Mises Daily

The Case for Natural Money

[An MP3 audio file of this article, read by Floy Lilley, is available for download.]


Studying Jörg Guido Hülsmann’s latest book, The Ethics of Money Production, is a vastly enriching experience. After building his case for natural money on the inviolability of an individual’s right to his own property, he then shows us how the state has spent the last 400 years usurping this right for the benefit of a privileged few through its protection of fractional-reserve banking.

It is the state’s insatiable appetite for revenue, he argues, that is the motivation behind the various monetary schemes it imposes on us, which on an international level begins with the classical gold standard and runs through today’s paper-money agreements. Although he doesn’t discuss the current economic crisis directly, his observations provide a much-needed correction to government’s “do something” approach.

In this essay, I will touch on some of Hülsmann’s more salient points, beginning with the origin of money.

Natural Money versus “Forced Money”

We know that in a barter economy the division of labor is primitive because trade is limited by the double coincidence of wants. A carpenter who needs shoes finds a shoemaker who needs a chair, and they enter into a mutually acceptable trade. But trade is also limited by the makeup of the goods themselves — how will the carpenter acquire a small amount of flour with the chair he has built?

Over time, market participants devised better ways to trade. Certain consumer goods were found to be highly marketable and possessed physical characteristics conducive to trade, such as homogeneity, divisibility, and portability, and came to be acquired not for consumption but to serve as media of exchange. Such goods are called money; more than that, they are natural monies because they originated through the voluntary cooperation of acting persons.

The production of natural money is ethical because it involves no violations of property rights and is the corollary of a completely free society in which private property is inviolable. The economy of such a society, Hülsmann tells us, may then be called a “free market,” which would likely harbor a variety of natural monies. With this understanding, the claim that the culprit of the current crisis is the free market puts its proponents in the awkward position of having to show causality from something that doesn’t exist.

Natural monies come and go; they exist because they satisfy human needs better than any other medium of exchange. When this is no longer true, market participants will stop using them and find something better. Natural money thus becomes a product of grass-roots democratic action, where people have the freedom to choose the best available monies.

“Forced money,” by contrast, “owes its existence to violations of property rights.” It satisfies the requirement of facilitating trade, but superior monies can’t be used without exposing the user to some degree of violence.

Gold, silver, and copper have been the natural monies of many societies for thousands of years. Though they possess physical characteristics that make them superior to other commodities for use as money, they are natural monies only because they were selected through voluntary human action.

Paper Money and the Free Market

If commodity money is the best available money, why do virtually all countries today use paper money instead?

First, as Hülsmann notes, in no period of human history has paper money spontaneously emerged on the free market. “Whenever and wherever it came into being, it existed only because the courts and the police suppressed the natural alternatives.”

Hülsmann also points out that no Western writer before the 18th century seemed to think paper money was even a possibility, nor did any philosopher of money ever criticize the then-existing commodity money on utilitarian grounds. For example, in The Laws, book 5, Plato wanted to outlaw natural money to make citizens more dependent on government, but he didn’t say it was inadequate as a money. Neither did Aristotle, the Church fathers, or the Scholastics. Before the 16th century, furthermore, there was no problem with hoarding or sticky prices, and apparently no need to stabilize the price level, purchasing power, or aggregate demand.


Of course, none of these observations persuades the paper-money crowd. According to them, the capitalist economies that emerged during the Renaissance required a different kind of money, one whose supply could keep pace with the fast action on the market. After 1500, new theories explaining this need “swamped the world,” as Hülsmann puts it — but so did the rejoinders. In other words, in the 20th century, when Rothbard observed that the supply of money, like all other goods, is best left to the free market, it was “anything but a novelty in the history of thought.”

We must ask then what was the rationale for imposing paper money on the economy? Hülsmann addresses some of the most widespread errors in attempting to justify government intervention in monetary affairs.

Paper-Money Fallacies

By far the biggest fallacy is the belief that a growing economy requires a growing money supply. If an economy grows by five percent, then the money supply must grow by the same amount, the argument goes, otherwise the additional goods cannot be sold. Since a growth rate as high as five percent is exceptional for precious metals, they must be rejected as money for a modern economy. Paper money, on the other hand, can be produced in any quantity cheaply and quickly.

