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[ 01-12-2003 ]
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[ Economics ]
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[http://www.mises.org/money/2s1.asp
Money In A Free Society: The "Proper" Supply of Money
What Has Government Done to Our Money?
Murray N. Rothbard
II. Money in a Free Society
The "Proper" Supply of Money
Now we may ask: what is the supply of money in society and how is that supply used? In particular, we may raise the perennial question, how much money "do we need"? Must the money supply be regulated by some sort of "criterion," or can it be left alone to the free market?
First, the total stock, or supply, of money in society at any one time, is the total weight of the existing money - stuff. Let us assume, for the time being, that only one commodity is established on the free market as money. Let us further assume that gold is that commodity (although we could have taken silver, or even iron; it is up to the market, and not to us, to decide the best commodity to use as money). Since money is gold, the total supply of money is the total weight of gold existing in society. The shape of gold does not matter - except if the cost of changing shapes in certain ways is greater than in others (e.g., minting coins costing more than melting them). In that case, one of the shapes will be chosen by the market as the money - of - account, and the other shapes will have a premium or discount in accordance with their relative costs on the market.
Changes in the total gold stock will be governed by the same causes as changes in other goods. Increases will stem from greater production from mines; decreases from being used up in wear and tear, in industry, etc. Because the market will choose a durable commodity as money, and because money is not used up at the rate of other commodities - but is employed as a medium of exchange - the proportion of new annual production to its total stock will tend to be quite small. Changes in total gold stock, then, generally take place very slowly.
What "should" the supply of money be? All sorts of criteria have been put forward: that money should move in accordance with population, with the "volume of trade," with the "amounts of goods produced," so as to keep the "price level" constant, etc. Few indeed have suggested leaving the decision to the market. But money differs from other commodities in one essential fact. And grasping this difference furnishes a key to understanding monetary matters. When the supply of any other good increases, this increase confers a social benefit; it is a matter for general rejoicing. More consumer goods mean a higher standard of living for the public; more capital goods mean sustained and increased living standards in the future. The discovery of new, fertile land or natural resources also promises to add to living standards, present and future. But what about money? Does an addition to the money supply also benefit the public at large?
Consumer goods are used up by consumers; capital goods and natural resources are used up in the process of producing consumer goods. But money is not used up; its function is to act as a medium of exchanges - to enable goods and services to travel more expeditiously from one person to another. These exchanges 3%3 are all made in terms of money prices. Thus, if a television set exchanges for three gold ounces, we say that the "price" of the television set is three ounces. At any one time, all goods in the economy will exchange at certain gold¦ratios or prices. As we have said, money, or gold, is the common denominator of all prices. But what of money itself? Does it have a "price"? Since a price is simply an exchange - ratio, it clearly does. But, in this case, the "price of money" is an array of the infinite number of exchange - ratios for all the various goods on the market.
Thus, suppose that a television set costs three gold ounces, an auto sixty ounces, a loaf of bread 1/100 of an ounce, and an hour of Mr. Jones' legal services one ounce. The "price of money" will then be an array of alternative exchanges. One ounce of gold will be "worth" either 1/3 of a television set, 1/60 of an auto, 100 loaves of bread, or one hour of Jones' legal service. And so on down the line. The price of money, then, is the "purchasing power" of the monetary unit - in this case, of the gold ounce. It tells what that ounce can purchase in exchange, just as the money - price of a television set tells how much money a television set can bring in exchange. What determines the price of money?
The same forces that determine all prices on the market - that venerable but eternally true law: "supply and demand." We all know that if the supply of eggs increases, the price will tend to fall; if the buyers' demand for eggs increases, the price will tend to rise. The same is true for money. An increase in the supply of money will tend to lower its "price"; an increase in the demand for money will raise it. But what is the demand for money? In the case of eggs, we know what "demand" means; it is the amount of money consumers are willing to spend on eggs, plus eggs retained and not sold by suppliers. Similarly, in the case of money, "demand" means the various goods offered in exchange for money, plus the money retained in cash and not spent over a certain time period. In both cases, "supply" may refer to the total stock of the good on the market.
