WEBVTT NOTE How Is Fiat Money Possible? 1 00:00:00.000 --> 00:00:05.000 My topic is, how is fiat money possible? 2 00:00:05.000 --> 00:00:12.000 Let me start out by explaining briefly what fiat money is. 3 00:00:12.000 --> 00:00:24.000 Fiat money is irredeemable paper money, that is money which is neither usable for any industrial purposes, 4 00:00:24.000 --> 00:00:32.000 Nor money that represents a claim or a title to a specified commodity. 5 00:00:34.000 --> 00:00:38.000 With respect to the question, is such a thing possible? 6 00:00:38.000 --> 00:00:40.000 We all know, of course, the answer. 7 00:00:40.000 --> 00:00:45.000 That is, yes, obviously fiat money is possible. 8 00:00:45.000 --> 00:01:00.000 As a matter of fact, since 1971, we have for the first time in world history a situation where the entire world is on a fiat money standard. 9 00:01:00.000 --> 00:01:09.000 There is no currency in the world that is redeemable into anything except the same thing that you turn in. 10 00:01:09.000 --> 00:01:22.840 My question is not is it possible but how, in which way can fiat money come into existence? 11 00:01:22.840 --> 00:01:32.880 Can it come into existence as the outcome of the interactions of self-interested individuals 12 00:01:32.880 --> 00:01:40.640 and in particular can it come into existence without violating in any way principles of 13 00:01:40.640 --> 00:01:51.080 justice or introducing or by introducing economic inefficiencies into the system and the answer 14 00:01:51.080 --> 00:02:01.640 that I will try to explain is it cannot, that is fiat money cannot arise in a just and economically 15 00:02:01.640 --> 00:02:04.640 in an efficient way. 16 00:02:04.640 --> 00:02:13.280 The purpose of my speech is generally systematic, but given the fact that the thesis that I 17 00:02:13.280 --> 00:02:25.320 try to defend here has been frequently disputed, I want to examine and critically analyze a 18 00:02:25.320 --> 00:02:34.680 a number of counter arguments to the thesis that I will advance here along the way. In 19 00:02:34.680 --> 00:02:42.440 particular, I want to analyze arguments advanced by the monetarist school of economics, especially 20 00:02:42.440 --> 00:02:49.680 by Milton Friedman, also by Irving Fisher, and the arguments that have been advanced 21 00:02:49.680 --> 00:02:54.680 by some Austrian renegades, Larry White and George Selgin. 22 00:02:58.640 --> 00:03:01.720 There are considerable differences between the monetarists 23 00:03:01.720 --> 00:03:04.300 and these Austrian renegades. 24 00:03:05.720 --> 00:03:09.580 Nonetheless, despite these differences, 25 00:03:09.580 --> 00:03:14.580 they hold in common the view that either a total 26 00:03:14.640 --> 00:03:18.880 or a partial fiat money is just 27 00:03:18.880 --> 00:03:23.880 and efficient and would spontaneously emerge on the market. 28 00:03:25.960 --> 00:03:30.960 I will try to point out various flaws in these arguments 29 00:03:31.320 --> 00:03:36.320 and along the way also try to clear up a number of errors 30 00:03:37.080 --> 00:03:41.080 and nonsensical statements that otherwise have been made 31 00:03:41.080 --> 00:03:44.020 in contemporary monetary theory. 32 00:03:44.020 --> 00:03:55.020 Let me begin by briefly recapitulating the basic insights of the Austrian School with 33 00:03:55.020 --> 00:04:03.300 respect to the origin of money first. Given that people have a certain amount of, a certain 34 00:04:03.300 --> 00:04:15.720 to demand for leisure, in general people prefer more exchange goods over less exchange goods. 35 00:04:15.720 --> 00:04:27.020 And because of this people prefer division of labor as being more productive over self-sufficiency. 36 00:04:27.020 --> 00:04:39.120 Money arises for the same selfish reasons, so to speak. People in a barter economy produce 37 00:04:39.120 --> 00:04:51.500 for exchange and it can happen that the supply of goods offered for exchange is mismatched 38 00:04:51.500 --> 00:05:00.060 with a demand for goods. It can happen in barter that a double coincidence of wants is 39 00:05:00.060 --> 00:05:11.260 absent. It is that I have what you want but you do not want what I have. In such a situation 40 00:05:11.260 --> 00:05:19.220 where we find that the supply of exchange goods is mismatched with the demand for these 41 00:05:19.220 --> 00:05:31.340 Goods, self-interested individuals can still improve their situation if they exchange a 42 00:05:31.340 --> 00:05:38.420 less marketable good or if they succeed in exchanging a less marketable good for a more 43 00:05:38.420 --> 00:05:42.540 marketable good. 44 00:05:42.540 --> 00:05:48.380 If they succeed in doing this and acquire a more marketable good for a less marketable 45 00:05:48.380 --> 00:05:57.820 good, then an additional demand component is added to this particular good that was 46 00:05:57.820 --> 00:06:05.940 traded for the fact that it was more marketable. An additional demand component is added to 47 00:06:05.940 --> 00:06:10.980 This is a pre-existing barter demand for this good. 48 00:06:10.980 --> 00:06:17.520 This additional demand component enhances the marketability of this particular good 49 00:06:17.520 --> 00:06:20.520 even further. 50 00:06:20.520 --> 00:06:27.880 This is noticed by other individuals that this good has increased marketability and 51 00:06:27.880 --> 00:06:41.880 Other people will now, for the same reason of covering their losses, so to speak, from oversupplies, also demand this particular good. 52 00:06:41.880 --> 00:06:55.880 Goods that are acquired not for the purpose of using them for any direct purpose, but using them in order to resell them, in order to acquire what people really want. 53 00:06:55.880 --> 00:07:07.380 Such goods are called the media of exchange and the definition of money is to be a medium of exchange. 54 00:07:07.380 --> 00:07:16.080 Money is the most easily resaleable good and the most generally accepted good. 55 00:07:16.080 --> 00:07:30.080 In the course of inter-regional trade, which also takes place because people, again, want to participate in the advantages offered by division of labor. 56 00:07:30.080 --> 00:07:39.080 In the course of the expansion of inter-regional trade, different types of money compete against each other, 57 00:07:39.080 --> 00:07:58.080 and there is a tendency in the market that one money will outcompete another money, such that at the end of the process, so to speak, only a single money commodity that is in worldwide use will emerge. 