The production of money

Let us suppose we have a society that uses Xasews as money. The entire stock of money is 100 billion Xasews.

What if it was only 10 billion? What about just 1 billion? Would this society be poorer? This would obviously not be the case, because what matters is how much wealth is created, not how much money there is. With only 10 billion Xasews all prices would simply be 1/10 of what they would be with 100 billion Xasews. Actually if we leave absurd scenarios out(like a society of 100 million people trying to use only 1 ounce of some metal to facilitate trade), we can even conclude that society can operate with any quantity of money.

Indeed, it is almost never the amount of money that is the topic of discussion. It is the changes in the amount of money that we consider important.
The current consensus is that the supply of money should grow over time. Several explanations have been given as to why this is so.

"The supply of money should grow to meet the needs of business."
There are several versions of this phrase, but the point is always the same. Somehow it is believed that since over time we produce more, have a larger population and obviously exchange more with each other, we need additional money. Simple demand/supply analysis shows us that this is completely false. The demand for money does indeed grow in this scenario, but there doesn't need to be an increase in supply to solve this "problem". All that needs to happen is for prices to fall(or to put it in another way; the objective exchange value of money needs to grow).

At this point the usual response is that we can't have that, because falling prices are bad for the economy. Why?

"Because it makes debts harder to repay, since their real value would rise."
First of all there is a creditor for every debtor, so it's not like wealth is dissipating. When debtors default assets simply change hands. This is nothing catastrophic. But even if it was, it doesn't apply to our example. Remember: we are talking about keeping the money supply stable. Creditors and potential debtors would know that the value of their debts would not fall over time, so they would negotiate a lower rate of interest!

A sudden and unexpected fall in prices is obviously another story, but I won't go into that here. Besides, even if that is harmful, it is not an argument against a stable money supply.

"Falling prices hurt profits."
Fortunately this argument is rarely used and only by non-economists. I remember a few years ago; I thought about this and it took me actual thinking to remember why this is false. Now I can't even recall why it seemed to make any sense to begin with.

Okay I'll try: A company invests X amount of money to produce something worth X+2. But let's say it takes 1 year to get the product on the market. Now after a year the price of the finished goods is no longer X+2, but X-1(since prices fell). We're losing money!

First of all it's quite weird to assume that the entrepreneur would be fooled like this. Second of all this is completely backwards.

We have to ask ourselves: why are prices falling? Because of greater productivity of course. Now who is responsible for this growth in productivity? It's the same entrepreneurs who supposedly suffer because of falling prices. So they are doing their best to shoot themselves in the feet? Obviously not. Prices fall because firms are able to lower costs through capital investment and innovation. The profit margin is not negatively affected, so this argument is complete nonsense.

Prices falling is not an independent phenomenon that firms would have to adapt to. Falling prices is how the market would adapt to what the firms are doing.

A real-life example could be the US during the 1880s, when the world was still largely on a gold standard. Prices fell 1-2% every year for over a decade, and it was one of the greatest economic booms in US history.

A few other arguments exist, but they fall under the category "theoretical macroeconomic nonsense", which is a subject I'll deal with in another post.

To put it bluntly; there simply is no economic reason for growing the money supply.

But the production of money isn't decided by the markets. It is decided by politicians, so we should look at the political reasons for money supply manipulation.

In my last post I showed how money emerged originally from the marketplace. This obviously meant that the production of money was done by private parties. For example in the late 1700s England had a great experiment with private mints. But when private minting went from copper coins to silver, it became clear that sooner or later they would start producing gold coins. The Royal Mint was not going to let that happen, and in the end the state monopolized the entire industry.

"Permit me to issue and control the money of the nation and I care not who makes its laws."
The state can tax, borrow and create money. This is how it funds its activities.

Let's suppose a society is ruled by a king and it has many different gold coins in circulation. These coins are being produced by private mints. One day the king decides to monopolize the minting of coins to "make things easier for business", to "standardize the coinage" and so on. All gold coins are to be given to the government mint to be melted and re-coined. 1 King Coin is defined as 1/10 of an ounce of gold. Of course this means the mint can now charge monopoly prices(in practice this means a new tax on the people).

One day the king decides to go to war. And a few days later he realizes he doesn't have enough money to pay his army. He can't raise taxes, because this would cause the population to revolt. On top of that he has borrowed all he can borrow. But he still has the mint. So to loot the population some more he secretly lowers the gold content of the coins. Now every new King Coin has only 1/15 of an ounce of gold(missing gold substituted with some other metal to keep it from being obvious).

The coins look exactly the same, but the population is actually being robbed. The government mint will at this point offer to melt and re-coin all worn-out coins for free. The king can also order everyone to turn in their coins for re-coinage to implement a new coin standard to "make them harder to counterfeit" and so on. For every new minted coin the king gets to keep some gold for himself.

