True freedom

"Freedom means that in some measure we entrust our fate to forces we do not control; and this seems intolerable to those positivist / rationalist who believe that men can master his fate; as if civilization and reason itself were the fate of his making"
F.A. Hayek

Monday, July 30, 2012

Adam Smith, the Professor from Kirkcaldy Part I

Adam Smith, the Professor from Kirkcaldy Part I
The Theory of Moral Sentiments, Moral Society and the Impartial Spectator 
Author: Pablo Paniagua
Editor: Victoria Finn

“Smith sought to do for moral philosophy what Isaac Newton had done for natural philosophy: to imagine and represent those invisible connecting principles that determine the course of nature. Newton's natural philosophical realm encompassed all in nature that envelopes humankind. Smith's moral philosophical realm was humankind.”
Jerry Evensky

Government authority emerges to establish order in society, but government is neither the original source of order nor the locus of control that establishes order in the ideal state. Order begins and ends with the individual citizen. In the beginning, a rude order is established by retribution based on a self-defined sense of justice. In the end, in the limit, a refined order is established by common acceptance of social norms, civic ethics, among citizens with self-command, the self-government, to enforce those norms about them-selves. Between this beginning and this end, in the course of humankind’s evolution from the rude state towards the ideal, the internal and external systems of governance-norms and positive laws respectively-share one another as systems of justice evolve.”
Jerry Evensky

Ambition, avarice, self-love, vanity, friendship, generosity, public spirit;
these passions mixed in various degrees, and distributed through society, have been from the beginning of the world and still are the source of all actions and enterprise which have ever been observed among”.
Adam Smith

Adam Smith, an enlightened life in the right place: Scotland:

Probably today in the Western World and also in several ex-Communist countries, everyone has heard about Adam Smith. The Scottish professor of Moral Philosophy is probably among the most cited, known and mentioned Economists in the world. However Adam Smith is also probably one of the least read and one of the most misrepresented, misunderstood and controversial figures in economic history. The misconceptions and controversy surrounding him are due to several poor one-sided interpretations of his work, attributed mostly to a narrow analysis of his political economic publication “An Inquiry into the Nature and Causes of the Wealth of Nations (WN). In order to better understand Adam Smith’s economic-social holistic framework and his final scope as an author, one must first understand his lesser known first book, “The Theory of Moral Sentiments (TMS). In this essay I will try to address Smith’s comprehensive view of society, the evolution of consciousness and human behavior through my interpretation of the TMS, mostly using the work of more recent scholars who have contributed to better understanding Smith’s Moral Theory; their novel analyses have situated Adam Smith in a higher and more humanitarian position, far beyond what had been imaginable three decades ago.
Adam Smith (June 5, 1723 – July 17, 1790), was born in the former small port named Kirkcaldy, in Fife, in northern Edinburgh. Surprisingly he did not study at the University of Edinburgh; his family instead decided to send him to Glasgow University. At the time Scotland was one of the most economical, enlightened and vigorous countries in the Western World; it had one of the highest literacy rates among Europeans countries and boasted 4 of the best universities in the world: Edinburgh, Glasgow, St. Andrews and Aberdeen. Meanwhile England had only 2 top universities: Oxford and Cambridge.
Smith’s Scotland was, fortunately for him, the place to be intellectually enlightened. The Acts of Union finalized in 1707 united England and Scotland under a single monarchy and parliament, creating an economic and trading integration between them. This union established a very important trade and commerce network in Northern Europe in the beginning of the XVIII Century. That permitted the Scottish and English to peacefully trade and export manufactured products to the rest of Europe. By the 1740s Glasgow and other Scottish ports were growing thanks to this trade union pact. Glasgow became the biggest transit port in which imported raw materials from America were packaged and manufactured then re-exported, principally to England and to a lesser degree to some other continental European countries.

