The Ethics of Money Production: Chapter 12

Chapter 12: Paper Money

Paper money never arised on the free market, it was always the preferred child of the state, protected by laws. The state creates a monopoly for one precious metal, either by forbidding others (Germany, France) or through bimetallism (England, USA). Then it grants the privilege of legal tender to the banknotes of a specific fractional reserve bank. Once are all other monies pushed off the market, this bank is allowed to refuse to redeem its banknotes. These become paper money; and such is the history of banking in the West. The first World War was financed in this way. Gold was used less and less, until it was completely abandoneded in 1971 in the US.

Paper money was always instituted through massive breaches of contract and of private property rights. It is kept in existence through legal privilege only.

However, producing paper money is not counterfeiting per se. It is not claimed, that it pretends to stand for something else, it stands for itself. Its promise is to give another banknote in exchange. Talk about a recursive definition.

2. The moment a central bank issues not only legal tender, but is freed from the obligation to make its payments, its banknotes turn into paper money. But the bank also changes: it is now a producer of money, even if it's paper money. The banknotes and the bank turn into something very different, without any outward change. This confuses many students of monetary politics, so it has to be emphasized.

(Hülsmann actually writes, that the bank changes into something completely different and shouldn't be called a bank anymore. To me, it still provides banking services for its customers, it is still a bank in a way. That its nature has deeply changed, is undeniable.

He also mentions something about "reverse transsubtsantiation". That was probably the first part, that was completely lost to me. Oh well.)

3. Banks of this kind cannot really go bankrupt. They can print any amount of paper money (which they freely admit, if the freely admit, if the terrible dangers of deflation are mentioned). Producers of commodity money don't have that privilege.

Instead, their greatest risk lies in hyperinflation. The constantly rising prices can lead to the complete abandoning of a currency ("flight from money") and the collapse of the economy. All hyperinflations were based on the inflation of paper money. But this hard limit seems to be a rather low risk: many have inflated in massive amounts, a few lesser currencies have collapsed in a hyperinflation, all the major ones persist.

4. Possibly the most visible consequences of paper money inflation is the explosion of public debt. For private debtors, how much can be borrowed depends on the value of their property and expected income. The limits stay, even if the availability of credit is growing with inflation.

A state cannot go bankrupt, as long as its central bank supports it. No wonder, despite is claims about independence are central banks created by laws and its top management appointed by their governments. And even if they don't directly throw money at the state, there are ample ways of making sure its demands are met. The result is growth of public debt far above the increase of money supply. (There are some more details here and example cases US and Germany. I'd wish to see more of the exact workings of the current banking system, but that is out of scope here.)

5. There are claims, that paper money could be more stable than commodity monies, if it would compete on the free market. But this is not only contrary to all historical experience, but runs into theoretical issues as well. A stable purchasing power is an illusion (see Chapter 4) and paper would have a hard time to survive competition anyway (Chapter 1).

The production of commodity money (like gold and silver) has definite limits and is unlikely to jump up quickly. With paper money, the possibility is well known and many speculate on its growth. This leads to the wasting of resources and potentially to larger problems. A few speculators, that lose their money, can be saved by printing more (or left to go bankrupt). But what if many speculate and get into trouble? Saving them means a high inflation; letting them fall to mass bankruptcies. The political pressures will make the second option rather hand to follow.

The very existence of a producer of paper money creates a moral hazard. A high inflation is in the end hard to avoid.

The signs of moral hazard are evident in the "bubbles" plaguing this financial system. In the dot-com boom and the housing bubble, market participants have been speculating with assets without regard to the price/earnings ratio and expecting, that someone in the future will buy it for even more. Whatever happens, things will always go up. In the US, the money supply is growing, but much of the new money is exported into other countries. Should they slow down their buying of US dollars, a large inflation (and potentially hyperinflation) will loom on the horizon.

States have attempted to curb these excesses through regulation, to cure the symptoms while letting the cause untouched. The result is merely driving the moral hazard into new areas. One could of course regulate everything likely to fall to it, that is everything. With paper money, you can choose between a hyperinflation and a centrally planned and a centrally planned economy. You might even get both.

6. From an ethical point of view, there is not much to say. Paper money was always created and continues to be kept in place by force. As there is no necessity for forced inflation, it is morally not acceptable.