.). The second way suggests that money be a “standard of value”.
The “standard of value” is not necessary for the entrepreneur. As long as he anticipates changes in the purchasing power of money, he will be well positioned to make a profit and economically calculate to compare different projects.
But even if the need were conceded, it is clear that paper money is no stable money. While Europe was using commodity money, the famous gold and silver inflation that occurred over a period of ~150 years resulted in ~0.3-3 percent inflation per annum. Compare this to the “conservative” monetary policies of the US and the European Union in just the last 5 years, which have varied between 5 and 10 percent per annum!
The Costs of Commodity Money. A claim by the advocates of paper money has been that the exchange services of money could be had at a much lower cost to society by using paper money, obviating the expenses of mining and minting. But this claim misses much. Firstly, the commodity underlying the commodity money is a built-in insurance policy that keeps the money from becoming worthless. I’m sure Zimbabweans wish their money had been gold, for now they are resorting directly to the panning of gold just for bread.
But paper money, too, has its costs, as we know from the Federal Reserve bureaucracy, numbering ~23,000 in 2004. And, of course, the entire Fed-watching industry that has arisen to interpret and forecast the actions of the Fed must also be considered a cost.
Not only all this, but Hülsmann points out that the industries of mining and minting are still with us, though paper money has been embraced by virtually all governments in the world. To put the last nails in the coffin of this fallacy, Hülsmann makes these brilliant points:
There is of course nothing wrong with experimenting with cheaper alternatives to gold and silver coins…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…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.
This now puts us at the end of Part 1 of Hülsmann’s book, having covered The Natural Production of Money. Part 2 on Inflation has much more to say. I am so happy to have bought this book. As a commenter has remarked, this book may be a bit advanced for those who have not yet read much in economics and ethics. A good sequence for reading may be:
The Ethics of Money Production (the book being live-blogged here)