Scotland was a very nurturing and fruitful place in the XVIII century. Glasgow was economically booming and intellectual and religious freedoms were rapidly expanding, the middle class was consistently growing in measure and wealth. Increased trade, cultural and intellectual effervescence formed the fertile soil for the Scottish Enlightenment to prosper; names like Francis Hutcheson (Irish) and David Hume were soon to appear in the intellectual spectrum. Hutcheson was a professor of Moral Philosophy at Glasgow University from 1730 to 1746, profoundly influencing and mentoring Adam Smith. Professor Hutcheson felt the necessity of creating a moral system which did not require relying on a deity or god as a source of superior moral entity and human self-control. He wanted establish a social moral framework that could be placed outside the religious orthodox system. David Hume following Hutcheson and added the reasoning skepticism to this moral system; finally Adam Smith followed and complemented what Hutcheson and Hume had started.     

After completing his degree in culturally booming Glasgow, Adam Smith moved to study at Oxford for six years, where (according to Smith) the educational quality was “deplorable”. Smith returned to Edinburgh in 1748 to give private lectures on ‘rhetoric and belles-lettres’, government and the history of science. He moved back to Glasgow as a professor of Logic in 1751 then the following year he took Hutcheson’s old chair of Moral Philosophy; during this appointment, he published his first book (the TMS) in 1759 at 36 years old. He resigned in 1764 when he had the opportunity to accompany a young aristocrat, the Duke of Buccleuch, to France where he met Voltaire, Quesnay and Turgot; he stayed in France until 1766. After this adventure, Smith spent the rest of his life moving between Kirkcaldy and Edinburgh. In 1776 he published the WN. At the end of his career, Smith was appointed as a Commissioner of Customs for Scotland. In 1787 he succeeded his friend Edmund Burke as Lord Rector of Glasgow University, where he diligently served for the rest of his life.

During his lifetime, Smith was mostly famous for the TMS rather than the WN. Unfortunately in the following centuries, specifically ever since the XIX Century, the TMS gradually fell into intellectual eclipse, creating solely a one-sided interpretation of his work. He was thereafter exclusively analyzed through the lens of his WN work in Political Economy rather than in a more aggregate perspective. This incomplete and predisposed analysis of Adam Smith was carried all the way through the XIX and the XX centuries, unfortunately bringing negative results in understanding his holistic system of necessary social institutions for a prosperous society. Smith was side-by-side with Hutcheson and Hume as the pioneers of human impartiality applied to Moral Ethics, but was surprisingly ignored in both Philosophy and Ethics. In addition, one of the biggest mistakes in understanding Smith’s philosophy was that most people interested in his work were chiefly economists. They mainly studied, read or quoted only the WN, creating a sort of philosophic dichotomy and disjunction of Smith’s dual works, generating a misinterpretation of the WN as well as its role within the bigger system. If the WN had been analyzed and read without acknowledging the first social moral framework already developed in the TMS, then the interpretation of WN would have been very limited and distorted, missing what Smith intended to convey through both books. As Amartya Sen wrote in his introduction in a later TMS version:

“The typical understanding of the WN has been constrained to the detriment of economics as a separate subject. The neglect applies, among other issues, to the appreciation of the demands of rationality, the need for recognizing the plurality of human motivations, the deep connection between social ethics and economics, and the co-dependent rather than free-standing role of institutions in general free markets in particular towards the functioning of the economy.”

Here Amartya Sen shed light on what Adam Smith really intended with his lifetime work. Smith had aimed at a bigger picture, trying also with a third publication on jurisprudence that he did not finish. He attempted to develop a coherent holistic social system with 3 fundamental spheres of human social interaction that reinforce each other and found a wealthy and stable society. According to Smith, these important spheres were: social traditions and moral rules, the organic institution of justice and common law and the self-interested actions of trade in the free-market process. If they could have understood his books as coherent parts of a larger, natural social evolutionary system, then they would have emerged as completely complementary; they show a very articulated system to understanding human social life in its entirety. Understanding the TMS and its deep philosophical relationship with the WN helps to better understand our human social interactions and the deep relationship between our moral social frameworks and the wealth of our nations. If Smith’s social system had been seen as a 3-legged chair which each leg reinforces the others in order to stand, his works would never have been considered disassociated with each other, nor considered Smith a “laissez-faire”, individualistic, or narrow-minded advocator. 

