Full Reserve Banking

CHAPTER 2

Increases in the Demand for
Money and the Ideal Money

2.1 Cash-Building Deflation and Its Social Function

Not only does Rallo describe how a fractional reserve banking system based on real bills works, but he also argues that such a system has important advantages vis-à-vis a full reserve system. Before I analyze the reasons Rallo provides for an elastic money supply that counteracts cash-building deflation, let us first look at the process of cash-building deflation itself.

The demand for money is the demand to hold money as a cash balance. Cash balances serve to reduce felt uncertainty, as money balances allow one to confront “unforeseen and indefinite expenditure” (Mises 1953, 303). When individuals want a higher cash balance, they attempt to buy money from others, who at the same time must reduce their cash balances. When a majority of or even all individuals demand to increase their cash balances, they cannot all increase their nominal cash balances at the same time if the money supply is constant. Yet they can increase their real cash balances.

The increase in the real cash balances is essential for economic actors. In the end, what counts is what a cash balance can buy and not its nominal value. When nominal prices fall, real cash balances increase for all money holders. And this is exactly the outcome of the market process when all individuals try to increase their nominal cash balances.

Therefore, to attain the desired outcome of an increase in real cash balances, there is no need for a special adjustment including changes in the supply of money. As Hülsmann (2000, 106) points out, “Unlike all other commodities, money itself constantly adjusts to the conditions of the market. The services rendered by any unit of money are constantly adjusted under the impact of change in the demand for and supply of money.”

There is also a social function of increases in the demand for money in times of crisis. The demand for money may increase sharply when uncertainty increases. In the wake of natural catastrophes, wars, or pandemics, uncertainty soars, as does the demand for money. The demand for money is satisfied in these situations usually by reducing consumption spending. Consumer goods are thereby set free that are urgently needed because production has been reduced due to the natural or human-induced catastrophes. If the demand for money did not increase and manifest itself in a reduction of consumption spending, then consumer-goods prices could rise more sharply in such scenarios. The price surge is dampened, and the demand for uncertainty preparation is fulfilled. The probability of a social panic induced by skyrocketing consumer-goods prices is reduced. Consumer goods are set free for those hit particularly hard by the catastrophes (Huerta de Soto 2021).

Furthermore, when individuals want to increase their cash balances, it is not only the case that they may buy less until prices fall to the desired level of real cash balances. When individuals want to increase their cash balances, they can also sell from the accumulated stocks of goods they hold. Finally, individuals may produce and work more to sell more goods and services and increase their cash balances, thereby driving down prices. In times of uncertainty, when more natural and human catastrophes than usual are expected, such an increase in output has a social function. There is (or is expected to be) a relative scarcity of goods and services due to the (possible) catastrophe. The expected destruction of goods and services may be partially offset by the increase in output that results from the attempts to increase cash balances.

Hence, there are two important social functions of cash-building deflation. First, consumer goods may be liberated and made available to those who are especially harmed in times of uncertainty. Second, output may increase, helping to reduce the damage. These social processes, however, are disrupted when new fiduciary media are produced in response to the increased demand for money. Then (nominal) cash balances increase without the need to sell stocks, reduce consumption spending, or increase production.

It is, therefore, unnecessary, and potentially even harmful, to prevent a cash-building deflation via credit expansion. Without credit expansion, prices will fall to the levels required for the desired real cash balances. The alternative is to increase the production of fiduciary media—i.e., the supply of money in its broader sense—to prevent a potential fall in prices.

The idea that quantities have to adjust instead of prices is in essence a Keynesian idea. John Maynard Keynes (1936) argued that Jean-Baptiste Say’s law (1964) was wrong and that there could be an overproduction of all goods and services. For instance, when there is unemployment, Keynesians typically do not recommend that wages adjust but recommend increasing another quantity—namely, aggregate demand. Similarly, when the demand for money increases, the market adjustment runs through the price mechanism and possibly a cash-building deflation. The alternative to the price adjustment is an increase in quantities—namely, the supply of fiduciary media. According to Rallo, this increase should and does occur through the automatic functioning of a fractional reserve banking system.

Finally, when talking about sharp increases in the demand for money due to higher perceived uncertainty, we should not forget that these are rather rare in a free market economy. In a free market the demand for money is rather stable (Bagus and Howden 2011a).

