I want to talk about the nature and origin of money and I also want to convey to you
a little bit an impression about the style of reasoning that the Austrian School of Economics
displays.
In economics we usually distinguish between two types of goods, consumer goods and producer
goods. Consumer goods are directly serviceable goods and producer goods are indirectly serviceable
And a third category of goods that is introduced in economics is money, which is defined as
a medium of exchange. And I want, in the first step, to try to derive, so to speak, how this
third type of goods, a medium of exchange, comes into existence, in which ways a medium
The medium of exchange is fundamentally different from consumer goods on the one hand and producer
goods on the other hand. The first step then, let me simply explain why it is that there
is exchange because without exchange obviously no such thing as a medium of exchange would
come into existence. In order to understand why there is exchange, one should engage in
A little thought experiment. Assume for a second that all individuals, which we refer to in economics as labor, and all nature-given resources, which we refer to in economics as land, would be perfectly identical to each other, such that every person would be a perfect clone of everybody else, and all the nature surrounding each individual would be also
Now, in this case, what would occur would be that every person would now, with the nature given resources, produce exactly the same quantities of exactly the same goods in exactly the same quality and would then consume them in exactly the same pattern.
Obviously, if this were the case, there would be no conceivable reason why people would ever want to engage in any exchange at all, because what would be the purpose of exchanging perfectly identical oranges for perfectly identical oranges?
We reach then indirectly the result that the idea of exchange only comes into existence insofar as either individuals are different from each other, or land, the nature given resources are different, or land and labor is different.
A very important insight that identical individuals, the ideal of egalitarians, would actually eliminate the very idea of division of labor.
Division of labor comes only into the minds of people insofar as differences exist.
Now, even if differences between people or land exist, it does not necessarily follow
that people will then engage in exchange. Then the idea becomes conceivable, but it
would still be possible that people would decide we remain in self-sufficient isolation
and produce everything we need for ourselves without ever bothering to exchange anything
against Goods Produced by Other Individuals. So why is it then that people do not remain
in self-sufficient isolation? Sociologists and psychologists frequently explain this fact
by pointing out that man doesn't like to be alone and he loves his brothers and sisters
and because of that they engage in exchange. However, it is always better if one can explain
explain a phenomenon with using less rather than more assumptions and in fact one needs
far less in terms of assumptions in order to explain why people do not remain in self-sufficient
isolation. We can actually assume that all people would hate each other and do not want
to associate with anybody else and still explain that division of labor arises. The reason
The reason for that is that as long as it is a case that people prefer more goods over
less goods, as long as people have purely selfish motives, they do not need to have
more, they might have more motives than purely selfish ones, but as long as they have purely
selfish motives, the division of labor can be explained because engaging in division
Engaging in division of labor, producing something for markets for other people and exchanging
goods produced by others for goods produced by oneself, increases the standard of living
of everyone engaging in participation of labor. There are two advantages that are usually
mentioned when it comes to division of labor. The first one is the so-called absolute advantage
Advantage of Division of Labor that refers to the situation that one person might be
good at producing one thing and another person might be good at producing something else
and then obviously it makes sense to specialize in those things which you are good and exchange
goods afterwards.
And the second reason is the so-called comparative advantage of division of labor that comes
comes into play if worst case scenario exists, that is one person is all around more efficient
and another person is all around less efficient, but even under those conditions the vision
of labor is mutually beneficial if the most efficient, the more efficient person concentrates
all of his efforts doing those things in which his advantage is relatively greater and the
The person who is all around less efficient concentrates his efforts on those things in
which his relatively lower efficiency is comparatively smaller. If they do this then again both individuals
will be better off. So now we have entered so to speak a stage of an exchange economy
and this exchange economy also referred to as a barter economy. People exchange consumer
Money has not yet arrived on the scene. What is necessary in order for money to develop is that another condition must be fulfilled. In order to explain this condition, one can engage in a little thought experiment.
Assume for a second that we would all have perfect certainty with respect to the future.
That is to say, we know precisely what we want in the future, how much we want of it, what we would be willing to pay for it.
And the same is true for you. You know exactly what you want, what I want, how much I want of it, when I want it, how I want it and all the rest of it.
No uncertainty whatsoever with respect to the future.
Now if this were the case, then we would forever remain in a barter economy.
That is to say, then all exchanges would be just exchanges between consumer goods and producer goods.
