Paper Money Collapse

The Folly of Elastic Money

Detlev S. Schlichter

• Publisher: Wiley
• Year: 2014
• ISBN:
  9781118877364
• Edition: 2
• Topic: Economics
• Subtopic: Economic Conditions
• Index: Economics

Explore the inevitable collapse of the fiat monetary system

Paper Money Collapse: The Folly of Elastic Money, Second Edition challenges the mainstream consensus on money and monetary policy. While it is today generally believed that the transition from 'hard' and inflexible commodity money (such as a gold standard) to entirely flexible and potentially unlimited fiat money under national central banks allows for superior economic stability, Paper Money Collapse shows that the opposite is true. Systems of highly elastic and constantly expanding money are not only unnecessary, even for growing economies, they are always extremely destabilizing. Over time, they must lead to substantial imbalances, including excessive levels of debt and distorted asset prices, that will require ever faster money production to sustain. Ultimately, however, there is no alternative to a complete liquidation of these distortions. Based on insights of many renowned economists and in particular of the Austrian School of Economics, the book explains through rigorous logic and in precise language why our system of flexible fiat money is incompatible with a market economy and therefore unsustainable. Paper money systems have always led to economic disintegration—without exception—throughout history. It will not be different for our system and we may be closer to the endgame than many think.

The updated second edition incorporates:

• A new introduction and an extended outlook section that discusses various "endgames"
• Responses to criticisms, alternative views, and a critical assessment of 'solutions'
• Comments on recent policy trends, including attempts to exit the 'easy money' policy mode
• An evaluation of new crypto-currency Bitcoin

Paper Money Collapse: The Folly of Elastic Money, Second Edition clarifies the problem of paper money clearly and eloquently, and proposes multiple routes to a solution.

Part One
The Basics of Money

Chapter 1
The Fundamentals of Money and Money Demand

Modern industrial society requires extensive division of labor. Extensive division of labor is feasible only in a market economy, that is, in an economy based on the voluntary contractual exchange of goods and services on markets. Such a system, by necessity, requires the institution of private property (clearly delineated ownership of goods and services) and a medium of exchange, money.¹ Modern civilization, and the degree of material provision (wealth) that we all associate with advanced civilization and that we have come to expect from it, requires trade, markets, private property, and money. Such an economic arrangement can be called, broadly, capitalistic.

Primitive societies may be able to do without these things. A strictly self-sufficient small community, maybe a single household, a clan, or a small village, may produce the bare necessities of life and distribute them according to the diktat of a leader or group of leaders, according to some central plan or agreement, or even according to established traditional rules. But such a society does not take advantage of the benefits of an extensive division of labor that wider trade relationships allow, and its members will struggle to become more prosperous. Autarky is a recipe for poverty. Very few people today want to live in such a society, and it is no surprise that the vast majority of mankind has left this way of life behind.

For the past 200 years communism has promised to erect a modern industrial society with a high standard of living for everyone but do so without private property, without free trade, and thus without money. In a proper communist commonwealth, where every resource is owned and allocated by the state, there is no place for market exchange and no place for money. Economics has demonstrated convincingly that no advanced industrial economy can ever operate along communist lines,^2,3 and the historic failure of self-proclaimed (albeit not fully consistent) communist societies in the twentieth century illustrates this poignantly. Capitalism is a term that still has negative connotations in many circles, but it is a fact that the only advanced, highly productive, and wealth-generating societies we know, whether from experience or theoretical investigation, are in a broad sense capitalist societies. They require private property, exchange (trade), and money.

The Origin and Purpose of Money

Money is the medium of exchange. Money facilitates the exchange of goods and services on markets. Of course, private property owners can exchange property without the help of money. They can trade goods (or services) directly for other goods (or services). Such exchanges are called direct exchange, or barter. Exchanges that involve a medium of exchange are called indirect exchange. The problem is that in a barter economy people cannot realize the full benefits of trade because transactions are possible only whenever each party wants precisely what the other party has to offer. Person A will sell his good “p” to person B only if whatever B has to offer in exchange, let us say good “q,” is precisely what A wants. If one of the two parties has nothing to offer that the other party has use for, then the trade will not take place. Economists call this condition double coincidence of wants, and it severely restricts the number of transactions that will occur in a barter economy. An additional impediment to trade is that many goods are indivisible. Please note that double coincidence of wants and limited divisibility hamper not only the exchange of physical goods for other physical goods but also the exchange of services. Despite these inevitable drawbacks of a barter economy, the exchange of goods and services started most certainly on such a limited scale with people exchanging what both parties to the trade found immediately useful.

It is obvious that in a barter economy people would pretty soon start to accept certain goods in trade, not because they want them but because these goods can be traded very easily for other things. There is a bigger market for some goods than for others; certain goods are more marketable; they are more fungible. For example, somebody may sell a goat for a sack of salt, not because he desires the salt but because he knows that salt is more easily traded for other things and that he stands a good chance of later exchanging the sack of salt for whatever he really desires. This is such logical behavior that it would be utterly surprising if it did not happen fairly quickly in any trading society. As more people start accepting the more fungible goods in trade, these goods become yet more fungible, and it is clear that they ultimately gain the status of generally accepted facilitators of trade. These goods could be cloth, beads, wheat, or precious metals. Whatever they are, they acquire a special place in the universe of traded goods. They are media of exchange. The most fungible good and the most generally used medium of exchange is ultimately called money. Now person B can buy product “p” from person A, although A has no use for B’s product “q.” B can instead sell “q” to C, D, or E; accept the medium of exchange from them as payment; and use that to buy “p” from A. Person A will accept the medium of exchange in the knowledge that others will also accept it in exchange for goods and services.⁴

Thus, no more than rational self-interest on the part of trading individuals is required to explain the emergence of media of exchange.⁵ It is in the interest of everybody who wants to participate in the free, voluntary, and mutually beneficial exchange of goods and services to use media of exchange. Indeed, it is in the interest of everybody to ultimately use only one good as the medium of exchange, the most fungible good, and that is called money.