58 00:07:58.080 --> 00:08:22.080 Historically, this has been gold, of course. This is essentially, in very brief form, the tradition of Turgol, Menger, Mises and Rothbard of monetary thought, Joseph Salerno talked about that yesterday. 59 00:08:22.080 --> 00:08:42.080 According to this tradition, money has one single function, that is, to serve as a medium of exchange, to be a facilitator of exchange, and money must, under all circumstances, arise as a commodity money. 60 00:08:42.080 --> 00:08:55.080 It must arise as a commodity money because something can be demanded as a medium of exchange only if it has already a pre-existing barter demand. 61 00:08:55.080 --> 00:09:09.080 As a matter of fact, money is that commodity that had a very high degree of marketability under barter conditions. 62 00:09:09.080 --> 00:09:19.280 At this moment now let me just make a few remarks regarding some alternative or rival theories 63 00:09:19.280 --> 00:09:31.800 of money. What about the idea of commodity reserve money? Money being backed by a bundle 64 00:09:31.800 --> 00:09:41.160 of Goods has been frequently proposed as an alternative to something like a gold standard. 65 00:09:41.160 --> 00:09:49.320 Can titles to bundles of good become money? The answer is no such a thing is absolutely 66 00:09:49.320 --> 00:09:58.400 impossible because bundles of goods are by definition less easily saleable than the most 67 00:09:58.400 --> 00:10:08.240 is easily saleable of the components of this bundle of goods and because of this, commodity 68 00:10:08.240 --> 00:10:17.300 reserve money is uniquely unsuited to become generally accepted as money. 69 00:10:17.300 --> 00:10:22.300 What about the idea of national monies? 70 00:10:22.300 --> 00:10:28.460 You notice that I emphasize the idea that money has a tendency to become an international, 71 00:10:28.460 --> 00:10:37.100 internationally used money. The idea of national money is of course an idea of Milton Friedman's. 72 00:10:37.100 --> 00:10:46.820 And what of the idea of optimal currency areas? Both ideas are obviously closely related. 73 00:10:46.820 --> 00:10:52.300 I would think that such an idea as national money or an optimal currency area seems to 74 00:10:52.300 --> 00:11:00.700 be entirely absurd except as an intermediate step, so to speak, in the development of money 75 00:11:00.700 --> 00:11:06.660 towards the ultimate goal of a one world type money. 76 00:11:06.660 --> 00:11:13.220 There are no more optimal currency areas than there are optimal trading areas. 77 00:11:13.220 --> 00:11:18.020 I have not encountered anybody who thinks that there are optimal trading areas. 78 00:11:18.020 --> 00:11:23.460 Everybody seems to think the optimal trading area is the world market. 79 00:11:23.460 --> 00:11:29.260 And the same, as far as I can see, applies also to money. 80 00:11:29.260 --> 00:11:35.260 It is, in a way, implied in the concept of a medium of exchange 81 00:11:35.260 --> 00:11:43.860 that it has a tendency towards becoming one and universal. 82 00:11:43.860 --> 00:11:53.020 I have been criticized with respect to this argument that I am confusing process and end 83 00:11:53.020 --> 00:12:02.700 state analysis, emphasizing the idea that there is an end state that money can possibly 84 00:12:02.700 --> 00:12:04.220 reach. 85 00:12:04.220 --> 00:12:14.740 This criticism has probably been inspired by Hayek who makes this distinction between process 86 00:12:14.740 --> 00:12:17.380 and end-state analysis. 87 00:12:17.380 --> 00:12:23.900 As far as I can see, again, this criticism is entirely unjustified. 88 00:12:23.900 --> 00:12:29.980 Actions are always goal-directed processes. 89 00:12:29.980 --> 00:12:39.220 Otherwise, if we have a process without a goal, what type of process would that be? 90 00:12:39.220 --> 00:12:43.820 That seems to be just random or noise. 91 00:12:43.820 --> 00:12:52.220 That a more widely or easily saleable medium of exchange is preferred to a less easily 92 00:12:52.220 --> 00:13:00.020 and less widely saleable one is as certain as that a more productive machine outcompetes 93 00:13:00.020 --> 00:13:08.860 a less productive one. A single and universally acceptable medium of exchange is as good as 94 00:13:08.860 --> 00:13:20.900 money can possibly get. What about the idea of separating money from the medium of exchange, 95 00:13:20.900 --> 00:13:28.460 From the Unit of Account, thesis like this have been advanced by Jaeger and Fama and 96 00:13:28.460 --> 00:13:35.140 Hall and Greenfield, various other authors. As far as I can see, this thesis is complete 97 00:13:35.140 --> 00:13:44.980 nonsense. In search of profit maximization, exchange producers will want to account in 98 00:13:44.980 --> 00:13:53.980 in terms of the most easily saleable and most generally acceptable commodity of all. 99 00:13:53.980 --> 00:14:03.660 By buying and selling, buying and selling markets are, if we have one world commodity 100 00:14:03.660 --> 00:14:13.400 money, buying and selling markets are thereby made the widest possible and a medium of exchange 101 00:14:13.400 --> 00:14:17.040 and the unit of account function 102 00:14:17.040 --> 00:14:19.840 are necessarily tied together. 103 00:14:19.840 --> 00:14:22.760 You cannot separate one from the other. 104 00:14:24.040 --> 00:14:28.840 What about other functions that are attributed to money? 105 00:14:30.200 --> 00:14:34.000 Frequently it is mentioned that money is a store of value. 106 00:14:35.480 --> 00:14:38.760 In this argument we would have to say, 107 00:14:38.760 --> 00:14:41.240 yes of course money is a store of value, 108 00:14:41.240 --> 00:14:44.480 But that is not the function of money. 109 00:14:44.480 --> 00:14:49.240 There are all sorts of goods that are stores of value, 110 00:14:49.240 --> 00:14:52.880 and there might well be goods that are better 111 00:14:52.880 --> 00:14:56.120 as a store of value than money is. 112 00:14:56.120 --> 00:14:58.800 And if we would discover that there are other goods 113 00:14:58.800 --> 00:15:02.800 that serve better as a store of value than money, 114 00:15:02.800 --> 00:15:06.040 that would certainly not be a sufficient argument 115 00:15:06.040 --> 00:15:10.360 to criticize money for not being as good 116 00:15:10.360 --> 00:15:19.560 a Store of Value as Other Goods. It is also the case that money is used generally as a 117 00:15:19.560 --> 00:15:27.260 standard of deferred payment, but again, other things might well also be used as a standard 118 00:15:27.260 --> 00:15:35.840 of deferred payment. That is not necessarily implied in the function of money. Nor, and 119 00:15:35.840 --> 00:15:43.000 And I want to emphasize this in particular, nor is money a measure of value. 