In the late 19th century and early 20th, the issue which occupied center stage of economic controversy was “the money question.” From the time of the Civil War greenbacks through Bryan’s “Cross of Gold” speech of 1896 until the establishment of the Federal Reserve System in 1913, politicians, academics, editors, and business people squared off in a heated debate over the proper monetary policy for the nation.
After the dramatic events of the Great Depression and the creation of the post-war monetary system, the issue became relatively dormant as attention turned to other things. But recently, “the money question” has emerged in full force once again. Its resurrection has come, not coincidentally, as an aftershock of a financial earthquake of staggering proportions.
What has happened is that the monetary chickens have come home to roost. Decades of government-managed money have produced a frightening flirtation with runaway prices. The American dollar has lost at least 80 percent of its 1940 value. The bond market has suffered fantastic losses. The devastation of dollar-denominated assets—savings, life insurance, pension funds, and the like—in real terms is tremendous. Faith and confidence in the future purchasing power of the dollar are everywhere in question.
We have been witness to nothing less than the historic demonetization of fiat money. The damage this process has wrought may yet assign government paper to the status of “barbarous relic” which Keynes once mistakenly ascribed to gold. Who can’ honestly survey the wreckage and pronounce of the monetary authorities, “This is a job well done”?
It is in this unfortunate set of circumstances that proposals for “monetary reform” are proliferating. It is not the objective of this essay to propose yet another or to endorse any particular one already advanced. Rather, the objective is to illuminate the intellectual path which any meaningful reform must take. The author leaves it to others to chart the specifics.
To begin with, monetary reformers must come to grips with something fundamental to the origin and history of money. They must rediscover what the Austrian economist Carl Menger told us in his path-breaking Principles of Economics in 1871: “Money is not an invention of the state. It is not the product of a legislative act. Even the sanction of political authority is not necessary for its existence.”
Of Natural Origin
The origin of money was entirely natural. It sprang from the awkwardness of barter and the desire for a marketable commodity to facilitate exchange. The first time man traded a good for something which he intended to use not for consumption himself but rather as a means to acquire what he really wanted, a medium of exchange—money—was born.
It was a revolutionary invention-the economic counterpart to the wheel—and it made possible trade and a division of labor inconceivable in a barter economy. It was truly an invention of the marketplace, of economizing individuals seeking to improve their well-being.
All sorts of commodities have served as media of exchange at one time or another. Cattle, cowry shells, furs and skins, wampum beads, tobacco, whale’s teeth, cigarettes, and even rats are examples. Primitive though these monies may seem, they had the qualities of familiarity and acceptability which made them marketable and hence, candidates for money.
In most markets of the world, the precious metals emerged as the primary money commodities. Durability, divisibility, high value in small quantities, and relative stability in purchasing power over time were characteristics which no other commodities could match. As early as 650 B.C., coins of gold and silver became almost singularly synonymous with the term “money” in the trading world.
Paper arrived later on the monetary scene as a “money substitute.” It took the form of promissory notes which pledged real money in payment for goods. Issued by early banks, for instance, they were redeemable or convertible on demand into the precious metals they represented.
Inflation Involves Government Control over Money
Governments, afflicted with an insatiable appetite for revenue, have generated history’s inflations by first assuming control over money. Then gold coins became only partially gold or without gold at all. Paper notes, stripped of their “backing,” became “fiat”—their value tied to the whims of the inflating authority. Monetary history records no instance of a people voluntarily choosing in the marketplace to use unbacked fiat paper as their money!
The problem with so much of monetary economics today is that it does not fully comprehend the inescapable conclusion that money is a market phenomenon—that it originated in the market, that it evolved in the market, and that the market laws of supply and demand apply to money just as they do to any other commodity traded in the market. I submit that no monetary reform is likely to succeed if it treats money as the invention and exclusive domain of a political monopoly. The essential task of true monetary reform, then, is to find a way to divorce money from politics and make it as much a product of the market as possible.
In this vein, the many proposals which call for minor alterations of the government’s monetary function sound a little like rearranging the deck chairs on the Titanic. Simply putting a different crew in charge of the ship or experimenting with the compass is not radical enough. In this case, the market may be just the lifeboat we should be looking for.
The objection may be raised, “Without a central authority, how will anyone know what the supply of money should be?” Well, does anyone know what the supply of green beans should be? How many quarts of milk should be produced? How many size 36 undershorts there ought to be? How is it that the market is able to provide these things without central planners and in just the right amounts?
The answer, of course, is the market’s mechanism of price. When costs are low and the price is high, the signal to producers is, “Make more!” Producers know they should not pile up anymore when costs exceed price. Why shouldn’t money respond similarly?
When gold was money, this mechanism certainly did work reasonably well. As long as it was profitable to mine gold, producers did. “Too much gold” on the market caused the value of gold to fall and the cost of mining to rise—a double whammy that prevented producers from engaging in a continuous inflation. The supply of money, therefore, had something to do with the real market demand for money.
With today’s fiat money, the mechanism is short-circuited. Double-digit price inflation is the market’s way of signaling that there’s too much of the green stuff around, but the signal never directly strikes the producer. There’s no chance that he will go broke in the process of creating more than the market demands. For the inflator of fiat money, the incentives are perverse: he grows bigger the more he does the very thing he shouldn’t be doing!
It is no sure bet that the debate over monetary reform will deal fundamentally with this question of political versus market money. We have lived for so long with the former and its ruinous consequences that suggesting the radical alternative may be tantamount to the impossible task of teaching blind people what it would be like to see.
Once it was believed that witches, warlocks, and demons were the causes of such calamities as bad weather. Elaborate contrivances were devised to drive them away. When men learned that it wasn’t so, they looked for more natural, scientific explanations. Perhaps it is time to relegate to superstition the idea that government should manage money and get on to the task at hand—putting money back in the marketplace where it belongs.