Economics teaches that any quantity of goods and services can be exchanged with virtually any quantity of money. If the economy grows but the money supply remains constant, prices will have a tendency to fall. It’s sometimes argued that if prices fall entrepreneurs will not be able to recover their costs and will face bankruptcy. But entrepreneurs have invariably shown the ability to anticipate future price reductions and compensate by lowering their expenditures. This, in fact, is the normal state of affairs in periods of a stable or falling price level, and was the experience of Germany and the United States during the last three decades of the 19th century.

A variation of the above fallacy is the alleged need to fight deflation. Though it can be defined in several ways, deflation most frequently refers to a sustained fall in the price level. In a deflation, bank customers will have difficulty repaying their debts, and this, in turn, will reduce bank liquidity and curtail credit.

Deflation, however, does not threaten the whole of society because, as credit does not create resources, neither does a curtailment of credit destroy resources. Deflation amounts to “a redistribution of productive assets from old owners to new owners,” Hülsmann writes, with the net impact on total production likely to be negligible.

“By far the biggest fallacy is the belief that a growing economy requires a growing money supply.”

If this is true, why does Ben Bernanke regard deflation as the great devil he must fight at any cost? Because deflation emphatically is a threat to those institutions responsible for inflationary increases in the money supply: fractional-reserve banks and their customers, which means “debt-ridden governments, entrepreneurs, and consumers.” Deflation tends to liberate “the underlying physical resources for new employment. The destruction entailed by deflation is therefore often ‘creative destruction’ in the Schumpeterian sense.” (William Greider noted that bankers championed “creative destruction” when it was affecting other people, but when it came knocking on their doors, the bankers were “not so accepting of their own fate.”)

Stabilization of the purchasing power of money (PPM) has been another excuse for abandoning natural money for paper money. On a free market, the best monies will prevail and will have a relatively stable PPM. If the money should experience violent fluctuations, people will abandon it and switch to a different money — if they’re free to do so.

Irving Fisher and others said that’s not good enough; government should fine-tune the PPM, and that requires paper money. But this is another instance of putting the fox in charge of the chicken coop; the result has been a complete disaster. In the modern era, managed currencies everywhere have depreciated and fluctuated as never before in the history of monetary institutions.

Adam Smith and David Ricardo popularized the view that paper money could do the job of commodity money, only at much lower production costs. Whatever appeal this might have vanishes when one remembers that money as such is not a consumer or capital good, but a facilitator of exchanges. Increasing its quantity doesn’t add to society’s wealth. Its utility lies in its exchange value, and increasing its supply tends to lower that value. Thus, the higher production costs of commodity money turn out to be one of its great advantages, because it cannot be multiplied at will. Paraphrasing Hülsmann, commodity monies have built-in insurance against inflation.


Most writers today define inflation as a lasting increase in the price level. Hülsmann adopts a different definition, one that was more or less accepted up until World War II: inflation is any expansion of the money supply that violates private-property rights. Unlike natural (voluntary) money production, which is regulated by the market forces of profit and loss, inflation is always an imposed increase of the money supply. With this definition, inflation can be seen as the cause of “unnatural income differentials, business cycles, debt explosion, moderate and exponential increases of the price level, and many other phenomena.” Hülsmann sets about to expose the causal connections in some detail.

“The higher production costs of commodity money turn out to be one of its great advantages, because it cannot be multiplied at will.”

People — mostly governments — inflate the money supply because they profit from it, and the history of monetary institutions is largely the history of inflationary schemes. Early owners of the new money are the winners because they buy goods and services at current prices. Later owners are the losers because they pay the higher prices that the money-supply increase creates.

Inflation began as the debasement of coins, or what Hülsmann refers to as the falsification (counterfeiting) of money certificates physically integrated with the monetary metal. The counterfeiter could either reduce the precious metal content of the coins or imprint a higher nominal figure on the coins.

Compared to fractional-reserve banking and paper money, debasement was a crude method of counterfeiting. Using debasement, English kings could only inflate the money supply by a factor of 0.3 over a 500-year period (1066–1601). When they had access to the advantages of fractional-reserve banking during the subsequent 200 years, however, that factor jumped to 16. And American monetary maestros pumped up the money supply by a factor of 5 in a mere 30 years (January 1973–January 2003) by feeding the fractional-reserve monster.

