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The Ethics of Money Production JÖRG GUIDO HÜLSMANN To the memory of Hans Sennholz The Ethics of Money Production JÖRG GUIDO HÜLSMANN Ludwig von Mises Institute Auburn, Alabama Copyright © 2008 by the Ludwig von Mises Institute Cover image: Detail from Sachsenspiegel manuscript, courtesy of the University of Heidelberg. All rights reserved. No part of this book may be reproduced in any manner whatsoever without written permission except in the case of reprints in the context of reviews. For information write the Ludwig von Mises Institute, 518 West Magnolia Avenue, Auburn, Alabama 36832. Mises.org. ISBN: 978-1-933550-09-1 Contents Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .ix Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1. Money Production and Justice . . . . . . . . . . . . . . . . . . . 1 2. Remarks about Relevant Literature . . . . . . . . . . . . . . . 7 Part 1: The Natural Production of Money. . . . . . . . . . . . . . . . . . 19 1. Monies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 1. The Division of Labor without Money. . . . . . . . . . . . 21 2. The Origin and Nature of Money . . . . . . . . . . . . . . . . 22 3. Natural Monies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 4. Credit Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 5. Paper Money and the Free Market . . . . . . . . . . . . . . . 29 6. Electronic Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 2. Money Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 1. Certificates Physically Integrated with Money. . . . . 35 2. Certificates Physically Disconnected from Money. . 38 3. Money within the Market Process . . . . . . . . . . . . . . . . . . 43 1. Money Production and Prices . . . . . . . . . . . . . . . . . . . 43 2. Scope and Limits of Money Production. . . . . . . . . . . 45 3. Distribution Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 4. The Ethics of Producing Money . . . . . . . . . . . . . . . . . 49 5. The Ethics of Using Money . . . . . . . . . . . . . . . . . . . . . 51 v The Ethics of Money Production 4. Utilitarian Considerations on the Production of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 1. The Sufficiency of Natural Money Production . . . . . 55 2. Economic Growth and the Money Supply . . . . . . . . 60 3. Hoarding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 4. Fighting Deflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 5. Sticky Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 6. The Economics of Cheap Money. . . . . . . . . . . . . . . . . 69 7. Monetary Stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 8. The Costs of Commodity Money . . . . . . . . . . . . . . . . 79 Part 2: Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 5. General Considerations on Inflation. . . . . . . . . . . . . . . . . 85 1. The Origin and Nature of Inflation. . . . . . . . . . . . . . . 85 2. The Forms of Inflation . . . . . . . . . . . . . . . . . . . . . . . . . 88 6. Private Inflation: Counterfeiting Money Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 1. Debasement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 2. Fractional-Reserve Certificates . . . . . . . . . . . . . . . . . . 91 3. Three Origins of Fractional-Reserve Banking . . . . . . 93 4. Indirect Benefits of Counterfeiting in a Free Society . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 5. The Ethics of Counterfeiting . . . . . . . . . . . . . . . . . . . . 98 7. Enters the State: Fiat Inflation through Legal Privileges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 1. Treacherous Clerks . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 2. Fiat Money and Fiat Money Certificates . . . . . . . . . 106 3. Fiat Inflation and Fiat Deflation . . . . . . . . . . . . . . . . 107 8. Legalized Falsifications. . . . . . . . . . . . . . . . . . . . . . . . . . . 109 1. Legalizing Debasement and Fractional Reserves . . 109 2. The Ethics of Legalizing Falsifications . . . . . . . . . . . 112 vi Contents 9. Legal Monopolies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 1. Economic Monopolies versus Legal Monopolies . . 115 2. Monopoly Bullion . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116 3. Monopoly Certificates . . . . . . . . . . . . . . . . . . . . . . . . . 118 4. The Ethics of Monetary Monopoly . . . . . . . . . . . . . . 119 10. Legal-Tender Laws. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 1. Fiat Equivalence and Gresham’s Law . . . . . . . . . . . 125 2. Bimetallism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 3. Legal-Tender Privileges for Money Certificates . . . 131 4. Legal-Tender Privileges for Credit Money . . . . . . . 138 5. Business Cycles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139 6. Moral Hazard, Cartelization, and Central Banks . . 142 7. Monopoly Legal Tender . . . . . . . . . . . . . . . . . . . . . . . 145 8. The Ethics of Legal Tender . . . . . . . . . . . . . . . . . . . . . 148 11. Legalized Suspensions of Payments . . . . . . . . . . . . . . . . 153 1. The Social Function of Bankruptcy . . . . . . . . . . . . . . 153 2. The Economics of Legalized Suspensions . . . . . . . . 156 3. The Ethics of Legalized Suspensions . . . . . . . . . . . . 157 Paper Money. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 1. The Origins and Nature of Paper Money . . . . . . . . 159 2. Reverse Transubstantiations . . . . . . . . . . . . . . . . . . . 162 3. The Limits of Paper Money . . . . . . . . . . . . . . . . . . . . 164 4. Moral Hazard and Public Debts . . . . . . . . . . . . . . . . 166 5. Moral Hazard, Hyperinflation, and Regulation . . . 168 6. The Ethics of Paper Money . . . . . . . . . . . . . . . . . . . . 172 The Cultural and Spiritual Legacy of Fiat Inflation . . . 175 1. Inflation Habits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 2. Hyper-Centralized Government . . . . . . . . . . . . . . . . 176 3. Fiat Inflation and War . . . . . . . . . . . . . . . . . . . . . . . . . 177 4. Inflation and Tyranny . . . . . . . . . . . . . . . . . . . . . . . . . 179 5. Race to the Bottom in Monetary Organization . . . . 179 6. Business under Fiat Inflation . . . . . . . . . . . . . . . . . . . 179 7. The Debt Yoke . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 vii 12. 13. The Ethics of Money Production 8. Some Spiritual Casualties of Fiat Inflation . . . . . . . 185 9. Suffocating the Flame . . . . . . . . . . . . . . . . . . . . . . . . . 188 Part 3: Monetary Order and Monetary Systems . . . . . . . . . . . . 193 14. Monetary Order . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 1. The Natural Order of Money Production . . . . . . . . 195 2. Cartels of Credit-Money Producers . . . . . . . . . . . . . 197 Fiat Monetary Systems in the Realm of the Nation-State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199 1. Toward National Paper-Money Producers: European Experiences. . . . . . . . . . . . . . . . . . . . . . . . . 199 2. Toward National Paper-Money Producers: American Experiences. . . . . . . . . . . . . . . . . . . . . . . . . 203 3. The Problem of the Foreign Exchanges . . . . . . . . . . 206 International Banking Systems, 1871–1971 . . . . . . . . . . 209 1. The Classical Gold Standard . . . . . . . . . . . . . . . . . . . 209 2. The Gold-Exchange Standard . . . . . . . . . . . . . . . . . . 214 3. The System of Bretton Woods . . . . . . . . . . . . . . . . . . 216 4. Appendix: IMF and World Bank after Bretton Woods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219 International Paper-Money Systems, 1971– ? . . . . . . . . 223 1. The Emergence of Paper-Money Standards . . . . . . 223 2. Paper-Money Merger: The Case of the Euro . . . . . . 228 3. The Dynamics of Multiple Paper-Money Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230 4. Dead End of the World Paper-Money Union . . . . . 235 15. 16. 17. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 1. Two Concepts of Capitalism . . . . . . . . . . . . . . . . . . . 237 2. Monetary Reform. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .243 Index of Names . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .257 Index of Subjects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .273 viii Preface I t has been a long-standing project of mine to give a concise exposition of monetary theory, with special emphasis on the ethical and institutional aspects of money production. Money and banking have been covered more than any other subject in economics. Still there is reason to hope that the following pages will not be superfluous, for they combine three elements that have not previously been integrated into a single work. First, this book applies the tradition of philosophical realism to the analysis of money and banking. The great pioneer of this approach was the fourteenth century mathematician, physicist, economist, and bishop, Nicholas Oresme, who wrote the first treatise ever on inflation and, in fact, the very first treatise on an economic problem. Oresme exclusively dealt with the debasement of coins, a form of inflation that is unimportant in our age. But the principles he brought to bear on his subject are still up to date and have by and large remained unsurpassed. In modern times, Oresme’s work has found its vindication in the writings of the Austrian School. The Austrian theory of banking and fiat money is the second element of our analysis. The Austrian School is justly famous as a standard-bearer of the realist tradition in economics, and also as a champion of free-market policies. Seven generations of Austrian economists have explained why private property rights provide a fundamental framework for social cooperation in a truly humane economy. They have stressed the counterproductive effects that result when property rights are violated by private individuals and governments. And they have granted no exception in the field of money and ix The Ethics of Money Production banking, demonstrating that without private initiative and its correlate—personal responsibility—the production of money is perverted into an instrument of exploitation. Only the free and responsible initiatives of private individuals, associations, and firms can create monetary institutions of the sort that truly benefit society and its members. The third element characterizing our approach is the analysis of the ethics of money and banking in line with the scholastic tradition of St. Thomas Aquinas and Nicholas Oresme. Scholasticism sought to integrate Aristotelian insights into the intellectual tradition of Christianity, under the conviction that science and ethics—and the projects of reason and faith generally—can be considered distinct branches of a unified system of knowledge. Murray Rothbard credits Thomism with a critical development in the field of ethics, for it demonstrated that the laws of nature, including the nature of mankind, provided the means for man’s reason to discover a rational ethics. To be sure, God created the natural laws of the universe, but the apprehension of these natural laws was possible whether or not one believed in God as creator. In this way, a rational ethic for man was provided on a truly scientific rather than on a supernatural foundation.1 It was this scholastic line of thought that gave rise to economics as a science. As Joseph Schumpeter wrote: It is within [the scholastics’] systems of moral theology and law that economics gained definite if not separate existence, and it is they who come nearer than does any other group to having been the “founders” of scientific economics.2 Thus the scholastic approach seems to be an appropriate starting point for an examination of the ethics of money 1Murray N. Rothbard, Economic Thought Before Adam Smith: An Austrian Perspective on the History of Economic Thought (Aldershot, England: Edward Elgar, 1995), p. 58. 2Joseph A. Schumpeter, History of Economic Analysis (New York: Oxford University Press, 1954), p. 97. x Preface production as well, both from the point of view of the history of ideas and for their contemporary application. The aforementioned three elements might at first seem to be odd bedfellows. I hope to show, however, that there is a reason why these three strains of thought have grown up alongside each other. We will see how, when they are applied to this one area, they serve as complementary aspects of a general realist theory of money—an ontology of money, as it were—and that all these aspects lead to the conclusion that a free market in money production is ethically superior to its logical alternative: money production based on legal exemptions and privileges. My special thanks go to Professor Jeffrey Herbener and Dr. Emmanuel Polioudakis for extensive commentary on the first draft of the manuscript and to Mr. Joseph Potts for revising and commenting on the final version. I am also indebted to Professor Larry Sechrest, Professor Roderick Long, Dr. Nikolay Gertchev, Dr. Jan Havel, Dr. Arnaud-Pellissier-Tanon, Dr. Lawrence Vance, and Mr. Robert Grözinger for their helpful comments, and to the Professors Thomas Woods, Joseph Salerno, William Barnett, Robert Higgs, and Christoph Strohm, as well as to Mssrs. Reinhard Stiebler, Brad Barlow, and Philipp Bagus for generous assistance in unearthing relevant literature. Many years ago my teacher Hans H. Lechner awakened my interest in the study of monetary policy, as I gratefully acknowledge. While writing the present book, I have been blessed with encouragement from Mr. Llewellyn Rockwell and my colleagues Hans-Hermann Hoppe, Mark Thornton, Jesús Huerta de Soto, Marco Bassani, Pascal Salin, Bertrand Lemennicier, and Philippe Nemo. Finally, I am grateful to Mr. Jeffrey Tucker for his unflagging support, as well as to my dear wife Nathalie for love and friendship while writing this book. Jörg Guido Hülsmann Angers, France August 2007 xi Introduction 1. MONEY PRODUCTION AND JUSTICE T he production of goods and services is not a purely technological matter. It always relies on a legal and moral framework, and feeds back on this framework. A firm or an industry can pursue its activities in a way that confirms and nourishes the basic legal and moral presuppositions of human cooperation; yet it can also, intentionally or unintentionally, contradict and destroy these foundations. Ethical problems of production have been assessed in a great number of industries, ranging from agriculture to textile manufacturing in developing countries to pharmaceuticals. Today only a few important industries have escaped such scrutiny. The most important of these is the production of money. Money is omnipresent in modern life, yet the production of money does not seem to warrant any moral assessment. To be sure, central bank representatives are lecturing the public on the importance of business ethics; but their concerns do not seem to apply to themselves.1 Similarly, the subject of business ethics is in a boom phase on campuses; but it is applied mainly to industrial corporations. And the churches and other religious institutions pronounce on many matters of politics; but monetary phenomena, such as paper money, 1See, for example, Jack Guynn, “Ethical Challenges in a Market Econ- omy” (speech delivered at Bridgewater College, Bridgewater, Virginia, April 11, 2005). The author is the president and CEO of the Federal Reserve Bank of Atlanta. 