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Wednesday, June 1, 2011

What’s So Funny About Peace, Love, and a Free Market in Money?

Ask any economist about whether he believes free trade is a good thing and the answer is almost always yes. No really, economists universally view exchange as mutually beneficial. Yes, sometimes we regret our purchases after the fact but universally, no matter what their positions are on other things, we believe free trade to be a net gain to society.

And what is one half of almost every exchange? Money. Based solely on this fact, it is easy to see the importance money play in any economy. Without money how could an exchange take place? Well, barter is an option but this sort of a direct exchange is extremely difficult.

If we produced everything ourselves, and did not exchange, then life would be more than tough. Many of the luxuries we enjoy would simply not be possible. In order to achieve the advanced material production, we have become accustomed that we need to engage in specialization and the division of labor. But under the division of labor, barter requires the double coincidence of wants. One must hope that the person who produces what they want will also want what they produce. Due to this problem, as Carl Menger explained, money, or a medium of exchange emerged. Now one accepts money not as an end in itself, but as a means of acquiring what one truly wants. You accept money because you know others will similarly accept it.

What this really tells us is that money was not created by the state. No central authority was needed to create it. It was an emergent spontaneous order; a result of human action, but not of human design. But something funny happened along the way. Trust in the ability of the market to provide money seems to have disappeared. The common view now seems to be that the state needs to hold the monopoly on the production of our currency.

Yet, we constantly face troubles with our monetary system. Many economists have attempted to solve these problems but even then kept the power solely in the hands of the state. Even Milton Friedman, for example, believed in favoring rules over discretion within the government monopoly over money. So, free trade is good, but only if a central authority can create and maintain our currency?

F.A. Hayek in the late 70s, “suggested a radical cure, – i.e., taking away the government monopoly of issuing money, and handing the task to private industry –partly as a bitter joke.” Hayek’s position on money shifted throughout his career but by 1975, the more he thought about it, his position went from a ‘bitter joke’ to completely supporting privatization of the money supply, as he explains in this 1977 Wall Street Journal article.

It is hard to see what is so “funny” about private money. After all, money was originally created and provided this way. Even in our more complex modern financial systems, private banks, not the state, originally provided bank notes, which are technically what our Federal Reserve notes are. And this system of free banking worked extremely well, as economist Lawrence White pointed out.

The state has a lot to gain through the monopoly profits earned with its control over money supply, but on the flip side we, as individuals, have a lot to lose. Maybe the real joke is with our current system, which is sad because the joke is on us.

Download The 1977 Wall Street Journal article Toward Free Market Money by F.A. Hayek here.

  • Nicholas Snow is a Visiting Assistant Professor at Kenyon College in the Department of Economics, and previously a Senior Lecturer at The Ohio State University Economics Department. His research focuses on the political economy of prohibition.