There would never be any disappointment.
Anybody who has ever produced for markets will be perfectly able to find the buyers
exactly at the time when he wants to find them, at the place where he wants to find them
The Theory of Money and Credit
The problem arises in a barter economy without the use of money and that is that people in such an economy obviously produce for two different reasons.
They produce on the one hand for the reason just to produce something for themselves which they themselves want to use.
And on the other hand they produce of course for the market.
That is to say they produce for other people with the expectation that they will be able to trade their goods against goods produced by others.
But if there is no certainty, then it can obviously occur that people who produced for market exchange encounter situations where they want to get rid of the product that they have produced because they have no personal use for it and want something else for it.
But the situation might arise that the person who has what I want does not want what I have.
And in this case, obviously an exchange cannot take place. An exchange can only take place in barter if two conditions are met at the same time. That is to say, I must have what you want and you must have what I want.
If that is not the case, this is called a double coincidence of ones, if this is not the case, an exchange is impossible.
So, now here we are in a situation where I have produced something for which I have no personal use, and I like to get the things that you have produced, and you also have produced for the market, you also have no personal use for the things that you offer, but you don't want the things that I have, whereas I want the things that you have. What do we do in such a situation?
Now in such a situation where a direct exchange is impossible, people can still improve their own situation if they succeed doing the following.
If I succeed in surrendering a good that has a relatively lower degree of marketability
and acquire a good from you that has a relatively higher degree of marketability.
Let me explain that briefly.
The degree of marketability of a good is simply the observation that some goods are frequently
Based on this observation now, if I have produced a good that has a relatively low degree of marketability, you have produced a good that has a relatively high degree of marketability, even though, let's say, I have a relatively low degree of marketability,
I do not personally like apples, assuming that apples are the goods that have a high degree of marketability, even if I personally do not like apples, I would still gain an advantage if I succeed in surrendering my less marketable goods against your apples being more marketable goods, because I can then take these apples, which I do not want to consume as apples, I can then
Then take these apples and resell the apples more easily because they are highly marketable
and acquire then in turn those things that I really desire.
That is to say, I demand goods on account of their high degree of marketability, not
because I want to use them as consumer or producer goods, but I demand them as a medium
of Exchange with the purpose of using these goods for resale purposes and acquire those
things that I really want to have in return. Now, let's say apples are this good that has
a high degree of marketability that a single person initially demands for the purpose of
reselling them. Then the degree of marketability of apples would obviously increase still more
because now apples are used in a group of individuals for two reasons. First for the
reason of eating apples and secondly for the reason of using them for resale purposes.
That is the marketability of apples increases. Accordingly the likelihood that other people
who are also stuck in the same situation where they have produced for markets but cannot
get rid of their goods and get those things that they really want that other people in
the same predicament will do exactly the same thing that I have done. That is to say they
will also be willing to surrender their goods against apples and do the same thing that
We do the same thing that I did using these apples as a medium of exchange for resale purposes and over a shorter or longer period of time we will then have what is called a common medium of exchange.
That is, all people will begin to use the same type of commodity for the same type of purpose to facilitate exchange.
We have then overcome the problem of double coincidence of once being necessary in order to engage in exchange.
We can then exchange whenever we want to exchange.
Now this medium of exchange is called a money.
Now, as I explained it, obviously all sorts of commodities that were initially traded in barter can be selected as a medium of exchange and historically all sorts of goods have in fact been selected as a medium of exchange.
From a point of economic theory we can only say with certainty that whatever the thing is that is being chosen as a medium of exchange must have originally been a commodity traded in barter.
It is not possible, for instance, that one can begin with a paper money. That is to say, with a piece of worthless paper.
Imagine I would have a piece of worthless paper and I want to acquire products from you,
and I would just write on my piece of paper $10 and would offer it to you for valuable oranges or whatever it is.
Obviously you would not accept it even if I would raise my offer and add another zero to it, you would still refuse the deal.
It must be a valuable commodity and we can say from the point of view of economic theory also
that there are certain characteristics that contribute to the likelihood that a specific
commodity might be chosen as money. Such characteristics are obviously scarcity, it must be scarce. Secondly,
it must be something that is divisible in order to allow me to make small and big purchases.
