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I.
Today's worldwide paper-, or
"fiat-," money regime is an economically and socially destructive
scheme — with far-reaching and seriously harmful economic and societal
consequences, effects that extend beyond what most people would imagine.
Fiat money is inflationary; it
benefits a few at the expense of many others; it causes boom-and-bust cycles;
it leads to overindebtedness; it corrupts society's
morals; and it will ultimately end in a depression on a grand scale.
All these insights, however, which
have been put forward by the scholars of the Austrian School of economics
years ago, hardly play any role among the efforts of mainstream economists,
central banks, politicians, or bureaucrats in identifying the root cause of
the current financial and economic crisis and, against this backdrop,
formulating proper remedies.
This should not come as a surprise,
though. For the (intentional or unintentional) purpose of policy makers and
their influential "experts" — who serve as opinion molders
— is to keep the fiat-money regime going, whatever it takes.
II.
The fiat-money regime essentially
rests on central banking — meaning that a government-sponsored central
bank holds the money-production monopoly — and fractional-reserve
banking, denoting banks issuing money created out of thin air, or ex
nihilo.
In The Mystery of
Banking, Murray N. Rothbard uncovers
the fiat-money regime — with central banking and fractional-reserve
banking — as a form of embezzlement, a scheme of thievery.[1]
Rothbard's conclusion
might need some explanation, given that mainstream economists consider the
concept of fiat money as an economically and politically desirable,
acceptable, and state-of-the-art institution.
An understanding of the nature and
consequences of a fiat-money regime must start with an appreciation of what
money actually is and what it does in a monetary exchange economy.
Money is the universally accepted
means of exchange. Ludwig von Mises
emphasized that money has just one function: the means-of-exchange function;
all other functions typically ascribed to money are simply subfunctions of money's exchange function.[2]
With money being the medium of
exchange, a rise in the money stock does not, and cannot, confer a social
benefit. All it does is reduce, and necessarily so, the purchasing power of a
money unit — compared to a situation in which the money stock had
remained unchanged.
What is more, an increase in the
money stock can never be "neutral." It will necessarily benefit
early receivers of the new money at the expense of the late receivers, or
those who do not receive anything of the new money stock — an insight
known as the "Cantillon effect."
Because a rise in the money stock
benefits the money producer most — as he obtains the newly
created money first — any rational individual would like to be the
among the money producers; or even better: to be the sole money producer.
Those who are willing to disrespect
the principles of the free market (that is, the unconditional respect of
private property) will want to obtain full control over money production
(that is, holding the money production monopoly).
Once people have been made to think
that the state (the territorial monopolist of ultimate decision making with
the right to tax) is a well-meaning and indispensible
agent, money production will sooner or later be monopolized by the state.
The (admittedly rather lengthy)
process through which government obtains the monopoly of money production has
been theoretically laid out by Rothbard in What Has
Government Done to Our Money?.[3]
Having obtained the monopoly of
money production, government will replace commodity money (in the form of,
say, gold and silver) with fiat money, and the regime of legalized
counterfeiting gets started.
Commercial banks will press for
fractional-reserve banking, meaning that they should be legally allowed to
issue new money (fiduciary media) through credit extension in excess
of the reserves they obtain from their clients. Fractional-reserve banking is
a rather attractive profit-making scheme for lenders; and it provides
government with cheap credit for financing its handouts (well) in excess of
regular tax receipts.
Fiat money will be injected through
bank-circulation credit: banks extend credit and issue new money
balances which are not backed by real savings. Economically speaking, this is
worse than counterfeiting money.
Fiat money is not only
inflationary, thereby causing all the economic and societal evils of eroding
the purchasing power of money and leading to a non-free-market related
redistribution of income and wealth among the people; banks' circulation
credit expansion also artificially lowers the market interest rate to below
the rate that would prevail had the credit and fiat-money supply not been
artificially lowered, thereby making debt financing unduly attractive,
especially for government.
It is the artificial lowering of
the market interest rate that also induces an artificial boom, which leads to
overconsumption and malinvestment, and which must
ultimately end in a bust. Mises put it
succinctly:
The boom
cannot continue indefinitely. There are two alternatives. Either the banks
continue the credit expansion without restriction and thus cause constantly
mounting price increases and an ever-growing orgy of speculation, which, as
in all other cases of unlimited inflation, ends in a "crack-up
boom" and in a collapse of the money and credit system. Or the banks
stop before this point is reached, voluntarily renounce further credit
expansion and thus bring about the crisis. The depression follows in both
instances.[4]
III.