Even though to us this system appears quite complementary, there is extensive literature regarding this apparent dichotomy between his two books, extensively misrepresented in the so called “Adam Smith Problem”. This is the whimsical belief that there is a substantial inconsistence between the moral system presented in the TMS (linked predominantly with sympathy and benevolence) and the opposing one exposed in the WN (related to plain selfishness).  This is a completely flawed theory and neglects the fact that Smith mentions and analyzes different heterogeneous sets of motivations and values in each book, including benevolence, sympathy and self-love among the sentiments which conduct human action.

It appears that the advocators of blind selfishness and extreme individualism who gained momentum (especially in the U.S. since the end of the “free-love” era in the 60s)  believed to mostly be founded and inspired by Adam Smith’s work. This is demonstrates a colossal lack of understanding of Smith’s true philosophy and a meager investigation of his intentions. Therefore, in order to understand Smith’s philosophy and real relevance of the social moral framework of human life that created the foundations for a prosperous and wealthy society, we should analyze his Moral Philosophy to put an end to this copycat image of Smith once and for all. 

Adam Smith’s Moral Philosophy and its implications in the social system:

“The administration of the great system of the universe . . . the care of the universal happiness of all rational and sensible beings, is the business of God, and not of man. To man is allotted a much humbler department, but one much more suitable to the weakness of his powers, and to the narrowness of his comprehension-the care of his own happiness, of that of his family, his friends, his country.”
Adam Smith

Smith was a pioneer in XVIII century Moral Philosophy, particularly in incorporating a humane role of impartiality, the evolution of consciousness and an essence of common universality in human ethics. In the TMS, Smith laid the social moral framework for a pre and current capitalist society; it provides the proper social moral lens in order to properly read the WN with a more complex and rich ethic perspective. The WN help us to understand the motivation that pushes human action within the economic sphere. Both the TMS and WN provide a structure for human rationality, the plurality and subjectiveness of human motivations; they both also establish a deeper understanding of the symbiotic relationship between economic prosperity and social moral ethics that restrain our sentiments. Thanks to Smith, these were then seen as connected systems rather than separate entities. Adam Smith helped us to understand the social necessity of developing a moral humanity to hold and sustain social institutions together in order for economic market systems and justice to flourish.

As a result, the  two books are deeply correlated and inherently dependent on one another. It is a big mistake to consider them mutually and morally disconnected or the presence of any form of moral dichotomy between them. The mentioned “Adam Smith Problem” indicates a sort of superficial inconsistency between his works. This analysis conveys that in the TMS there is a marked global sense of “social prosperity” through a common social good, especially highlighted through sympathy towards other human beings and (as the analysis goes) presents a huge discrepancy with the WN, which promotes “selfishness” and individualistic behavior. The “Adam Smith Problem” is a huge misconception; he never intended to leave behind the perspective of sympathy and benevolence. In fact Smith considered the TMS as his finest achievement and worked on a 6th edition of the TMS just before he died. In both books readers can see that Smith mention various motivations and sentiments which explain different spheres of human action. Self-love is just one of the motivations, preponderantly the most important one, but Smith also extensively worked treating and exposing other fundamental social motivations from a moral system based on sympathy, which are fundamental for a prosperous society.

Indeed Smith refuted any form of selfishness and he even associated it with rapacity and human neglect for your fellow man. Mature self-love, according to Smith, is instead a vital part of human virtues and is a completely different thing than selfishness. Selfishness presupposes positioning oneself as the only concentration and preoccupation to the point to be chosen over others, even if it hampers them. Mature self-love on the other hand is care and attention to oneself while taking into account your interests as well as others’ interests; it involves a higher degree of human respect and social interaction. It’s a more socially harmonic term and involves care for the rest of society and respect for the fundamental traditions and rules of social morality.   

Smith believed that the self-love principle explained a consistent part of human interaction, although he specifically stated that it was not the only one. Self-love is particularly consistent in helping understand economic phenomena but Smith was well aware of further motivations regarding other social spheres; for example he begins: “How selfish so ever man maybe supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it”.  Indeed Smith understood, as probably no one else at the time, that the whole foundation of a capitalist and free-market society is based on cooperation and respect, which in turn is deeply based on the fundamental structure of shared social ethics and human morality.