One important cause of a surge in the demand for money is the uncertainty that comes along with the bust after an artificial boom. The recession, however, is caused by credit expansion unbacked by real savings. Ironically, it is the production of fiduciary media in response to an increase in the demand for money that may trigger an unsustainable boom, as I will discuss in more detail in section 4.

It is not only a central bank’s policy of price stabilization in times of economic growth that destabilizes the economy (Huerta de Soto 2012, chap. 6; Machlup 1940, 177; Hayek 1933, 114; Mises 1928). The policy of price stabilization through the production of fiduciary media at times when the demand for money is increasing also destabilizes the economy—and the demand for money. It is, thus, unfortunate that Rallo appeals to surges in the demand for money to justify credit expansion. The possibility of granting loans unbacked by real savings is exactly what the real bills doctrine promotes and what triggers such surges. Granting loans unbacked by real savings fosters boom-and-bust cycles, and the demand for money becomes more volatile than it would be in a free market.

2.2 The Ideal Money

The question of the ideal money is one source of divergence of opinion between the banking school and the currency school. It is due to their view on the ideal money that the banking-school theorists, among them Rallo, believe that fractional reserve banking can be beneficial.

The best money is the one that is chosen by individuals on the free market. There are several characteristics that make a medium of exchange more prone to become money, such as low storage and transportation costs, easy handling, durability, divisibility, resistance to tarnishing, homogeneity, recognizability, and strong nonmonetary demand (Bagus 2009, 2015b). The market-chosen (nonmanipulated) money allows for efficient economic calculation, which is an essential guide for human action in a society based on the division of labor (Mises 1998, 225, 230–31).

Mises (1998, 418) and Rothbard (2001, 670) consider that any quantity of money can fulfill its function as a medium of exchange once a medium of exchange has been established as money. Changes in the demand for money will lead to changes in its purchasing power but not affect money’s social usefulness. In particular, an increase in the purchasing power of money does not reduce the money’s usefulness as a medium of exchange (Bagus 2006, 114).

Mises (1998, 518–19) points out that cash building is not a problem in a market economy. Friedrich von Hayek also believes that the idea that the money supply must be elastic and respond to changes in the demand for money is erroneous. He states that “the cry for an ‘elastic’ currency which expands or contracts with every fluctuation of ‘demand’ is based on a serious error of reasoning” (Hayek 1931, xiii).

Rallo, however, in good banking-school company, believes that a good money responds to increases (decreases) in demand with compensating increases (decreases) in its supply. In short, money should have an elastic supply. In Rallo’s envisioned fractional reserve banking system, the supply of fiduciary media adjusts to demand. When the demand for money increases, fiduciary media are issued. The increased demand for money is caused by the needs of trade. When the fiduciary media are redeemed into cash, the fiduciary media disappear following John Fullarton’s law of reflux.

These arguments concerning the need for a reaction of the supply of money to changes in the demand for money concur with the so-called monetary-equilibrium theory, which is part of the Keynesian and monetarist analysis (Huerta de Soto 2012, 677). As we will see in section 2.4, the monetary-equilibrium theory, because of its macroeconomic approach, prevents understanding of the underlying microeconomic processes and leads its proponents to identify problems that dissolve when viewed through microeconomic lenses.

But why, according to Rallo, is credit expansion based on real bills beneficial if the demand for money increases? Rallo (56, 57) argues that increases in the demand for money in a free market lead to problems. He even titles a section of his book (53) “The problem of the increase in the demand for money.” But what are these alleged problems?

These problems can be divided into three kinds: unnecessary resource costs; unnecessary coordination problems due to price rigidities; and a lack of stability, making entrepreneurial forecasting more difficult. I will deal with them in turn.

2.3 Rallo’s Arguments in Favor of an Elastic Money Supply

2.3.1 Resource Costs of a Full Reserve Money Standard

Rallo argues that an increase in the demand for money withdraws money stuff from nonmonetary purposes (for instance, from the production of gold jewelry in the case of a gold standard) and directs more factors of production toward mining, and that this reduces the welfare of society (53). Rallo emphasizes that Mises offers only clearinghouses as a way to accommodate the increase in the demand for money. The Spanish economist maintains that this is insufficient. Rallo’s preferred solution to the problem is fractional reserve banking based on real bills.

But is it really a problem for a pure gold standard when the demand for money increases?