1 The Ethics of Money Production central banks, dollarization, currency boards, and so on, are hardly mentioned at all. For example, Catholic social teaching only vaguely says that economic activity presupposes a “stable currency”2 and that the “stability of the purchasing power of money [is] a major consideration in the orderly development of the entire economic system.”3 There are very detailed statements of Christian doctrine when it comes to the morals of acquiring and using money; for example, the Christian literature on usury and on the ethics of seeking money for money’s sake is legendary. But important though these problems may be, they are only remotely connected to the moral and cultural aspects of the production of money, and especially to the modern conditions under which this production takes place. Here we face a wide gap. Things are not much better if we turn to the discipline that is supposed to be most concerned about money production, namely, economic science. There are innumerable economic writings on money and banking, but the number of works that are truly helpful in understanding the moral and spiritual issues of money production is rather small. The more recent literature in this field has tended to be especially myopic in regard to our concerns. Monetary economics deals with discount and open-market policies, and with the typical goals of policy-makers, such as price stability, economic growth, full employment, and so on. But it does not usually offer any wider historical, theoretical, and institutional perspective. For example, few textbooks actually address the workings of a gold standard; yet a basic acquaintance with this institution is necessary to 2John Paul II, Centesimus Annus (1991), §§19, 48. 3John XXIII, Mater et Magistra (1961), §129. There is also no entry on our subject in the recent official compilation of documents pertaining to Catholic social doctrine; see Pontifical Council for Justice and Peace, Compendium of the Social Doctrine of the Church (Vatican: Libreria Editrice Vaticana, 2004). 2 Introduction understand the present state of monetary affairs in the Western world, as well as our political options. The same textbooks also tend to suffer from an overly narrow conception of economic analysis, focusing on the relations between a few macroeconomic aggregates, such as the money supply, the price level, and national production. This focus might have a certain pedagogical justification, but it is nevertheless much too restrictive to do justice to our subject. The production of money has an enormous impact on the relationships between human persons and groups such as families and private associations. The rules of money production determine to a large extent the transformation of monetary systems through time.4 All of this is important from a moral and spiritual point of view. Yet it simply vanishes from our intellectual radar screen if we look on money and banking only through macroeconomic spectacles. Finally, few works actually make the step of integrating economic and moral categories. The great bulk of the literature either offers no moral assessment of monetary institutions at all, or it sets out on moral criticism of existing institutions without a thorough grasp of economics. Unfortunately, the latter shortcoming is particularly widespread, even among concerned and well-intentioned theologians and teachers of business ethics. Let us emphasize that this gap concerns most notably the moral aspects of modern monetary institutions—in particular banks, central banks, and paper money. The Bible provides rather clear-cut moral guidance in regard to the production of money in ancient times, in particular with regard to gold and silver coin making.5 Similarly, the medieval scholastics had 4Few works in current literature stress this point. See Angela Redish, Bimetallism—An Economic and Historical Analysis (Cambridge: Cambridge University press, 2000); T.J. Sargent and F.R. Velde, The Big Problem of Small Change (Princeton, N.J.: Princeton University Press, 2002). 5For an overview, see Rousas J. Rushdoony, “Hard Money and Society in the Bible,” in Hans Sennholz, ed., Gold Is Money (Westport, Conn.: Greenwood, 1975). 3 The Ethics of Money Production developed a very thorough moral doctrine dealing with the old ways of making money. The first scientific treatise on money, Nicholas Oresme’s Treatise on the Alteration of Money, made important breakthroughs and is filled with insights that are still relevant in our day.6 Prior to his writings, the teaching office of the Catholic Church had addressed these problems, most notably Pope Innocent III’s Quanto (1199), which denounced debasement of coins made out of precious metals. But then the gap appears as soon as we turn to modern conditions. The old precepts about coin making do not exhaust the problems we confront in the age of paper money. And perhaps we encounter here the main reason why contemporary popes did not follow up on their medieval predecessors with any statement addressing the monetary institutions of our age. In our book we purport to show how high the price of this gap is. Our exposition will be arranged around the economics of money production.7 Adam Smith and many of his followers have 6See Nicholas Oresme, “A Treatise on the Origin, Nature, Law, and Alterations of Money,” in Charles Johnson, ed., The De Moneta of Nicholas Oresme and English Mint Documents (London: Thomas Nelson and Sons, 1956). 7The notion that economic considerations must be taken account of in moral deliberation is not foreign to Christian thought. For a discussion of the scholastic doctrine of “Common Good” and the related problem of scaling values, see Jacob Viner, “Religious Thought and Economic Society,” History of Political Economy 10, no. 1 (Spring 1978): 50–61. The ethical implications of social science—especially economics—have recently been discussed with much vigor in Leland B. Yeager, Ethics as Social Science: The Moral Philosophy of Social Cooperation (Cheltenham, U.K.: Edward Elgar, 2001). The existence of such implications is also recognized and emphasized in Catholic social doctrine. To put the matter in very simple terms: while the general mission of the Church (evangelization) stresses certain universal principles of faith and morals, the application of these principles to concrete problems (such as money production) must also rely on information provided by the social sciences. See Second Vatican Council, Gaudium et Spes, No. 36 (1965); Hervé Carrier, Nouveau regard sur la doctrine sociale de l’église (Vatican: Pontifical 4 Introduction called economics a moral science, and rightly so. Economics not only deals with moral beings—human persons—but it also addresses a great number of questions that have direct moral relevance. In the present case, this concerns most notably the question of whether any social benefits can be derived from the political manipulation of the money supply, or the question of how inflation affects the moral and spiritual disposition of the population. The economics of money production will lead us quite naturally to considerations of a juridical, moral, historical, and political nature. Our goal is not to be exhaustive, but to paint a broad picture in sufficient detail. Accordingly, we will first deal with what we will call the “natural production of money” (Part One) and discuss the ways it can be improved in light of moral considerations. Then we will turn to inflation, the perversion of natural money production (Part Two). Here we will place great emphasis on the difference between two types of inflation. On the one hand, there is private inflation, which springs up spontaneously in any human society, but which is combated by the power of the state. On the other hand, there is fiat inflation, which as its name says actually enjoys the protection of the state and is therefore an institutionalized perversion of money production. In the final part (Part Three) we will then apply these distinctions in a brief analysis of the monetary systems of the West since the seventeenth century. We will argue that natural money production can work; that it has worked wherever it has been tried; and that there are no tenable technical, economic, legal, moral, or spiritual reasons to suppress its operation. By contrast, there are a great number of considerations that prove conclusively the harmful and evil character of inflation. And in our time inflation has become persistent and aggravated because various legal provisions actually protect the monetary institutions that produce this inflation. Council “Justice and Peace,” 1990), pp. 42–44, 200–02 ; Pontifical Council for Justice and Peace, Compendium of the Social Doctrine of the Church, §9, pp. 4–5. 5 The Ethics of Money Production Money production is therefore a problem of justice in a double sense. On the one hand, the modern institutions of money production depend on the prevailing legal order and thus fall within one of the innermost provinces of what has been called social justice.8 On the other hand, the prevailing legal order is itself the very problem that causes perennial inflation. Legal monopolies, legal-tender laws, and the legalized suspension of payments have unwittingly become instruments of social injustice. They breed inflation, irresponsibility, and an illicit distribution of income, usually from the poor to the rich. These legal institutions cannot be justified and should be abolished at once. Such abolition is likely to entail the elimination of the predominant monetary institutions of our age: central banks, paper money, and fractional-reserve banking.9 Yet far from seeing herein merely an act of destruction, 8The concept of social justice has been developed by Luigi Taparelli d’Azeglio, Saggio teoretico di diritto naturale appogiato sul fatto (5 vols., Palermo: Antonio Muratori, 1840–43). Pius XI adopted it for his exposition of Catholic social doctrine in Quadragesimo Anno. He said in particular: The public institutions themselves, of peoples . . . ought to make all human society conform to the needs of the common good; that is, to the norm of social justice. If this is done, that most important division of social life, namely, economic activity, cannot fail likewise to return to right and sound order. (§110) And the man who wrote the first draft of this encyclical emphasized that social justice was supposed to have an impact on economic institutions via the legal framework: “it shall bring about a legal social order that will result in the proper economic order.” Oswald von Nell-Breuning, Reorganization of Social Economy: The Social Encyclical Developed and Explained (Milwaukee: Bruce, 1936), p. 250. For an excellent discussion of social justice see Matthew Habiger, Papal Teaching on Private Property, 1891 to 1991 (Lanham, Md.: University Press of America, 1990), pp. 103–29. 9Fractional-reserve banks do not keep all the money that their cus- tomers deposit with them, but lend a part of the deposit to other people; in most textbooks this is called “bank money creation.” The customer’s bank account is therefore only partially (fractionally) backed by corresponding money under direct control of the bank. Below we will deal with this type of business in more detail. 6 Introduction such an event can be greeted as a restoration of monetary sanity and as a necessary condition for a more humane economy. It is true that these are rather radical conclusions. However, one must not shy away from taking a strong stance in the face of great evil; and great evil is precisely what we confront in the present case. Our goal is not to press a partisan program, however. We seek merely to acquaint the reader with the essential facts needed for a moral evaluation of monetary institutions.10 2. REMARKS ABOUT RELEVANT LITERATURE The argument for natural money production and against inflation goes back many centuries, to the fourteenth century French bishop, Nicholas Oresme.11 Before him, St. Thomas 10A good number of authors who have analyzed the modern problems of money production from a Christian point of view have arrived at very similar conclusions, and did not hold back these views out of any misconceived notion of temperance. Fr. Dennis Fahey started his book quoting from a letter to the Apostolic Delegate in Great Britain. The letter was from the pen of a group of mainly Catholic businessmen and scholars. The authors state that they had “studied the fundamental causes of the present world unrest” and “have long been forced to the conclusion that an essential first step . . . is the immediate resumption by the community in each nation of its prerogative over the issue of money including its modern credit substitutes.” Money Manipulation and Social Order (Dublin: Browne & Nolan, 1944). And Fr. Anthony Hulme concluded his exquisite study quite along the same lines: The work was written to show that there is a problem, to show that the problem is chiefly one of creation of interest bearing debt which is permitted to be used as basis for money, to show the way in which this is permeated by the rights to a return on money lent. (Morals and Money [London: St. Paul Publications, 1957], p. 160) 11On Oresme see in particular Émile Bridrey, La théorie de la monnaie au XIVe siècle, Nicolas Oresme (Paris: Giard & Brière, 1906), Pierre Souffrin and Alain P. Segonds, eds., Nicolas Oresme, Tradition et innovation chez un intellectuel du XIVe siècle (Paris: Les Belles Lettres, 1988); Lucien Gillard, “Nicole Oresme, économiste,” Revue historique 279 (1988); Jeanne Quillet, ed., Autour de Nicole Oresme, Actes du Colloque Oresme organisé à l’Université de Paris XII (Paris : Bibliothèque de l’histoire de la philosophie, 7 The Ethics of Money Production Aquinas and others had considered various aspects of the problem. But none of them had tackled it from a consistent point of view and none of them had presented their ideas in a treatise. There were the beginnings of a doctrine, but this doctrine was scattered throughout the writings of Aquinas, Buridan, and others.12 Oresme’s great achievement was to integrate these previous works, as well as his own penetrating insights, into a treatise—the first treatise on money ever. The great historian of medieval economic thought Victor Brants pointed out that there is certainly merit in assembling such a work. And Brants observed very justly that Oresme was unsurpassed for centuries; he expressed “ideas that were very much on the point, more on the point than those that would dominate long after him.”13 In hindsight we can certainly say that Oresme’s “Treatise” has stood the test of time. Translations into English, German, and French are still in print and 1990); Bertram Schefold, ed., Vademecum zu einem Klassiker der mittelalterlichen Geldlehre (Düsseldorf: Wirtschaft & Finanzen, 1995). Recent surveys of the literature are in J.H.J. Schneider, “Oresme, Nicolas,” Biographisch-Bibliographisches Kirchenlexikon 6 (Nordhausen: Bautz, 1993); and in Hendrik Mäkeler, “Nicolas Oresme und Gabriel Biel: Zur Geldtheorie im späten Mittelalter,” Scripta Mercaturae 37, no. 1 (2003). A recent work stressing the political implications of Oresme’s “Treatise” is C.J. Nederman, “Community and the Rise of Commercial Society: Political Economy and Political Theory in Nicholas Oresme’s De Moneta,” History of Political Thought 21, no. 1 (2000). 