 According to Smith, self-love is a necessary and basic condition for spurring the division of labor and human creativity; however this sole motivation it is not sufficient enough to reassure long-term human self-discipline, social stability or a nation’s prosperity. Trust, mutual confidence, benevolence and reciprocal respect towards others create the base for voluntary cooperation, enhancing exchanges, trade and production and protection under a common law system of jurisprudence. Today Smith would surely ask those laissez-fare individualist fundamentalists: how can you base a society with the complexity of the current division of labor without benevolence, confidence and human-morality? Smith would agree with them that self-love pushes human nature to be involved in trade and production, but he complemented and enriched this notion with humanitarian, respectful, social morality that supports its foundation.

For Smith, the pursuit of self-interest appears to broadly explain the main driving force of economic activity and exchange. In his famous quote from the WN, Smith wrote: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not their humanity but to their self-love.” Contrarily, what is not usually quoted is something which Adam Smith mentioned earlier in the same chapter: “In civilized society, man stands at all times in need of the co-operation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons.“ Unfortunately people misunderstand the famous quote and apply it to every single sphere of social human interaction, therefore cataloging Smith as the father of selfishness. Adam Smith in his most famous quote only addresses the necessity of self-love in order to explain economic activity and the exchanges executed in a market economy.   

Smith clearly understood the necessity of a healthy and well-functioning market economy based on individuals being free and following their self-interests. It does not mean that he didn’t belief in any other human social institution organically and spontaneously developed. In fact in his work, he clearly presupposes that social traditions, rules of social morality, as well as the common law are social institutions that evolve with society through individuals’ interactions and are the foundations which reassure prosperity. He warned us against how selfishness and the lack of civic ethics would undermine the liberal open society. Then, a question arises: how can we keep humanity away from rapacity and selfishness? Smith proposed the necessary moral institutions that could hold society together and control human selfishness. He helped us realize that the best way to address and channel individual human action based on self-interest is through a system of social ethics arising from spontaneous order, without any rational or planned design but rather from the evolution and formation of rules and traditions conforming to that moral social system. 

Controlling selfishness and rapacity, according to Smith, should not have to come from government control or state police; it must come from human self-control. Self-governing humans will be the pillar of a free civic ethic society, but how can we assess our sentiments and actions in order to possess a rightful measure of self-control? The answer that Smith provides relies on social sympathy and social approbation. Smith intended that sympathy in some way enables people to use their imagination and a higher degree of abstraction to put ourselves in the place of others. However, in another higher degree of abstraction and impartiality, Smith said we would detach our sentiments from that reflection by imagining a form of an abstract and impartial human being (an abstraction of ourselves) that would judge our actions and then feel sympathy or disapproval.   

Social sympathy is the only way in which we can measure how proper or improper our sentiments are and also of our eventual actions, analogously our sympathy is the measure in which we assess other people’s sentiments. If my feelings are aligned with others’ sentiments, we would be in a sympathetic relationship in regards to my actions and there would be a general social approbation of my actions. We, as social human beings, desire harmonious sentiments among us because according to Smith, social man naturally seeks social approbation and harmony in their sentiments.

Humans adjust their actions and feelings towards the correct measure of sentiments that will bring the desired sympathy from others, which is a natural human inclination. This desire of sympathy is seen as a common harmony among sentiments and actions that will eventually set the common social moral sentiments; as a result, it creates civil society’s boundaries and foundations of a spontaneous and evolutionary regulation of human sentiments and social traditions. Hence when a person has a set of sentiments, he will imagine an abstract human form which possesses impartiality towards our moral sentiments; this helps him to measure and understand the discrepancies between the human abstraction or impartial spectator. He then seeks to converge the moral sentiments in order to reach a level compatible with the impartial spectator allowing him to act and thereafter receive social sympathy and approval for his behavior. 

Evensky noticed that Smith clearly understood that a Libertarian open society needs a shared set of moral sentiments because these are the last remaining forms of control and justice. State police is not a free societies’ ultimate control. According to Evensky, the ultimate control should be a society’s shared moral sentiments: “A liberal society can only be constructive and sustainable to the degree that the hearts of the citizens embody a properly measured sentiment of justice and regulate themselves by that measure”.

