21: Principle of Sound Money
Through the nineteenth century, the principle of sound money remained tied to free-market ideals: private ownership of the means of production and the freedom of labor encouraged production to be tended by those best fitted" for a given task; a consumer able to determine what articles he would purchase according to his own values and choose the supplier that best met his needs. In effect, this was a system in which all factors, including money, were negotiated among participating parties.
Such a system can perpetuate only by peaceful cooperation, needing only protection against those who would seek to subvert the voluntary nature of interaction to their own action by means of deception or force. The chief problem is that the machinery of state, intended to protect the people from "domestic gangsters" itself comes to embody the traits and tendencies it was intended to defend against: "tyrannical government" bent on "enslaving the citizenry" to aggregate power and wealth to those who control the means of force against their own constituents.
It is only possible to grasp the meaning of "sound money" in the former context, as money itself is an instrument of exchange among people without force or coercion. Money itself loses its soundness when it is debased, or when there is an intrusion into the manner in which it can be exchanged: the ability of buyers and sellers to negotiate a fair exchange among themselves, including the medium through which such exchanges take place.
Von Mises refers to the politics of his time as "cryptodespotism" - a clumsy but accurate term - in that economic means are used to subvert the freedom of the people. To implement state-issued currency, to place tariffs on certain goods and provide subsidies for others, and to engage in the fixing of prices and wages are all covert methods of interfering in the economic behavior of citizens, the totality of their productive and consumptive acts, as a means of accomplishing its own end (to reward its supporters to the detriment of its detractors).
In general, the state finds fault with the concept of freedom, in that it impedes its ability to implement totalitarian control. The notion is that what is not controlled by the state may not be guaranteed by the state - that if individuals are allowed to interact at their own discretion, there is no certainty that they will act in a responsible manner - that unless government controls and commands every act from the planting to the harvest to the delivery of food, society faces the risk of starvation. And conversely, that only by the assistance of government can the citizens be assured of the satisfaction of their most basic needs.
(EN: A few other writers spring to mind while considering this assertion. Saint-Exupery's allegory of the king who would command the sun to rise and claim that it only did so by virtue of his authority, and O'Rourke's examination of famine in contemporary times that concluded that mass starvation does not occur for lack of food, but because access to food was prevented by a despots seeking to exert control.)
The principle of sound money is based on the ability of those who participate in changes to determine the terms of their exchange, and the ability of a market to derive a common medium of exchange as an derivative of the choices made by participants in exchange. It is undermined by the attempt, by any party, to subvert the voluntary nature of exchange - and in terms of the current discussion, "government's propensity to meddle" in matters of commerce constitutes such a subversion.
Historically, sound money was based on a metallic standard: the coins used in exchange have value by virtue of the metal from which they are fashioned. Any token coinage or paper money substitute is value only on the condition that it can be redeemed, without delay, for metal. In this regard, the supporters of sound money are agreed.
The disagreement among them arose over the choice of a particular metal - gold or silver- which would be used as a medium of exchange. And solving this dispute was the initial intrusion of the state into modern money systems: to impose a requirement of one or the or the other for "official" business (i.e., taxation in various guises) and then to impose the same requirement on private exchange.
The use of state coercion to settle this dispute was "a serious blunder," which led the state to discover, and avail itself of, various means of control over the economic system in general. (EN: It is also a blunder in the sense that it undermines the very principles on which it is based - the freedom of participants in an exchange to agree upon the terms of their exchange absent external coercion. In retrospect, the cause would have been better served by standing back and letting the market decide which metal to favor, or even to continue using both.)
Compounding the problem was that economic decisions made and enforced buy government are devised by politicians with little understanding of economics. Von Mises also finds fault with those who do understand economics, in their failure to defend the principles of sound currency, but instead to abandon them in an attempt to devise an alternate system that would serve the same ends by other means - in effect, to help government fashion a means of controlling economic activity that would mitigate the damage done by such control, in effect, seeking to treat a wound rather than to prevent injury.
