The Ethical Rules of Producing Money

0:00Ladies and gentlemen, I'm very glad to be with you here this evening, this early evening, not only because the Mises Institute is a great place to be in general and to meet wonderful people, but because they gave me a 30-minute commercial break for my new book. So this book has just been published by the Mises Institute, The title is The Ethics of Money Productions and I'll give you just a short introduction to this very important work. It's a sturdy bind. It can be an assault weapon or defense. And you see here on the front cover an excerpt, an image from the Saxon Spiegel, the Saxon Mirror.

0:53The Saxons is a German tribe. We still have lower Saxony in Germany today and Saxony. And in the Middle Ages, that was the way you composed law books. Not with words, but stayed with images. It was kind of a comic. And this is the scene where it says that, render unto Caesar what belongs to Caesar, unto God what belongs to God, and various other things. and various other things. And so that's how the populace was educated in basic terms of law, the common man. And I started reading this by curiosity and showed it to my girls. I found this very wonderful picture and thought it would be fine for the cover of my book. And it is also significant in that the book is the result of research that started with a short course that I gave in the last year when I was here in Auburn, A short course on the history of money and the history of monetary theory in particular was a course that I gave to a group of retired people

1:56at the request of a great supporter of the Mises Institute who was the leader of this group and asked me to do this. And so one of the thinkers that we discussed in this class was Nicholas Oresme which is a scientist from the 14th century, he was an astronomer, mathematician, physicist, economist and least of all he was a bishop. He was the bishop of the French town of Lisieux which much later on became famous because it was the town where St. Teresa of the Child of Jesus of the Child of Jesus lived in her order. So Nicholas Oresme wrote in fact the first treaties that we have in the history of economic thought are exclusively dedicated to an economic subject. So there was a lot of writing before on monetary questions but dispersed in writings mainly dedicated to other subjects, ethics for example, how to run a country and so on.

3:08And Oresme was the first one to dedicate an entire treatise on this subject and the title of his treatise was a treatise on the alteration of money. And as we can infer from this treatise, Oresme thought that it was a mortal sin to alter money at all. Now money in his day was essentially commodity money, it was composed of gold and silver In the 13th or 14th century there were hardly any gold coins circulating within Europe and he therefore proposed the essential conclusion of his deductions on the ethics of money production that once a coin has been introduced into the market it should be preserved by the government, by its issuer, in a physically identical form throughout the ages.

4:01The ages. It was a sin to alter money, in particular to debase money. Now the debasement of money was the inflation of those ages. To inflate the money supply, from a physical point, from a technical point of view, implied that you imprinted on the same coin, which was, for example, a 10 gram of silver coin, and you imprinted that it was worth now 20 grams of silver or 40 grams of silver, the very same coin, it has a higher denomination, all the other way around, you take the same coin which was 10 grams silver coin and you take half of the silver out of it and replace it with something else. So this is of course inflation. It's an increase of the nominal quantity of money beyond the level it would have reached if the debasement had not taken place, if the money producer had adhered to Orisma's principle.

5:00And Orisma thought that this was not only a sin, it was a mortal sin. Mortal Sin, for those of you who are not catholic, might be some, implies that you go burn in hell. Now, Oresme was not only a bishop, he was the confessor to Charles VII, King of France. Now you imagine the poor Charles, his pockets empty, his wife crying for new riches, his subjects and his evil princes and so on in the countryside, his vessels on whose corporation he depends, crying out for more subsidies, and what has he got to give them?

5:51He has just a few pennies in his purse left, he would have to raise taxes, encountering the bloody resistance of his population, if he ever dared to raise taxes. There's nobody there to give him credit in the 14th century. And then comes his confessor and tells him he will go burn in hell if he inflates the money supply. Okay, so I found this just wonderful. It was more than charming, it was admirable. And I thought it was time to have an update on this for the 21st century. So that's what this book is all about. Now of course we have made great progress from the 14th century onward.