12A very thorough study of Aquinas’s monetary thought and its sources of inspiration is in Fabian Wittreck, Geld als Instrument der Gerechtigkeit. Die Geldrechtslehre des Hl. Thomas von Aquin in ihrem interkulturellen Kontext (Paderborn: Schöningh, 2002). More generally on the “School of Paris” (to which Aquinas belonged) see Odd Langholm, Economics in the Medieval Schools: Wealth, Exchange, Value, Money and Usury According to the Paris Theological Tradition, 1200–1350 (Leiden: Brill, 1992). 13In the original: “des idées très justes, plus justes que celles qui dom- inèrent longtemps après lui.” Victor Brants, L’économie politique au Moyen-Age: esquisse des théories économiques professées par les écrivains des XIIIe et XIVe siècles (reprint, New York: Franklin, [1895] 1970), p. 187, footnote 2; and p. 190. 8 Introduction monetary economists all over the world admire the work for its conciseness, clarity, and depth. Later on the case for natural money production and against inflation was taken up and refined in various directions through the writings of the “proto-currency school” branch of the School of Salamanca (Saravia de la Calle, Martín Azpilcueta, Tomás de Mercado).14 Yet none of these authors seems to have produced a treatise that could match Oresme’s earlier work. Another two centuries later, however, economists such as Richard Cantillon, David Hume, Étienne de Condillac, John Wheatley, David Ricardo, and William Gouge published noteworthy contributions on problems of money production.15 These writers had more or less dropped the scholastic 14See Huerta de Soto, “New Light on the Prehistory of the Theory of Banking and the School of Salamanca,” Review of Austrian Economics 9, no. 2 (1996). Modern translations of these writings are not readily available. However, thanks to the Acton Institute, two works of the School of Salamanca have recently been translated and published in English: Juan de Mariana, “A Treatise on the Alteration of Money,” Journal of Markets and Morality 5, no. 2 ([1609] 2002); and Martín de Azpilcueta, “Commentary on the Resolution of Money,” Journal of Markets and Morality 7, no. 1 ([1556] 2004). Since we cannot go into detail, let us merely remark that both works lack the lucidity and penetration that can be found in Oresme’s treatise. Moreover, Azpilcueta’s work does not really deal with money, but with exchange in general and in particular with the concept of just price. It considers monetary problems (such as the distinction between the monetary and nonmonetary use of coins) only to the extent that they affect this concept. To the present author it is a mystery why the original title “comentario resolutorio de cambios” has been rendered as “commentary on the resolution of money.” A literal translation would be “commentary settling problems of the theory of exchange.” 15See Richard Cantillon, La nature du commerce en général (Paris: Insti- tut national d’études démographiques, 1997); David Hume, Essays (Indianapolis: Liberty Fund, 1987); Étienne Condillac, Le commerce et le gouvernement, 2nd ed. (Paris: Letellier, 1795); John Wheatley, The Theory of Money and Principles of Commerce (London: Bulmer, 1807); David 9 The Ethics of Money Production concern for the spiritual dimension of the question, but they pioneered a realistic economic analysis of fractional-reserve banking and paper money. Some of these writings are still in print today and have thus stood the test of time. We do not disparage their merit and their brilliance in noting that they, too, in the new field of banking and paper money, could not quite match the achievement of the old master, Oresme, in the field of commodity money. In our age, the authors who have contributed most to the analysis of our problem were two agnostic Jews, Ludwig von Mises (1881–1973) and Murray N. Rothbard (1926–1995), who in turn were followers of the founder of the Austrian School of economics, Carl Menger (1840–1920).16 Mises integrated the theory of money and banking within the overall theory of subjective value and pioneered a macroeconomic analysis in the realist tradition. In Rothbard’s work, then, the Austrian theory of money found its present apex. Rothbard not only developed Ricardo, Works and Correspondence (Cambridge: Cambridge University Press, 1951–73), vol. 4; William Gouge, A Short History of Paper Money and Banking in the United States (New York: Kelley, 1968). 16See Carl Menger, Grundsätze der Volkswirtschaftslehre (Vienna: Braumüller, 1871); idem, Untersuchungen über die Methode der Socialwissenschaften und der politischen Oekonomie insbesondere (Leipzig: Duncker & Humblot, 1883), pp. 161–78; idem, “Geld” (1892); Ludwig von Mises, Theorie des Geldes und der Umlaufsmittel (Leipzig: Duncker & Humblot, 1912); Human Action (Auburn, Ala.: Ludwig von Mises Institute, [1949] 1998); Nurray N. Rothbard, Man, Economy, and State, 3rd ed. (Auburn, Ala.: Ludwig von Mises Institute, 1993); idem, What Has Government Done to Our Money?, 4th ed. (Auburn, Ala.: Ludwig von Mises Institute, 1990); idem, The Mystery of Banking (New York: Richardson & Snyder, 1983); idem, The Case Against the Fed (Auburn, Ala.: Ludwig von Mises Institute, 1994). See also F.A. Hayek, Free Choice in Currency (London: Institute of Economic Affairs, 1976); Henry Hazlitt, The Inflation Crisis and How to Resolve It (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, [1978] 1995); Hans Sennholz, Age of Inflation (Belmont, Mass.: Western Islands, 1979); idem, Money and Freedom (Spring Mills, Penn.: Libertarian Press, 1985). Among the earlier noteworthy contributions to the Austrian theory of money and banking see in particular Fritz Machlup, Die Goldkernwährung (Halberstadt: Meyer, 1925); F.A. Hayek, Monetary Nationalism and International Stability (New York: Kelley, [1937] 1964). 10 Introduction and refined the doctrine of his teacher Mises; he also brought ethical concerns back into the picture, stressing natural-law categories to criticize fractional-reserve banking and paper money. Our work is squarely built on the work of these two writers. Important living authors in this tradition are Pascal Salin, George Reisman, and Jesús Huerta de Soto.17 The affinity between Austrian School economics and the scholastic tradition is fairly well known among experts.18 The 17See in particular Pascal Salin, La vérité sur la monnaie (Paris: Odile Jacob, 1990); George Reisman, Capitalism (Ottawa, Ill.: Jameson Books, 1996); Jesús Huerta de Soto, Money, Bank Credit, and Economic Cycles (Auburn, Ala.: Ludwig von Mises Institute, 2006). See also Mark Skousen, Economics of a Pure Gold Standard, 3rd ed. (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1996); Walter Block, “Fractional Reserve Banking: An Interdisciplinary Perspective,” Walter Block and Llewellyn H. Rockwell, Jr., eds., Man, Economy, and Liberty (Auburn, Ala.: Ludwig von Mises Institute, 1988); Hans-Hermann Hoppe, The Economics and Ethics of Private Property (Boston: Kluwer, 1993), chap. 3; idem, “How Is Fiat Money Possible?—or, The Devolution of Money and Credit,” Review of Austrian Economics 7, no. 2 (1994); Hans-Hermann Hoppe, Jörg Guido Hülsmann, and Walter Block, “Against Fiduciary Media,” Quarterly Journal of Austrian Economics 1, no. 1 (1998): 19–50; Jörg Guido Hülsmann, Logik der Währungskonkurrenz (Essen: Management Akademie Verlag, 1996); special issue on “L’Or, fondement monétaire du commerce international” in Le point de rencontre—libéral et croyant, vol. 49 (October 1996); special issue on “Deflation and Monetary Policy” in Quarterly Journal of Austrian Economics 6, no. 4 (2003). 18It is indeed more than a mere affinity. Rothbard and Huerta de Soto have explored the historical roots of Austrian economics in the economic writings of the late-scholastic School of Salamanca. See Murray Rothbard, “New Light on the Prehistory of the Austrian School,” Edwin Dolan, ed., The Foundations of Modern Austrian Economics (Kansas City: Sheed & Ward, 1976), pp. 52–74; idem, Economic Thought Before Adam Smith (Cheltenham, U.K.: Edward Elgar, 1995), chap. 4; Alejandro Chafuen, Faith and Liberty: The Economic Thought of the Late Scholastics, 2nd ed. (New York: Lexington Books, 2003); Jesús Huerta de Soto, “New Light on the Prehistory of the Theory of Banking and the School of Salamanca”; idem, “Juan de Mariana: The Influence of the Spanish Scholastics,” Randall Holcombe, ed., 15 Great Austrian Economists (Auburn, Ala.: Ludwig von Mises Institute, 1999). See also Jean-Michel Poughon, “Les fondements juridiques de l’économie politique,” Journal des Économistes 11 The Ethics of Money Production modern Austrian School distinguishes itself by a quest for realism that pervades both its arguments and the problems it deals with. Much more so than any other present-day paradigm in economic science, its cognitive approach and its practical conclusions are in harmony with the scholastic tradition. One historian of economic thought characterized the scholastic approach to the analysis of economic phenomena in the following words: they did not examine an economic problem as an autonomous phenomenon, consisting of measurable variables, but only as an adjunct of the social and spiritual order and in the context of the cura animarum, the care of souls.19 Austrians share the scholastic belief that there is no such thing as an economic science dealing with autonomous variables. Economic problems are aspects of larger social phenomena; et des Études Humaines 1, no. 4 (1990). On the School of Salamanca, see in particular Marjorie Grice-Hutchinson, The School of Salamanca (Oxford: Clarendon Press, 1952); Wilhelm Weber, Geld und Zins in der spanischen Spätscholastik (Münster: Aschendorff, 1962); Ramon Tortajada, “La renaissance de la scolastique, la Réforme et les théories du droit naturel,” A. Béraud and G. Faccarello, eds., Nouvelle histoire de la pensée économique (Paris: La Découverte, 1992), vol. 1, chap. 2. 19Julius Kirshner, “Raymond de Roover on Scholastic Economic Thought,” introduction to R. de Roover, Business, Banking, and Economic Thought in Late Medieval and Early Modern Europe (Chicago: University of Chicago Press, 1974), p. 21. Kirshner’s teacher, de Roover, stated: The great difference between scholastics and contemporary economics is one of scope and methodology: the Doctors approached economics from a legal point of view. They attached excessive importance to formalism, so that the study of economics nearly reduced itself to an investigation into the form and nature of contracts. (Ibid., p. 21) At the end of the present work, the reader will be in a better position to judge the extent to which this approach is “excessive” or justifiable in the light of useful results. 12 Introduction and it is most expedient to deal with them as such, rather than to analyze them in some twisted separation.20 Not surprisingly, Austrian economics has inspired the few viable modern contributions to the moral analysis of money production. Apart from Rothbard’s works, we need to mention in particular Bernard Dempsey’s Interest and Usury (1943). From the pen of a trained Thomist philosopher and economist, this book is a path-breaking contribution to the moral analysis of fractional-reserve banking and thus covers some of the ground of our present study. Dempsey has shown that economic analysis can be successfully blended with the scholastic philosophical tradition into something like the natural theology of money and banking. The reason is that “there is no irreconcilable conflict of basic principle; both parties proceed from truths known from natural reason alone.”21 Two decades later, Friedrich Beutter undertook a systematic moral assessment of inflation in our time and came to 20In a brilliant essay, the Lutheran theologian Wilhelm Kasch has argued that the present-day separation of monetary theory and theology has harmed both disciplines. It has driven theology toward a gnostic denial of the world; and it has turned monetary theory into a narrow auxiliary discipline of central-bank policy. Kasch points out that monetary theory, precisely because it is so narrowly conceived, is in the process of misunderstanding its subject matter and losing any scientific foundation, turning itself into a barren intellectual game. See Wilhelm Kasch, “Geld und Glaube. Problemaufriß einer defizitären Beziehung,” idem, ed., Geld und Glaube (Paderborn: Schöningh, 1979). This problem persists to the present day. The discussion of the theological and moral aspects of money production typically revolves around the—vague—central-bank objective of monetary stability. See for example H. Hesse and O. Issing (eds.), Geld und Moral (Munich: Vahlen, 1994). 21Dempsey, Interest and Usury (Washington, D.C.: American Council of Public Affairs, 1943), p. 116; see also pp. 1–6. Based on this work, Fr. Dempsey received his Ph.D. in economics at Harvard under Schumpeter. On Dempsey’s economics see Stephen D. Long, “Bernard Dempsey’s Theological Economics: Usury, Profit, and Human Fulfillment,” Theological Studies 12, no. 1 (1996); idem, Divine Economy: Theology and the Market (London: Routledge, 2000), pp. 195–214; John T. Noonan, The Scholastic Analysis of Usury (Cambridge, Mass.: Harvard University Press, 1957), pp. 403–06. 