Virtues and Shortcomings of the Gold Standard
The primary value of a gold standard is that it enables buyers and sellers to negotiate pricing without interference of a third party, namely government. It also imposes upon government the necessary of fiscal responsibility of their own dealings: the government's expenditures are limited to their financial reserves, which cannot be arbitrarily increased by tinkering with their currency.
This leads to the chief criticism of the gold standard: that the limited availability of gold would lead to a limited availability of money. As a result, the value of each unit (ounce) of gold would become increasingly precious and inflate in value, to the point at which there was an insufficient amount to conduct business, and the economy would be stifled.
Alternately, it is argued that the increased value of gold would cause the factors of production to be shifted toward mining and refinement to produce more gold. And in such instances those who are in such industries would gain a disproportionate amount of leverage in the marketplace. Such objections arise at specific periods of time - such as the 1850's, when gold production increased considerably in America (California) and Australia, giving a temporarily increased purchasing power in the international markets. This criticism is absent beforehand and subside quickly after.
Taken together, it seems that some critics maintain that reliance on a gold standard causes prices inflation and others that it causes price deflation. Clearly, both cannot be true. While a sharp increase or decrease in the availability of gold can influence the general price of goods, the effect is temporary and the market seeks equilibrium - it seems to be the desire of such critics to force such adjustments to occur more quickly or gradually than it naturally occurs.
It's also noted that economic argument about the worth of any commodity represent a specific interest. The seller of potatoes wishes there to be higher prices for potatoes, and does not wish an increase in the price of any other good, as his profits are harmed when the goods he sells fall in value against the goods he wishes to buy. The interest and benefit of the buyer of potatoes is exactly the opposite. Each side wishes the price of the good to serve his own interests rather than the other parties.
When politicians intervene, they necessarily side with one party or the other, rather than allow them to negotiate a fair price among themselves. Should the politician desire more votes, he will side with the more numerous buyers. Should the politician desire more money, he will side with the wealthier suppliers (provided they provide him with money, above or beneath the table).
To the uninformed, fiat money seems like a kind of conjuring: "a magic word spoken by the government creates out of nothing a thing that can be exchanged against any merchandise a man would like to get." Politicians, like wizards, cause value to appear. For the slightly less naive, this facility seems likewise appealing, for the government has the power to print money for its own ends and does not therefore need to resort to the seizure of their own property by means of force or taxation (which itself is an indirect form of force).
Such notions are contrary to the basic theories of money - in that money is valued only insofar as it represents a value. In commodity based money, the more notes that are issued, the smaller the amount of the backing commodity each note represents - such that if a mint were to issue 750 tokens for 750 ounces of silver, each token is worth one ounce. IF the mint prints 250 more tokens for its own use, without silver to back it, then the token will be valued as the 0.75 ounce of silver it can be exchanged for, and will trade as such regardless of its face value.
The same is true of fiat money: the more that is issued, the less purchasing power each unit has; and traders will account not only for the debasement of the currency, but for the potential for it to be debased further before it can be redeemed. Thus, under a system of fiat currency, the currency is devalued not to reality, but to a pessimistic estimation of its probable future value.
If the prices of consumer goods are, as they must be, based on a fixed supply and the value of money fluctuates at the whim of government, as it must be when it is not based on physical commodity, then market prices will fluctuate as a consequence. It is the naive perception of the public that money has a fixed value against which the price of merchandise seems to constantly rise - and more accurate in most circumstances to understand that the supply of goods is more or less stable in a mature market, and that it is the money that is decreasing in value.
The example is given of a housewife who needs a new frying pan. If she perceives that prices are in flux, her thought may be to wait until prices drop again before making the purchase. If she perceives prices to be steadily rising, she may have incentive to buy now because it will only be more expensive in future. If she recognizes that the change in price is due to the devaluation of money, the perspective becomes that it is wiser to buy immediately rather than "keep these scraps of paper that the government calls money one minute longer."