6:41If we compare now Oresme's relationship to his government, to the relationship between our government today and their monetary experts. Of course, well, George Bush doesn't have a confessor, right? At least I wouldn't know, and Bernanke probably not, almost certainly not. So, I mean, what is their relationship with monetary experts? Well, they have all the monetary experts around telling them that it's actually good to inflate the money supply. That's what you need to do. It's perfectly innocuous from a moral point of view and it's good from the point of view of collectivist morals. It's good for the aggregate because you promote growth, you prevent catastrophes such as deflation.

7:26And so it's the thing to do. Now, so here, of course, you are in the capital of the disagreeing few who do not share this mainstream consensus who hold up the position that has been first formulated by Oresme in the 14th century and has been developed in the century that would follow by the classical economists and by their successors in the 19th century and in the 20th century. That what today figures as mainstream opinion on monetary thought was discredited at the end of the 19th century and at the beginning of the 20th century as monetary crankism.

8:14It was only due to what we today know as the Keynesian Revolution that we have a complete revulsion of the picture that those who were before the monetary cranks, and other things whom nobody took serious, now are the great experts, writing the obits in the journals and having the chairs at the universities, whereas those who were the orthodox monetary theorists in former times will give conferences in other places that are not covered by the New York Times, but attract increasing numbers of good people that will change the picture eventually, again. Now, in my talk, I will first of all make the distinction between enforceable ethical rules and not enforceable ethical rules and we'll move on to discuss three different topics, namely, first of all, how a natural monetary order would operate, what a natural monetary order is and how it would operate, and then we'll try to set out for a brief ethical assessment of the natural monetary order and in the last step we'll talk a little bit about monetary systems which cover our present-day monetary systems and see how they present themselves from a moral point of view.

9:37So as far as ethical rules are concerned, I will mainly focus on enforceable rules and enforceable rules concerned especially the protection of property rights and the respect of property rights. So violations of property rights in the form of theft or robbery, fraud, embezzlement and so on are violations of ethical rules that can be enforced. We enforce with the use of the police and armies, if need be, that these rules be respected among all members of society. On the other hand, there are non-enforceable rules. For example, there are things like, you should be polite or we should care for others in our relationships with them, we should seek for good ends in the pursuit of the use of our means, we should be moderate in the use of our means, we should have courage if we confront resistance to the pursuit of good ends and so on. These are also ethical rules, but they are not enforceable ethical rules. We would not use I will focus mainly on the central ethical rule, which is the respect for property rights, the respect and protection of property rights.

10:56And this central ethical rule is constitutive for a natural monetary order. In a natural monetary order, we have the right to a natural monetary order. The central ethical rule is constitutive for a natural monetary order. In a natural monetary order, we have universal respect of private property rights. All private property rights are acquired by homesteading, by production and by exchange and by gifts. These are the only ways to acquire property rights. and they may not be acquired without the consent of the previous owner, that is why theft and robbery, fraud, embezzlement and so on.

11:43In such a world, which is of course a hypothetical world because such a world has never existed but which could exist and could serve as an example We have also a natural monetary order in which money is produced naturally, that is, money is being produced under the respect of other people's property rights. In such a natural monetary order we have certain types of monies that are being produced, which I suggest to call natural monies, which are called natural monies in this book. What are natural moneys that are those commodities that are very marketable, in particular the precious metals for the reasons that we explain to our students in our first year classes, so they are easily recognizable, they have a high purchasing power per weight unit, they are homogeneous, they can be subdivided into small units and so on.

12:45So therefore the precious metals are natural monies. They are natural monies because they serve two purposes, a non-monetary purpose and a monetary purpose. They are used for jewelry and other industrial employments and are therefore evaluated outside of a monetary economy. And because they have such value outside of their use in indirect exchanges, they can also be used as monies. They can be used to serve as intermediaries in exchanges. So they are natural monies. And such monies are therefore being produced under the respect of property rights. Therefore, there is in such natural economic order a natural growth of the money supply.

13:35This natural growth is constrained by the same principles that constrain the growth of the quantities of all other goods. What are these principles? Well, it's actually one basic principle, namely that demand rules production. Demand rules production because by spending their money on various goods, Consumers determine the receipts, the selling receipts of all producers and the different producers compete on the factor markets for labor and land and produced factors of production, machines, trucks and so on and this competition therefore determines the cost of production.