Money is not the creation of the state. It is not the result of acts of legislation, and its emergence did not require a society-wide agreement of any sort. Money came into existence because the individuals who wanted to trade found a medium of exchange immediately useful. And the more people began to use the same medium of exchange, the more useful it became to them.⁶

Money is a social institution that came about spontaneously. Other such institutions are the concepts of private ownership and of clearly delineated property and the rules and standards according to which property titles can be transferred. All these institutions came into being because people saw the immediate benefit from extended human cooperation, of cooperation that goes beyond the immediate family or clan. Such cooperation allows an extended division of labor that enhances the supply of goods and services for everyone who participates in it.

Not only does the existence of money not require a state organization to issue it, but it is also inconceivable that money could have come into existence by any authority (or any private person or institution) declaring its unilaterally issued paper tickets money.⁷ That money does exist in this form today is obvious. Yet, as the Austrian economist Carl Menger showed more than 100 years ago, money could have come into existence only as a commodity.⁸ For something to be used for the very first time as a medium of exchange, a point of reference is needed as to what its value in exchange for other goods and services is at that moment. It must have already acquired some value before it is used as money for the first time. That value can only be its use value as a commodity, as a useful good in its own right. But once a commodity has become an established medium of exchange, its value will no longer be determined by its use value as a commodity alone but also, and ultimately predominantly, by the demand for its services as money. But only something that has already established a market value as a commodity can make the transition to being a medium of exchange.

Which commodity was used was up to the trading public. Not any good was equally useful as money, of course. Certain goods have a superior marketability than other goods. It is no surprise that throughout the ages and through all cultures, people almost always came to use precious metals, in particular gold and silver, as these two possessed the qualities that were ideal for a medium of exchange: durability, portability, recognizability, divisibility, homogeneity, and, last but not least, scarcity.⁹ Indeed, the very rigidity of their supply made them attractive. The fact that nobody could produce them at will made them eligible. They could be mined, of course, but that took time and involved considerable cost. And their essentially fixed supply contrasted with the inherently flexible supply of the goods and services for which money was being exchanged, thus ensuring that exchange relationships were not further complicated by a volatile money supply.

An Anthropologist’s Challenge

The anthropologist and political activist David Graeber has recently challenged this account of the origin of money. In his book Debt: The First 5,000 Years,¹⁰ he makes the following three claims:

1. The barter economy is a myth told by economists, and it is not supported by anthropological evidence.
2. What was common instead was the “gift” economy, in which people hand over goods or perform services without immediate payment but under the mutual understanding that, at a later point in time, a reciprocal service or handing over of a good will be performed.
3. Money originated as an accounting device employed by Sumerian temple workers (i.e., state bureaucrats) in Mesopotamia as early as 3500 b.c.

Graeber believes he has undermined the traditional explanation for the rise of the monetary economy but in fact he has done no such thing. As we will see, he has simply failed to apply concepts of economics accurately to the societies he analyzed, either because he misunderstood these concepts or refuses to employ them correctly. Be that as it may, this has led him into confusion.

As to point 1: Graeber gives this chapter the title “The Myth of Barter” and quotes fellow anthropologist Caroline Humphrey as stating that “No example of a barter economy, pure and simple, has ever been described, let alone the emergence from it of money; [. . .].”¹¹ But these somewhat grandiose claims are not supported by evidence. Graeber qualifies them by stating that “all this hardly means that barter does not exist,”¹² only that it is almost never employed between fellow villagers but is usually confined to trading with strangers. Graeber himself provides three examples of primitive societies for which barter is an important part of their lives: the Nambikwara of Brazil, the Gunwinggu people of western Australia, and the Pukhtun of northern Iraq.

“What all such cases of trade through barter have in common is that they are meetings with strangers who will, likely as not, never meet again, and with whom one certainly will not enter into any ongoing relations.”¹³

I am not aware that economists have made this distinction between trading with fellow villagers and strangers, and I am not clear why this distinction should be of any significance for understanding the benefits of barter and the emergence of indirect exchange through money. Graeber does not make this clear. The fact that barter is (mainly) employed for trading with strangers seems to somehow discredit it in his view, although why is never explained.

Graeber has certainly not shown that barter is a myth. To the contrary, his examples illustrate vividly the power of trade. Trade is, by definition, to the benefit of both parties to the transaction. Otherwise, why would they trade? In Graeber’s examples, people overcome tribal hostilities and inborn animosity to strangers because they evidently realize that they benefit from trading with people outside their intimate circle of friends and family. Trade is a form of extended human cooperation—extended because it allows cooperation across political or established familial borders. It is this process that creates “society.” Trade, first through barter, then through indirect exchange via money, enhances wealth and furthers peace, and it allows humans to build societies that are extensive and open, rather than closed and tribal. Such a pro-market interpretation seems to elude Graeber.

Regarding point 2: Instead Graeber considers much more important the exchanges between people among whom fairly close social ties already exist. Here, he discovers a form of exchange that he believes has escaped the economists or has been shamefully neglected by them. People hand over goods or perform services without receiving immediate payment, but in the knowledge that at some future point in time the o...