There were other differences between inflation then and now. When princes of old debased their coins, their subjects considered it a cheat. When today’s leaders debauch their currency, they proclaim it as wise and necessary monetary policy, and until recently most people believed them. It has taken the hocus-pocus of massive “stimulus “ solutions to begin to shake their faith, though the new messiah is trying to restore it.

The Rise of Fractional-Reserve Banking

The grip of government on our lives cannot be adequately explained without reference to fractional-reserve banking, paper money, and the laws protecting these institutions. Hülsmann provides a compelling explanation of the relationship between government growth and modern banking.

“The history of monetary institutions is largely the history of inflationary schemes.”

As he tells us, banks developed as money warehouses in northern Italy beginning in the late 16th and early 17th centuries and soon became fractional-reserve banks, meaning they issued certificates in excess of the actual money they had in reserve. Unlike warehouse banks, fractional-reserve banks cannot meet all their obligations at once and are subject to the perpetual nemesis of all fractional-reserve schemes: the bank run.

The usual explanation for the corruption of warehouse banking into fractional-reserve banking is the simple one of bankers’ giving in to temptation. While true, this is not the sole cause. Fractional-reserve banking was in part a defense against government confiscation. When Charles V was robbing the reserves of banks in Seville in the mid-1500s, for example, the bankers decided to evade the plunder by loaning a large portion of their deposits to commerce and earning a profit. The threat of confiscation somewhat diminished the bankers’ guilt.

Legalizing False Certificates

In an ethical society, laws would punish counterfeiting as an instance of fraud and theft, and, once the false certificates were discovered, market participants would abandon their use and switch to alternatives.

But governments can legalize certain kinds of counterfeiting. This can be accomplished in several ways. One method is for government to spin language in such a manner that certificate imprints can take on any contractually binding meaning. For example, the courts might see nothing wrong with a gold coin marked “one ounce of gold” that in fact has less gold or no gold at all. Legalization here means that the government refuses to enforce the laws against bank counterfeiting. Legalizing false money certificates is the foundation of all other monetary privileges, such as legal monopolies and legal-tender laws.

But even when it holds a monopoly on the supply of coins and banknotes, the government cannot yet open the inflationary floodgates; market participants are still free to evaluate the coins and banknotes and can switch to other monies if their local monopoly supplier is irresponsible. Legal monopoly reduces the range of options and diminishes the full use of one’s property, but it does not eliminate choice per se, and that remaining choice continues to keep the government in check.

From the government’s perspective, legal-tender laws solve this problem. They attack choice at the root by overruling any contractual agreement a person might make with respect to money.

“In an ethical society, laws would punish counterfeiting as an instance of fraud and theft.”

There is another sense in which legal tender corrupts choice. If the unhampered market can be thought of as assigning “votes” to money users — one penny, one market vote, as Frank Fetter wrote in 1905 — then the imposition of fractional-reserve banking through legal-tender laws creates votes out of nothing and assigns those votes to the first users of the new money: bankers and government. A privileged money creates a privileged society.

Historically, legal-tender laws usually established a fiat equivalence between the privileged money and other monies. If gold and silver are legal tender, and gold is decreed to trade with silver at 1/20, but will trade at 1/15 on the market, the undervalued silver will gradually disappear from daily transactions. Legal-tender laws inflate the legally privileged money and deflate the others.

With silver scarce, its purchasing power rises, and it becomes difficult to make small purchases. People will be inclined to rely instead on fractional-reserve banknotes and demand deposits, which can be created quickly. If government then makes its notes legal tender, along with gold, the notes increase in demand because no one wants to pay in real money (gold). Notes are consequently redeemed less often, which increases bank reserves of gold. In the fractional-reserve system, this enables banks to issue more banknotes.

For the government, fractional-reserve banknotes are a godsend. It was fairly easy for laymen to distinguish debased coins from sound coins. Paper certificates, though, circulate without any distinctions.

Privileged banknotes entail a “race to the bottom” of worthlessness, but as long as they’re redeemable in gold there is a limit to how much they can be inflated. Removing that limit converts them into pure paper money.