Mises (1998, 418) recognizes that “one may call wasteful all expenditures incurred for increasing the quantity of money.” However, Mises continues, even though papermoney production in a fiat money standard appears to be cheaper, it comes with important costs.

The most fundamental question is how many factors of production should be employed to produce money or maintain the monetary system. There are maintenance costs in any monetary system. In a fiat money standard, such costs include the wages of monetary policy makers, among many other things (Huerta de Soto 2012, 778–81). There are also mining and maintenance costs under a gold standard (or a bitcoin standard, for that matter).

Gold or bitcoin mining entails costs as in any other human action. In a free market, individuals decide freely how many factors of production to use for gold mining and for jewelry production. Costs are subjective. It does not make sense to say that alternatives to the ends chosen by freely interacting individuals are less costly than the ends chosen. Subjectively, actors make these choices because they prefer them. Why would someone consider these choices to be detrimental to the welfare of society? Utility and welfare are subjective concepts. From a value-free point of view, one simply cannot say that welfare is higher when there is less gold mining and more fiduciary media production or when there is less coinage and more jewelry production.

There are several monetary systems, with different costs, that can be chosen. The choice can be made either by the government or by the people. Mises (1998, 419) states that the market should select money, not the government. The market’s selection should be the criterion for the costs. Thus, to argue that a freely chosen gold standard would reduce welfare is problematic.

2.3.2 The Origin of Money and Constant Purchasing Power

Indeed, when it comes to choosing the best money in the eyes of market participants, we are talking about the origin and evolution of money. When money arises out of a barter economy, a certain commodity starts to face a demand to be used as a medium of exchange. The demand for a medium of exchange increases, thereby driving up its purchasing power. This is a natural part of the evolution of money. Indeed, price deflation in terms of the future money is part and parcel of the process in which money evolves. The purchasing power of the commodity that prevails in the competitive process in which money evolves will not remain stable or constant. It will increase because of the additional demand to use it as a medium of exchange.

Rallo argues that an elastic money supply with stable purchasing power is preferable. But why should the emerging money’s purchasing power be held constant? Would that not slow down the process of the evolution of money? Rallo defends the idea that the ideal money has stable purchasing power. Consequently, it seems that he would have to argue that for a commodity to become money, its supply must be very elastic. The supply of the commodity (or its substitutes) must increase quickly when demand for it increases rapidly in the process of monetization.

Most actors, however, would likely prefer a medium of exchange that increases in value and does not allow for such important increases in its quantity. Moreover, the evolution of institutions such as money never ends. Thus, it is arbitrary to argue that no stabilization of the purchasing power of money is needed during the evolution of a medium of exchange on its way to becoming money, while arguing that in a later phase, once a money has been established, it would be somehow advantageous to stabilize its purchasing power through the issue of fiduciary media. New media of exchange may arise and compete with the existing ones. A natural part of this evolution is that emerging competitors face higher demand and increases in their purchasing power.

2.3.3 Price Rigidities in a Full Reserve Money Standard

Sometimes it is argued that deflation is problematic because of price rigidities. Indeed, Rallo (112) argues that social welfare decreases when the demand for money increases and all prices have to fall. The loss in social welfare comes because prices do not all fall to the same extent—i.e., there are price rigidities.

As stated in section 2.1, individuals who want to increase their cash balances buy less and sell more until prices fall. And all prices are flexible in the long run in a free market. The price fall may cause losses for producers that do not manage to cut factor prices fast enough. In this case there is a redistribution to the detriment of the entrepreneur and to the advantage of the factor owner—for instance, a worker. The factor owner forecast prices better than the entrepreneur. The forecasting of profits and losses is not unique to times of falling prices, as I have stated elsewhere: “Both employers and employees anticipate future prices and take them into account when they make long-term contracts. Surely, they can err, but in both directions, while general prices are falling or rising” (Bagus 2006, 117).

When factor owners have secured a long-term contract in a time of falling prices, leading to accounting losses for the company, there are two possibilities. First, the contract is renegotiated and the price paid to the factor owner is lowered to make the company profitable again. Then the rigidity of the long-term contract ends. Second, the factor owner insists on the longterm contract and the agreed-upon price. Then the company may become bankrupt and the factor owner unemployed. A new company may then hire the factor owner at a lower price, as his discounted marginal value product has fallen because of price deflation. In this case there is redistribution but not necessarily a fall in overall production. A new company takes the place of the old company.

