What Has Government Done to Our Money?

by Murray N. Rothbard

  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 3,000 tons of gold in the society, all 3,000 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, once 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 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 nonmonetary 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.

  Stabilize the Price Level?

  Some theorists charge that a free monetary system would be unwise, because it would not “stabilize the price level,” i.e., the price of the money-unit. Money, they say, is supposed to be a fixed yardstick that never changes. Therefore, its value, or purchasing power, should be stabilized. Since the price of money would admittedly fluctuate on the free market, freedom must be overruled by government management to insure stability.12 Stability would provide justice, for example, to debtors and creditors, who will be sure of paying back dollars, or gold ounces, of the same purchasing power as they lent out.

  Yet, if creditors and debtors want to hedge against future changes in purchasing power, they can do so easily on the free market. When they make their contracts, they can agree that repayment will be made in a sum of money adjusted by some agreed-upon index number of changes in the value of money. The stabilizers have long advocated such measures, but strangely enough, the very lenders and borrowers who are supposed to benefit most from stability, have rarely availed themselves of the opportunity. Must the government then force certain “benefits” on people who have already freely rejected them? Apparently, businessmen would rather take their chances, in this world of irremediable uncertainty, on their ability to anticipate the conditions of the market. After all, the price of money is no different from any other free price on the market. They can change in response to changes in demand of individuals; why not the monetary price?

  Artificial stabilization would, in fact, seriously distort and hamper the workings of the market. As we have indicated, people would be unavoidably frustrated in their desires to alter their real proportion of c
ash balances; there would be no opportunity to change cash balances in proportion to prices. Furthermore, improved standards of living come to the public from the fruits of capital investment. Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers. Forcible propping up of the price level prevents this spread of higher living standards.

  Money, in short, is not a “fixed yardstick.” It is a commodity serving as a medium for exchanges. Flexibility in its value in response to consumer demands is just as important and just as beneficial as any other free pricing on the market.

  11.

  Coexisting Moneys

  So far we have obtained the following picture of money in a purely free economy: gold or silver coming to be used as a medium of exchange; gold minted by competitive private firms, circulating by weight; prices fluctuating freely on the market in response to consumer demands and supplies of productive resources. Freedom of prices necessarily implies freedom of movement for the purchasing power of the money-unit; it would be impossible to use force and interfere with movements in the value of money without simultaneously crippling freedom of prices for all goods. The resulting free economy would not be chaotic. On the contrary, the economy would move swiftly and efficiently to supply the wants of consumers. The money market can also be free.

  Thus far, we have simplified the problem by assuming only one monetary metal—say, gold. Suppose that two or more moneys continue to circulate on the world market—say, gold and silver. Possibly, gold will be the money in one area and silver in another, or else they both may circulate side by side. Gold, for example, being ounce-for-ounce more valuable on the market than silver, may be used for larger transactions and silver for smaller. Would not two moneys be impossibly chaotic? Wouldn't the government have to step in and impose a fixed ration between the two (“bimetallism”) or in some way demonetize one or the other metal (impose a “single standard”)?

  It is very possible that the market, given free rein, might eventually establish one single metal as money. But in recent centuries, silver stubbornly remained to challenge gold. It is not necessary, however, for the government to step in and save the market from its own folly in maintaining two moneys. Silver remained in circulation precisely because it was convenient (for small change, for example). Silver and gold could easily circulate side by side, and have done so in the past. The relative supplies of and demands for the two metals will determine the exchange rate between the two, and this rate, like any other price, will continually fluctuate in response to these changing forces. At one time, for example, silver and gold ounces might exchange at 16:1, another time at 15:1, etc. Which metal will serve as a unit of account depends on the concrete circumstances of the market. If gold is the money of account, then most transactions will be reckoned in gold ounces, and silver ounces will exchange at a freely-fluctuating price in terms of the gold.

  It should be clear that the exchange rate and the purchasing powers of the units of the two metals will always tend to be proportional. If prices of goods are fifteen times as much in silver as they are in gold, then the exchange rate will tend to be set at 15:1. If not, it will pay to exchange from one to the other until parity is reached. Thus, if prices are fifteen times as much in terms of silver as gold while silver/gold is 20:1, people will rush to sell their goods for gold, buy silver, and then rebuy the goods with silver, reaping a handsome gain in the process. This will quickly restore the “purchasing power parity” of the exchange rate; as gold gets cheaper in terms of silver, silver prices of goods go up, and gold prices of goods go down.

  The free market, in short, is eminently orderly not only when money is free but even when there is more than one money circulating.

  What kind of “standard” will a free money provide? The important thing is that the standard not be imposed by government decree. If left to itself, the market may establish gold as a single money (“gold standard”), silver as a single money (“silver standard”), or, perhaps most likely, both as moneys with freely-fluctuating exchange rates (“parallel standards”).13

  12.