Adam Smith clearly saw the necessity of a harmonious and stable moral society to create a healthy framework of human values supporting a market economy. As Amartya Sen stated in his introduction to the TMS, “Smith was both a proponent of plural social institutional structures and champion of social values that transcended the profit motive in principle as well as in actual reach”.  Indeed Smith understood that both the market system and economy are not only based on the narrow idea of selfishness but rather enormously depend on motives beyond just simple self-love; there is prudence, benevolence and other sentiments which sustain self-constraint for a better social outcome. One of Adam Smith’s most important contributions was his insight into the existence of a deep symbiotic relationship between social ethics, philosophy and economics; if it appropriately worked, it would ensure the social framework for a nation’s prosperity and wealth.
To be continued next week...

Tuesday, July 3, 2012

Money, part 2.

Natural money, centralized creation, sub-optimality and self-organizing processes
Author: Pablo Paniagua
Editor: Victoria Finn

The centralized creation of money, Fiat money, the price system and sub-optimality:

Money is nothing more than a medium of exchange and it completely fulfills its function when the exchange of goods and services is carried on more easily with its help than would be possible by means of barter. Attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by an expansion of its circulation.”
Ludwig von Mises

It is extremely important to understand money’s origin and evolution as a spontaneous order of an evolutionary self-coordinating system in which individuals spontaneously come up with the best available solution in a free and noncoercive interaction. Real Money will always be like this under a completely free-market economy, meaning that if we let people spontaneously and freely decide their own money to facilitate their transactions, every single society in the world would end up adopting some sort of the most marketable commodity generally linked with a type of metal; in most cases, it would end up being gold.

As we saw in last week’s article related to languages, any attempt to apply reason and knowledge to create an institution as complex and important as money, language and others is just a futile attempt and falls in the rational-positivist trap. The fact that believing we can establish some sort of “artificial” money through reason and planned coordination, we will always fall short on the real scope of what money should do. Since it is planned by some centralized authority, it will always be an unnatural outcome of what society would have spontaneously and naturally chosen.    

The majority of optimal results in complex societies come from free individual coordination. As we have seen in languages, and in this case money, the optimal solution fitting for a complex system in a decentralized society will always lie in the hands of unprompted determination. It is therefore out of the individual’s capacity, understanding and design. Like Mises stated in his quote above, any attempt to apply human knowledge towards reforming the monetary system can bring unintended consequences and will eventually undermine and impede the coordination of individuals and therefore damage the source of economic growth. This problem of unintended consequences arises every time politicians, technocrats and statesman intervene and corrupt the money system, imposing other forms of state money such as Fiat money or a paper money system. 

The Fiat money system, also understood as a paper money system, is not similar to commodity money in the sense that the Fiat system is not freely adopted by the collaboration and interaction of individuals. Fiat money’s structure is generally imposed by an oppressive state, which systematically constrains and forces people to use it. As we have seen through money’s evolution, humans freely adopted some sort of inelastic commodity money as a way to subconsciously and spontaneously keep it neutral and away from the centralized authorities. The inelastic supply of a commodity keeps the amount of money in the economy stable and allows for better entrepreneurial economic calculations. It also keeps it out of politicians’ and technocrats’ reach and temptation to expand the monetary base in order to promote their own interests. Unfortunately nowadays we live in a global money system which is artificially created and imposed by the state. Our current money system is just a scheme of paper money backed by thin air and therefore is not redeemable for anything: metal or any other good. Fiat money is just paper with faces of deceased presidents on it which can be printed at will and can meet the central authority’s arbitrary goals. Fiat money completely bypasses the natural spontaneous decision of real individuals’ interactions. For more than 40 years we have sadly been living in this extremely unrestricted, global, arbitrary paper money scheme in which states can freely print as much money as they want. When President Nixon in 1971 ended the last relationship between the dollar and gold, it ended the last relationship between paper money and the most marketable good. Now this is the very first time in history that we have an international abuse and misuse of political paper money.