13 The Ethics of Money Production conclusions very much akin to those of Nicolas Oresme. He argued that inflation, in principle, is morally evil and that it could only be licit to overcome ”epochal” conflicts and crises.22 In our day, Thomas Woods has brilliantly argued that Austrian economics on the one hand and Christian morals— Catholicism in particular—on the other hand are fully compatible. In The Church and the Market (2005), he gives a concise statement of the Austrian analysis of the labor market, of money and banking, of foreign aid, and of the welfare state; and he shows that this analysis provides crucial information for an adequate moral assessment of the market economy and of government interventionism. Unfortunately, these works have been rather exceptional. During most of the past 150 years, Christian writers, and Catholic intellectuals in particular, have been quarreling with the economic institutions of the modern world; and this uneasy relationship had ample foundations in fact, as we will see in more detail. But whereas these thinkers refused to make peace with the secular world, they fatefully made their peace with pro-inflation doctrines that became fashionable again during the Great Depression. And this in turn vitiated their moral assessment of modern monetary institutions. A good case in point is Anthony Hulme’s book Morals and Money. Truly excellent in its exposition of what the Bible and the Christian moral tradition have to say about money, it also endorses age-old mercantilist fallacies about the workings of money within the economy. Hulme believes that the money supply has to grow along with output and that the slowing down of aggregate spending is disadvantageous, as is hoarding, deflation, and the diversion of spending streams into financial markets. This leads him straight to the conclusion that “our currency needs to be managed.”23 He deplores the inflation produced by fractional-reserve banks, but not 22See Friedrich Beutter, Zur sittlichen Beurteilung von Inflationen (Freiburg: Herder, 1965), pp. 173, 178–79. 23Hulme, Morals and Money, p. 71. 14 Introduction because it is inflationary (after all he believes that inflation is necessary), but because it benefits private agents. The solution to present-day monetary calamities is not to abolish the institutions of inflation root and branch, but to hand the inflation machine over to elected politicians.24 In short, misconceptions about the economic role of the money supply have vitiated the efforts of scholars to develop a cogent moral assessment of modern monetary institutions. We will therefore discuss the crucial question whether there are any social benefits to be derived from the manipulation of the natural production of money in a special chapter (chap. 4) of the present work. Another group of noteworthy studies integrating moral concerns and Austrian economics comes from the pen of evangelical scholars who call themselves “Christian Reconstructionists.” In particular, Gary North’s Honest Money (1986) brilliantly combines biblical exposition and economics. Any serious attempt to come to grips with money and banking from a moral point of view must take account of the arguments presented in North’s work.25 24The same characteristic set of ideas (acceptance of the basic case for inflation; therefore only rejection of “private” fractional-reserve banking, while endorsement of “public” fiat paper money) can be identified in all major Catholic authors until the early post-war period. See for example, Fathers Francis Drinkwater, Money and Social Justice (London: Burns, Oates & Washbourne, 1934); Charles Coughlin, Money! Questions and Answers (Royal Oak, Mich.: National Union for Social Justice, 1936); and Dennis Fahey, Money Manipulation and Social Order (1944); Oswald von Nell-Breuning and J. Heinz Müller, Vom Geld und vom Kapital (Freiburg: Herder, 1962). A critique of Coughlin and Fahey is in Thomas Woods, The Church and the Market (Lanham, Md.: Lexington Books, 2005), pp. 106–09. Hilaire Belloc and John Ryan maintained similar economic views as Coughlin and Fahey. For a present-day work of this orientation see Joseph Huber and James Robertson, Creating New Money (London: New Economics Foundation, 2000). 25This should not be taken as an all-out endorsement of North’s more general enterprise of developing a “Christian economics.” The present author does not believe that there is such a discipline, just as there is no Bolshevist mathematics or Muslim quantum physics. 15 The Ethics of Money Production Other authors have argued along similar lines, yet without attaining the level of sophistication displayed in North.26 Money and banking are fascinating subjects. They have attracted a panoply of writers who have neither the knowledge nor the intellectual ability to master this field. The quantitative dominance of these poor writings might have contributed to throwing the entire enterprise of integrating ethics and monetary economics into disrepute. But there is also another strong mechanism at work that helps account for the dearth of scholarship along these lines: professional and institutional bias. The general thrust of the above-mentioned works is to cast serious doubts on the necessity and expediency of the government-sponsored production of money through central banks and monetary authorities. The authors argue that money and banking should best be subject to the general stipulations of the civil law. The government should not run or supervise banks and the production of paper money. Its essential mission is to protect property rights, especially the property of bank customers; any further involvement produces more harm than good. Now it is one of the home truths of the economics profession that virtually all of its members are government employees. Even more to the point, a great number of monetary economists are employees of central banks and other monetary authorities; and even those monetary economists who are “only” regular professors at state universities derive considerable prestige, and sometimes also large chunks of their income, from research conducted on behalf of monetary authorities. 26Among the better works of this group we might mention Howard Kershner’s God, Gold, and Government (Englewood Cliffs, N.J.: PrenticeHall, 1957), R.J. Rushdoony’s Institutes of Biblical Law (Nutley, N.J.: Craig Press, 1973) and The Roots of Inflation (Vallecito, Calif.: Ross House Books, 1982), Ian Hodge’s Baptized Inflation (Tyler, Texas: Dominion Press, 1986), and Tom Rose’s God, Gold, and Civil Government (2002). See also Roland Baader, Geld, Gold und Gottspieler (Gräfelfing: Resch, 2004). 16 Introduction Economists relish in pointing out the importance of economic incentives in the determination of human behavior. While virtually no section of society has escaped their scathing criticism, until very recently few of them have been concerned about their own incentives. Yet the facts are plain: championing government involvement in money and banking pays the bills; promoting the opposite agenda shuts the doors to an academic career. No consistent economist could expect monetary economists to lead campaigns against central banks and paper money.27 He who acquaints himself with the modern scientific literature on money and banking must not close his eyes to these facts. 27See Lawrence H. White, “The Federal Reserve System’s Influence on Research in Monetary Economics,” Econ Journal Watch 2, no. 2 (2005): pp. 325–54. Significantly, the only recent successful campaign for monetary reform that was led by professional economists had to avoid the involvement of “experts” employed with monetary authorities. When Fritz Machlup, Milton Friedman, and others prepared the reform of the Bretton Woods system in the late 1960s, they studiously excluded any intellectuals employed by or affiliated with the IMF. Institutional backing came from outside the monetary establishment, namely, from the American Enterprise Institute. The movement eventually rallied in the town of Bürgenstock in Switzerland. See the eyewitness account of one of the members of the Bürgenstock Group in Wolfgang Kaspers, “The Liberal Idea and Populist Statism in Economic Policy: A Personal Perspective,” Hardy Bouillon, ed., Do Ideas Matter? Essays in Honour of Gerard Radnitzky (Brussels: Centre for the New Europe, 2001), p. 118. 17 Part 1 The Natural Production of Money 1 Monies 1. THE DIVISION OF LABOR WITHOUT MONEY T o understand the origin and nature of money, one must first consider how human beings would cooperate in a world without money—in a barter world. Exchanging goods and services in such a barter world confronts the members of society with certain problems. They then turn to monetary exchanges as a means for alleviating these problems. In short, money is a (partial) solution for problems of barter exchanges. But let us look at this in just a little more detail. The fundamental law of production is that joint production yields a greater return than isolated production. Two individuals working in isolation from one another produce less physical goods and services than if they coordinated their efforts. This is probably the most momentous fact of social life. Economists such as David Ricardo and Ludwig von Mises have stressed its implication: even if there are no other reasons for human beings to cooperate, the greater productivity of joint efforts tends to draw them together. The higher productivity of the division of labor, as compared to isolated production, is therefore the basis of a general “law of association.”1 1David Ricardo first formulated this law as a law of comparative cost within the context of the theory of foreign trade. Later economists such as Pareto, Edgeworth, Seligman, and Mises argued that it was in fact a general law of exchange. Mises coined the expression “law of association.” 21 The Ethics of Money Production Without money, people would exchange their products in barter; for example, Jones would barter his apple against two eggs from Brown. In such a world, the volume of exchanges— in other words, the extent of social cooperation—is limited through technological constraints and through the problem of the double coincidence of wants. Barter exchanges take place only if each trading partner has a direct personal need for the good he receives in the exchange. But even in those cases in which the double coincidence of wants is given, the goods are often too bulky and cannot be subdivided to accommodate them to the needs. Imagine a carpenter trying to buy ten pounds of flour with a chair. The chair is far more valuable than the flour, so how can an exchange be arranged? Cutting the chair into, say, twenty pieces would not provide him with objects that are worth just one twentieth of the value of a chair; rather such a “division” of the chair would destroy its entire value. The exchange would therefore not take place. 2. THE ORIGIN AND NATURE OF MONEY These problems can be reduced through what has been called “indirect exchange.” In our example, the carpenter could exchange his chair against 20 ounces of silver, and then buy the ten pounds of flour in exchange for a quarter ounce of silver. The result is that the carpenter’s need for flour, which otherwise would have remained unsatisfied, is now satisfied through an additional exchange and the use of a “medium of exchange” (here: silver). Thus indirect exchange provides our carpenter with additional opportunities for cooperation with other human beings. It extends the division of labor. And it thereby contributes to the material, intellectual, and spiritual advancement of each person. In the history of mankind, a great variety of commodities—cattle, shells, nails, tobacco, cotton, copper, silver, gold, See David Ricardo, Principles of Political Economy and Taxation (London: Penguin, 1980), chap. 7, footnote; Ludwig von Mises, Socialism (Indianapolis, Ind.: Liberty Fund, 1981), pp. 256–61; idem, Nationalökonomie (Geneva: Union, 1940), pp. 126ff.; idem, Human Action (Auburn, Ala.: Ludwig von Mises Institute [1949] 1998), pp. 158–63. 22 Monies and so on—have been used as media of exchange. In the most developed societies, the precious metals have eventually been preferred to all other goods because their physical characteristics (scarcity, durability, divisibility, distinct look and sound, homogeneity through space and time, malleability, and beauty) make them particularly suitable to serve in this function. When a medium of exchange is generally accepted in society, it is called “money.” How does a commodity such as gold or silver turn into money? This happens through a gradual process, in the course of which more and more market participants, each for himself, decide to use gold and silver rather than other commodities in their indirect exchanges. Thus the historical selection of gold, silver, and copper was not made through some sort of a social contract or convention. Rather, it resulted from the spontaneous convergence of many individual choices, a convergence that was prompted through the objective physical characteristics of the precious metals. To be spontaneously adopted as a medium of exchange, a commodity must be desired for its nonmonetary services (for its own sake) and be marketable, that is, it must be widely bought and sold. The prices that are initially being paid for its nonmonetary services enable prospective buyers to estimate the future prices at which one can reasonably expect to resell it. The prices paid for its nonmonetary use are, so to speak, the empirical basis for its use in indirect exchange. It would be extremely risky to buy a commodity for indirect exchange without knowing its past prices; as a consequence, the spontaneous emergence of a medium of exchange is virtually impossible whenever such knowledge is lacking. On the other hand, when it exists, then there can arise a monetary demand for the commodity in question. The monetary demand then adds to the original nonmonetary demand, so that the price of the money-commodity contains a monetary component and a nonmonetary component. Although in a developed economy the former is likely to outweigh the latter quite substantially, it is important to keep in mind that the monetary use of a commodity ultimately depends on its nonmonetary use. The medieval scholastics called money a res fungibilis et primo usu 23 The Ethics of Money Production consumptibilis.2 It was in the very nature of money to be a marketable thing that had its primary use in consumption. 