A fiat-money regime depends
essentially on the demand for money. As long as people are willingly
holding fiat money (and fiat-money-denominated government, bank, and
corporate bonds, for that matter), the fiat-money regime can be run quite
smoothly, for then people raise their demand for fiat money as its supply
increases.
As a result, the rise in the money
stock does not show up in a change in overall prices of goods and services
(while it goes unnoticed that prices would have declined had there be no
fiat-money expansion).
If, however, people's demand for
fiat money declines relative to the supply of fiat money, the system gets
into trouble, for then a rise in the fiat-money supply will show up in price
increases — be it consumer or asset prices.
Rising prices, in turn, especially
when it comes to accelerating prices increases, bring fiat money's hitherto
rather subtle redistribution of income and wealth to the surface. Once people
start realizing that fiat money is inflationary, the demand for fiat money
starts declining.
If people expect ever-greater
increases in the fiat-money supply going forward (without any limit, so to
speak), the demand for fiat money falls (drastically) or even collapses
altogether. This is what triggers a crack-up boom, as Mises called it.[5]
People desperately exchange fiat
money against other vendible items, bidding up the money prices of goods and
services, thereby setting into motion a downward spiral, leading to
ever-greater losses of the purchasing power of fiat money.
In such an extreme scenario, fiat
money can actually become completely destroyed. This is what occurred in the 1923 German
hyperinflation, when government issued ever-greater amounts of
money, and eventually no one accepted the Reichsmark
as money any longer.
To keep the fiat-money regime
going, therefore, people must keep their confidence in the value of fiat
money. This, in turn, explains the critical role of government-sponsored
opinion molders in keeping the fiat-money regime going.
Especially in the field of monetary
economics, government-favoring economists take great effort to convince
people of the advantages of the fiat-money regime, painting the fiat-money
regime — and thus central banking and fractional-reserve banking
— in the brightest colors.
What is more, people must be made
to think that they benefit from fiat money, that there is actually no
alternative to a government-sponsored fiat-money regime,
and that abandoning fiat money and replacing it with commodity money would be
economically disastrous.
There is an additional and
no-less-important factor that works toward upholding the fiat-money regime.
It is what can rightly be termed as collective corruption[6]:
sooner or later an ever-greater number of people will develop a vital
interest in keeping the fiat-money regime going.
This is because a fiat-money regime
allows government to expand strongly, thereby corrupting an ever-greater
number of people: people seek (allegedly prestigious) jobs, generous
handouts, and business opportunities offered by government. People
increasingly team up with government, making their personal career and
business success dependent on an expanding government apparatus. And many
people even start investing their lifetime savings in fiat-denominated
"secure" government bonds.
As a result, sooner or later a
government default becomes a no-go. In times of crisis, the printing of
ever-greater amounts of money for shoring up government finances (and the
finances of government beneficiaries) will be cast as the policy of the least
evil.
To the great number of those who
have become dependent on the government apparatus, printing money to finance
government's empty coffers will be seen as preferable to letting financially
overstretched public sectors and banks go bankrupt.
The incentive structure provoked by
fiat money therefore works toward pushing the system beyond its limit. In
other words, fiat money will go through high inflation — even
hyperinflation — first before a depression unfolds.
A fiat-money regime cannot be
upheld indefinitely, though, because it erodes — via ever-greater
government interventionism — the very pillar on which the free market
system rests: private property.
Mises put it as
follows:
It would be a mistake to assume
that the modern organization of exchange is bound to continue to exist. It
carries within itself the germ of its own destruction; the development of the
fiduciary medium must necessarily lead to its breakdown.[7]
The erosion of the free-market
system, in turn, entails a decline of the economy's production capacity,
thereby making it increasingly impossible for debtors to service their
liabilities, thereby increasing the incentive for running the printing press.
As the Austrian economists have
shown, however, there is no escape from the disastrous economic consequences
caused by fiat money; high inflation, or hyperinflation, wouldn't do the
"trick." In fact, it would make ensuing depression even worse.
The sooner the fiat-money boom is
brought to a halt, the lower will be the costs of the ensuing depression
— a reasoning already expressed by the Prussian philosopher Immanuel
Kant (1724–1804), who noted in his Prolegomena (1783), "It
is never too late to become wise; but if the change comes late, there is
always more difficulty in starting a reform."[8]
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