120 00:15:43.000 --> 00:15:51.800 This is one of the ideas that had great attraction up to this day in the monetarist tradition 121 00:15:51.800 --> 00:15:54.320 of economic thought. 122 00:15:54.320 --> 00:16:01.800 They hold up to this day that money has the function of serving as some measure of value. 123 00:16:01.800 --> 00:16:11.800 Now, why are these arguments pointing out that money's function is to be a measure of value wrong? 124 00:16:11.800 --> 00:16:17.800 Let me give you some counter-arguments here. 125 00:16:17.800 --> 00:16:25.800 For, if you compare, say, a ruler being the measure of space, 126 00:16:25.800 --> 00:16:33.800 What is the demand for a measuring instrument like a ruler at any given point in time for 127 00:16:33.800 --> 00:16:40.960 a single person? We can say the demand for rulers at any given point in time and space 128 00:16:40.960 --> 00:16:49.800 is one. We only need one ruler and with one ruler we can measure all of space. We do not 129 00:16:49.800 --> 00:16:59.340 need thousands of rulers to make spatial measurements, one single one would do it all. And obviously 130 00:16:59.340 --> 00:17:08.180 there is a demand for money that is higher than just one unit of it. Secondly, a ruler 131 00:17:08.180 --> 00:17:17.740 or any other measuring instrument scales. A ruler is not being exchanged in the course 132 00:17:17.740 --> 00:17:25.540 of Making the Measurement. On the other hand, money obviously is being exchanged in the 133 00:17:25.540 --> 00:17:33.380 course of allegedly measuring value. But if that is the case and money is an exchange 134 00:17:33.380 --> 00:17:43.060 good, then it seems to follow that the marginal utility of money continuously changes with 135 00:17:43.060 --> 00:17:50.680 each exchange of money. If my supply of money goes down as a force of spending it, the marginal 136 00:17:50.680 --> 00:18:05.740 utility of money increases. If my money supply increases, then the marginal utility decreases. 137 00:18:05.740 --> 00:18:15.860 If money, however, is an exchange good, contrary to rulers and scales, then nobody would want 138 00:18:15.860 --> 00:18:19.740 that money should be stable valued. 139 00:18:19.740 --> 00:18:31.600 Instead, as for all other goods, everybody would prefer that the value of this good increases 140 00:18:31.600 --> 00:18:32.780 over time. 141 00:18:32.780 --> 00:18:38.340 People do not want stable money, they would prefer a money that increases in purchasing 142 00:18:38.340 --> 00:18:39.340 power. 143 00:18:39.340 --> 00:18:51.100 Lastly, what about the thesis that the demand for money as non-interest-bearing cash would 144 00:18:51.100 --> 00:18:59.860 disappear if there existed no legal restrictions in the securities markets? 145 00:18:59.860 --> 00:19:07.340 Such a thesis has been advanced by Pharma in a slightly different version by Neil Wallace 146 00:19:07.340 --> 00:19:11.140 from the Rational Expectations School. 147 00:19:11.140 --> 00:19:20.280 They claim that absence of any legal restrictions, only interest paying titles to either debt 148 00:19:20.280 --> 00:19:31.960 or equity portfolios such as money market funds would remain in existence and all non-interest-bearing 149 00:19:31.960 --> 00:19:39.760 cash would disappear entirely. 150 00:19:39.760 --> 00:19:48.520 The first problem with this thesis is if there is no interest-bearing cash anymore in circulation, 151 00:19:48.520 --> 00:19:56.760 What would then be the unit of denomination that is used for all of these securities? 152 00:19:56.760 --> 00:20:03.360 And the second and more important argument against this is the following. 153 00:20:03.360 --> 00:20:10.520 People who assume that money could entirely disappear from circulation must make the assumption 154 00:20:10.520 --> 00:20:23.520 We are in equilibrium. A single person might have no demand for money. It can happen that 155 00:20:23.520 --> 00:20:32.120 the person is simply cashless. But the demand for money generally can only disappear if 156 00:20:32.120 --> 00:20:42.280 people would have perfect foresight with respect to the future conditions of markets because 157 00:20:42.280 --> 00:20:50.960 in such a situation with perfect foresight all exchanges including credit transactions 158 00:20:50.960 --> 00:21:04.280 can be arranged in the form of direct exchanges without the interposition of money, but obviously 159 00:21:04.280 --> 00:21:14.080 this is entirely inapplicable to the real world where there exists uncertainty or else 160 00:21:14.080 --> 00:21:21.160 Money could disappear only, and this is what Neil Wallace, for instance, assumes, and that 161 00:21:21.160 --> 00:21:28.880 is in line with the general egalitarianism of the Chicago school, that all goods are 162 00:21:28.880 --> 00:21:37.080 equally marketable. If all goods are equally marketable, then by definition there exists 163 00:21:37.080 --> 00:21:47.400 is no difference with respect to the saleability of cash and any type of securities. But in 164 00:21:47.400 --> 00:21:54.240 this situation, obviously, equal saleability is only possible if all goods are perfectly 165 00:21:54.240 --> 00:22:02.320 identical to each other. If all goods are perfectly identical to each other, we can 166 00:22:02.320 --> 00:22:11.080 can, however, not even explain why people even engage in division of labor and exchange. 167 00:22:11.080 --> 00:22:18.640 This idea of all goods have equal salability is in a way the complement to the Chicago 168 00:22:18.640 --> 00:22:32.120 view, which Gary Becker is a typical example, that all individuals are also the same. 169 00:22:32.120 --> 00:22:41.880 All individuals are the same, and all capital goods are the same, according to Chicago economists. 170 00:22:41.880 --> 00:22:47.240 Capital is just a homogeneous blob, and if it is a homogeneous blob, then every good 171 00:22:47.240 --> 00:22:54.960 is equally saleable to any other. In the absence of these absurd assumptions, we have to come 172 00:22:54.960 --> 00:23:02.520 come up with the conclusion that the demand for money cannot possibly disappear. 