Unemployment tends to disappear in the market process. It is either voluntary or caused by government intervention. Hutt (1977) speaks of “preferred idleness” when the unemployment is voluntary. If increases in the demand for money lead to preferred idleness, from a value-free point of view we cannot say that this is suboptimal or represents a loss in social welfare.

I should also point out that in the case of a price deflation, it may well be that factor prices (costs) fall faster than a company’s selling prices. What is essential for the entrepreneur is the price differential, which may increase in times of falling prices. Indeed, it is a neoclassical error to believe that prices follow, and are determined by, costs. It is the other way around, as Böhm-Bawerk (1891) points out. It is costs that follow expected future prices because entrepreneurs bid for factors of production in anticipation of the expected price of the good they intend to sell in the future (taking into account all factors that may influence this price). Thus, costs logically move before selling prices. It is the task of entrepreneurs to anticipate price changes like all relevant other future changes (Bagus 2006). Of course, entrepreneurs may err; then they suffer losses.

When entrepreneurs make losses, they simply have bid too much for the services of factors of production. However, entrepreneurs can bid too much for factors of production in times of falling, rising, or constant prices. This is independent of the general tendencies of prices. And why would the percentage of entrepreneurs that bid too much for the services of factors of production be systematically higher in times of falling prices caused by an increase in the demand for money than in times of stable and rising prices (Bagus 2006, 110)?

It is also important to point out that with uncertainty-induced cash building, relative prices have to change. It is not a sign of spurious rigidities that relative prices change, but a sign of a change in subjective valuations. Suppose there is a natural catastrophe and the scale of the destruction is unclear. People may want to increase their cash balances by cutting back on consumer purchases and investments that they find less necessary. They could cancel a vacation to the affected area or cease investing in companies that may be affected adversely by the catastrophe. Then the relative prices of these goods and assets fall more than other prices. The idea that relative prices must not change but must be maintained by increases in the supply of money is absurd and counterproductive. A system that is designed or intended to keep relative prices stable unequivocally will lead to distortions, as subjective valuations and relative prices continuously change.

2.3.4 Absence of Price Stability in a Full Reserve Money Standard

Rallo maintains that the ideal money has a stable value. He argues that his preferred system of fractional reserve banking based on real bills would stabilize the purchasing power of money because increases (decreases) in the demand for money would be met with increases (decreases) in the supply of money. In this context, Rallo (99–100) maintains that instability of the purchasing power of money creates arbitrary winners and losers.

However, is price stability desirable per se? There are several problems with Rallo’s (102) argument that ideal money has stable purchasing power.

First, it is true that changes in the purchasing power of money create winners and losers (for instance, changes in the purchasing power of money affect creditors and debtors). But this is true for all changes in market data. When consumers start to value ice cream higher relative to other goods, milk producers will benefit relative to the producers of other goods, whose demand shrinks. When actors value money higher in relation to other goods and want to increase their cash balances, people who own money (or the claim to money in the future—i.e., creditors) will win, while others, especially debtors, will lose. In both cases there are winners and losers due to changes in market data (namely, subjective valuations). Either all market changes must be considered arbitrary, or none of them must be. In any case, Rallo does not prove that “arbitrary” market changes have to be prevented.

It is an entrepreneurial task to anticipate prices. Part of the entrepreneurial task is to anticipate the purchasing power of money. Thus, entrepreneurs must, can, and do forecast changes in the demand for money. Those who anticipate it better than others will gain, while others, who are worse in their anticipation, may lose. There is nothing arbitrary about this redistribution; it is entrepreneurial.

Second, the purchasing power of money always changes. It can never be neutral (Mises 1998, 413– 16). There are no stable valuations (Mises 1998, 220). Regardless of how much Rallo desires it to be so, there is no stable money. Subjective valuations change, and, consequently, so does the purchasing power of money. Mises points out that if purchasing power changes slowly, there is no problem for economic calculation. As the purchasing power of money will always change, who is to decide which changes in the purchasing power of money are too large? When is money so volatile that real bill fractional reserve banking is needed for stabilization? It is an unscientific value judgment to argue that without real bill fractional reserve banking, the purchasing power of money would be too volatile. It is market participants who decide which money to choose.