More money doesn't make society richer, but it makes those richer who get to use the new money first. Those who receive the new money last obviously suffer the most from this transfer of wealth. In this case the king and the soldiers get to use the new money first; the rest of the population later. The king is taking advantage of the inflation tax.

Eventually people realize what's going on, they storm the castle and the king's head ends up decorating the pointy end of a farmer's pitchfork. People stop going to the government mint and also start treating the newer coins differently from the old ones. After all the gold contents are different.

The king's son(the new ruler) has a bunch of new coins at the mint, but people will now ask higher prices against those. The prince has a solution. He enacts a law that says that all coins are to be treated equally. New coins, old coins and worn-out coins are now of the same value before the law. Economically they are obviously not. The law artificially overvalues coins with less gold and undervalues the ones with more gold.

"Bad money drives out good"
Gresham's Law is more accurately actually "bad money drives out good under legal tender laws", and what the prince enacted was indeed a legal tender law. If you have crap and diamonds, but you are told that you can make payments with either, then it shouldn't be a surprise when diamonds disappear from circulation. Who would ever use diamonds to pay for anything?

Why not?
This is actually how it happened. Government monopolized money production to tax the people through deceit and coercion. Usually it did it to wage war. Even the often misquoted Gresham's Law turns out to be a consequence of legal tender laws.

It is said that the state must be in charge of money, because the private sector can't handle it. Yet the monopolization of money was never preceded by some market failure in money. The state simply took the industry over and the topic has been untouchable for some 100 years now.

The inflation tax is more popular than ever, so this story wasn't even really history. Unfortunately people no longer know what good money even is, so no one is pitchforking politicians Juan de Mariana -style.

You might be thinking: "Wait moment, is this guy suggesting we completely privatize the production of money?!?"
My answer: "Why not?"

How that could work in practice might be a topic for a later post, but for now I'll leave it here. Hmmm... this ended up being much more radical than expected.

Books to read on the subject:
-What Has Government Done To Our Money? by Murray Rothbard
-The Theory of Money and Credit by Ludwig von Mises
-The Ethics of Money Production by Jörg Guido Hulsmann

Juan de Mariana: http://mises.org/daily/3937

Some thoughts on money

I gave a small presentation on money at school, so I thought I'd write down some of the thoughts I have on this subject.

Most people don't really think about the origins of money. Money is just euros, dollars, pounds and such. It's coins, pieces of paper and ones and zeros on a computer in a bank and it is all created by wise men and women at a central bank.

Money was not, however, invented in a bureaucratic department by the state. It came from the marketplace.

A long, long time ago when we still had direct exchange(i.e. barter), someone figured out that it was wise for him to trade his goods for some other goods not because he wanted to consume them, but because he knew he could later trade them for something else that he wanted to consume. This is what money is: a common medium of exchange. Something that makes indirect exchange possible.

The way this happened implies that money had to have some non-monetary value before it could become a common medium of exchange. If I simply put my picture on a piece of paper, named this new money "Xasew" and tried to trade 5 Xasews for a bottle of coke, it obviously wouldn't work. How could the person I was trading with trust me when I told him it was a fair deal(or how could it be even known by me if it was a fair deal)? More importantly, how could this person go and trade these Xasews for something else later on? He would have no way of knowing what he could get with it! Even if the originator of money was trust-worthy, a good of no non-monetary value could not have originally emerged as money, because its price in terms of other goods would be unknown to market participants.

Obviously if a certain good is chosen as money by the community and this money over time loses all of its other functions except that of being a common medium of exchange, then there is no problem. The value of this money in terms of other goods has had time to establish itself, which means a money can continue as money even when it has no other uses.

Some features have been especially demanded in money. It must be marketable, easily divisible, it should have a high value-per-unit, it should be durable, homogeneous and easily recognizable. Over time the market process weeds out the less suitable moneys, until only a few or only one remains. History tells us that when people get to choose, they tend to prefer two commodities especially: Gold and silver.

Until 1971 most currencies were tied(although loosely) to gold. This is no longer the case, but a point must be made here: The current paper money system we use could not have come into existence had it not been for the original link to gold. Small pieces of paper probably have some uses, but other than that our current paper moneys operate only because of their monetary value. If that monetary value is lost(i.e. hyperinflation) then those pieces of paper are gone forever. On the other hand gold and silver, goods no longer serving as media of exchange, still have value and could become money again at any time.

Ok I'm gonna stop here. I guess the point here was that money is not a creature of the law, nor a creature of the state. It is a creature born of spontanious order.

Books to read on the subject:
-What Has Government Done To Our Money? by Murray Rothbard
-The Theory of Money and Credit by Ludwig von Mises