3. NATURAL MONIES We may call any kind of money that comes into use by the voluntary cooperation of acting persons “natural money.”3 To cooperate voluntarily in our definition means to provide mutual support without any violation of other people’s property, and to enjoy the inviolability of one’s own property.4 2A thing that is fungible and primarily used in consumption. See Oswald von Nell-Breuning, “Geld,” Lexikon für Theologie und Kirche, 2nd ed. (Freiburg: Herder, 1960), vol. 4, p. 633. This insight was anticipated in Aristotle’s Politics, book 1, chap. 9, who placed great emphasis on the fact that people make money out of a thing that is one of the most useful things anyway, and which can be most conveniently handled. The same point was later a staple of economic thought. See in particular, John Law, Money and Trade Considered etc. (Edinburgh: Anderson, 1705), chap. 1; Adam Smith, Wealth of Nations (New York: Modern Library, 1994), bk. 1, chap. 4, pp. 24–25; Carl Menger, Grundsätze der Volkswirtschaftslehre (Vienna: Braumüller, 1871), chap. 8, p. 253; Ludwig von Mises, Theory of Money and Credit (Indianapolis: Liberty Fund, 1980), chap. 1, p. 44. 3The concept of natural money is not much used in the contemporary literature, but it has a venerable tradition in economics. See for example William Gouge, A Short History of Paper Money and Banking (reprint, New York: Augustus M. Kelley, [1833] 1968), pp. 7–17, where the author speaks of “real money”; Frédéric Bastiat, “Maudit Argent,” Journal des économistes (April 1849); appeared in translation in Quarterly Journal of Austrian Economics 5, no. 3 (2002); idem, Harmonies économiques, 2nd ed. (Paris: Guillaumin, 1851), chap. 1 on natural and artificial organization; and Angel Rugina, Geldtypen und Geldordnungen (Stuttgart: Kohlhammer, 1949), pp. 46–47. See also Carlo Lottieri, Denaro e comunità (Naples: Alfredo Guida, 2000), pp. 72ff. 4See Mises, Human Action, chaps. 8 and 15; Murray N. Rothbard, The Ethics of Liberty, 2nd ed. (New York: New York University Press, 1998); Hans-Hermann Hoppe, A Theory of Socialism and Capitalism (Boston: Kluwer, 1989); idem, The Economics and Ethics of Private Property (Boston: Kluwer, 1993); idem, Democracy—The God That Failed (New Brunswick, N.J.: Transaction, 2001). 24 Monies The role of private property as a fundamental institution of human society is of course a staple of historical experience and social science. It is also a staple of Christian social thought, rooted in the Sixth and Ninth Commandments. Within the Catholic Church, the popes emphasized that private property must be held inviolable, not out of any juridical dogmatism in favor of the well-to-do, but because they perceived such inviolability to be the first condition to improve the living standards of the masses.5 They upheld this notion knowing full well that property owners are often bad stewards of their assets. They upheld it even in the cases in which the owners do not, as a matter of fact, use their private means to promote the good of all of society. And they upheld it in those cases in which the owners did not even have the slightest intention to pursue the common good. In short, the popes championed the distinction between justice and morals— between the right to own property and the moral obligation to make good use of this property.6 A violation of one’s moral obligation could not possibly justify the slightest infringement of property rights. Private property is sacred even if it is abused or not used: That justice called commutative commands sacred respect for the division of possessions and forbids invasion of others’ rights through the exceeding of the limits of one’s own property; but the duty of owners to use their property only in a right way does not come under this type of justice, but 5Pope Leo XIII wrote: “The first and most fundamental principle, there- fore, if one would undertake to alleviate the condition of the masses, must be the inviolability of private property” (Rerum Novarum, §§11, 15). His successors have similarly emphasized the moral character of private property. For example, John XXIII stated that “private ownership must be considered as a guarantee of the essential freedom of the individual, and at the same time an indispensable element in a true social order” (Mater et Magistra, §111). 6See on this distinction Thomas Aquinas, Summa theologica, IIa–IIae, q. lxvi, art. 2, answer; Leo XIII, Rerum Novarum, §22. 25 The Ethics of Money Production under other virtues, obligations of which ‘cannot be enforced by legal action.’ Therefore, they are in error who assert that ownership and its right use are limited by the same boundaries; and it is much farther still from the truth to hold that a right to property is destroyed or lost by reason of abuse or non-use.7 In the case of a society in which private property is inviolable, we may speak of a “completely free society” and its economic aspect may then be called a “free market” or a “free economy.” Such an economy, if perfected by charity, truly promotes “economic and civil progress.”8 The monetary corollary of such a society is, as we have said, natural money—or rather all the different natural monies that would exist in such a society, for there are good reasons to assume that a free society would harbor a variety of different monies, which would all be natural monies in our sense. Notice that natural money is an eminently social institution. This is so not only in the sense that it is used in interpersonal exchanges (all monies are so 7Pius XI, Quadragesimo Anno, §47. He is quoting Leo XIII’s encyclical Rerum Novarum. Generally speaking, the Catholic attitude toward property has two characteristic features. First, each property owner is morally commanded to use his property as though it were the property of all. Middle-class Christians should use their property with “liberality” and rich Christians should use it with “magnificence.” See Summa theologica, II–II, q. 66, a. 2, ad 3, and II–II, q. 134, a. 2 and a. 3. Second, private property rights are derived from a “fundamental property right”— the fact that God destined the earth to serve all of mankind. See Rerum Novarum, §§7 and 8; Gaudium et Spes, §69. Austrian economists have placed great emphasis on the fact that private property in the means of production has much more beneficial social effects than coerced communal ownership. See in particular Mises, Socialism, pp. 27–32. In other words, the destination of the means of production to serve the broad masses is an built-in feature of a free economy. On property rights in Christian dogma, see John Paul II, Centesimus Annus, §§30–43; see also Matthew Habiger, Papal Teaching on Private Property, 1891 to 1991 (New York: University Press of America, 1990); Pontifical Council for Justice and Peace, Compendium of the Social Doctrine of the Church §171–84, pp. 96–104. 8John Paul II, Centesimus Annus, §42. 26 Monies used), but also in the sense that they owe their existence exclusively to the fact that they satisfy human needs better than any other medium of exchange. As soon as this is no longer the case, the market participants will choose to discard them and adopt other monies. This freedom of choice assures, so to speak, a grass-roots democratic selection of the best available monies—the natural monies. Where property rights are violated, especially where they are violated in a systematic manner, we may no longer speak of a completely free society. It is possible that natural monies would still be used in such societies, namely, to the extent that the violations of property rights do not concern the choice of money. But wherever people are not free to choose the best available monies, a different type of money comes into existence—”forced money.” Its characteristic feature is that it owes its existence to violations of property rights. It is used, at least to some extent, because superior alternative monies cannot be used without exposing the user to violence. It follows that such monies are tainted from a moral point of view. They may still be beneficial and used in indirect exchanges, but they are in any case less beneficial than natural monies, because they owe their existence to violations of private property, rather than to their relative superiority in satisfying human needs alone. Gold, silver, and copper have been natural monies for several thousand years in many human societies. The reason is, as we have said, that their physical characteristics make them more suitable to serve as money than any other commodities. Still we call them natural monies, not because of their physical characteristics, but because free human beings have spontaneously selected them for that use. In short, one cannot tell on a priori grounds what the natural money of a society is. The only way to find this out is to let people freely associate and choose the best means of exchange out of the available alternatives. Looking at the historical record we notice that, at most times and most places, people have chosen silver. Gold and copper too have been used as monies, though to a lesser extent. 27 The Ethics of Money Production 4. CREDIT MONEY Natural money must possess two qualities. It must first of all be valuable prior to its monetary use, and it must furthermore be physically suitable to be used as a medium of exchange (at any rate more suitable than the alternatives). The historical monies we have mentioned so far derive their prior value from their use in consumption. Even in the case of the precious metals this is so. It is true that they are not destroyed in consumption, as for example tobacco and cotton, but they are nevertheless consumed as jewelry, ornament, and in a variety of industrial applications. Now there are other monies that do not derive their prior value from consumption. The most important cases are paper money and electronic money, to which we will turn below. But there is also credit money, the subject of the current section. As the name says, credit money comes into being when financial instruments are being used in indirect exchanges. Suppose Ben lends 10 oz. of silver to Mike for one year, and that in exchange Mike gives him an IOU (I owe you). Suppose further that this IOU is a paper note with the inscription “I owe to the bearer of this note the sum of 10 oz., payable on January 1, 2010 (signature).” Then Ben could try to use this note as a medium of exchange. This might work if the prospective buyers of the note will also trust Mike’s declaration to pay back the credit as promised. If Mike’s reputation is good with certain people, then it is likely that these people will accept his note as payment for their goods and services. Mike’s IOU then turns into credit money. Credit money can never have a circulation that matches the circulation of the natural monies. The reason is that it carries the risk of default. Cash exchanges provide immediate control over the physical money. But the issuer of an IOU might go bankrupt, in which case the IOU would be just a slip of paper. Not surprisingly, therefore, credit money has reached wider circulation only when the credit was denominated in terms of some commodity money, when the reputation of the issuer was beyond doubt, and when it was the only way to 28 Monies quickly provide the government with the funds needed to conduct large-scale war. This was for example the case with the American Continentals that financed the War of Independence and with the French assignats that financed the wars of the French revolutionaries against the rest of Europe. In the early days, credit money had also been issued in other forms than paper. In particular, IOUs made out of leather have been repeatedly used as money starting in the ninth century.9 Credit money is only a derived kind of money. It receives its value from an expected future redemption into some commodity. In this respect it crucially differs from paper money, which is valued for its own sake. And this brings us to the next topic. 5. PAPER MONEY AND THE FREE MARKET So far we have singled out the precious metals to illustrate our discussion because, historically, the precious metals have been the money of the free market, and also because to the present day no other commodities seem to be more suitable to be used as media of exchange. But the contention that gold, silver, and copper are the best available monies seems to be contradicted by the fact that, today, there is virtually no country in the world that uses precious metals as monies. Rather, all countries use paper monies.10 This universal practice seems to have a ready explanation in the observation that paper money is even more advantageous than the precious metals, for at least three reasons: (1) its costs of production are 9See Rupert J. Ederer, The Evolution of Money (Washington, D.C.: Public Affairs Press, 1964), pp. 92–93; Elgin Groseclose, Money and Man: A Survey of Monetary Experience (New York: Frederick Ungar, 1961), p. 119. 10Paper money must not be confused with credit money made out of paper, or with money certificates made out of paper. The latter can be redeemed into commodity money; the former cannot. Note that economists have used the expression “paper money” both in the narrow sense in which we use it here and in a larger sense, which covers paper money in the narrow sense as well as credit money and paper certificates for money. 29 The Ethics of Money Production far lower; (2) its quantity can be easily modified to suit the needs of trade; and (3) its quantity can be easily modified to stabilize the value of the money unit. Before we turn to analyzing these alleged advantages in more detail, we have to deal with the even more fundamental question of whether paper money is a market phenomenon in the first place. Does it owe its existence to the free choice of the money users, or to legal privileges? If the former is the case, there seems to be no fault with paper money—quite to the contrary. But if it exists only due to compulsion and coercion; that is, due to violations of property rights—its alleged advantages must be examined very carefully. Now if we turn to the empirical record, we confront the stark fact that, in no period of human history, has paper money spontaneously emerged on the free market.11 No Western writer before the eighteenth century seems to have even considered that the existence of paper money was possible. The idea arose only when paper certificates for gold and silver gained a larger circulation, especially in the context of largescale government finance.12 In the eighteenth, nineteenth, and twentieth centuries, various experiments with paper money 11A good overview is in John E. Chown, A History of Money (London: Routledge, 1994), part 3. See also George Selgin, “On Ensuring the Acceptability of a New Fiat Money,” Journal of Money, Credit, and Banking 26 (1994); Kevin Dowd, “The Emergence of Fiat Money: A Reconsideration,” Cato Journal 20, no. 3 (2001). Note again that paper money must not be confused with credit money. 