  Money Warehouses

  Suppose, then, that the free market has established gold as money (forgetting again about silver for the sake of simplicity). Even in the convenient shape of coins, gold is often cumbersome and awkward to carry and use directly in exchange. For larger transactions, it is awkward and expensive to transport several hundred pounds of gold. But the free market, ever ready to satisfy social needs, comes to the rescue. Gold, in the first place, must be stored somewhere, and just as specialization is most efficient in other lines of business, so it will be most efficient in the warehousing business. Certain firms, then, will be successful on the market in providing warehousing services. Some will be gold warehouses, and will store gold for its myriad owners. As in the case of all warehouses, the owner's right to the stored goods is established by a warehouse receipt which he receives in exchange for storing the goods. The receipt entitles the owner to claim his goods at any time he desires. This warehouse will earn profit no differently from any other—i.e., by charging a price for its storage services.

  There is every reason to believe that gold warehouses, or money warehouses, will flourish on the free market in the same way that other warehouses will prosper. In fact, warehousing plays an even more important role in the case of money. For all other goods pass into consumption, and so must leave the warehouse after a while to be used up in production or consumption. But money, as we have seen, is mainly not “used” in the physical sense; instead, it is used to exchange for other goods, and to lie in wait for such exchanges in the future. In short, money is not so much “used up” as simply transferred from one person to another.

  In such a situation, convenience inevitably leads to transfer of the warehouse receipt instead of the physical gold itself. Suppose, for example, that Smith and Jones both store their gold in the same warehouse. Jones sells Smith an automobile for 100 gold ounces. They could go through the expensive process of Smith's redeeming his receipt, and moving their gold to Jones's office, with Jones turning right around and redepositing the gold again. But they will undoubtedly choose a far more convenient course: Smith simply gives Jones a warehouse receipt for 100 ounces of gold.

  In this way, warehouse receipts for money come more and more to function as money substitutes. Fewer and fewer transactions move the actual gold; in more and more cases paper titles to the gold are used instead. As the market develops, there will be three limits on the advance of this substitution process. One is the extent that people us these money warehouses—called banks—instead of cash. Clearly, if Jones, for some reason, didn't like to use a bank, Smith would have to transport the actual gold. The second limit is the extent of the clientele of each bank. In other words, the more transactions taking place between clients of different banks, the more gold will have to be transported. The more exchanges are made by clients of the same bank, the less need to transport the gold. If Jones and Smith were clients of different warehouses, Smith's bank (or Smith himself) would have to transport the gold to Jones's bank. Third, the clientele must have confidence in the trustworthiness of their banks. If they suddenly find out, for example, that the bank officials have had criminal records, the bank will likely lose its business in short order. In this respect, all ware-houses—and all businesses resting on good will—are alike.

  As banks grow and confidence in them develops, their clients may find it more convenient in many cases to waive their right to paper receipts—called bank notes—and, instead, to keep their titles as open book accounts. In the monetary realm, these have been called bank deposits. Instead of transferring paper receipts, the client has a book claim at the bank; he makes exchanges by writing an order to his warehouse to transfer a portion of this account to someone else. Thus, in our example, Smith will order the bank to transfer book title to his 100 gold ounces to Jones. This written or
der is called a check.

  It should be clear that, economically, there is no difference whatever between a bank note and a bank deposit. Both are claims to ownership of stored gold; both are transferred similarly as money substitutes, and both have the identical three limits on their extent of use. The client can choose, according to this convenience, whether he wishes to keep his title in note, or deposit, form.14

  Now, what has happened to their money supply as a result of all these operations? If paper notes or bank deposits are used as “money substitutes,” does this mean that the effective money supply in the economy has increased even though the stock of gold has remained the same? Certainly not. For the money substitutes are simply warehouse receipts for actually-deposited gold. If Jones deposits 100 ounces of gold in his warehouse and gets a receipt for it, the receipt can be used on the market as money, but only as a convenient stand-in for the gold, not as an increment. The gold in the vault is then no longer a part of the effective money supply, but is held as a reserve for its receipt, to be claimed whenever desired by its owner. An increase or decrease in the use of substitutes, then, exerts no change on the money supply. Only the form of the supply is changed, not the total. Thus the money supply of a community may begin as ten million gold ounces. Then, six million may be deposited in banks, in return for gold notes, whereupon the effective supply will now be: four million ounces of gold, six million ounces of gold claims in paper notes. The total money supply has remained the same.

  Curiously, many people have argued that it would be impossible for banks to make money if they were to operate on this “100 percent reserve” basis (gold always represented by its receipt). Yet, there is no real problem, any more than for any warehouse. Almost all warehouses keep all the goods for their owners (100 percent reserve) as a matter of course—in fact, it would be considered fraud or theft to do otherwise. Their profits are earned from service charges to their customers. The banks can charge for their services in the same way. If it is objected that customers will not pay the high service charges, this means that the banks' services are not in very great demand, and the use of their services will fall to the levels that consumers find worthwhile.