It must be something that is portable, that must be easy to carry around, and it must
have a relatively high value per unit weight. Lead, for instance, would not be a likely
candidate to be chosen as money. And it must obviously also be to a certain extent a durable
Now, once in a given region a generally used medium of exchange has come into existence, and again, for purely selfish reasons, so to speak, we can also explain why there will be a tendency in the market towards a one-word exchange.
World Commodity Money arising in the market.
For the same reason that we have one commodity being picked within a region to serve as a
medium of exchange, once various regions begin to trade with each other, and again they begin
to trade with each other for the same reason that particular individuals begin to trade
with each other for purely selfish reasons, because all regions participating in division
of labor will be better off. That is, once different regions begin to trade with each
other, we have initially different types of money in existence and are still in a situation
of partial barter. That is to say, if I want to buy something in a different region, I
I can only do so if I first exchange my money for the money being used in that different region
and then I can go about and purchase my products. So this is still tedious.
The tendency will then be that one type of money will tend to out-compete the other type of money
with the ultimate result that as the world market expands and encompasses in fact the
entire world, gradually parallel to this, there will also a world commodity money developing.
And this of course has been historically the gold standard. That is, a commodity money
that was used on a worldwide scale and by being used on the worldwide scale facilitated exchange to the utmost degree possible.
We are then completely out of barter. I can exchange my goods for buy and sell anywhere I want without delay and any difficulties.
Now to the second important fundamental insight about the nature of money. The first one being money must originate as a commodity money. It cannot possibly begin as a paper money. The second fundamental insight regarding money is that contrary to consumer goods and producer goods, in one respect money is fundamentally different from consumer goods and paper money.
and Producer Goods. For consumer goods and producer goods we would have to say upon the question what is the optimal supply of consumer goods or what is the optimal supply of producer goods, the answer would have to be the more consumer goods we have the better and the more producer goods we have the better.
However, this law, the more the better, does not hold for money.
Again, recall, the purpose of money is to serve as a facilitator of exchange.
Now, why does this law not hold for money?
In order to see this, again, a simple thought experiment will immediately explain why that is.
Assume that the money supply would be doubled overnight. However, the amount of consumer goods and producer goods in existence remains exactly the same as the day before.
Now would mankind then be twice as rich? And the answer is, of course, no way would mankind be twice as rich.
The standard of living depends exclusively on the amount of consumer goods and producer goods in existence.
All that would now happen with twice as much money but the same amount of consumer and producer goods is that the purchasing power of money, what we can buy per unit of money would roughly fall in half.
That is, the standard of living for society as a whole remains completely unaffected by this.
The same is of course also true if the money supply were to fall in half overnight.
But again, consumer goods and producer goods in existence remaining exactly the same as before.
Society would then not be only half as rich, but they would be just as rich as the day before.
Instead, the purchasing power of money would roughly double.
Now, saying roughly falling in half or roughly doubling,
that indicates already that I have to make a little amendment to this story.
Because if it were really the case that increases in the money supply for instance
would only lead to a loss in the purchasing power of money,
we could discover, so to speak, no motive why anybody would ever want to engage in inflationary policies.
However, while what I said before, by and large, prices will double or will fall in half if we double or cut in half the money supply, under the surface, an increase in the money supply would redistribute the existing income from one person to another.
That is to say, even though the overall wealth in society will not be increased, it does not mean at the end of the inflationary process everybody will be exactly as rich as he was before, some people will be richer and some people will be poorer.
In which way? Imagine that we would all find our money supply doubled in the morning and assume two different types of people.
One person who now holds onto his money and spends it, let's say, in a month, and the other person immediately rushing out to spend all his newly found fortunes.
It should be clear that the person who spends his money immediately will drive up some prices, those prices on which he spends his money.
On the other hand, the person waiting, spending his money, will encounter a situation where some prices have already risen, are already higher, when he begins to purchase.
That is to say, the person who spends his money first, will gain at the expense of those people who spend their money later.
and if jumping a little bit ahead here in my story and if of course we assume
what is the case in reality that money increases in the money supply do not
appear in all of our wallets at the same time but appear of course at specific
points in society and usually appear of course at the point of the government
itself or the government central bank, then you can clearly recognize that by increasing
the money supply first within the system of banks and governments, they spending the money
first, then prices begin to rise of those products on which they spend it. We have not
seen any of this money yet. Our income has still remained. However, we now have to pay
If we pay higher prices for those products which the government and the first receivers of government money have driven up due to the fact that they have received larger amounts of money, then we can see that there is a systematic income redistribution going on, so to speak, from the hands of the general public who receives the new money late or not at all onto those people who receive the new money first.
