Monetary Inflation and Counterfeiting
Suppose that a precious metal such as gold becomes a society's money,
and a certain weight of gold becomes the currency unit in which all prices and assets are reckoned.
Then, so long as the society remains on this pure gold or silver standard,
In the gold standard, there will probably be only gradual annual increases in the supply of money from the output of gold mines.
The supply of gold is severely limited and it is costly to mine further gold.
And the great durability of gold means that any annual output will constitute a small portion of the total gold stock accumulated over the centuries.
The currency will remain of roughly stable value in a progressing economy.
The increased annual production of goods will more than offset the gradual increase in the money stock.
The result will be a gradual fall in the price level, an increase in the purchasing power of the currency unit or gold ounce year after year.
The gently falling price level will mean a steady annual rise in the purchasing power of the dollar or franc, encouraging the saving of money and investment in future production.
A rising output and falling price level signifies a steady increase in the standard of living for each person in society.
Typically, the cost of living falls steadily while money wage rates remain the same, meaning
that real wage rates or the living standards of every worker increase steadily year by
year.
We are now so conditioned by permanent price inflation that the idea of prices falling
every year is difficult to grasp, and yet prices generally fell every year from the
The beginning of the Industrial Revolution in the latter part of the 18th century, until 1940, with the exception of periods of major war, when the governments inflated the money supply radically and drove up prices, after which they would gradually fall once more.
We have to realize that falling prices did not mean depression, since costs were falling due to increased productivity, so that profits were not sinking.
If we look at the spectacular drop in prices, in real, even more than in money terms, in
recent years in such particularly booming fields as computers, calculators and TV sets,
we can see that falling prices by no means have to connote depression.
But let us suppose that in this idle of prosperity, sound money and successful monetary calculation,
A serpent appears in Eden, a temptation to counterfeit, to fashion a near-valueless object
so that it would fool people into thinking it was the money commodity.
It is instructive to trace the result.
Counterfeiting creates a problem to the extent that it is successful, that is, to the extent
that the counterfeit is so well-crafted that it is not found out.
Suppose that Joe Dokes and his merry men have invented a perfect counterfeit.
Under gold standard, a brass or plastic object that would look exactly like a gold coin.
Or, in the present paper money standard, a ten dollar bill that exactly simulates a ten
dollar Federal Reserve note.
What would happen?
In the first place, the aggregate money supply of the country would increase by the amount
counterfeited.
Equally important, the new money will appear first in the hands of the counterfeiters themselves.
Counterfeiting, in short, involves a two-fold process, one, increasing the total supply
of money, thereby driving up the prices of goods and services and driving down the purchasing
power of the money unit, and two, changing the distribution of income and wealth by putting
disproportionately more money into the hands of the counterfeiters.
The first part of the process, increasing the total money supply in the country, was
the focus of the quantity theory of the British classical economist from David Hume to Ricardo,
and continues to be the focus of Milton Friedman and the monetarist Chicago School.
David Hume, in order to demonstrate the inflationary and non-productive effect of paper money,
in effect postulated what I like to call the Angel Gabriel model, in which the angel, out
After hearing, please, for more money, magically doubled each person's stock of money overnight.
In this case, the angel Gabriel would be the counterfeiter, albeit for benevolent motives.
It is clear that while everyone would be euphoric from their seeming doubling of monetary wealth,
society would in no way be better off.
For there would be no increase in capital or productivity or supply of goods.
As people rushed out and spent the new money, the only impact would be an approximate doubling
of all prices, and the purchasing power of the dollar or franc would be cut in half,
with no social benefit being conferred.
An increase of money can only dilute the effectiveness of each unit of money.
Milton Friedman's more modern, though equally magical, version is that of his helicopter
Effect, in which he postulates that the annual increase of money created by the Federal Reserve
is showered on each person proportionately to his current money stock by magical governmental
helicopters.
While Hume's analysis is perceptive and correct so far as it goes, it leaves out the
vital redistributive effect. Friedman's Helicopter Effect seriously distorts the analysis by
by being so constructed that redistributive effects are ruled out from the very beginning.
The point is that while we can assume benign motives for the Angel Gabriel, we cannot make
the same assumption for the counterfeiting government or the Federal Reserve.
Indeed, for any earthly counterfeiter, it would be difficult to see the point of counterfeiting
if each person is to receive the new money proportionately.
In real life, then, the very point of counterfeiting is to constitute a process, a process of transmitting
new money from one pocket to another and not the result of a magical and equi-proportionate
expansion of money in everyone's pocket simultaneously.