173 00:23:02.520 --> 00:23:10.240 Now back to the question if money originates as a commodity money, how can it become fiat 174 00:23:10.240 --> 00:23:11.240 money? 175 00:23:11.240 --> 00:23:20.600 The Turgot-Rothbard tradition of monetary thought answers this question by saying it 176 00:23:20.600 --> 00:23:30.120 can come into existence via money substitutes, that is checks and banknotes, but it can come 177 00:23:30.120 --> 00:23:40.440 into existence only in a fraudulent manner, by unilateral expropriation and only at the 178 00:23:40.440 --> 00:23:46.240 price of introducing all sorts of economic inefficiencies. 179 00:23:46.240 --> 00:23:49.080 Now why is this? 180 00:23:49.080 --> 00:23:58.040 Let's assume a developed monetary economy where we have money proper, commodity money, 181 00:23:58.040 --> 00:24:05.320 and money substitutes as claims to money. 182 00:24:05.320 --> 00:24:13.340 This fact that we have money proper and money substitutes has no impact on the total money 183 00:24:13.340 --> 00:24:21.100 Money Supply, it only changes the composition of the supply of money. 184 00:24:21.100 --> 00:24:29.500 Both types of money allegedly trade at par, and there is no savings involved here since 185 00:24:29.500 --> 00:24:39.740 there exists a one-to-one correspondence between paper tickets and species. 186 00:24:39.740 --> 00:24:46.060 But there is of course an added convenience that results from the fact that people can 187 00:24:46.060 --> 00:24:53.580 hold money proper and money substitutes. 188 00:24:53.580 --> 00:25:00.420 This is a way how paper tickets can acquire purchasing power. 189 00:25:00.420 --> 00:25:11.860 that is they can acquire purchasing power riding piggyback on a commodity money such as gold. 190 00:25:11.860 --> 00:25:22.260 These tickets can only free float from now on if redeemability into the species that 191 00:25:22.260 --> 00:25:29.460 originally made it possible that these tickets could acquire purchasing power, if redeemability 192 00:25:29.460 --> 00:25:39.700 is suddenly suspended but this obviously requires that the money owners are being expropriated 193 00:25:39.700 --> 00:25:49.900 through the bank and obviously no one would agree to this except of course the bank. 194 00:25:49.900 --> 00:25:58.120 With respect to fractional reserve banking, that is a partial fiat money, we likewise come 195 00:25:58.120 --> 00:26:03.800 come up with the conclusion that such a development would have to be classified as fraudulent 196 00:26:03.800 --> 00:26:06.480 and economically inefficient. 197 00:26:06.480 --> 00:26:12.880 Again, assume a single loan and deposit bank. 198 00:26:12.880 --> 00:26:24.440 As far as the loan banking function is concerned, we have savers depositing money in the bank 199 00:26:24.440 --> 00:26:34.140 and they enter a time contract. They engage in a temporary property transfer and extend 200 00:26:34.140 --> 00:26:42.960 a commodity credit. This commodity credit then becomes embodied in some illiquid productive 201 00:26:42.960 --> 00:26:53.280 assets, and because of this savers are capable of receiving an interest payment. As far as 202 00:26:53.280 --> 00:26:59.960 As far as the loan banking function is concerned, the banks make the profit through the interest 203 00:26:59.960 --> 00:27:06.440 differential, the interest that they pay to the depositors versus the interest that they 204 00:27:06.440 --> 00:27:10.200 charge the borrowers. 205 00:27:10.200 --> 00:27:23.500 As far as the deposit function is concerned, deposit banks engage in 100% reserves. Every 206 00:27:23.500 --> 00:27:35.020 deposit note is backed 100% by specie. No interest is being paid on deposit notes. Instead, 207 00:27:35.020 --> 00:27:45.920 We have to pay a warehousing fee. These notes then are redeemable at par against the specie. 208 00:27:45.920 --> 00:27:53.120 And the profit, as far as the deposit banking function is concerned, consists of the fee 209 00:27:53.120 --> 00:28:02.200 paid to the bank for its safeguarding of money. Both the loan and the deposit banks would 210 00:28:02.200 --> 00:28:10.240 would be able to earn a normal rate of profit in the deposit and the loan business. 211 00:28:10.240 --> 00:28:16.320 Fractional reserve banking is banking where the savings and deposit functions are, so 212 00:28:16.320 --> 00:28:18.040 to speak, confused. 213 00:28:18.040 --> 00:28:27.120 That is, savers are given withdrawal rights, instant withdrawal rights, and depositors 214 00:28:27.120 --> 00:28:39.180 receive interest on their deposits. Technically, fractional reserve banking is done by loaning 215 00:28:39.180 --> 00:28:50.640 out excess reserves that the bank possesses. They loan them out into time contracts and 216 00:28:50.640 --> 00:28:57.720 receive interest for it. The legal consequence of this, and that shows the absurdity of the 217 00:28:57.720 --> 00:29:06.460 whole thing, the legal consequence of this is the following. For some time now, the depositor 218 00:29:06.460 --> 00:29:16.200 and the borrower are entitled to exclusive control over the same commodity. Obviously, 219 00:29:16.200 --> 00:29:24.000 Such a thing is absurd. There cannot be two exclusive owners of the same commodity during 220 00:29:24.000 --> 00:29:35.280 the same time span. It is fraudulent on the part of the bank even if it would not be uncovered, 221 00:29:35.280 --> 00:29:44.560 even if it is not discovered that such a thing goes on. Because it affects also third parties, 222 00:29:44.560 --> 00:29:52.040 because of the inflationary impact that results from issuing uncovered notes. 223 00:29:52.040 --> 00:30:00.960 It is also economically absurd because the depositor allegedly owns homogeneous money, 224 00:30:00.960 --> 00:30:09.280 but in fact the borrower has taken the money and has invested it in non-homogeneous capital 225 00:30:09.280 --> 00:30:18.440 and when the underlying time preference rate, the degree to which people prefer present 226 00:30:18.440 --> 00:30:27.720 goods over future goods, reestablishes itself, then this has to resolve in some sort of business 227 00:30:27.720 --> 00:30:28.720 cycle. 228 00:30:28.720 --> 00:30:42.720 That is, the liquidation of these invested funds implies losses both for the borrower as well as for the depositor. 