So while inflation does not at all increase in the money supply, does not at all increase overall standards of living, it does engender a massive amount of redistribution of income and wealth from the hands of the general public to the government and the central bank.
Now a third point that needs to be emphasized.
If we look at the interest of money owners, what would money owners wish to occur to their money in terms of the purchasing power that money has?
Would people want to have money that loses purchasing power over time?
Would people want to have money that maintains a relatively stable purchasing power over time?
Or would people prefer to have money that increases in purchasing power over time?
There are some economists like monetarists, Milton Friedman and his followers,
and its followers, who without giving any reason for that, simply assume that people would prefer stable money, that is a money whose purchasing power remains pretty much the same in the course of time.
Now given that we live in an inflationary environment, that sounds surely good.
However, it seems to me that this is a rather daring claim to say that people would prefer a stable money even over a money that increases in purchasing power.
Take another example. What would you like to see to happen to your house, that it increases in value over time, that it keeps the value over time, or that it loses value over time?
Now, my guess is that, of course, everybody would say, guess I want my house to increase in value over time and to have it, to see it only remain stable in value over time is, so to speak, only the second best solution, obviously better than losing value over time, but certainly I would like it to increase in value over time.
Now I would contend that this is by and large also true for money, that by and large people prefer if the purchasing power of money in the course of time increases and this in fact is what has happened under a commodity money standard as a gold standard, not as a necessity, that is there is no economic law that
would help us predict that this increases in the purchasing power of money will of necessity be the case.
But as an empirical regularity, it has indeed been the case that under the gold standard,
a commodity money standard, the purchasing power per unit of money has in fact over several centuries increased.
Of Great Britain, for instance, we have a relatively long time series of statistics and we know, for instance, that prices, let's say, in 1760 were lower than they were in 1660, and we know that prices in 1860 were lower than they were in 1760,
and in 1914 they were still lower than they were in 1860. Prices under the gold standard gradually fell to 3% per year.
That is, we observe for the overall economy something similar to what we can still discover in certain sectors of the economy nowadays.
Nowadays, let's say in the sector of computer or electronics, where we see that every year
prices of these products actually fall. Now, nowadays this is of course an unusual phenomenon
that takes place only in certain sectors. The overall tendency is of course for prices
to rise. For several hundred years under the gold standard, this tendency characterized,
and so to speak the development of the overall economy that almost all prices gradually fell in the course of time.
Now at this point obviously three observations come to mind.
If it is true that money must originally develop as a commodity money,
If it is true that money then has a tendency to become an internationally used commodity money,
and if it is true that this international commodity money has by and large the tendency of increasing in purchasing power of money,
then the current situation should strike one as extremely odd.
is to say, what we observe here is of course, we do not have a commodity money, we have a paper money.
The second thing is, we do not have an international commodity money, instead we have freely fluctuating paper currencies, 120 different currencies.
And thirdly, we also do not have anywhere a situation where the purchasing power of money increases in the course of time.
Instead, we have almost an unstoppable tendency towards inflation, in some countries more, in some countries less,
but nowhere do we have a situation where we don't have inflation, losing purchasing power of money.
Now, what explains this phenomenon?
In order to explain this phenomenon we briefly have to talk about the nature of government because it is the result of government interference in monetary affairs that has changed the original situation to the present disastrous situation.
Now, governments are institutions that are very different from normal firms.
Normal firms have to produce something and have to find voluntary buyers for their products.
That is, they earn their money in the old-fashioned, honest way.
I'm not saying that all firms do that. Sometimes they do that in cooperation with government.
The idea of a private firm is of course to sell something that consumers may or may not buy.
On the other hand, governments of course do not finance themselves in such a way.
Governments finance themselves essentially in no different way than a highway robber does.
saying that here I'll offer you some nice thing in return but you must give me the money whether you like what I offer you in return or not.
That is, they finance themselves through taxation.
Another way of financing themselves, which is similar to taxation, but not as easily visible as having the same impact as taxation, is by engaging in counter-fitting activities.
Under a gold standard, however, and of course governments, just like any other institution, prefer higher income over lower income.
So they can raise taxes, but people do not like if taxes are constantly raised.
So they look for a different method of increasing their income. This different method is, by and large, counterfeiting.
Under the gold standard, however, counterfeiting is difficult to do.