(EN: The author does not translate this to the larger scale: the market as a whole will seek to rid itself of currency that represents a falling value - but if no-one wishes to keep it, it is equally true that no-one will wish to accept it. The natural consequence is to abandon one form of money and seek another - that is, to abandon government-issued currency and use a more stable one, or to revert to direct barter.)
In sum, it is highly inadvisable to base a system of currency on the intentional deception of the majority of the citizenry. He refers to the quote by Lincoln: "You can't fool all of the people all of the time." Eventually, the masses come to understand the schemes of their rulers. That is, the inflationary scheme like any confidence game has a limited duration. And it is very much a confidence game.
The propaganda of inflationist proclaim that the gold standard collapsed and need never be tried again. But it is important to note that the gold standard did not collapse so much as it was abolished by governments to pave the way for fiat currency. The "grim apparatus" of state - guards, regulators, courts, prisons, and even executioners - was necessary to prevent citizens from choosing their own medium of trade and accept government-issued currency in its stead.
The most remarkable thing about fiat money is its complete failure. In the short term, it was "successful" at mitigating naturally occurring economic fluctuations be seeking to serve the interests of some at the expense of others within the confines of a domestic economy. But in international markets, gold remains the world's money: each national currency is valued against gold, and the exchange rates among currencies reflect their gold value. While force of government can be brought to bear to force "scraps of paper" on their own citizens, the global market remains steadfastly on the gold standard.
(EN: In the present age, one can say that the gold standard remains to the degree that governments retain their sovereignty and the ability to refuse to accept the currency of other nations. The United States has gained considerable power in the international arena and has the ability to compel other nations, buy threat of economic sanctions or military reprisal, to accept the dollar, even to the point of lesser nations' currency being effectively pegged to the dollar.)
Of course, the gold standard cannot function if the ownership of gold is made illegal, and hosts of judges, police, and informers are effective in enforcing such a law (EN: Such as occurred in 1965 in the United States.) But otherwise, the gold standard remains fully serviceable, and can be fully functional, would government merely abstain from interfering in the subjects of their citizens in the marketplace.
Another round of criticism suggests that the gold standard is incompatible with credit expansion: in effect, that the gold standard requires individuals to trade exclusively in "present goods" and renders them unable to increase their purchasing power by trading in, or borrowing upon, the value of goods that they will create in the future.
This is decidedly untrue: just as individuals are willing to extend credit to a miner who has no gold presently, but can pay them in future, so can credit be extended to individuals even though they do not have the present goods to cover their debts, provided there is reasonable expectation of their ability to produce these same goods in future.
What credit expansionists fail to recognize is that, regardless of the value of money, the value of credit discounts future goods according to their risk and the inconvenience in the delay of having them. An apple today is of greater value than an apple next year, or a hundred years from now. Hence the amount of credit that one party is willing to extend another, as well as the interest rate, has nothing to do with the stock of any present good and does not change with the present availability of a different commodity.
It is also a fact, independent of the basis of currency, that there is a definitive ceiling on credit - that is, the lifespan of the debtor. An individual may borrow against his future earnings only so long as he can be expected to have them. One could not argue that choosing one basis or another for currency would make it any wiser for a creditor to extend a thirty-year loan to a ninety-year-old man.
Further, that the adoption of a currency that has no objective value tied to a specific commodity introduces yet another factor that a creditor must consider: the fluctuation in the value of money itself. If the fiat money of the future is expected to be of lesser value than the fiat money of the present - which has invariably been so - then the tendency would be to extend even less credit, at an even higher rate, in consideration of this additional level of risk.
The Full-Employment Doctrine
One of the "oldest and most naive" beliefs about money is insufficiency of supply: the merchant asserts that business is bad because people don't have enough money to purchase his wares, the customer maintains he cannot have the things he desires because he hasn't enough money to purchase them. And both conclude that, if only there were enough money, people could buy more things and the economy would improve.