The Emergence of Paper Money

Banknotes become paper money through progressive infringements on private property and through breaches of contract perpetrated by central banks. When government grants a monopoly legal-tender status to the notes of a fractional-reserve bank, then allows the bank to suspend the contractually agreed-upon redemption of its notes, it turns those notes into paper money.

“A privileged money creates a privileged society.”

Paper money, by its very nature, is a form of fiat inflation: it is always and everywhere in greater supply than it would be on the free market, where it could not sustain itself at all. The banknotes of the world became paper money on August 15, 1971 when the United States declared it would no longer redeem its dollars in gold.

While the threat to gold miners is bankruptcy, the threat to paper-money producers like the Fed is hyperinflation. There’s really no limit to how much paper money it can produce. As a privileged central bank, it cannot go bankrupt, and neither can the government that appoints the Fed’s leaders go bankrupt.

In December 2002, Alan Greenspan claimed that “a prudent monetary policy maintained over a protracted period can contain the forces of inflation.” But even “prudent” central bankers can’t avoid economic crises. As Hülsmann argues, “the mere possibility of inflating the money supply creates moral hazard” (emphasis added). Users of commodity money do not speculate on the sudden availability of gold and silver miraculously emerging from the mines. By contrast, people do speculate on the “good will” of the paper-money producers, and they’re right most of the time.

Inflation’s Legacy

Inflation’s standard definition is too narrow to provide an appreciation of the extent of its harm; it is far more than a deterioration of the currency’s purchasing power. It’s also much more than a “hidden tax.” Government’s perennial fiat inflation is a subtle WMD. Consider the following:

  1. In funding wars, it allows government to ignore the fiscal resistance of its citizens.

  2. It benefits the central government at the expense of secondary and tertiary governments.

  3. It turns moral hazard and irresponsibility into an institution, and guarantees recurring economic crises.

  4. By making credit cheap, it encourages businesses to finance their ventures through borrowing rather than equity. Because of market competition, few firms can resist the offer of low credit, making them more dependent on banks. As Pius XI noted in 1931, it puts a dictatorship in the hands of lenders who regulate the lifeblood of the entire economic system.

  5. Fiat inflation drives people to invest in capital markets where few will have the expertise, time, and inclination to monitor their investments properly. In former times people could save simply by holding gold and silver coins.

  6. Under a perennially increasing price level, the average citizen finds his best strategy is personal debt, which weakens self-reliance and independence.

  7. Under chronic fiat inflation, people will tend to choose their employment based on monetary returns. Money then becomes the prime or only consideration for personal happiness.

  8. Perennial inflation deteriorates product quality. Industries that cannot compensate for inflation with technological innovation turn to other means, such as producing an inferior product under the same name. Lying, which is bound up with fractional-reserve banking, tends to spread like a cancer over the rest of society.

  9. By fueling the exponential growth of the welfare state, fiat inflation fosters the decline of the family. Families become degraded into “small production units that share utility bills, cars, refrigerators, and especially the tax bill.” The welfare state drives the family and private charities out of the “welfare market.”

As Hülsmann concludes, “fiat inflation is a juggernaut of social, economic, cultural, and spiritual destruction.”

The Classical Gold Standard

The myth that governments are servants of their people is fully exposed in the history of money production. From antiquity to the present day, governments have always sought to steal from their citizens through manipulation of the money supply. In modern times, this has taken on the trappings of a science. To oppose it now means to oppose virtually the entire economics profession, most of whose members happen to be on the government payroll in one way or another.

The classical gold standard was ushered in following Germany’s victory over France in 1871. Libertarians and monetary conservatives often hail this period as a halcyon era we need to resurrect. But while that standard had desirable results, such as boosting the international division of labor, it was still an imposed standard. As such, it demonetized silver and thus brought about a strong fiat deflation, which in turn reinforced fractional-reserve banking throughout the banking hierarchies.

As Hülsmann makes clear, the inherent fragility of fractional-reserve banking is well known to bankers and motivates them to devise means of postponing the crisis it inevitably produces. The classical gold standard was one such scheme. It was not imposed as a means of limiting inflation. It served as a pretext for national governments to bring the monetary systems of their countries under their control. Rather than “a bulwark of liberty,” it was a “breakthrough for the societal scourge of our age — omnipotent government.”