Third, it is not true that a stabilized price level reduces information costs overall. While some information costs may be reduced by ensuring a more stable price level, other information costs may increase. For instance, prices fixed by the government may reduce information costs in the sense that entrepreneurs can forecast future prices more easily. However, these fixed prices no longer reflect the subjective valuations of market participants, which involve important costs of discoordination. Indeed, as will be shown in section 4, real bill fractional reserve banking distorts interest rates, which no longer reflect subjective intertemporal valuations, potentially triggering business cycles.

Fourth, changes in the purchasing power of money transmit important information. When the demand for money increases, prices tend to fall, transmitting this change in preference to market participants. When the demand for money increases as an individual stops purchasing a certain consumer good, important information is generated in the market as the relative price of this product falls. When this fall in prices is counteracted with increases in the money supply through credit expansion, things change. Then interest rates are artificially reduced, and there may be artificial boom-and-bust cycles. While prices may remain stable, economic actors may not be aware of the distortions. The business cycle, in the end, makes planning more difficult and increases uncertainty and price volatility.

Moreover, when the demand for money increases and the fractional reserve banking system reacts with an increase in fiduciary media, there will be redistributional effects as the new fiduciary media enter the economy in specific places. As fiduciary media are introduced into specific places, the change in relative wealth positions and prices causes adjustment costs as well—not to speak of the adjustment costs due to the business cycle that may be prompted.

Fifth, as mentioned in section 2.1, the demand for money may become more volatile because the credit expansion unbacked by real savings sets in motion the business cycle (Bagus and Howden 2011c). Instead of forecasting the demand for money, entrepreneurs in a price-stabilizing fractional reserve banking system must forecast the effects of the injection of fiduciary media on redistribution, on relative prices, on the business cycle, and on the demand for money.

It is true that sharp increases in uncertainty due to catastrophes are hard to anticipate. And one could argue that in Rallo’s version of the real bills doctrine, entrepreneurs have to anticipate one less factor: changes in the demand for money. However, in a market economy all goods and services may change their price and thereby affect the demand for other goods, including money. To stabilize the price of any good may reduce uncertainty on one end but may increase it on the other. One could also argue that with a price control on milk, entrepreneurship is easier because one less factor must be forecast. However, the probability of distortions and business cycles increases, making entrepreneurship more difficult.

Sixth, and also mentioned in section 2.3.2, ceteris paribus market participants prefer a money that constantly increases in purchasing power to a money with a constant purchasing power. This is because money is always held in a cash balance to protect against the uncertainty of the future. When money gains in purchasing power, it protects better against uncertainty than otherwise. Therefore, ceteris paribus all actors prefer to hold their cash holdings in a money that increases in purchasing power.

As a counterargument, Rallo (100) makes the case that buyers would not give up a money that is expected to rise in value. This is basically the idea that price deflation leads to problems because people postpone purchases (or do not buy at all, as Rallo seems to imply). However, there is the universal fact of time preference. Even though it is expected that gasoline prices will be 10 percent lower next year or that the new iPhone will be sold at lower prices within 2 years, people prefer to fill their tank and use the iPhone today rather than in the future and, consequently, are willing to give up money in return.

Finally, when the demand for money increases, Rallo thinks, the best result would be that this demand is satisfied without a change in relative prices because this would cause arbitrary winners and losers. As mentioned in section 2.3.3, relative prices will change if there is an increase in real cash balances due to falling prices. Some prices will fall more than others. For instance, when uncertainty increases because of the danger of war, people might increase their cash balances by abstaining proportionally more from vacation spending than from spending on groceries. As a consequence, prices of tourist services will fall more than prices of groceries. This change in relative prices is not a distortion but reflects subjective preferences. Maintaining stable prices through monetary expansion would frustrate the adjustment and distort relative prices.

2.4 The Implicit Macroeconomic Approach behind Rallo’s Ideal Money

The idea of a flexible money supply that adjusts the quantity of money to the demand for it is related to the theory of monetary equilibrium.

The theory of monetary equilibrium is, by its very nature, macroeconomic and at odds with the microeconomic Austrian approach. It focuses on the general price level instead of actions of individuals who want to increase their cash holdings (Huerta de Soto 2012, 688; Van Den Hauwe 2006). The level of aggregation is too high, inhibiting the view of the underlying microeconomic processes.