When a central authority artificially creates a monetary system, it is suboptimal and against the free interaction of individuals; even worse, it opposes individuals’ natural needs since it has been created by a central authority, so it primarily answers the needs of certain groups and their politic agendas. On the contrary a system spontaneously created does not respond to anyone’s interests; it is almost inelastic and therefore cannot be increased at will or capriciously intervened. Real money only answers to individuals’ interests and indirectly to the whole good of society. Artificial systems created by human reason and political authority will always improve the positions of those who impose it on others in the first place. Hence the artificially created money will always be biased and will be used as leverage to meet specific political goals. The optimal system for a complex society is not another unnatural, politicized, planned  Fiat money like the ones  hundreds of cultures have tried, imposed and failed, but rather a natural money system in which there is neither master nor any intended political or nationalist end.

Since Fiat money systems have been created by states, they have the tendency to experience secular inflations since there is practically no cost of printing paper. States have the tendency to just keep printing it, especially if it statistically creates some increases in growth measures. Unfortunately this monetary base inflation and expansion will eventually benefit some people at the expense of others since is uses the monetary expropriation of wealth (see article on the Cantillon Effect and the redistribution of wealth). Not only will it do that but as Mises stated, “this expansion of the monetary base is the constant source of ineffective and shortsighted stimulation of the economy, which eventually end in boom and bust cycles.” The people who benefit the most from these artificial systems are of course those who created and imposed it on the rest of society; it also benefits those who are at the beginning of the monetary expansion, those who first receive the money. It is no surprise then why people in the government and financial banking institutions are obviously willing to promote and back money printed by the state and use laws and enforcement to impose this system on others. 

Politicians love this monetary scheme since they can create and command money’s expansion through fractional reserve banking and artificially low interest rates in order to artificially encourage investment and credit. The system falsely promotes short term growth that might help them get reelected. This injection of artificial money in the economy is neither wanted nor necessary for the better exchanging of goods, creation of wealth or growth in an economy. 

The true source of sustainable long term growth is real savings. New money printed by the state and poured into the economy will only disrupt and damage the price system’s coordination, change relative prices and impede a correct form of economic calculation for entrepreneurs. This can lead to massive misallocations of capital and investments. These huge distortions will consequently end in recessions and liquidation of the previous artificially-created growth. Fortunately for the politician who started the expansion, he can enjoy the short term stimulus while neglecting the long term misallocation crises and economic damage that will only become self-evident when he is no longer in office. At that point during a massive paper money crisis, he would be either be reelected or else it would be someone else’s recession problem. In the long run we are all dead, right? Unfortunately those who make long term capital structure misallocations haven’t read Keynes.

The price system and the symbiotic relationship with money:

“Fundamentally in a system in which the knowledge of the relevant fact is dispersed among many people, prices can act to co-ordinate the separate actions of different people in the same way as subjective values help the individuals to co-ordinate the parts of his plan.”
Friedrich A. von Hayek

“Prices in short are seen as a continuous information collecting and disseminating process, but it is the institutional monetary framework that determines, both the extent and the degree of success in which prices will be able to perform their potential signaling and
allocative function.”
Friedrich A. von Hayek

Money is totally indispensable in a complex, decentralized society. It has a fundamental and symbiotic relationship with the price system’s coordination. In a society in which knowledge is so heterogeneous and rich, the only way that fundamental information about competitiveness, efficiencies and cost-opportunities can be transmitted is through a common pricing language. Hence money steps in as the universal common language and prices can be seen as pure words facilitating this communication among individuals and economic actors. Money enhances the extension of human cooperation and allows a more reliable and stable source of market value calculation, increasing reciprocal cooperation beyond our awareness.

Hayek’s second quote helps us to understand that the adoption or creation of any form of monetary framework will determine the degree of the price system’s success as an information disseminator. Similar to any spontaneously created language determining the level of success of the words adopted (remember Esperanto?), the chosen money system (whether it is a natural commodity or an artificial and imposed paper monetary system) will in the long run determine the success and extension of the price mechanism’s real role and coordination in society. Hayek clearly understood the symbiotic relationship between the price system and money: he saw that paper money systems are so far away from the natural spontaneous outcome of commodity money that they can only generate false signals, huge distortions and misinformation in the price system, covertly dampening a potentially superior resource allocation.