229 00:30:42.720 --> 00:30:51.720 The liquidation would only not imply any losses if capital would indeed be a homogeneous blob, 230 00:30:51.720 --> 00:31:10.720 Now, let me make these points in a slightly different and more elaborated way and ask the 231 00:31:10.720 --> 00:31:19.360 question, why is it impossible to achieve some sort of unanimous agreement to abolish 232 00:31:19.360 --> 00:31:24.360 commodity money and substitute fiat money for it. 233 00:31:25.040 --> 00:31:29.360 What I want to show is that there simply exists no motive 234 00:31:29.360 --> 00:31:32.720 why people would ever want to do anything like this. 235 00:31:34.120 --> 00:31:37.520 Friedman holds the opposite view. 236 00:31:37.520 --> 00:31:42.520 Friedman contends that a pure commodity money standard 237 00:31:42.920 --> 00:31:46.780 such as gold tends to break down 238 00:31:46.780 --> 00:31:56.180 because it is economically inefficient and similar, similarly to Friedman George Selgin 239 00:31:56.180 --> 00:32:05.940 for instance, thinks that fractional reserve banking is a natural and more efficient outgrowth 240 00:32:05.940 --> 00:32:12.460 out of a system that started out with 100% reserve bank. 241 00:32:12.460 --> 00:32:22.560 Assume again one bank and money proper and notes in circulation. 242 00:32:22.560 --> 00:32:31.540 The first problem that we would encounter is would people voluntarily want to give up 243 00:32:31.540 --> 00:32:41.960 using what is nowadays called outside money, that is money proper, and substitute what 244 00:32:41.960 --> 00:32:49.720 What is called inside money, bank notes and checks for it. As long as people would not 245 00:32:49.720 --> 00:32:58.120 give up using outside money in circulation, money proper in circulation, it seems to be 246 00:32:58.120 --> 00:33:07.120 clear that they demonstrate that they prefer outside money over inside money or at least 247 00:33:07.120 --> 00:33:24.560 Now, would people want to substitute inside money for outside money completely? 248 00:33:24.560 --> 00:33:30.640 With respect to this problem, I think even the tradition of Turgot to Rothbard has been 249 00:33:30.640 --> 00:33:36.720 too generous in admitting the assumption that such a substitution can take place. 250 00:33:36.720 --> 00:33:44.960 I want to explain why such a substitution of inside money for outside money, paper money 251 00:33:44.960 --> 00:33:54.760 for genuine commodity money is to happen only to a very limited extent. 252 00:33:54.760 --> 00:34:02.000 Money substitutes, needs to be recalled, money substitutes are just that, substitutes. 253 00:34:02.000 --> 00:34:11.600 And they have one permanent and decisive disadvantage as compared to money proper. And because of 254 00:34:11.600 --> 00:34:20.340 this, the public would never want to make a complete substitution of inside money for 255 00:34:20.340 --> 00:34:26.840 outside money. Now what is this permanent disadvantage that substitute money has as 256 00:34:26.840 --> 00:34:28.720 compared with commodity money. 257 00:34:30.480 --> 00:34:34.960 The reason is this, notes, paper notes, 258 00:34:34.960 --> 00:34:39.960 can be redeemable at par only if and to the extent 259 00:34:41.500 --> 00:34:45.160 that a deposit fee has been paid to the bank. 260 00:34:47.000 --> 00:34:49.920 But deposit fees are of course not paid 261 00:34:49.920 --> 00:34:52.360 for an indefinite period of time, 262 00:34:52.360 --> 00:34:56.280 they are only paid for a certain period of time. 263 00:34:56.280 --> 00:35:12.280 If the notes are redeemed after the date up to which a depositing fee has been paid, then redeemability charges must be made by the bank. 264 00:35:12.280 --> 00:35:24.280 The bank must ask the person who wants to redeem the note to pay up the depositing fee that has not been paid yet. 265 00:35:24.280 --> 00:35:32.280 And notes then must trade at a discount against money proper. 266 00:35:32.280 --> 00:35:41.280 Only genuine money, commodity money, is always and indefinitely accepted at par. 267 00:35:41.280 --> 00:35:48.280 And notes are only temporarily accepted at par. 268 00:35:48.280 --> 00:36:07.280 It is a mistake to think that notes trade at a premium over money, it is sometimes thought to be this way because people think there is a money price being paid for note acquisition. 269 00:36:07.280 --> 00:36:12.280 But fundamentally, the thing is just the other way around. 270 00:36:12.280 --> 00:36:28.280 Notes trade at a permanent discount, and the price paid, so to speak, for the acquisition of notes is not the price paid for notes, it is the price paid for guarded money. 271 00:36:28.280 --> 00:36:40.540 Now, as long as the demand for outside money is in existence, and my argument tried to 272 00:36:40.540 --> 00:36:47.040 make the point that the demand for outside money could never possibly disappear, as long 273 00:36:47.040 --> 00:36:57.640 as there is a demand for outside money, the argument that monetarists make, we should 274 00:36:57.640 --> 00:37:06.640 substitute fiat money for commodity money in order to save is obviously, obviously absurd. 275 00:37:06.640 --> 00:37:11.320 People demonstrate through their own actions that they are not interested in doing this 276 00:37:11.320 --> 00:37:13.920 type of saving. 277 00:37:13.920 --> 00:37:20.640 Now assume nonetheless that exclusive, for the sake of argument, that exclusively notes 278 00:37:20.640 --> 00:37:27.360 circulate and the commodity money is all in the banks. 279 00:37:27.360 --> 00:37:33.960 Would there then be a savings motive as the Chicago School assumes? 280 00:37:33.960 --> 00:37:44.800 That is, wouldn't it then be a waste to guard all the money in the bank and shouldn't this 281 00:37:44.800 --> 00:37:55.400 money go all to non-monetary uses and instead a free-floating paper currency be established? 282 00:37:55.400 --> 00:38:08.720 I want to show that the answer is no, and why this argument is fallacious. First, this 283 00:38:08.720 --> 00:38:17.480 argument can certainly not mean that the bank would get now all the money that is deposited 284 00:38:17.480 --> 00:38:24.360 in it. Who would agree to such a savings? That is, you keep the note, and the bank keeps 285 00:38:24.360 --> 00:38:27.840 It's all the genuine money deposited in the bank. 286 00:38:27.840 --> 00:38:31.920 That seems to be a funny type of savings. 287 00:38:31.920 --> 00:38:37.800 Instead, in order to make any sense out of this argument, in order to get the savings, 288 00:38:37.800 --> 00:38:46.000 we want to, each depositor would of course insist, I want to get my money back first. 