When someone has a higher demand for beer, he can directly satisfy this demand by buying more beer. When someone has a higher demand for cash balances, he can directly satisfy this demand by abstaining from consumption or selling additional goods and services. If all individuals want higher real cash balances, prices fall and directly satisfy the desire. Most likely, not all individuals will want to increase their real cash balances in the same proportion; some might not want to increase them at all. The result is achieved through individual decisions to buy and sell and to abstain from doing so. How would a real bill fractional reserve bank fulfill these preferences of individuals wanting to adjust their real cash balances?

Increasing fiduciary media to satisfy an increased demand for money has the following problem: The additional supply of fiduciary media that results from the discounting of real bills does not directly reach those who have a higher demand for money (Huerta de Soto 2012, 688–93; Bagus and Howden 2011b). The fiduciary media first get to the companies that discount real bills and then to the factor owners of the investment projects financed with these fiduciary media. From there, the fiduciary media will flow through the economy until they reach those who want to increase their cash balances. Thus, when new fiduciary media are produced by real bills, discounting these fiduciary media will only indirectly reach those individuals who want to increase their real cash balances, causing distortions on the way.

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The “uncertainty demand” for money may be distinguished from the “transaction demand” for money, which is the demand for money to facilitate exchange. The transaction demand for money may fall—for instance, when companies economize on money, such as when they increasingly use secondary media of exchange and introduce compensation schemes. Clearing systems economize on money and facilitate payment dates by reducing the transaction demand. Financial innovations such as credit cards and PayPal accounts are other examples that reduce the transaction demand for money. The ceteris paribus result of such economizing is what Salerno (2021) has called “good inflation.” Due to the economizing innovation, there is an “excess” in cash balances. People spend this excess, bidding up prices. The price inflation thereby performs the vital function of bringing real cash balances back to the desired level. This increase in prices is a one-shot event triggered by the general adoption of the financial innovation, with no systematic effect on the credit market and market interest rates.

At the same time that there are factors that reduce the transaction demand for money, there are also counteracting factors that may offset the former: a further differentiation in the division of labor, productivity increases, split-offs of companies, or a lengthening of the structure of production via new companies increases the transaction demand for money.

The payment innovations such as the introduction of clearing systems that reduce the transaction demand for money act in principle like dishoarding or increases in money proper (for example, from gold mining) under a gold standard. When individuals find new money, they can use it to add to their cash balances, increase their investment spending, or increase their consumption spending. Similarly, individuals who economize on their money spending can spend more on consumer goods or investment goods in line with their time preference. When they spend the new or freed-up money exclusively on investment goods, reducing their relative consumption spending (increasing savings), factors of production will be reshifted toward more roundabout production processes. This lengthening of the structure of production is sustainable and in line with the decrease in time preference that itself is reflected in the altered proportions of consumption and investment spending. In any case, it is a one-shot event that may be classified as a business fluctuation. Entrepreneurs are in the business of forecasting changes. Changes take place in all spheres, including the demand for money and time preference. A change in economic data is not the cause of a business cycle and a general depression. It just leads to a business fluctuation with higher profits in some sectors and lower profits in other sectors (Rothbard 2000). Yet such fluctuations do not constitute cyclical movements of general booms that inevitably end in a general depression, after which the cycle starts all over again.

Thus, payment innovations do not cause a business cycle. And again, there are the aforementioned tendencies that increase the transaction demand for money and compensate for the payment innovations. On the long-run influences on the demand for money, see Rothbard (2001, 675–76).

Note that for an increase in real cash balances to occur, it is not necessary that all prices be “perfectly” flexible downward. Some prices will fall more than others, until the desired increase in real cash balances is achieved. The increase can thereby come very quickly when individuals abstain from buying (Bagus and Howden 2011b).

If the demand for money increases because of deflationary expectations, there may be less consumption and relatively more investment. The real yield on investments increases because the increase in the purchasing power of money adds to the yield of the investment.

We should not forget that the Federal Reserve System was installed to achieve the ideal of an elastic currency as well. Paul Warburg, the intellectual architect of the Fed, in his justification for the creation of the Fed, does not appeal to the objective of full employment or price stability. Rather, Warburg argues that the Fed would achieve an “elastic currency” according to the “needs of trade” (Murphy 2021, 46–47). Warburg pursued the very same objective that Rallo has in mind, albeit with different means. Zhu (2013) similarly emphasizes the main original objective of the Fed to provide an elastic money supply: “The Federal Reserve’s central founding purpose was to provide a more flexible supply of currency and bank reserves in order to stem banking panics.”