The fallacy inherent in both beliefs is that money itself equates to the ability to trade. But money is merely a token of exchange that represents the value one has to trade, in the form of labor or goods. If all wages were doubled, and all prices were doubled, the economy would not be improved - though it is often imagined by both parties that one could increased without influencing the other. Such is the nature of wishful thinking and selective attention to facts.
In recognition of this, the "full employment" doctrine arose: essentially, that in order for the economy to have the maximum amount of activity, people must produce the maximum amount of value (goods) possible. This has the appearance of reason, hence the notion of full employment has been pursued as a goal of government and economists such as Keynes.
However, wage rates are a market phenomenon. On the level of the individual, some men are more productive than others and can command a higher wage by virtue of their industriousness. On the level of the market, the supply of labor is matched with the needs of production, and a surplus of labor cheapens its value: doubling the amount of workers does not double the amount of wages paid.
The minimum-wage standard, often pursued by government and labor unions, is in effect a minimum-price standard. By fixing the price of labor, any man who is worth less than the arbitrary minimum will remain unemployed - he is not worth the minimum wage, and those who might make use of him are not able to offer him a fair price for his labor. If forced to employ labor at a price above their worth, this will increase the price of goods beyond their worth, labor being a chief component in the costs of production.
Von Mises remarks that, in his time, it's unfashionable to express such ideas. There is widespread public support of the notion that high wages are good for the consumer, and the promise of more income for less work has such appeal with the masses that politicians, journalists, and even professors dare not speak out against it for fear of reprisal. In effect, these individuals are compelled for their own protection to bow to popular opinion, even when it is utterly unsupported by fact.
As such, it is forbidden to consider that increased wage rates spur inflationism and decrease employment and, instead, maintain that both phenomena can be solved by simply printing more money - to enable people to buy more goods, which enables producers to sell more goods, which requires them to hire more people, in a cycle of continuous improvement.
The perpetual failure of this tactic has done nothing to dissuade politicians from employing it, or labor unions from demanding it, which has resulted in an increase in nominal wages, but a decrease in the purchasing power of the worker, and an increase in importation of cheaply-made foreign goods. As it is politically unwise to suggest the failure of the system, the blame is placed on the very phenomena that have been abandoned to create such a system: negotiation of prices between buyer and seller that is uncorrupted by external interests and is based upon a sound and stable currency.
The Argument in Favor of Inflation
Economic arguments in favor of inflation are untenable, but there does remain a political argument in its favor that bears consideration. It is not a theory that is publicly espoused, or spoken of overtly, but it is implicit a considerable amount of legislative policy on the subject of currency.
While its supporters may grasp that inflationism is a self-defeating policy, they nonetheless believe that in certain "emergency" situations, recourse to inflation is justified, or perceived as "the lesser evil" to be chosen to avoid what they perceive to be more prescient threats.
Von Mises identifies the desire to build a military force as one such factor: to muster a large force, to pay the soldiers, and to manufacture the material equipment needed requires significant capital. Both labor and goods must be diverted from use in the civilian economy to serve a military purpose. This is but one example.
Where the majority of citizens recognize this need and are supportive of government action by committing their own resources to its accomplishment, the budget can be accumulated without tampering with the monetary system. Where the majority of citizens do not recognize and are not supportive of government action, covert means are necessary to obtain purchasing power without overtly extracting it from the citizens, to avoid civil unrest and a reaction against government. Hence, the government's recourse is to tamer with the currency system to grant itself purchasing power by debasing the currency rather than obtaining funds in sound currency by less covert means.
And this is the reason it is seldom discussed overtly, given the contemporary notion is that government rules by the will of the people. Inflation is, in effect, the mechanism by which government undertakes certain actions contrary to the will of the people. Such is the nature of statism, and a totalitarian government that seeks to gain autocratic power. At best, politicians may claim to be serving the "true interests" of the people in spite of what they believe to be their own best interests.
So long as the people remain ignorant, they can easily be cheated by means of economic policy. The means by which a public can be kept ignorant, or misdirected as to the true cause of inflation, has already been discussed in some length in previous sections of this chapter.