289 00:38:46.000 --> 00:38:52.560 And then we would have a situation where either the bank gets the tickets back, the notes 290 00:38:52.560 --> 00:38:59.560 In any case, the bank would now be empty. Then the problem arises. Now the production 291 00:39:14.160 --> 00:39:21.160 costs of these tickets, which was formerly the cost of attracting gold depositors, now 292 00:39:22.560 --> 00:39:27.560 has fallen almost or practically to zero. 293 00:39:27.920 --> 00:39:29.600 The production cost of the tickets 294 00:39:29.600 --> 00:39:31.760 was under a gold standard not zero 295 00:39:31.760 --> 00:39:33.720 because the production cost involves 296 00:39:33.720 --> 00:39:36.480 attract gold depositors to come to me 297 00:39:36.480 --> 00:39:37.920 and then they get a ticket. 298 00:39:37.920 --> 00:39:40.480 Now, however, there's no depositing anymore. 299 00:39:40.480 --> 00:39:43.040 Paper floats around freely. 300 00:39:43.040 --> 00:39:45.580 Production costs are practically zero. 301 00:39:47.920 --> 00:39:50.640 The notes had earlier on acquired 302 00:39:50.640 --> 00:39:59.840 purchasing power, writing piggyback on commodity money, but how can the bank or the public, 303 00:39:59.840 --> 00:40:08.440 whoever now owns the tickets, sell these tickets to anyone, or how would anybody want to accept 304 00:40:08.440 --> 00:40:14.320 these tickets? 305 00:40:14.320 --> 00:40:22.060 Would these tickets be bought or sold for non-money goods at the old exchange ratios 306 00:40:22.060 --> 00:40:27.320 that were established while the commodity money standard was still in existence? 307 00:40:27.320 --> 00:40:32.800 And the answer seems to be obvious, no such a thing is absolutely impossible, at least 308 00:40:32.800 --> 00:40:40.000 as long as there exists free entry into the note production business. 309 00:40:40.000 --> 00:40:47.240 If the price paid for the tickets exceeded their cost of production, people would immediately 310 00:40:47.240 --> 00:40:52.480 print additional notes up and we would have hyperinflation. 311 00:40:52.480 --> 00:40:59.520 And certainly no one would buy notes for more than it would cost him himself to print up 312 00:40:59.520 --> 00:41:00.520 these tickets. 313 00:41:00.520 --> 00:41:06.680 Now it is interesting that Friedman realizes this. 314 00:41:06.680 --> 00:41:12.340 Friedman realizes, it is also disputed by some people but I think he is correct in this, 315 00:41:12.340 --> 00:41:22.680 Friedman realizes that a pure fiat money requires a monopoly bank and a monopoly note issuer. 316 00:41:22.680 --> 00:41:30.780 Under competitive conditions, a fiat money regime would immediately lead to hyperinflation 317 00:41:30.780 --> 00:41:34.260 and then to a breakdown of the monetary system 318 00:41:34.260 --> 00:41:38.620 and then to a re-emergence of a commodity money, 319 00:41:38.620 --> 00:41:41.140 which according to Friedman is wasteful. 320 00:41:42.260 --> 00:41:45.860 So the solution to this is there must be a restriction 321 00:41:45.860 --> 00:41:49.780 to free entry into the note production business. 322 00:41:49.780 --> 00:41:51.540 There must be a monopoly. 323 00:41:53.020 --> 00:41:56.900 The monopolist can of course also cause hyperinflation, 324 00:41:56.900 --> 00:41:59.980 but since he is not operating in a competitive environment, 325 00:41:59.980 --> 00:42:03.480 He must not cause hyperinflation. 326 00:42:03.480 --> 00:42:08.480 He can restrict the production of paper tickets 327 00:42:08.760 --> 00:42:11.660 and indeed he must restrict the production 328 00:42:11.660 --> 00:42:15.020 of paper tickets if he wants to stay in business at all. 329 00:42:17.120 --> 00:42:20.980 The bank now takes in notes, 330 00:42:20.980 --> 00:42:23.660 either in the form of time contracts 331 00:42:23.660 --> 00:42:26.700 to be loaned out and earning interest 332 00:42:26.700 --> 00:42:36.140 or in the form of deposit in exchange for the issuance of substitutes of substitutes 333 00:42:36.140 --> 00:42:40.300 and against a depositing fee. 334 00:42:40.300 --> 00:42:47.040 And the social savings now would be the difference, so to speak, between the guarding cost for 335 00:42:47.040 --> 00:42:55.140 commodity money versus the guarding cost necessary in order to guard money substitutes. 336 00:42:55.140 --> 00:43:03.780 But now there are two problems that arise. The first one is, who should own such a bank? 337 00:43:03.780 --> 00:43:12.620 And the second one is, what should be the principles of operation for this bank? And 338 00:43:12.620 --> 00:43:18.940 the problem is, we have to explain, can there be agreement? Can people pursuing their selfish 339 00:43:18.940 --> 00:43:36.340 Let me first consider the ownership problem. Just as people would want to get their genuine 340 00:43:36.340 --> 00:43:42.460 money back in order to profit from the savings themselves and not let the banks do all the 341 00:43:42.460 --> 00:43:50.460 savings, and they do all the losing. If a specific individual or group of individuals 342 00:43:50.460 --> 00:43:59.180 would become the owner of this bank, no agreement would be possible because this monopolist 343 00:43:59.180 --> 00:44:06.780 would have been capitalized in the form of having inflated assets. That is, the owner 344 00:44:06.780 --> 00:44:14.900 would gain from the fact of being a monopolist and the general public would get nothing of 345 00:44:14.900 --> 00:44:20.820 the social savings, so to speak. 346 00:44:20.820 --> 00:44:29.100 What people would want to insist on is a real part of the social savings that result from 347 00:44:29.100 --> 00:44:40.260 and the substitution of fiat money for commodity money, and not just a specific owner. 