12Note that the Bank of England was established in 1694, a few years after the creation of the Bank of Sweden. Probably it was the French philosopher Montesquieu who first held that a pure “sign money,” or, as he called it, “ideal money” was possible. See Charles de Montesquieu, De l’esprit des lois (Paris: Gallimard/Pléiade, 1951), book 22, chap. 3, p. 653. However, he thought that anything but “real money” (commodity money) would invite abuses, an opinion shared by many later illustrious economists such as David Ricardo and Ludwig von Mises. An exception was James Steuart, who actually endorsed a pure “money of account.” See James Steuart, An Inquiry Into the Principles of Political Economy (London: Millar & Cadell, 1767), book 3, chap. 1. 30 Monies have taken place in the West.13 Governments have issued paper money along with the legal obligation for each citizen to accept it as legal tender. They overrode the stipulations made in private contracts and forced creditors, say, to accept payments in paper “greenbacks” rather than in gold or silver. In most cases, however, governments have transformed previously existing paper certificates for gold and silver into paper money by outlawing the use of gold and silver, and of all other suitable commodities and certificates. The experience of other cultures and times tells the same story. Paper money had been introduced in China in the twelfth century, equally through compulsion and coercion by the ruler.14 In all known historical cases, paper money has come into existence through government-sponsored breach of contract and other violations of private-property rights. It has never been a creature of the free market. The historical record does not of course provide a decisive verdict on the question whether paper money can spontaneously emerge on a free market. Can we settle the issue on theoretical grounds? Here the following consideration comes into play. By its very nature, paper money provides only monetary services, whereas commodity money provides two kinds of services: monetary and commodity services. It follows that the prices paid for paper money can shrink to zero, whereas the price of commodity money, will always be positive as long as it attracts a nonmonetary demand. If the prices paid for a paper money fall to zero, then this money can never be re-monetized again, because short of an already-existing 13It is still useful to read contemporary analyses of these events. See for example William Gouge, A Short History of Paper Money and Banking in the United States, part 2; Adolph Wagner, Die russische Papierwährung (Riga: Kymmel, 1868), chap. 8, pp. 116–80; Karl Heinrich Rau, Grundsätze der Volkswirtschaftslehre, 7th ed. (Leipzig & Heidelberg: Winter, 1863), §310–17, pp. 391–415; William Graham Sumner, History of Banking in the United States (New York: Augustus M. Kelley, [1896] 1971). 14See Jonathan Williams et al., Money: A History (London: Palgrave Macmillan, 1998), chap. 6. 31 The Ethics of Money Production price system the market participants could not evaluate the money unit. Thus the use of paper money carries the risk of total and permanent value annihilation. This risk does not exist in the case of commodity money, which always carries a positive price and which can therefore always be re-monetized. It does not take much fantasy to predict the practical implications of this fact. In a truly free market, paper money could not withstand the competition of commodity monies. The more farsighted and prudent market participants would get rid of their paper money first, and the others would follow in due course. At the end of this process, which could be consummated in but a few seconds, but which could conceivably also last a few years, the paper currency would be completely eradicated.15 The preceding analysis leads to the conclusion that no money can remain in circulation only because it has been in circulation up to now. The ultimate source of its value—the rock bottom of its value—must be something else than the mere fact that, so far, people have been willing to accept it.16 All kinds of psychological motivations might provide such a source for a while, but they will all collapse under the pressure of a substitution process of the kind we have described above. What then? Can the armed power of the government keep money in circulation? The government’s fiat can indeed confer value on paper money—the value of not getting into trouble with the police.17 But this observation only confirms 15See Hülsmann, Logik der Währungskonkurrenz (Essen: Management Akademie Verlag, 1996), pp. 260–74, 307. 16See Benjamin Anderson, The Value of Money (reprint, Grove City, Penn.: Libertarian Press, [1917]), chap. 7 “Dodo-Bones,” p. 125. 17Georg Holzbauer argued that the value of paper money was ulti- mately rooted in the fact that the government forces its citizens to use those paper slips to pay taxes. It thus had a “tax foundation.” See Georg Holzbauer, Barzahlung und Zahlungsmittelversorgung in militärisch besetzten Gebieten (Jena: Fischer, 1939), pp. 85–87. For a similar argument see Yuri Kuznetsov, “Fiat Money as an Administrative Good,” Review of Austrian Economics 10, no. 2 (1997): 111–14. 32 Monies our point that paper money is not a market phenomenon. It cannot flourish in the fresh air of a free society. It is used only when police power suppresses its competitors, so that the members of society are given the stark choice of either using the government’s paper money or forgoing the benefits of a monetary economy altogether.18 6. ELECTRONIC MONEY The preceding observations can be directly applied to the case of electronic money. An economic good that is defined entirely in terms of bits and bytes is unlikely ever to be produced spontaneously on a free market, for the very same reasons that we just discussed in the case of paper money. And despite the dedicated efforts of various individuals and associations, no such money has in fact ever been produced since the creation of the Internet made electronic payments possible. At present, only government money has been produced in electronic form; and as in the case of paper money, governments could do this only because they have the possibility to suppress competition. On the free market, the new information technologies have been unable to create any new monies. They have been able to develop various new instruments to access and transfer money. These new electronic techniques of dealing with money are very efficient and beneficial, but they must not be confused with the creation of electronic money. 18Below we will examine whether fiat paper money is viable in the long run, and how it stands up to moral standards. 33 2 Money Certificates 1. CERTIFICATES PHYSICALLY INTEGRATED WITH MONEY T he precious metals would have become monies even if coinage had never been invented, because even in the form of bullion their physical advantages outweigh those of all alternatives. There is however no doubt that coinage added to the benefits derived from indirect exchange, and that it therefore contributed to the spreading of monetary exchanges. Coinage allows the exchange of precious metals without engaging in the labor-intensive processes of weighing the metal and melting it down. One can determine a metal weight by simply counting the coins.1 Coinage endows a mass of precious metal with an imprint that certifies its weight. The typical imprint says something to the effect that the coin weighs a total of so and so many grams or ounces (gross weight), with this or that proportion or absolute content of precious metal (fine weight). This is why coin names were typically the names of weights, for example, the pound, the mark, the franc, or the ecu. Notice that the service depends entirely on the trustworthiness of the certifier, that is, of the minter. If the market participants cannot trust the certificate, they will rather do without the coin and go through the extra trouble of weighing 1See Aristotle, Politics, bk. 1, chap. 9. 35 The Ethics of Money Production the metal and possibly melting it down to determine its content of fine metal. A trustworthy coin economizes on this trouble and thus adds to the value of the bullion contained in the coin; for example, a trustworthy 1-ounce silver coin is more valuable than 1 ounce of silver bullion.2 People therefore pay higher prices for coins than for bullion, and the minter lives off this price margin.3 Because the value of the certificate depends on the trustworthiness of the minter, coins are typically used within limited geographical areas. Only the people who know the minter are likely to accept his coins. All others will insist on being paid in bullion or in coins they trust. This does not mean that in practice every village needs a different set of coins. The geographical radius within which a coin is used can grow very large and it can even become world encompassing if the minter has an excellent reputation. This was for example the case with the Mexican dollar coins that in the early nineteenth 2An early writer who stressed this fact was Nicholas Copernicus. See Copernicus, “Traité de la monnaie,” in L. Wolowski, ed., Traité de la première invention des monnoies, de Nicole Oresme . . . et Traité de la monnoie, de Copernic (Paris: Guillaumin, 1864), pp. 52–53. “L’empreinte de garantie ajoute quelque valeur à la matière elle-même” (p. 53). 3Most historical coins have been fabricated in government mints. This has misled many people into believing that the superior value of coins as compared to bullion demonstrates that the legal sanctioning of a coin is the source of its superior value as compared to bullion. For example, the ancient Greeks called money “noumisma” (from “nomos”—the law); and at the beginning of the twentieth century, the German professor Knapp popularized what he called the “state theory of money.” The idea that government fiat was a source of value has inspired many extravagant theories and political schemes. As we shall see, the truth is that government-enforced legislation can provide a few privileged coin makers with a monopoly rent. But this has nothing to do with coinage per se. Even without any legal sanction, trustworthy coins are more valuable than bullion. This value difference springs, as we have seen, from the service of certification. Historically, private coinage came first and only later did governments take over. See Arthur Burns, Money and Monetary Policy in Early Times (New York: Augustus M. Kelley, [1927] 1965), pp. 75–77, 442–44. 36 Money Certificates century circulated freely in most parts of the U.S. and which have bequeathed their name to the present-day currency of this country. Historically, minters have offered additional services that complement the certification of weights. Thus one of the perennial problems of coining precious metals is that used coins might contain a smaller quantity of precious metal than freshly minted coins. If this happens, people are inclined to hold back the good coins for themselves and to trade only the bad coins. To overcome this problem, minters could offer their coins in combination with an insurance service: they could offer to exchange any slightly used coin against a new one. This policy would guarantee the stability and homogeneity of the coinage through time. Thus the insured coins would trade at even higher prices, from which price differential (the premium) the replacement expenses can be paid. A great number of monetary thinkers from the Middle Ages to our times have held that coinage should be entrusted to the princes or governments, who, because they were the natural leaders of society, were also the people to be naturally trusted. The medieval scholastics knew full well that the princes frequently abused this trust, placing for example an imprint of “one ounce” on a coin that contained merely half an ounce, pocketing the other half of an ounce for themselves. Therefore Nicholas Oresme postulated that the princes did not have the right to alter the coins at all, unless they had the consent of the entire community, that is, the entire community of money users. Economic science has put us in a position to understand that competitive coinage is an even better way of preserving the trustworthiness of coins. There is no economic reason not to allow every private citizen to enter the minting business and to offer his own coins. It is true that a private minter too might abuse the trust his customers put in him and his coins. But punishment is immediate: he will lose all these customers. People will start using other coins issued by people they have reason to trust more. In a way, this competitive process also fulfills Oresme’s postulate that the entire community of money users decide about coinage. He held that “money is the 37 The Ethics of Money Production property of the commonwealth.”4 On a free market, the money owners can assert this property right smoothly and swiftly. Each person who no longer trusts the minter A simply stops using A’s coins and begins to use the coins of minter B. Thus he leaves the A community and joins the B community. Competition in coinage is no panacea. Abuses are always possible and in many cases they cannot easily be repaired. The virtue of competition is that it offers the prospect of minimizing the scope of possible abuses. And its great charm is that it involves the entire community of money users, not just some appointed or self-appointed office holders. Down here on earth this seems to be all we can hope for. 2. CERTIFICATES PHYSICALLY DISCONNECTED FROM MONEY If certificates may add to the value of bullion then certificates may have a value on their own. Therefore they can also be traded without being physically integrated with the precious metal of which they certify the quantity. Then they are money substitutes. Issuing such money substitutes was the generally accepted practice in the cities of Amsterdam and Hamburg for almost two centuries. The Bank of Amsterdam (established in 1609) issued paper notes that certified that the holder of the note was the legal owner of so-and-so much fine silver deposited in the vaults of the bank. These banknotes could be redeemed any time at the counters of the Bank, on the simple demand of the present owner.5 As a consequence, they were traded in lieu of the silver itself. Rather than exchanging physical silver, people made their purchases with the banknotes 4Nicholas Oresme, “A Treatise on the Origin, Nature, Law, and Alter- ations of Money,” in Charles Johnson, ed., The De Moneta of Nicholas Oresme and English Mint Documents (London: Thomas Nelson and Sons, 1956), p. 16. 