14:25Cost of production ultimately determined of course by the expected receipts that will from selling a product so consumer demand rules both the receipts and the cost of every single company every single investment project and consumers are therefore called sovereign so that's essential teaching of Austrian economics now in such an economy money is no particular case at all it's just a commodity like all other commodities it is being produced to an increased extent If the demand for money increases, it is being produced to a smaller extent if the demand for money diminishes. Therefore, there is in such an economy, as a general rule, no reduction of the money supply, there is a constant moderate growth of the money supply, there is no sudden strong increase of the money supply, No very strong growth rates of the money supply simply because it's costly to produce money and if we want to create something like a 10% or 20% or 50% increase of the money supply, this would entail costs to a very considerable extent that simply would make the production not worthwhile, would become non-profitable.

15:51so such growth rates of the money supply would not simply not exist and as a consequence the variations of the price level would be moderate too there would be some decrease of the price level some increase of the price level but no strong increases and no strong decreases of the price level and in such an environment as the professor Klein has explained to us this afternoon entrepreneurs can operate perfectly well the essential tool of entrepreneurs is This economic calculation essentially means that we compare the profitability of different investment projects. Let's say you have an investment project A where you spend 100 ounces of gold on factors of production and you can expect selling receipts of 130 ounces of gold.

16:39You have another project in which you also spend 100 ounces of gold on your factors of production of Production and you can expect 150 ounces of gold of receipts and we have a 30% return on investment here and a 50% return on investment here so we can compare these to physically different heterogeneous investment projects in terms of the same unit namely profit rate and can decide ourselves if we so like to realize the ones that in our judgment promise the highest profit So this is the mechanism that integrates all of the entire economy and this mechanism works irrespective of the level of the price level and it works irrespective of the evolution of the price level. We can calculate profit rates at a constant price level, at a decreasing price level and at an increasing price level. In order to compare different investment projects plays no role, whatever, how the price level moves.

17:45So the market economy works perfectly well or can work perfectly well and smooth in such a natural monetary order. Let's then turn to assess this natural monetary order. First observation is, of course, the ethical rules of money production are respected, at least the very fundamental, the enforceable rule, namely the one that says, well, low-shale, not steel. Those shall not even think of stealing, two commandments dedicated to this point, which is therefore not quite a detail. So the ethical rules are respected, and one might think therefore that everything is to the best in the best of all possible worlds, But so do not think our friends the Cajuns, before them our friends the mercantilists, before them our other friends, the inflationists, the plague that has existed from ancient times, recorded in Greece and in Roman literature, in our day of course.

18:56So what is their argument? Well, it's not sufficient that the ethical rules are being respected. That's an individualistic point of view. We need to take into account the operation of the system as a whole. And in such a case, it might be worthwhile to create through government intervention, create through force, through a violation of those individualistic property rights. A higher growth rate of the money supply than would otherwise have existed. Now such a higher growth rate that would otherwise have existed, that only comes into being through the violation of property rights, I call in my book inflation. So that's what inflation is all about.

19:42So our friends, the inflationists say, inflation can be beneficial. And here we have, well, it's obviously impossible to address all their arguments because that's the whole point of the discipline that we call monetary economics. It's the analysis of cause and effect as far as increases and decreases of the money supply are concerned. And it's precisely on this point that Austrians disagree with all the rest of the profession. There are many points of agreement between Austrian economists and other economists, free market economists as we call them sometimes, as far as housing market is concerned and agricultural policies and education and so on, we always find alliances.

20:31But when it comes to money, the Austrians are suddenly alone. So there the Austrians are the only ones today who defend the positions that had first been defined by Oresmy in the 14th century and then by the classical economists later on and their successors. So Austrians do not believe that we can, by inflation, improve the aggregate behavior of the economy. I'll just go through maybe three or four examples in order to illustrate this point. One essential idea of the inflation is, a typical point is, it's not necessarily an argument that is firmly held by academic economists, but it's very popular within the non-economists, rest of the population, according to this argument, you need to have a growing money Money Supply if the economy grows. Let's say the economy grows by 5% or by 10%. Then it's necessary to accommodate this growth by corresponding increase of the money supply.