What happens, then, if the supply of gold increases, demand for money remaining the same? The "price of money" falls, i.e., the purchasing power of the money - unit will fall all along the line. An ounce of gold will now be worth less than 100 loaves of bread, 1/3 of a television set, etc. Conversely, if the supply of gold falls, the purchasing power of the gold - ounce rises.
What is the effect of a change in the money supply? Following the example of David Hume, one of the first economists, we may ask ourselves what would happen if, overnight, some good fairy slipped into pockets, purses, and bank vaults, and doubled our supply of money. In our example, she magically doubled our supply of gold. Would we be twice as rich? Obviously not. What makes us rich is an abundance of goods, and what limits that abundance is a scarcity of resources: namely land, labor and capital. Multiplying coin will not whisk these resources into being. We may feel twice as rich for the moment, but clearly all we are doing is diluting the money supply. As the public rushes out to spend its new - found wealth, prices will, very roughly, double - or at least rise until the demand is satisfied, and money no longer bids against itself for the existing goods.
Thus, we see that while an increase in the money supply, like an increase in the supply of any good, lowers its price, the change does not - unlike other goods - confer a social benefit. The public at large is not made richer. Whereas new consumer or capital goods add to standards of living, new money only raises prices - i.e., dilutes its own purchasing power. The reason for this puzzle is that money is only useful for its exchange value. Other goods have various "real" utilities, so than an increase in their supply satisfies more consumer wants. Money has only utility for prospective exchange; its utility lies in its exchange value, or "purchasing power." Our law - that an increase in money does not confer a social benefit - stems from its unique use as a medium of exchange.
An increase in the money supply, then, only dilutes the effectiveness of each gold ounce; on the other hand, a fall in the supply of money raises the power of each gold ounce to do its work. We come to the startling truth that it doesn't matter what the supply of money is. Any supply will do as well as any other supply. The free market will simply adjust by changing the purchasing power, or effectiveness of the gold - unit. There is no need to tamper with the market in order to alter the money supply that it determines.
At this point, the monetary planner might object: "All right, granting that it is pointless to increase the money supply, isn't gold mining a waste of resources? Shouldn't the government keep the money supply constant, and prohibit new mining?" This argument might be plausible to those who hold no principled objections to government meddling, thought it would not convince the determined advocate of liberty. But the objection overlooks an important point: that gold is not only money, but is also, inevitably, a commodity. An increased supply of gold may not confer any monetary benefit, but it does confer a non - monetary benefit - i.e., it does increase the supply of gold used in consumption (ornaments, dental work, and the like) and in production (industrial work). Gold mining, therefore, is not a social waste at all.
We conclude, therefore, that determining the supply of money, like all other goods, is best left to the free market. Aside from the general moral and economic advantages of freedom over coercion, no dictated quantity of money will do the work better, and the free market will set the production of gold in accordance with its relative ability to satisfy the needs of consumers, as compared with all other productive goods. [10]
9. The Problem of "Hoarding"
The critic of monetary freedom is not so easily silenced, however. There is, in particular, the ancient bugbear of "hoarding." The image is conjured up of the selfish old miser who, perhaps irrationally, perhaps from evil motives, hoards up gold unused in his cellar or treasure trove - thereby stopping the flow of circulation and trade, causing depressions and other problems. Is hoarding really a menace?
In the first place, what has simply happened is an increased demand for money on the part of the miser. As a result, prices of goods fall, and the purchasing power of the gold - ounce rises. There has been no loss to society, which simply carries on with a lower active supply of more "powerful" gold ounces.
Even in the worst possible view of the matter, then, nothing has gone wrong, and monetary freedom creates no difficulties. But there is more to the problem than that. For it is by no means irrational for people to desire more or less money in their cash balances.
Let us, at this point, study cash balances further. Why do people keep any cash balances at all? Suppose that all of us were able to foretell the future with absolute certainty. In that case, no one would have to keep cash balances on hand. Everyone would know exactly how much he will spend, and how much income he will receive, at all future dates. He need not keep any money at hand, but will lend out his gold so as to receive his payments in the needed amounts on the very days he makes his expenditures. But, of course, we necessarily live in a world of uncertainty. People do not precisely know what will happen to them, or what their future incomes or costs will be.
