Natural
money, centralized creation, sub-optimality and self-organizing processes
Author: Pablo Paniagua
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
Sources:
-
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.
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