348 00:44:40.260 --> 00:44:46.700 The bank must be owned by everyone, everybody must be a co-owner of the bank. 349 00:44:46.700 --> 00:44:54.580 But to say this does not answer the question, at least not to the degree of precision that 350 00:44:54.580 --> 00:45:05.820 is actually needed for the following reason, should only be money owners or also money 351 00:45:05.820 --> 00:45:10.380 less people become the owner of the bank? 352 00:45:10.380 --> 00:45:16.460 Only the clients of the bank or also the non-clients of the bank? 353 00:45:16.460 --> 00:45:26.260 And what about the ownership and profit shares that each individual should get? 354 00:45:26.260 --> 00:45:37.020 Should the share of ownership and profits depend on each individual's initial money 355 00:45:37.020 --> 00:45:47.060 Endowment or should it depend on the size of the deposit that various people hold in 356 00:45:47.060 --> 00:45:54.100 the bank? But such things, the initial money endowment and the amount of money being deposited 357 00:45:54.100 --> 00:46:03.220 in banks changes of course all the time. Should everybody own the same share and get the same 358 00:46:03.220 --> 00:46:09.680 amount of profits redistributed to him, but then we would have the problem that large 359 00:46:09.680 --> 00:46:15.780 money holders would of course want to get a larger share of the profits than people 360 00:46:15.780 --> 00:46:20.620 who hold no money at all or very small deposits. 361 00:46:20.620 --> 00:46:27.420 It seems to be clear that here it is absolutely impossible to achieve an agreement of how 362 00:46:27.420 --> 00:46:33.140 the ownership question with respect to this bank should be resolved if the ownership of 363 00:46:33.140 --> 00:46:41.140 If the ownership problem cannot be resolved, then it also seems to follow that this substituting 364 00:46:41.140 --> 00:46:48.380 and saving is something that people would not deliberately ever want to have happen. 365 00:46:48.380 --> 00:46:53.860 The second problem is a problem of how should this bank operate. 366 00:46:53.860 --> 00:47:01.100 Regardless of how this ownership problem is resolved, a monopolist, because he is shielded 367 00:47:01.100 --> 00:47:05.260 from Competition will tend to be inefficient. 368 00:47:07.300 --> 00:47:11.660 He will tend to operate at higher than the minimum cost. 369 00:47:12.980 --> 00:47:16.940 Actually, the cost of a monopolist might be higher 370 00:47:16.940 --> 00:47:21.940 than the cost of competitively guarding genuine gold money. 371 00:47:23.860 --> 00:47:27.140 And who will then supervise and guard 372 00:47:27.140 --> 00:47:30.060 against abuse of the bank's power? 373 00:47:30.060 --> 00:47:42.060 All of these public choice considerations are completely absent, at least from Milton Friedman's earlier writings on these issues. 374 00:47:42.060 --> 00:47:52.060 In addition, assume that the bank engages in loan and deposit banks. 375 00:47:52.060 --> 00:48:08.060 Both functions are strictly separated. It makes a profit on interest differential as far as loan banking is concerned and on the depositing fees as far as deposit banking is concerned. 376 00:48:08.060 --> 00:48:25.060 But a fiat money bank must also now assume the function of replacing the worn out notes, even the worn out notes of non-clients of this bank. 377 00:48:25.060 --> 00:48:37.060 Otherwise, people would not want to replace a permanent commodity money by a perishable fiat money. 378 00:48:37.060 --> 00:48:47.060 Under the gold standard, under the commodity money standard, where there practically exists no perishability of money, 379 00:48:47.060 --> 00:48:55.060 every individual money holder assumes this risk himself, and the risk is absolutely very, very limited, 380 00:48:55.060 --> 00:49:00.060 that indeed there is a certain amount of perishing going on. 381 00:49:00.060 --> 00:49:10.380 But who would agree to assume the risk of losing all purchasing power once a note has 382 00:49:10.380 --> 00:49:18.420 been worn out or has been torn apart? Obviously people would only agree to a substitution 383 00:49:18.420 --> 00:49:26.260 of a fiat money for a commodity money if there is a guarantee that if a note is worn out 384 00:49:26.260 --> 00:49:38.600 However, as long as there are any operating costs connecting with this function of replacing 385 00:49:38.600 --> 00:49:46.620 worn-out notes by new ones, and as long as this bank would follow, for instance, the 386 00:49:46.620 --> 00:49:53.820 later Friedman's recommendation of a frozen monetary base, that is, we have paper money 387 00:49:53.820 --> 00:49:59.820 in existence and we never increase the paper money in existence. As long as they would 388 00:49:59.820 --> 00:50:09.780 follow the frozen monetary base rule and replace old notes one to one by new ones and free 389 00:50:09.780 --> 00:50:21.220 of charge, this part of the bank would have to make permanent losses. In order to be profitable, 390 00:50:21.220 --> 00:50:28.800 The bank must be allowed the power to create new money. It must be able to do something 391 00:50:28.800 --> 00:50:36.220 like the early Friedman thought that follow a three or five percent growth rule. It might 392 00:50:36.220 --> 00:50:41.420 not be three or five percent, but in any case it must be able to just create additional 393 00:50:41.420 --> 00:50:50.620 supplies of money. Yet as soon as the bank starts inflating, that is bringing more notes 394 00:50:50.620 --> 00:50:58.820 into circulation. It doesn't matter how big the amount of inflation is. Redistributive 395 00:50:58.820 --> 00:51:07.940 effects must resolve. The new money will not reach every person at the same point in time. 396 00:51:07.940 --> 00:51:11.700 Some people will get the money earlier and some people will get it later. Some people 397 00:51:11.700 --> 00:51:18.740 are made richer and others are made poorer. And because of this, because of these redistributive 398 00:51:18.740 --> 00:51:28.580 Effects. There cannot possibly be any agreement on an inflationary policy of the bank, but 399 00:51:28.580 --> 00:51:39.100 the bank must engage in inflationary policies in order not to incur any loss. Even the fact 400 00:51:39.100 --> 00:51:46.260 that people might get the bank profits paid out to them would be no consolation for the 401 00:51:46.260 --> 00:51:53.260 and the fact that these profits are complemented by unequal losses of various individuals. 402 00:51:55.260 --> 00:52:11.260 The later Friedman realizes this too. Friedman, an article a few years ago, comes to the conclusion 403 00:52:11.260 --> 00:52:22.140 And his earlier argument that fiat money represents a social savings is actually quite false. 404 00:52:22.140 --> 00:52:29.260 He realizes, for instance, that the cost of, that this article is called, the cost of irredeemable 405 00:52:29.260 --> 00:52:37.220 paper money, he realizes, for instance, that the cost of irredeemable paper money are first 406 00:52:37.220 --> 00:52:44.860 Inflationary tendencies have drastically increased as compared with what inflationary tendencies 407 00:52:44.860 --> 00:52:49.260 there were under a commodity money standard. 