The more uncertain and fearful they are, the more cash balances they will want to hold; the more secure, the less cash they will wish to keep on hand. Another reason for keeping cash is also a function of the real world of uncertainty. If people expect the price of money to fall in the near future, they will spend their money now while money is more valuable, thus "dishoarding" and reducing their demand for money. Conversely, if they expect the price of money to rise, they will wait to spend money later when it is more valuable, and their demand for cash will increase. People's demands for cash balances, then, rise and fall for good and sound reasons.
Economists err if they believe something is wrong when money is not in constant, active "circulation." Money is only useful for exchange value, true, but it is not only useful at the actual moment of exchange. This truth has been often overlooked. Money is just as useful when lying "idle" in somebody's cash balance, even in a miser's "hoard." [11] For that money is being held now in wait for possible future exchange - it supplies to its owner, right now, the usefulness of permitting exchanges at any time - present or future - the owner might desire.
It should be remembered that all gold must be owned by someone, and therefore that all gold must be held in people's cash balances. If there are 3000 tons of gold in the society, all 3000 tons must be owned and held, at any one time, in the cash balances of individual people. The total sum of cash balances is always identical with the total supply of money in the society. Thus, ironically, if it were not for the uncertainty of the real world, there could be no monetary system at all! In a certain world, no one would be willing to hold cash, so the demand for money in society would fall infinitely, prices would skyrocket without end, and any monetary system would break down. Instead of the existence of cash balances being an annoying and troublesome factor, interfering with monetary exchange, it is absolutely necessary to any monetary economy.
It is misleading, furthermore, to say that money "circulates." Like all metaphors taken from the physical sciences, it connotes some sort of mechanical process, independent of human will, which moves at a certain speed of flow, or "velocity." Actually, money does not "circulate"; it is, from time, to time, transferred from one person's cash balance to another's. The existence of money, one again, depends upon people's willingness to hold cash balances.
At the beginning of this section, we saw that "hoarding" never brings any loss to society. Now, we will see that movement in the price of money caused by changes in the demand for money yields a positive social benefit - as positive as any conferred by increased supplies of goods and services. We have seen that the total sum of cash balances in society is equal and identical with the total supply of money. Let us assume the supply remains constant, say at 3,000 tons. Now, suppose, for whatever reason - perhaps growing apprehension - people's demand for cash balances increases. Surely, it is a positive social benefit to satisfy this demand. But how can it be satisfied when the total sum of cash must remain the same? Simply as follows: with people valuing cash balances more highly, the demand for money increases, and prices fall.
As a result, the same total sum of cash balances now confers a higher "real" balance, i.e., it is higher in proportion to the prices of goods - to the work that money has to perform. In short, the effective cash balances of the public have increased. Conversely, a fall in the demand for cash will cause increased spending and higher prices. The public's desire for lower effective cash balances will be satisfied by the necessity for given total cash to perform more work.
Therefore, while a change in the price of money stemming from changes in supply merely alters the effectiveness of the money¦unit and confers no social benefit, a fall or rise caused by a change in the demand for cash balances does yield a social benefit - for it satisfies a public desire for either a higher or lower proportion of cash balances to the work done by cash. On the other hand, an increased supply of money will frustrate public demand for a more effective sum total of cash (more 33 effective in terms of purchasing power).
People will almost always say, if asked, that they want as much money as they can get! But what they really want is not more units of money - more gold ounces or "dollars" - but more effective units, i.e., greater command of goods and services bought by money. We have seen that society cannot satisfy its demand for more money by increasing its supply - for an increased supply will simply dilute the effectiveness of each ounce, and the money will be no more really plentiful than before. People's standard of living (except in the non - monetary uses of gold) cannot increase by mining more gold. If people want more effective gold ounces in their cash balances, they can get them only through a fall in prices and a rise in the effectiveness of each ounce.
[10] Gold mining is, of course, no more profitable than any other business; in the long - run, its rate of return will be equal to the net rate of return in any other industry.
[11]At what point does a man's cash balance become a faintly disreputable "hoard," or the prudent man a miser? It is impossible to fix any definite criterion: generally, the charge of "hoarding" means that A is keeping more cash than B thinks is appropriate for A.
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