Chapter VI

THE PRODUCTION OF MONEY in a free society is a matter of free association. Everybody from the miners to the owners of the mines, to the minters, and up to the customers who buy the minted coins, all of them benefit from the production of money. None of them violates the property rights of anybody else, because everybody is free to enter the mining and minting business, and nobody is obliged to buy the product.

Things are completely different once we turn to money production in interventionist regimes, which have prevailed in the West for the better part of the past 150 years. Here we need to mention in particular two institutional forms of monetary interventionism: (fraudulent) fractional-reserve banking and fiat money. The common characteristic of both these institutions is that they violate the principle of free association. They enable the producers of paper money and of money titles to expand their production through the violation of other people’s property rights.

Banking is fraudulent whenever bankers sell uncovered or only partially covered money substitutes that they present as fully covered titles for money. These bankers sell more money substitutes than they could have sold if they had taken care to keep a 100 percent reserve for each substitute they issued.¹⁹

The producer of fiat money (in our days typically: paper money) sells a product that cannot withstand the competition of free-market monies such as gold and silver coins, and which the market participants only use because the use of all other monies is severely restricted or even outlawed. The most eloquent illustration of this fact is that paper money in all countries has been protected through legal tender laws. Paper money is inherently fiat money; it cannot thrive but when it is imposed by the state.²⁰

In both cases, the production of money is excessive because it is no longer constrained by the informed and voluntary association of the buying public. On a free market, paper money could not sustain the competition of the far superior metal monies. The production of any quantity of paper money is therefore excessive by the standards of a free society. Similarly, fractional-reserve banking produces excessive quantities of money substitutes, at any rate in those cases in which the customers are not informed that they are offered fractional-reserve bank deposits, rather than genuine money titles.

This excessive production of money and money titles is inflation by the Rothbardian definition, which we have adapted in the present study to the case of paper money. Inflation is an unjustifiable redistribution of income in favor of those who receive the new money and money titles first, and to the detriment of those who receive them last. In practice the redistribution always works out in favor of the fiat-money producers themselves (whom we misleadingly call “central banks”) and of their partners in the banking sector and at the stock exchange. And of course inflation works out to the advantage of governments and their closest allies in the business world. Inflation is the vehicle through which these individuals and groups enrich themselves, unjustifiably, at the expense of the citizenry at large. If there is any truth to the socialist caricature of capitalism—an economic system that exploits the poor to the benefit of the rich—then this caricature holds true for a capitalist system strangulated by inflation. The relentless influx of paper money makes the wealthy and powerful richer and more powerful than they would be if they depended exclusively on the voluntary support of their fellow citizens. And because it shields the political and economic establishment of the country from the competition emanating from the rest of society, inflation puts a brake on social mobility. The rich stay rich (longer) and the poor stay poor (longer) than they would in a free society.²¹

The famous economist Josef Schumpeter once presented inflation as the harbinger of innovation. As he had it, inflationary issues of banknotes would serve to finance upstart entrepreneurs who had great ideas but lacked capital.²² Now, even if we abstract from the questionable ethical character of this proposal, which boils down to subsidizing any self-appointed innovator at the involuntary expense of all other members of society, we must say that, in light of practical experience, Schumpeter’s scheme is wishful thinking. Credit expansion financed through printing money is in practice the very opposite of a way to combat the economic establishment. It is the preferred means of survival for an establishment that cannot, or can no longer, sustain the competition of its competitors.

It would not be uncharitable to characterize inflation as a large-scale rip-off, in favor of the politically well-connected few, and to the detriment of the politically destitute masses. It always goes in hand with the concentration of political power in the hands of those who are privileged to own a banking license and of those who control the production of the monopoly paper money. It promotes endless debts, puts society at the mercy of “monetary authorities” such as central banks, and to that extent entails moral corruption of society.²³

¹⁹See Hans-Hermann Hoppe, Jörg Guido Hülsmann, and Walter Block, “Against Fiduciary Media” Quarterly Journal of Austrian Economics 1, no. 1 (Spring 1998): 19–50; Hülsmann, “Has Fractional-Reserve Banking Really Passed the Market Test?” Independent Review 7, no. 3 (2003); and the literature quoted in Hülsmann, “Banks Cannot Create Money” Independent Review 5, no. 1 (2000). This point is by the way undisputed by all participants in the present debate on fractional-reserve banking. In contrast to the present author, however, Lawrence White seems to believe that historical fractional-reserve banking has rarely if ever been fraudulent. See White, “Accounting For Fractional-Reserve Banknotes and Deposits—or, What’s Twenty Quid to the Bloody Midland Bank?” Independent Review 7, no. 3 (2003).

²⁰Notice that this point holds true only for genuine paper monies, not necessarily for national paper currencies consisting of money substitutes backed by commodity money. Neither does our contention necessarily apply to credit monies, such as the paper pound during the Napoleonic Wars. For the distinction between money, fiat money, and credit money, see Mises, Theory of Money and Credit, pp. 73–76.

²¹In this regard, inflation works in an unholy alliance with the tax code. The main advantage of the successful newcomer is that he has high revenues. But present-day corporate and income tax rates effectively prevent him from accumulating capital quickly enough to sustain the competition of the establishment. As a result, there are virtually no more firms that make it from the very bottom into the major league of corporate capitalism. It took a technological revolution to overcome these obstacles and bring a few firms such as Microsoft to the top of corporate America. Most other firms are increasingly dependent on credit to finance any large-scale ventures. But financial intermediation is today a highly regulated business, and all major banks are already allied with the industrial establishment. What would be their incentive to finance a venture that destroys the value of some of their other holdings?

A similar situation prevails in individual finance. Consider just the most important case of private debt, namely, debts incurred for building or purchasing a home. Under the prevailing tax code, individuals can deduct interest they pay on their mortgages from their tax bill, but they cannot make any similar deductions if they finance their home out of their own pocket. The result is that virtually nobody even thinks of financing a home the way it has been done in former times, namely, by first saving money and then paying for the house in cash. And paper money has made it possible to always provide new credits for willing homeowners. The printing press of the Federal Reserve has fueled a housing boom just as it has fueled the 1990s boom of the stock market. The stock market boom has already ended in a resounding crash. The housing boom is next in line.

²²See Josef A. Schumpeter, Theorie der wirtschaftlichen Entwicklung (Leipzig: Duncker & Humblot, 1911); translated as Theory of Economic Development (Cambridge, Mass.: Harvard University Press, 1949).

²³See on this point the concise statements in Robert Higgs, “Inflation and the Destruction of the Free Market Economy,” Intercollegiate Review (Spring 1979).