5It is not necessary for us to dwell here on the nuances of early “bank money.” The most accessible presentation is in Adam Smith, Wealth of Nations, bk. 4, chap. 3, part 1, appendix. 38 Money Certificates that certified ownership of a sum of silver deposited at the Bank. Apart from paper notes, the main types of such substitutes are token coins, certificates of deposit, checking accounts, credit cards, and electronic bank accounts on the Internet. Despite the physical variety of these types, each of them features three fundamental characteristics: intermediation, titles, and the holding of “reserves.”6 Certification in the present case is not as integral as in the case of imprints that are struck in to the money material itself—the regular coins that we discussed above. Rather, the money substitute relates to a quantity of money that is removed from the eyes of the partners to the exchange. The money itself is held at some other place, namely, at the bank or treasury department or whichever other organization has issued the certificate. Thus there is in the present case not only monetary intermediation in the weak sense that a third party certifies quantities of money exchanged by the other two parties; but also in the strong sense that this third party actually physically controls the money at the time of the exchange. Furthermore, money substitutes do not merely certify the physical existence of a certain amount of precious metal; they are also a legal title to that amount. The rightful owner of a one-ounce-of-silver banknote, for example, is the rightful owner of one ounce of silver deposited in the vaults of the institution that issued the banknote. Finally, the money supplies held by the issuer of the substitutes are called the “reserves.” This terminology is established in economic science, but it should be used with some caution. Many students of money and banking believe that certificates such as book entries in bank accounts are the real monies, because they are actually used in daily exchanges, 6For most of the problems we will discuss in the present work, these common features are more important than the differences. For brevity’s sake, we will therefore mostly address the case of banknotes. In certain important respects banknotes differ from other money substitutes. We will discuss these differences at the appropriate place in Part Two. 39 The Ethics of Money Production whereas the money held by the institutions that make the account entries are just the reserves. But the truth is quite different. In all such cases, the so-called reserves are in fact the real money, whereas the account entries are only money substitutes.7 What are the advantages and disadvantages of certificates disconnected from the money itself? The main advantage is that the costs of storage, transportation, and certification (minting) can be reduced. The main disadvantage is that the potential for abuse is greater than in the case of coinage. Fraudulent bankers can embezzle on the property of their customers far more easily than fraudulent minters. A look at the history of institutions reveals that this temptation was virtually impossible to resist, especially when certification was not competitive. In the case of the Bank of Hamburg it took almost 150 years before abuse set in (at any rate, before it became manifest). Other bankers fell from grace much more quickly. For example, the goldsmiths who in the mid-1600s had taken 7One also needs to keep in mind that objects like banknotes can have very different economic natures. Today virtually all banknotes are government-enforced paper monies. But in former times, they were usually certificates for gold or silver. U.S. Federal Reserve notes had been gold certificates until August 1971 (under the 1944 Bretton Woods system, foreign central banks could redeem them until 1971, when the system collapsed). Since then, they have been paper money. Thus although on the level of their physical appearance they remained unchanged, dollar notes did change their economic nature. Similarly, a token coin bears more physical resemblances to a gold coin than to a paper certificate. But from an economic point of view, paper certificates and token coins are in one class of phenomena: they are both substitutes that are physically disconnected from money. The coin form per se is here irrelevant. In particular, notice that tokens also need to be distinguished from coins that contain a more or less large amount of precious metal in alloy. In the latter case, the certificate is still physically connected with the money material. In short, the physical aspects of things are often irrelevant from an economic point of view. The point has been stressed for example in Oswald von Nell-Breuning, “Geldwesen und Währung im Streite der Zeit,” Stimmen der Zeit 63, no. 10 (July 1933). We will discuss this important phenomenon in more detail in Part Two. 40 Money Certificates over the certification business in the city of London, after the English king had robbed the gold deposited in the Tower, very soon started using the deposits in their lending operations. Thus they turned themselves into “fractional-reserve bankers,” meaning that only a part (a fraction) of their issue was covered by underlying money reserves. In short, the potential abuse of substitutes is a very considerable disadvantage. One may therefore justly doubt that on a free market they could have gained any larger circulation. Even David Ricardo, the great champion of paper currency, admitted that it was unlikely that such substitutes could withstand the competition of coins. The only sure way to bring paper notes into circulation was to impose them on the citizenry: “If those who use one and two, and even five pound notes, should have the option of using guineas, there can be little doubt which they would prefer.”8 But our point is not to speculate about the significance that paper certificates would have on the free market. We merely wish to point out that paper certificates and token coins might conceivably play a role here, and that they have been used very widely in the past, though very often under some sort of imposition. In a free society, the market participants would constantly weigh the advantages and disadvantages of the various certification products. It is true that they would not be able to prevent all abuses. But again, the point is that a competitive system minimizes the possible damage. 8David Ricardo, “Proposals for an Economical and Secure Currency,” Works and Correspondence, Piero Sraffa, ed. (Cambridge: Cambridge University Press, 1951–73), vol. 4, p. 65. In Ricardo’s eyes, free choice in money could not be permitted because consumer preference for gold and silver coins would mean that, “to endulge a mere caprice, a most expensive medium would be substituted for one of little value.” Ibid. We will deal with the costs of commodity money in a subsequent section. 41 3 Money within the Market Process 1. MONEY PRODUCTION AND PRICES T he basic economic fact of human life is the universal condition of scarcity. Our means are not sufficient to realize all of our ends. In particular, our time is limited and thus we have to make up our mind how to use it, whether in paid work, in family or communal activities, or in personal leisure. But all other means at our disposal are limited too: our cash holdings, our financial assets, the size and quality of our cars and houses, and so on. Thus whatever we do, we have to choose how to use these resources, which also means that we decide at the same time how not to use them. Now the use of all means of action is conditioned by the law of diminishing marginal value. According to this law, the relative importance of any unit of an economic good for its owner—or, as economists say, the marginal value of any unit—diminishes as we come to control a greater overall supply of this good, and vice versa. The reason is that each additional unit enables us to pursue new objectives that we would not otherwise have chosen to pursue. Therefore, these objectives are necessarily less important for the acting person than the objectives that he would have pursued with the smaller supply. It follows, for example, that the marginal value of an additional mouthful of water is very different for a person travelling in a desert than for the same person swimming in a 43 The Ethics of Money Production lake. And the marginal value of a 200 square-foot room added to our house is very different, depending on whether the present size of our house is 500 or 5,000 square feet. Similarly, the marginal value of an additional dollar depends on how many dollars its owner already holds in his cash balance. It follows that the production of any additional unit of money makes money less valuable for the owner of this additional unit than it would otherwise have been. In particular, it becomes less valuable for him as compared to all other goods and services. As a consequence, he will now tend, as a buyer of goods and services, to pay more money in exchange for these other goods and services; and as a seller of goods and services, he will now tend to ask for higher money payment. In short, money production entails a tendency for money prices to increase. This tendency will at first show itself in the prices paid by the money producer himself. But then it will spread throughout the rest of the economy because those individuals who sold their goods and services to the money producer now also have larger cash balances than they otherwise would have had. For them too, therefore, the relative value of money will decline and they too will therefore tend to pay higher prices for the goods and services that they desire. It follows that still other people will have higher cash balances than otherwise and thus a new round of price increases sets in, and so on. This process continues until all money prices have been adjusted to the larger money supply. It is true that, for reasons that are too special to warrant our attention at this place, some prices might decrease in this process. But the overall tendency is for prices to increase. Thus the overall tendency of money production is to increase prices beyond the level they would otherwise have reached. This implies in turn that the purchasing power of any unit of money diminishes. Let us emphasize again that the process through which money production tends to increase the price level is spread out in time. It therefore affects the different prices at different points of time—there is no simultaneous increase of all prices. Furthermore, there is no reason why prices should change uniformly or in some fixed proportion to the change of the money supply. Hence, money production entails a tendency 44 Money within the Market Process for prices to increase, but this increase occurs step by step in a process spread out through time and affects each price to a different extent.1 2. SCOPE AND LIMITS OF MONEY PRODUCTION How much money will be produced on the market? How many coins? How many paper certificates? The limits of mining and minting, and of all other monetary services are ultimately given through the preferences of the market participants. As in all other branches of industry, miners and minters will make additional investments and expand their production if, and only if, they believe that no better alternative is at hand. In practice this usually means that they will expand coin production if the expected monetary return on investments in mines and mint shops is at least as high as the monetary returns in shoe factories, bakeries, and so on. The returns of the various branches of human industry ultimately depend on how the individual citizens choose to use the scarce resources that they own. In their capacity as consumers, the citizens choose to spend their money on certain products rather than on other products, thus determining the revenue side of all branches of industry. In their capacity as owners of productive resources (labor, capital, land), the citizens choose to devote these resources to certain ventures rather than in other ventures, thus determining the cost side of all branches of industry. Ultimately, therefore, it is the individual citizens who through their personal choices determine the relative profitability of all productive ventures. Each citizen engages in cooperation with some of his fellows, and by the same token he also withholds cooperation from others. This selection process or market process encompasses all productive 1In contemporary monetary analysis, these effects are commonly called “Cantillon effects” after Richard Cantillon, the first economist to stress that increases of the money supply do not affect all prices and monetary incomes at the same time and to the same extent. See Richard Cantillon, La nature du commerce en général (Paris: Institute national d’études démographiques, 1997), part 2, chap. 7. 45 The Ethics of Money Production ventures and therefore creates a mutual interdependence between all persons and all firms. On a free market, the production of money is fully embedded in this general division of labor. Additional coins are made as long as this production offers the best available returns on the resources invested in it. It is curtailed to the extent that other branches of industry offer better prospects. Moreover, just as the choices of individual citizens determine the relative extent of the production of money, as compared to other productions, they also determine the number of different coins that will be produced. Above we stated that money was a generally accepted medium of exchange. It is not merely conceivable that several monies will be in parallel use; this has been in fact the universal practice until the twentieth century. In the Middle Ages, gold, silver, and copper coins, as well as alloys thereof, circulated in overlapping exchange networks. At most times and places in the history of Western Europe, silver coins were most widespread and dominant in daily payments, whereas gold coins were used for larger payments and copper coins in very small transactions. In ancient times too, this was the normal state of affairs. The parallel production and use of different coins made out of precious metals is therefore the natural state of affairs in a free economy. Oresme constantly warned of altering coins, but he stressed that the introduction of a new type of coins was not such an alteration so long as it did not go in hand with outlawing the old coin.2 3. DISTRIBUTION EFFECTS When it comes to describing the distribution effects resulting from money production, economists ever since the times of Nicholas Oresme and Juan de Mariana typically cite just 2See Nicholas Oresme, “A Treatise on the Origin, Nature, Law, and Alterations of Money,” in Charles Johnson, ed., The De Moneta of Nicholas Oresme and English Mint Documents (London: Thomas Nelson and Sons, 1956), chaps. 