408 00:52:49.260 --> 00:52:57.860 He has realized that the predictability of future market conditions has become lower 409 00:52:57.860 --> 00:53:02.220 than it was under a commodity money standard. 410 00:53:02.220 --> 00:53:12.700 He has realized that long-term investment plans, long-term investment projects have been decreased 411 00:53:12.700 --> 00:53:21.020 as compared to what they were under a more stable commodity money standard. 412 00:53:21.020 --> 00:53:28.260 He realizes that the number of investment and hard money advisors, who all of course 413 00:53:28.260 --> 00:53:35.260 use some resources as well has drastically increased since we have a pure fiat money 414 00:53:35.420 --> 00:53:42.420 standard as compared with what it was under a commodity money standard. Friedman thinks 415 00:53:44.300 --> 00:53:51.300 that gold production actually increased since we are off the gold standard because people 416 00:53:51.300 --> 00:54:09.100 Friedman believes that money market funds would likely not have developed at all if 417 00:54:09.100 --> 00:54:16.820 we would have stayed on a commodity money standard. Friedman realizes that currency 418 00:54:16.820 --> 00:54:24.080 The future markets would also not likely have developed if we would have stayed on a commodity 419 00:54:24.080 --> 00:54:26.300 money standard. 420 00:54:26.300 --> 00:54:35.380 And all of this obviously involves waste, waste created by the existence of fiat money 421 00:54:35.380 --> 00:54:38.700 which Friedman originally advocated. 422 00:54:38.700 --> 00:54:44.640 Now you would think a person who realizes all of this should come up with the conclusion 423 00:54:44.640 --> 00:54:50.880 I think we should just go back to a commodity money standard, however Friedman dogmatically 424 00:54:50.880 --> 00:54:59.120 clings to the view that despite the refutation of his own thesis, that is, fiat money represents 425 00:54:59.120 --> 00:55:07.440 a savings over a commodity money, despite the obvious refutation, he still thinks that 426 00:55:07.440 --> 00:55:14.400 The gold standard is absolutely ridiculous and the fiat money standard should still be continued. 427 00:55:14.400 --> 00:55:22.400 Despite his own positivist methodology that says economics is prediction, he predicted 428 00:55:22.400 --> 00:55:30.680 that we would save, he found out that we didn't, but he still didn't accept the conclusion 429 00:55:30.680 --> 00:55:35.760 that unfortunately I was wrong. 430 00:55:35.760 --> 00:55:42.240 There can be no monopoly agreement, that was one thing that I pointed out, and there can 431 00:55:42.240 --> 00:55:50.440 also be no agreement on a frozen monetary base, because a frozen monetary base would so to 432 00:55:50.440 --> 00:55:54.680 speak a losing proposition. 433 00:55:54.680 --> 00:56:02.800 Fiat money does not naturally replace commodity money as a more efficient money, but commodity 434 00:56:02.800 --> 00:56:09.800 Money is deliberately destroyed at all money holder's expense. 435 00:56:12.560 --> 00:56:19.560 I'm not quite sure about the time. 436 00:56:22.400 --> 00:56:29.400 Okay, now then briefly, why is fractional reserve banking impossible? 437 00:56:29.400 --> 00:56:43.000 Impossible. And let me only make one little argument that deals with arguments that were 438 00:56:43.000 --> 00:56:57.080 advanced by George Selgin and Larry White. They make the point, doesn't freedom of contract 439 00:56:57.080 --> 00:57:09.600 No, the mistake in that argument is simply that freedom of contract exists only with 440 00:57:09.600 --> 00:57:14.680 respect to the properties of the contracting parties. 441 00:57:14.680 --> 00:57:19.320 People are free to make any contract with respect to things that they own, but people 442 00:57:19.320 --> 00:57:25.260 are not free to make contracts with respect to properties owned by others. 443 00:57:25.260 --> 00:57:29.340 This is precisely what goes on in fractional reserve banking. 444 00:57:29.340 --> 00:57:30.980 So much about that argument. 445 00:57:30.980 --> 00:57:44.460 I want a brief, another brief remark on the idea that we can have option clauses, saying, 446 00:57:44.460 --> 00:57:52.380 putting on the note a remark that in case we can't pay up, we have to wait for some time. 447 00:57:52.380 --> 00:57:59.740 When such notes that have an option clause become money, Larry White for instance claims 448 00:57:59.740 --> 00:58:09.740 that that is possible and I want to give you an argument that shows that it is not possible. 449 00:58:09.740 --> 00:58:17.560 Money notes with an option clause printed on top are clearly only tradable at a discount 450 00:58:17.560 --> 00:58:21.680 against notes that have no option clause attached to it. 451 00:58:21.680 --> 00:58:28.440 And not only that, what is more decisive in order to refute the idea that money or notes 452 00:58:28.440 --> 00:58:36.760 with an option clause can be the most easily resaleable good is simply this. 453 00:58:36.760 --> 00:58:44.440 Notes with an optional clause printed on top of it only confer a conditional property title 454 00:58:44.440 --> 00:58:46.720 to people. 455 00:58:46.720 --> 00:58:55.600 But anything that is a conditional property title is by definition less easily and saleable 456 00:58:55.600 --> 00:59:03.480 and less generally acceptable than an unconditional property title to some extent. 457 00:59:03.480 --> 00:59:07.320 The illustration is, let me just give one example for this. 458 00:59:07.320 --> 00:59:13.280 If you buy airline tickets, these guys frequently draw analogies between airline tickets and 459 00:59:13.280 --> 00:59:14.280 notes. 460 00:59:14.280 --> 00:59:19.360 Let's say you have an airline ticket that has all sorts of conditions attached to it. 461 00:59:19.360 --> 00:59:24.000 You can only fly thirsty and whatever it is and only out of this airport and you have an 462 00:59:24.000 --> 00:59:30.440 unconditional airline ticket. You can anytime you can just come and go. Now when it comes 463 00:59:30.440 --> 00:59:39.360 to the resaleability at par value of an optional airline ticket or a conditional airline ticket 464 00:59:39.360 --> 00:59:47.760 versus an unconditional airline ticket, which one will be more generally acceptable at par, 465 00:59:47.760 --> 00:59:52.760 the conditional one or the unconditional one? The answer should be obvious. Thank you.