In this case, a paper money system and in particular their centralized and controlled monetary supply is arbitrary and politically directed. The system’s most relevant characteristic is not only its political bias but also the fact that it interferes with the symbiotic relationship between natural money and prices, creating great disturbances. It alters entrepreneurial expectations because it intervenes and creates changes in relative prices, leading to distortions in the capital accumulation which will eventually result in a form of malinvestment. Arbitrarily supplied paper money creates deep unforeseen structural changes in the economy, especially in the global capital structure of goods’ production processes. This is the sort of sub-optimality that I wish to address in this essay; paper money is never really fully exposed to market forces and is severely dependent on centralized decisions and political aims. It is these capricious forces which will always prevail and push the paper money supply even further into the long run, creating secular inflation of the monetary base and making money ever more elastic, unstable and politicized. This in turn makes the entrepreneurial calculation ever more difficult. It creates so many price distortions in the long run which undermine the whole degree of the price system’s success and makes it impossible to fully differentiate between prices that are corrupted by paper money and those that are not.  A political and unnatural selected money system erodes the free market system, its society and the true entrepreneurial function. It dampens the correct resource allocation system through the price mechanism of coordination and corrodes a nation’s long term production capacity. 

Finally it is necessary to again stress the relevance of a natural social institution like money; when money is organically created, it achieves its basic objective to facilitate exchanges and indirectly creates a healthy and stable framework for entrepreneurial economic calculation. When money is organically created, it means that its origin lies outside any particular interest or economic ambition, therefore it does not answer to any authority. Prices under this system fully reflect the market system coordination since these prices are the most “natural” and “unadulterated” as possible, reflecting only the true market economy interactions. These unadulterated prices are the most relevant and unadulterated source of information for entrepreneurs in order to make their capital investments and allocations.

Unfortunately when paper money is introduced and created by a central authority, it clashes with the natural money institution’s real objective. This form of money answers to political control and is created with economic purposes, therefore its market economy implementation is disturbing. It constantly alters the price mechanism that disseminates the relevant information for an efficient resource allocation. The elastic money supply by the central banks makes the money supply deeply intertwined with the economy’s capital structure, changing the potential capital accumulation. Hence when paper money is being constantly and discriminately introduced, it interferes with the real information of the natural prices and creates huge unintended misallocations.  This is the most fundamental flaw and sub-optimal source which generates constant danger to potential organic growth in the economy.

In a nutshell, a paper money scheme is unnatural, monopolized, centralized and fundamentally in opposition to any form of free human interaction. Paper money undermines the free market society’s real values and individuals’ free collaboration; it brings potentially enormous and unintended consequences, crises, instability, misallocations and sub-optimality.  We have seen the damage of adopting an artificial and politically created paper money system but we have also understood that a commodity money system is far from totally perfect. A commodity system is also keen to unbalances and distortions but at least these distortions are free from politics and centralized planners. There will always be distortions based on natural interactions and based on man’s freely adopted money which are not imposed by a coercive authoritarian state.

“It is never too late to become wise, but if change comes late, there is always more difficulty in starting a reform.”
Immanuel Kant

“It would, indeed, be harsh to ask what has become of this respect for money in our time…. To restore this respect and the corresponding discipline in money and credit policy is one of the most important conditions for the durable success of all our efforts to restore and maintain a free economy and, therewith, a free society.”
Wilhelm Röpke


-          Michael Polanyi, The Logic of Liberty, the Liberty Fund, Inc 1998.
-          F.A. Hayek, The Fatal Conceit, Chicago Press 1988.
-          F.A. Hayek, Individualism & Economic Order, Ludwig Von Mises Institute, 2009.
-          Carl Menger, Problems of Economics and Sociology, University of Illinois press 1963.
-          Carl Menger, Principles of Economics, Ludwig Von Mises Institute, 2007.
-          David Boaz, Libertarianism, The Free Press, 1997.
-          Detlev Schlichter, Paper Money Collapse , John Wiley & Sons, 2011.  
-          Ludwig von Mises, The Theory of Money and Credit, Signalman Publishing, 2009.
-          Ludwig von Mises, Human Action: the Scholar’s Edition, Ludwig Von Mises Institute, 2008.