21:35Otherwise, so the argument goes, you could not sell all these new goods. So you have 5% more goods and services entering the market. How do we sell them? All the money is already being taken by the other goods. What's wrong with this argument is that the prices of goods and services is not independent of the money supply and of their own quantities. What happens in such a case is simply that all the prices start to diminish. If the quantity of those other goods increase, then their relative value diminishes. The more you have of a thing, the less it's valuable, the less it's scarce, and so the prices that we pay for them diminish.

22:24If you hear this for the first time, well, you're ready to accept this and then you might actually move on to the second objection that goes something like this. Okay, so we know then that our prices will diminish, we'll have something like a deflation, a price level deflation, but isn't this a bad thing too? because now our poor entrepreneurs, they have bought at higher prices in the past, now they need to sell at lower prices in the present. Now that's the wrong argument, too, because entrepreneurs, at least, well, those who we Austrians call entrepreneurs, they do not operate that mechanically. An entrepreneur is not somebody that has a fixed idea of what he wants to do, launches his production plan and then sees at which price he will be able to sell his goods.

23:14That's not how it works. An entrepreneur works is to imagine a production that he will sell at some point in the future on the market and imagine which price he can realize for his goods. What is the total selling receipt that I can realize with my production? And based on this estimate of his future selling receipts, he then goes to the factor markets and sees whether he can realize his project, whether he can buy all the factors of production that are necessary at a price that is sufficiently low. So if such an entrepreneur anticipates that prices will diminish in the future because the economy grows, well then he will simply start bidding down factor prices in the present. And if he is not able to do this, if he doesn't find anybody who is working right now for a lower wage and doesn't find any land owner who is willing to rent his land for a lower price and so on, well he will simply not start his project.

24:11No fundamental problem here. Well, I'm running out of time, therefore, maybe just one other typical argument that is advanced, it concerns the cost of gold and silver, we are told that from an aggregate point of view, it's more suitable to use gold and silver rather than, excuse me, more suitable to use paper money rather than gold and silver because gold and silver are costly, whereas paper money is less costly, It's actually cheap to produce, you just need a little paper and a little ink. If you want to increase the quantity of money by the factor of 10, you just add a little ink and you add a zero on each bank note.

24:56So it's easy. Now, this argument presupposes, it holds only true for the following case. In the case that the only service rendered by money consists in its exchange value. And it's being exchanged for other goods. First assumption, second assumption, the only kind of costs that are relevant are those that are needed for the production of the physical object. In this case, it's true, paper money is less expensive than gold and silver money. But that's not the relevant comparison. In fact, the benefits are not the same. It's not just an exchange service that is rendered by money, but gold and silver also render at least one other service, namely a guarantee against a sudden depreciation of the purchasing power.

25:44It's precisely because gold and silver are costly to produce that their quantity cannot be increased at libitum. So there's an inbuilt insurance against inflation in them. So, and then even if they are more costly to produce because they do not provide the same service, they provide greater services than paper money, it's no longer clear whether they are more or less expensive. And it depends on the subjective value judgments of all market participants, whether they are so. We wouldn't say to somebody who wants to drive a Mercedes Benz, we say, look, I mean this car only renders transportation services, why don't you drive a Fiat Panda or something, right? Another small car, I don't want to take the smallest cars that you have in the US, a Kia, right?

26:31Nothing against Kia, it's a wonderful company probably in producing now in Georgia, their cars. Well, these are very inexpensive cars and they provide less services than Mercedes-Benz cars, okay? Now, whether that's better or worse is for each consumer to judge, right? Some buy Mercedes-Benz and others buy a Kia, so there's nothing wrong with the one or the other. But why should we say in general, well, that's the thing to do and the other thing is not the thing to do? Now, I could go on for quite a time, well, going through the list, but in every single case the conclusion would be the same. From an Austrian point of view, paper moneys or, let's say, the production of money through the violation of property rights does not confer aggregate benefits.