2, 3, and 13; and chap. 9, pp. 13–14. 46 Money within the Market Process one such effect. They point out that the increased money supply brings about a tendency for the increase of all money prices—a fall of the purchasing power of money. Then they argue that the reduced purchasing power benefits debtors, because the amount of debt they have to pay back is now worth less than before, and that this benefit therefore necessarily comes at the expense of the creditors. This way of presenting things is not fully correct. It is true that an increased money supply tends to bring about higher money prices, and thus diminishes the purchasing power of each unit of money. But it is not true that this process necessarily operates in favor of the debtor and to the detriment of the creditor. A creditor may not be harmed at all by a 25 percent decrease in the purchasing power of money if he has anticipated this event at the point of time when he lent the money. Suppose he wished to obtain a return of 5 percent on the capital he lent, and that he anticipated the 25 percent depreciation of the purchasing power; then he would be willing to lend his money only for 30 percent, so as to compensate him for the loss of purchasing power. In economics, this compensation is called “price premium”—meaning a premium being paid on top of the “pure” interest rate for the anticipated increase of money prices. This is exactly what can be observed at those times and places where money depreciation is very high.3 A creditor might actually benefit from lending money even though the purchasing power declines. In our above example, this would be so if the depreciation turned out to be 15 percent, rather than the 25 percent he had expected. In this case, the 30 percent interest he is being paid by his debtor contains three components: (1) a 5 percent pure interest rate, (2) a 15 percent price premium that compensates him for the depreciation, and (3) a 10 percent “profit.” 3Late scholastic Martín de Azpilcueta argued that price premiums were not per se usurious, but legitimate compensations for loss of value. See Martín de Azpilcueta, “Commentary on the Resolution of Money,” Journal of Markets and Morality 7, no. 1 (2004) §48–50, pp. 80–83. 47 The Ethics of Money Production The same observations can be made, mutatis mutandis, for the debtors. They do not necessarily benefit from a depreciating purchasing power of money, and they can even earn a “profit” when money’s purchasing power increases if the increase turns out to be less than that on which the contractual interest rate was based. It all depends on the correctness of their expectations. There is however another distribution effect of the production of money. This effect is far more important than the one we have just described because it does not depend on the market participant’s expectations. It is an effect that the market participants cannot avoid by greater smartness or circumspection. To understand this distribution effect we must consider that exchange and distribution are not disconnected activities. In the market process, they are but one and the same event. Brown sells his apple for Green’s pear. After the exchange, the distribution of apples and pears is different from what it otherwise would have been. Every exchange thus entails a modification of the “distribution” of resources that would otherwise have come into being. It follows that any production of additional goods and services is bound to have such an impact on distribution. The new supply of product redirects the distribution of wealth in favor of the producer. Consider the case of money production. Here too the additional quantities that leave the production process, when sold, first benefit the first owner: the producer. He can buy more goods and services than he otherwise could have bought, and his spending on these things in turn increases the incomes of his suppliers beyond the level they would otherwise have reached. But the additional money production reduces the purchasing power of money. It follows that it also creates losers, namely, those market participants whose monetary income does not rise at first, but who have to pay right away the higher prices that result when the new money supply spreads step by step into the economy. Money production therefore redistributes real income from later to earlier owners of the new money. As we have pointed out, 48 Money within the Market Process this redistribution cannot be neutralized through expectations. Even the market participants who are aware of it cannot prevent it from happening. They can merely try to improve their own relative position in it, supplying early owners of the new money, preferably the money producer himself. This distribution effect is a key to understanding monetary economies. It is the primary cause of almost all conflicts revolving around the production of money. As we shall see in more detail, it is therefore also of central importance for the adequate moral assessment of monetary institutions. To avoid possible misunderstandings, however, let us emphasize that the distribution effects springing from production are not per se undesirable. They are an essential element of the free market process, which puts a premium on continual production in the service of consumers and does not reward inactivity. 4. THE ETHICS OF PRODUCING MONEY Aristotle emphasized the beneficial character of monetary exchanges, which facilitate and extend the division of labor. He merely denounced the practice of turning money into a fetish and desiring it for its own sake.4 The scholastic writers of the Middle Ages adopted by and large the same point of view, but they also went beyond Aristotle, who focused on the ethics of using money, by discussing the ethics of money production.5 The scholastics did not question the legitimacy of producing money per se. As in the case of using money, however, they stated that money production had to respect certain ethical rules. Nicholas Oresme and others stressed that all coins 4See Aristotle, Politics, bk. 1, chap. 9. This was also the position of the Church Fathers and later Christians. For an overview see Christoph Strohm, “Götze oder Gabe Gottes? Bemerkungen zum Thema ‘Geld’ in der Kirchengeschichte,” Glaube und Lernen 14 (1999): 129–40. 5This was a natural development of the distinction between the right to private property and the moral obligation to use one’s property in a Christian way. See above, section on natural monies. 49 The Ethics of Money Production should be clearly distinguishable from one another. In particular, it would not be licit that a minter produces coins that by their name, imprint, or other features resemble other coins that contain more precious metals.6 In other words, the benefits of competition in coinage result from a strict application of the Ninth Commandment: “You shall not bear false witness against your neighbor.” This is the reason why coins up to the early modern period traditionally had weight names such as mark and franc. But this proved to be an improvident choice because coined metal, as we have seen, has by the very nature of things a different value than bullion metal.7 The word “ecu” for example was on the one hand used in the same sense in which we use today the word “ounce”—it was the name of a weight. But it was also the name of a gold coin that (originally) was supposed to be the equivalent of one ounce of silver. Just imagine what it would mean if, today, we had a silver currency consisting of 1-ounce silver coins that we called “ounces.” The expression “ounce” would then be unsuitable to be used in setting up contracts because it is ambiguous. It makes a difference whether we are talking about certified weights, as in coins, or uncertified weights as in gold nuggets. One would therefore have to specify in each contract whether payment is to be made in weight-ounces or coin-ounces. But then the practice of using weight names for coins loses its point. The mere weight name as such is not specific enough. 6Oresme, “Treatise,” chap. 13, insisted, for example, that coins contain- ing alloys should have a different color. 7Juan de Mariana and other medieval theologians have postulated that the value of coined metal should be made equal to the value of bullion. Many secular writers such as John Locke and Charles de Montesquieu have espoused the same point of view. And even first-rate economists such as Jean-Baptiste Say and Murray Rothbard came close to endorsing this position when they postulated that coins be named after their fine content of precious metal. But all these views are misguided because, as we have said, the value difference between coins and bullion of equal weight is not a perversion of human judgment that could be overcome with a moral postulate, but a fact that lies in the very nature of things. 50 Money within the Market Process This does not mean, of course, that the weight contents of fine metal should not be imprinted on the coin. Quite to the contrary, this is exactly what successful minters have done in the past, what they do now, and what they will do in the future. The point is that it makes no sense to call a coin after its content of fine metal; such a name does not reduce ambiguities, but increases them. Coinage in a competitive system would have to rely on a scrupulous differentiation of the coin producers. It would not be sufficient that each minter print on his coin something like “this coin contains five grams of fine silver” because, as we have seen, some minters would offer additional services such as the exchange of used for new coins. At the very least, therefore, the name of the minter and any supplementary information needed to identify him would be required. Present-day gold coins such as the Krugerrands, the Eagles, and the Maple Leafs already fulfill this requisite: they feature both a unique name and they state the weight of fine gold contained in the coin. 5. THE ETHICS OF USING MONEY The Catholic tradition warned in the strictest terms against abuses of money, but it did not deny that, if practiced within the right moral boundaries, the use of money and the paying and taking of interest were natural elements of human society.8 Jesus himself, when explaining the rewards given to the faithful in the coming Kingdom of Heaven, used an illustration involving the positive use of money and banking. He stated that the Kingdom of Heaven would parallel the reward given for good stewardship of money, and that hell would wait for those who made no use of money at all. Two stewards who used the money entrusted to them in trade and made a 100 percent profit, found the praise of the master and were invited to share in his joy. But one steward who buried the money given to him in the ground was severely chided as “wicked” and “lazy.” The master pointed out that he could have turned 8This position was foreshadowed in Aristotle, Politics, bk. 1, chap. 9. 51 The Ethics of Money Production the money into some profit by simply putting it in a bank: “Should you not then have put my money in the bank so that I could have got it back with interest on my return?” He therefore commanded his other servants to take the money away from this servant and to throw him out of the house: “And throw this useless servant into the darkness outside, where there will be wailing and grinding of teeth” (Matthew 25: 26–30). Thus the use of money and banking may very well be considered legitimate from a Christian point of view. In any case, in the present work we are primarily interested in the economics and ethics of producing money rather than of using money in credit transactions.9 We can therefore avoid discussing one of the most vexatious problems of Catholic social doctrine, namely, the problem of usury. In very rough terms, usury is excessively high interest on money lent. This raises of course the question how one can distinguish legitimate from illegitimate “excessive” interest. Theologians have pretty much exhausted the range of possible answers. Some medieval theologians went so far as to claim that any interest was usury. Others such as Conrad Summenhardt held that virtually no interest payment that the market participants voluntarily agreed upon could be considered usury. The teaching office of the Catholic Church has repudiated the former opinion without taking a position on the latter. It rejects “usury” but allows the taking of “interest” on several grounds that are independent of (extrinsic to) the usury problem.10 It does not endorse on a priori grounds just any credit 9Nicholas Oresme distinguished three ways of gaining through money in unnatural ways: (1) the art of the money-changer: banking and exchange, (2) usury, and (3) the alteration of the coinage. “The first way is contemptible, the second bad and the third worse.” See Oresme, “Treatise,” chap. 17, p. 27. 10For an overview see Eugen von Böhm-Bawerk, Capital and Interest (South Holland, Ill.: Libertarian Press, 1959), vol. 1, chaps. 2 and 3; John T. Noonan, The Scholastic Analysis of Usury (Cambridge, Mass.: Harvard University Press, 1957); Raymond de Roover, Business, Banking, and Economic Thought in Late Medieval and Early Modern Europe (Chicago: 52 Money within the Market Process bargain made on the free market. It affirms that taking and paying interest is not per se morally wrong, but at the same time retains the authority to condemn some interest payments as usurious. This concerns especially the case of consumer credit, because taking interest might here be in violation of charity. Similarly, while interest on business loans is per se legitimate, some business loans might be illegitimate because of particular circumstances. Below we will follow Bernard Dempsey in arguing that interest payments deriving from fractional-reserve banking are tantamount to “institutional usury.”11 University of Chicago Press, 1974); and H. du Passage, “Usure,” Dictionnaire de Théologie Catholique 15 (Paris: Letouzey et Ane, 1909–1950). See also A. Vermeersh, “Interest,” Catholic Encyclopedia 8 (1910); idem, “Usury,” Catholic Encyclopedia 15 (1912); and Bernard Dempsey, Interest and Usury (Washington, D.C.: American Council of Public Affairs, 1943). A good discussion of “interesse” as compared to “usury” is in Victor Brants, L’économie politique au Moyen-Age (reprint, New York: Franklin, 1970), pp. 145–56. Further discussion of the history of this concept is in Ludwig von Mises