What can you do if gold is used as money? What you can do is once in a while you call in the gold coins and promise to the public that you want to re-mint them and make them look shinier and then you return the gold coins to them.
But in the course of melting them down and re-minting them, you simply reduce the gold content of the coins, let's say by 10%.
You give to the public the same number of coins, but each coin has 10% less gold than the coins that they originally did deliver to the government.
And the 10% that you extract from each coin, you appropriate yourself.
You mint 10% new coins, each one of them with 10% less gold content.
Now obviously, this is also nothing else but a 10% tax increase because there will be no inflation resulting.
You can buy less and the king or whoever is in charge of the government can buy 10% more.
Obviously, this cannot be done very frequently and because of that governments were not very happy
with the fact that they had to operate under a gold standard. Now, what did they do in
order to get rid of this? What they did was, and again I want to just very briefly indicate
the steps, what they did was essentially first to monopolize the minting process, to say
look if there are competing minters of gold, they will cheat you. They will not be honest
and say in saying how much gold is in there and all the rest of it and the
public by and large being ignorant of course might have bought this sort of
idea even though it should be perfectly clear that as long as there exists
competition in the field of minting the likelihood of cheating is very low
because every producer of gold coins will of course only wait for the moment
that he finds out that his competitor is actually cheating and then we'll use it
in the form of advertising and say, look here, this guy is a cheater, buy my gold coins,
I'm an honest man. So competition by and large forces people to be honest whether they want
to be honest or not. As soon as the minting process is, however, monopolized, only the
government can mint and certify how much is in there and nobody else can do it, then of
course cheating becomes immediately a great danger because even if you find out that there
There is cheating going on. What can you do? They are the only ones who are permitted to
do so. So that is the first step that they do. Then, again, in different countries that
process went slightly in a slightly different fashion, but by and large the pattern is always
the same. Then they usually insist that, and under the gold standard, of course, not only
gold coins are used for transactions, but people also use, and I'll explain that in
in my next lecture in detail. But people also use of course tickets, paper tickets that
are titles to gold. They don't want to schlep the gold around but deposit it in certain
institutions and they get a deposit ticket for it. And if the public has absolutely no
doubt that the deposit ticket for gold can be at any time redeemed for the real thing,
Then people are actually willing to accept also paper tickets in exchange.
So the next step consists in only the government, so to speak, can print these notes, these
warehouse receipts to gold.
And the third step is then once people begin to use notes, initially backed by gold, to
who then at one moment say, okay tough you guys, tough luck you guys, we will from now
on no longer redeem these paper tickets into gold.
This is by and large the process how paper money comes into existence, that is it comes
on the existence riding piggyback on an initial commodity money standard such as gold.
Paper by itself could never have acquired any purchasing power, but paper as tickets
to a commodity of course can acquire purchasing power. But if you then cut the tie and don't
redeem any longer paper tickets for gold, then of course this paper still can retain
its acquired purchasing power and float on its own. Now this of course occurred in the
in the United States in 1933 when the gold standard was abolished and then on international
level in 1971 when even the last remnants of the gold standard were abolished and now
with paper tickets only being issued by the government monopolizing it and no longer any
obligation to redeem it, it should be perfectly clear that you could not possibly expect anything
but a permanent tendency towards inflation.
Let me just give you one analogy that explains it.
Imagine I would tell you,
you are the only person in the country
who can print money, greenbacks.
Everybody else in the country,
if he tries to do the same thing,
will be treated as a criminal and will be locked up.
Now, what will you do?
And the answer should be perfectly clear.
Unless you were an angel,
You will of course immediately begin printing because at almost zero cost you can print
these tickets up and then you can go out and buy a Mercedes and a BMW, pay off your mortgage
for your house and all the rest of it. You will of course and also immediately find that
you have more friends than you ever imagined that you have because they will all come to
you and explain to you that they of course have the same type of desires that you have.
Can there be any doubt whatsoever that if this institutional setup is in place, that there can be anything else but inflation?
And also, can there be any doubt in anybody's mind that those institutions that have precisely this privilege that I just described,
that those institutions and people working for these institutions will do everything under the sun
to intellectually malign and smear those people who attack the whole scam as being a scam.
Of course, there can be no doubt.
That is, those people will do everything under the sun to keep this magic wand
and to smear all people who attack them for causing constant inflation as being neanderthal men.