Pooling Gold

The onset of World War I in 1914 killed the classical gold standard before it could collapse on its own. An international arrangement called the gold-exchange standard replaced it in 1925 and lasted until 1931. Under the classical standard, the central banks kept their entire reserves in gold, while the commercial banks kept their reserves mostly in central banknotes. The gold-exchange standard took this pooling arrangement to an international level, with the Fed and the Bank of England remaining true central banks and, as the holders of gold, serving as the central banks of the world. Other central banks kept a large portion of their reserves in US and British notes. The gold-exchange standard collapsed following the 1929 Crash when various governments turned to protectionism or imposed foreign-exchange controls. It died in September 1931, when the Bank of England suspended payments.

“The myth that governments are servants of their people is fully exposed in the history of money production.”

The world suffered through a period of fluctuating exchange rates until the end of World War II, when the Bretton Woods system was adopted. As Hülsmann explains, it amounted to “a gold-exchange standard writ large.” Under the classical system, gold was pooled in each nation’s central bank; under the gold-exchange standard, the number of pools was cut to two — and under Bretton Woods, one. All the arrangements were devised to facilitate the “flexibility” of banknotes, and each was far more expansionary than its predecessor.

Under Bretton Woods, the participating nations agreed to pool the world’s gold reserves at the Fed, which already had the largest gold supply in world history. The Fed continued to redeem its notes in gold to other governments and central banks, which in turn redeemed their own notes in dollars. To a great extent, participants were dependent on the good will of the Fed, which alone had the power to allocate the world’s banknotes — dollars — at its discretion.

“Restraint was not part of its mission,” Hülsmann tells us, “and the very anchor of the system — the Fed — was particularly ruthless in its inflation of the dollar supply.” When it collapsed in 1971, the gold reserves of the Fed were nearing exhaustion. Bretton Woods thus concluded 100 years in which three “cartels of central banks had flooded the western world with their banknotes without nominally abandoning the gold standard.”

International Paper-Money Systems

When the United States suspended payment of gold, it converted the world’s banknotes to paper money. It also created the horror of fluctuating exchange rates that weakened the international division of labor and brought “misery and death” to millions. Yet paper-money standards have emerged. How is this possible?

We need to consider what government wants — more power and revenue — and the means available to attain it. The easiest way for governments to get additional revenue over and above taxes and debt is to encourage foreigners to make investments in their countries. But to do so they must provide sufficient financial safeguards. A government seeking investors, for example, might float bonds denominated in the paper money of a country whose investments it seeks. The issuing of government bonds denominated in US dollars or euros is today a widespread practice.

The territories with the largest capital markets will be the ones whose paper money will be adopted as international standards, and, in the 30 years following the fall of Bretton Woods, those territories have been Europe, Japan, and the United States. Consequently, the euro, the yen, and the dollar are the three most important monetary standards today.

As Hülsmann notes, the standard money producers cooperate with one another to maintain their positions. In a dollar crisis, for instance, the euro producers will commit to stabilizing the dollar-euro exchange rate so that dollar countries won’t switch standards. And since paper-money producers know they can count on their competitors to help them out, they have a strong incentive to collude and expand their production.

Would a single global paper money such as the one Keynes proposed at Bretton Woods avoid the pitfalls of competing paper monies? Absolutely not, Hülsmann answers. All paper monies, whether national or global, are subject to moral hazard. They will either collapse in hyperinflation or invite increasing government control over all economic resources.

Is There Any Hope?

$24 $20

“We need to sweep aside privileged money and let the market work.”

We need to sweep aside privileged money and let the market work. It might seem an impossible goal, but history provides some encouragement. As the author notes, China used paper money for 500 years and suffered from hyperinflations and other monetary problems. When political leaders stopped suppressing silver and copper coins, monetary sanity returned. In US history, the framers repudiated the inflationism of the country’s past in the Constitution’s very first article; and Andrew Jackson defeated his inflationist foes during his presidency.

An ideal order of natural money production based on a universal respect for private property could exist today, he says, “technically at a moment’s notice.” With it so close at hand, it remains only to convince others that it should exist. Students of Hülsmann’s book will find it a rich resource for such an undertaking.

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