Whether counterfeiting is in the form of making brass or plastic coins that simulate gold
or of printing paper money to look like that of the government, counterfeiting is always
a process in which the counterfeiter gets the new money first.
This process was encapsulated in an old New Yorker cartoon in which a group of counterfeiters
are watching the first ten dollar bill emerge from their home printing press.
One remarks, boy, is retail spending in the neighborhood in for a shot in the arm.
And indeed it was. The first people who get the new money are the counterfeiters, which
they then use to buy various goods and services. The second receivers of the new money are
the retailers who sell those goods to the counterfeiters and on and on the new money
ripples out through the system going from one pocket or till to another. As it does
And so, there is an immediate redistribution effect. For first, the counterfeiters, then
the retailers and so forth, have new money and monetary income which they use to bid
up goods and services, increasing their demand and raising the prices of the goods that they
purchase. But as prices of goods begin to rise in response to the higher quantity of
Money, those who haven't yet received the new money find the prices of the goods they
buy have gone up, while their own selling prices or incomes have not risen.
In short, the early receivers of the new money in this market chain of events gain at the
expense of those who receive the money toward the end of the chain, and still worse losers
are the people.
For example, those on fixed incomes such as annuities, interest or pensions who never
receive the new money at all.
Monetary inflation then acts as a hidden tax by which the early receivers expropriate,
that is, gain at the expense of, the late receivers.
And of course, since the very earliest receiver of the new money is the counterfeiter, the
counterfeiter's gain is the greatest.
This tax is particularly insidious because it is hidden, because few people understand
the processes of money and banking, and because it is all too easy to blame the rising prices
or price inflation caused by the monetary inflation on greedy capitalists, speculators,
wild spending consumers, or whatever social group is the easiest to denigrate.
Obviously, too, it is to the interest of the counterfeiters to distract attention from their own crucial role by denouncing any and all other groups and institutions as responsible for the price inflation.
The inflation process is particularly insidious and destructive because everyone enjoys the feeling of having more money, while they generally complain about the consequences of more money, namely higher prices.
But since there is an inevitable time lag between the stock of money increasing and its consequence in rising prices, and since the public has little knowledge of monetary economics, it is all too easy to fool it into placing the blame on shoulders far more visible than those of the counterfeiters.
The big error of all quantity theorists from the British classicist to Milton Friedman is to assume that money is only a veil and that increases in the quantity of money only have influence on the price level or on the purchasing power of the money unit.
On the contrary, it is one of the notable contributions of Austrian School economists and their predecessors, such as the early 18th century Irish-French economist Richard Cantillon, that in addition to this quantitative, aggregative effect, an increase in the money supply also changes the distribution of income and wealth.
The ripple effect also alters the structure of relative prices, and therefore of the kinds and quantities of goods that will be produced, since the counterfeiters and other early receivers will have different preferences in spending patterns from the late receivers who are taxed by the earlier receivers.
Furthermore, these changes of income distribution, spending, relative prices and production will be permanent and will not simply disappear as the quantity theorists blithely assume when the effects of the increase in the money supply will have worked themselves out.
In sum, the Austrian insight holds that counterfeiting will have far more unfortunate consequences for the economy than simple inflation of the price level.
There will be other and permanent distortions of the economy away from the free market pattern that responds to consumers and property rights holders in the free economy.
This brings us to an important aspect of counterfeiting which should not be overlooked.
In addition to its more narrowly economic distortion and unfortunate consequences, counterfeiting gravely cripples the moral and property rights foundation that lies at the base of any free market economy.
Thus, consider a free market society where gold is the money. In such a society, one can acquire money in only three ways.
a. by mining more gold, b. by selling a good or service in exchange for gold owned by someone else, or c. by receiving the gold as a voluntary gift or bequest from some other owner of gold.
Each of these methods operates within a principle of strict defense of everyone's right to his private property.
But say a counterfeiter appears on the scene. By creating fake gold coins, he is able to acquire money in a fraudulent and coercive way, and with which he can enter the market to bid resources away from legitimate owners of gold. In that way, he robs current owners of gold just as surely and even more massively than if he burglarized their homes or safes.
For this way, without actually breaking and entering the property of others, he can insidiously steal the fruits of their productive labor and do so at the expense of all holders of money and especially the later receivers of the new money.
Money, counterfeiting therefore is inflationary, redistributive, distorts the economic system
and amounts to stealthy and insidious robbery and expropriation of all legitimate property
owners in society.