27:20What it does is to benefit one segment of the economy at the expense of all others. For what happens if we increase the money supply is to confer a new purchasing power to the first users of this additional money. And they will start spending the money bidding up prices, so prices will slowly increase one after another throughout the economy. and other people will therefore have to start paying those higher prices even though they have not yet received any additional monetary income. So what paper money does and what inflation does is to redistribute income within society, it does not confer any aggregate benefits. Final point on monetary systems, that is monetary orders that are premised on the violations of property rights that entail therefore some sort of inflation.

28:17We can distinguish the following forms of violations of property rights that are discussed in more detail in the book, in particular four forms. The first one is the legalization of fractional reserve money certificates. Fractional reserve certificates can be banknotes, covered only partially by underlying reserves. It can also be debased coins. Second, violation of property rights comes through the imposition of monopolies, legal monopolies for certain types of money. For example, we shall only use gold coins rather than gold or silver and copper coins and so on. Or we shall only use the coins and the banknotes made by the company A and not by other companies, so and so.

29:05So we have monopoly rights, this is an infringement of property rights. Third, we have, most importantly, legal tender laws, which oblige all market participants to accept certain types of money In view of payments stipulated in terms of another money, for example, if we make a contract, I'll buy your car for a thousand ounces of silver, then illegal tender laws in the US allow me not to actually pay in silver, even though I promised so in my contract, but to make an equivalent payment in terms of US dollars. Okay, dollar notes. Now this of course leads to the very perverse incentive for each market participant to use the money that is least valuable.

29:52That is called Gresham's Law, so actually the least valuable money is being used at the expense of the better monies. And the fourth violation of property rights comes when central banks suspend payments, so this is no longer the case today, Today central banks are no longer suspending payments, they are producing paper money. But suspension of payments is a violation of contractual obligations. Final word on paper money. Paper money, or what is the same thing, electronic money, electronic money issued by central banks today, is by its very nature an inflationary form of money. And that is so because it can only be produced under the violation of property rights.

30:39There is no free market situation. There has never been a single historical free market situation in which free paper money tickets have been introduced competitively. An example I always give to my students is, well, imagine I show up and say, well, I print my piece of paper and I write on it, Three Hultzmanns. I tend this to you and say, now you're going to work for me for a year. Great deal. I assure you, it's a great deal. And they know that something fishy is going on. And the reason is simply, well, how can you evaluate the sheet of paper that I'm handing over to you? Because it's not being used. Nobody has ever accepted this as a means of exchange. So how can we evaluate this? How can we form an opinion on its value?

31:29So that's the logical problem that prevents any introduction of paper money in a competitive context and therefore as a matter of fact paper monies have exclusively been introduced by imposition by the force of government power in the form of legal tender laws and in the form of suspension of payments of former banknotes. And the impact of paper money of inflation in general then is negative. The two main negative forms of impact are, first of all, an enormous redistribution. You've just seen the slides from Professor Salerno. The money supply in M2 has increased by the factor of 4 and money base has also increased by the factor of 4 within the last 20 years.

32:22Now imagine what this means in terms of redistribution. It means that those who were at the high end of this injection of the new money into the economy were in each single year, were commanded an extra 10% of national revenue at the expense of all other market participants, a form of redistribution that cannot be justified by any ethical principle that I'm aware of. And the second negative consequence is the business cycle that several speakers have mentioned this afternoon. And if we increase the money supply, especially if we increase it very strongly, there's a risk that we decrease the interest rate below the equilibrium level and therefore create inter-temporal misallocations and therefore impoverish our society.

33:15So in conclusion, therefore, we can notice three points. First of all, there is such a thing as a natural monetary order. and this natural monetary order is possible and beneficial can serve us as an orientation for monetary reform that was precisely realized by all Austrian writers from Mises to Rothbard to present day writers. Second, the performance of a natural monetary order cannot be improved through government interventions, cannot be improved by the force of the state. All that the state does is to increase the money supply beyond the level it would otherwise have reached, thereby only entailing redistribution and business cycles. And the third point is that the monetary order deteriorates when the rules, the basic ethical rules of money production are violated.

34:09It deteriorates into fractional reserve banking, into paper money systems that create these negative aggregate consequences and are unjustifiable, Thank you very much for your attention.