Argumentation:Paper money

This list attempts to gather arguments for and against fiat money (often called paper money) and the inflationary the policies accompanying it; contrasted with frre market commodity money (also called natural money).

Economical Arguments

The significant authors here are Mises and Hayek.

Rising prices

The production of money decreases the value of already existing units of money, therefore, money prices tend to rise.

This is true for any type of money; however, commodity money has alternative uses besides its monetary function, and it becomes cheaper for these purposes.

Fiat money, in turn, tends to be notoriously easy to produce in large amounts and has no other uses.

Economical Growth

There are claims, that economical growth is only possible with a corresponding growth in the money supply - otherwise, how could be the additional goods and services bought? Simply: any given amount of goods and services can be exchanged against any amount of money. If more goods are produced, their money prices will sink.

There are of course technical limitations. Assuming a long period of robust economical growth, some forms of money (like gold coins), could possibly shrink enough to be impractical. But this is no problem on the free market - people can switch to another form of money, like silver coins. In a free market, there are strong incentives to do this change swiftly and efficiently.

Some might object, that if businesses are forced to sell for lower prices, these could be too low if compared to their costs, leading to their bankruptcy. It is forgotten, that the businessman could foresee the sinking prices and strive to lower their costs appropriately. This is standard procedure in times of stable and sinking levels of prices, as is observed in dynamically growing industries (computers, IT, etc.), where such a situation is normal.

Deflation

Deflation is one of the greatest dangers the increase of money supply is supposed to prevent. What exactly are these dangers?

- There is no historical evidence, that deflation is damaging to long-term economical growth. - An unexpected strong deflation can motivate people to alter their behavior, that much is true. But that does not necessarily mean a slowing down of production in general. The consumers will eventually buy the goods and services they desire, even if observing constantly sinking prices: they would like to enjoy them sooner rather than later (good old time preference). It can be therefore expected, that consumption during a deflation period will continue at a marginally slower rate, but the total production will actually grow: because resources unused for consumption are saved, and as such serve to increase production further.

(It can be said, that any abrupt change in the structure of consumer demand and prices will tend to have negative effects. It can be also said that a) in a free market are price changes likely to be smoother and b) an inflationary system is not exactly immune to these shocks either. This could handle some more working out.)

- a deflation can indeed damage the banking industry, as it complicates the clearing of debts. If one assumes a string of bankruptcies on the side of customers, a bank's liquidity may be stretched to such a degree, that it goes bankrupt itself. (Again, any 'dramatic change', no matter its cause can have such negative effects.) However, the negative effects will impact mostly the industries most profiting from inflation, like banks and highly indebted companies. This problem will eventually adjust itself.

A reduction in bank credit does not destroy any resources, it merely guides them to other applications. The dangers of deflation are not as terrible as it is claimed.

Hoarding

Everyone is a holder of money to some degree.

Hoarding, or excessive holding of money is supposed to be a great danger paper money will prevent. But how can it cause damage to the economy? Any amount of money can serve for exchange. In the worst case, if a large part of the population became hoarders, they might cause a given currency to be replaced by another. (Note, that there are perfectly reasonable AND moral reasons to hold large amounts of money. Also, hoarding is subjectively defined and the only way to find out whether someone is hoarding is to analyze each case on its own. Acting against hoarding in general can complicate the lives of many.)

What if the government attempts to raise the supply of money to stop the hoarding? More money will push to create higher prices, which may motivate the 'hoarders' to hoard even more.

Holding money

According to some authors, not only hoarding, but holding money in general is unproductive and detrimental to the economy. Some make a softer claim: that an (unanticipated) increase in the demand for money "pushes the economy below its potential".

Holding money is useful. Because it can be employed for the instant satisfaction of the widest range of possible needs, it provides its owner with the best possible protection against uncertainty. In the real world, there is always uncertainty. To the extent a man's perception of uncertainty increases, so will his holdings of money. This is investment into the removal of perceived uncertainty: the person will be better prepared to face an uncertain future.

Even if all or most people would attempt to increase their cash holding, the physical production structure would be unaffected. With people striving to increase the size of their cash holdings, the money prices of goods will be bid down, and the purchasing power per unit money will rise. This results in a higher purchasing power of money and lower prices of goods.

Transfer of wealth

The positive effect of "having more money" benefits the producer of money and those getting it first; while the negative effects impact the latecomers. This redistribution of wealth may be limited to some degree (for example by doing business with those that get the money sooner), but cannot be avoided.

(The question, whether the transfer of wealth is desirable, is ethical, not economical in nature.)

Debtors

It is often asserted, that higher money prices benefit debtors, as it lowers the relative value of their debts. This may not always be the case: if the lender's estimate of the rising prices is too high, the debtor may end up paying more on account of the expected inflation.

(The question, whether the benefiting of debtors is desirable, is ethical, not economical.)

Ethical Arguments

While ethical considerations are not part of economical analysis, they are nonetheless relevant to the discussion. For several authors (Rothbard, Hülsmann) it is a major concern.

Force

No paper currency was produced in the free market, it was always forced on its users by government decree. This curtailing of civil liberties, in particular the freedom of association and freedom of contract alone makes a strong argument against fiat money.

Other Arguments

Historical impact

Mises argues, that the debasement of money was part of the reason why the ancient civilization of the Roman Empire has collapsed.

Oresme hints at a similar conclusion.

Further Resources

Some more works to process:

• An overview of the most widely accepted present-day criticisms of natural money: James Kimball, “The Gold Standard in Contemporary Economic Principles Textbooks: A Survey,” Quarterly Journal of Austrian Economics 8, no. 3 (2005) http://mises.org/journals/qjae/pdf/qjae8_3_4.pdf
• Ludwig von Mises, The Theory of Money and Credit (1912) - the fundamental issues related to sound money that are crucial for a market economy. http://mises.org/books/Theory_Money_Credit/Contents.aspx
• Murray N. Rothbard, What has Government Done to Our Money? (1964) http://mises.org/money.asp
• Murray N. Rothbard, The Case Against the Fed (1994) http://mises.org/books/fed.pdf