As Huerta de Soto (2012, 684n123) points out:

Curiously, like Keynesians and monetarists, modern free-banking theorists are obsessed with supposed, sudden, unilateral changes in the demand for money. They fail to see that such changes tend to be endogenous and to occur throughout an economic cycle which is first triggered by shifts in the supply of new money the banking system creates in the form of loans. The only other situations capable of producing a sudden rise in the demand for money are exceptional, like wars and natural disasters. Seasonal variations are comparatively less important and a free-banking system with a 100-percent reserve requirement could counteract them with a seasonal transfer of gold and slight price modifications.

Mises (1998, 418) states:

The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of money or a definite weight of money; he wants to keep a cash holding to a definite amount of purchasing power. As the operation of the market tends to determine the final state of money’s purchasing power at a height at which the supply of and the demand for money coincide, there can never be an excess or a deficiency of money. . . The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.

See also Mises (1953, 85): “Changes in the value of money are accommodated in such a way to the demand for it that, despite increases or decreases in its quantity, the economic position of mankind remains the same.”

As Rothbard (2001, 670) puts it, “We conclude that there is no such thing as ‘too little’ or ‘too much’ money, that, whatever the social money stock, the benefits of money are always utilized to the maximum extent” (emphasis in the original).

While gold mining under a gold standard (increases in the money supply) does not increase or decrease gold’s usefulness as a medium of exchange, the costs of gold mining must be considered as necessary costs to uphold this particular monetary standard and, from the point of view of the freely interacting individuals, as welfare enhancing. Voluntary abstention from gold mining under a gold standard would save these mining costs but would not change the benefits of the use of money. The use of coercion to prohibit gold mining, while not changing the benefits of the use of money, would, however, decrease the welfare of the coerced individuals. From our point of view, Mises’s and Rothbard’s claim that any quantity of money allows society to reap the full benefits of money’s use is, therefore, completely compatible with the view that the optimal money is the one that is chosen in the market. See also Barnett and Block (2004).

I believe Mises’s statement to be an unnecessary concession.

That is also true for entrepreneurs. Entrepreneurs do not prefer a money whose purchasing power falls just because they want higher prices for their products. For entrepreneurs qua entrepreneurs, their margin—i.e., the difference between buying and selling prices—is essential. This difference is independent of the general tendency of prices, as costs may move before selling prices do. Entrepreneurs do not hoard merchandise to reduce uncertainty; rather entrepreneurs qua actors hold cash balances in order to mitigate uncertainty. Therefore, ceteris paribus, entrepreneurs prefer cash holdings that gain in purchasing power to those that do not.

Rallo (102–5) uses neoclassical tools such as demand and supply functions to argue that the supply of an ideal money should be elastic and the demand inelastic in order to stabilize the equilibrium value of money. He also indicates that for the demand function to be very inelastic, the marginal utility of money should be constant (104). However, in the field of human action there is no room either for constant marginal utility (which is a logical impossibility because an additional unit at the disposal of an actor is necessarily ranked lower on the value scale than the previous marginal unit), supply and demand functions, or equilibrium prices. As stated in section 2.4, the very idea of monetary equilibrium and stabilization of total spending is a macroeconomic idea that hides the underlying microeconomic processes, leading to fateful theoretical errors. The neoclassical idea of equilibrium prices contrasts with the Misesian idea of a “plain state of rest” (1998, 246) in which no further transactions take place because neither sellers nor buyers are interested in an exchange.

As Mises (1998, 415, 416) puts it:

While money can be thought of only in a changing economy, it is in itself an element of further changes. Every change in the economic data sets it in motion and makes it the driving force of new changes. Every shift in the mutual relation of the exchange ratios between the various nonmonetary goods not only brings about changes in production and in what is popularly called distribution, but also provokes changes in the money relation and thus further changes. Nothing can happen in the orbit of vendible goods without affecting the orbit of money, and all that happens in the orbit of money affects the orbit of commodities. . . . A world of the kind which the necessary requirements of neutral and stable money presuppose would be a world without action. . . . Money is an element of action and consequently of change. (emphasis added)

Mises (1998, 225) writes:

Economic calculation does not require monetary stability in the sense in which this term is used by the champions of the stabilization movement. The fact that rigidity in the monetary unit’s purchasing power is unthinkable and unrealizable does not impair the methods of economic calculation. What economic calculation requires is a monetary system whose functioning is not sabotaged by government interference. . . . For the sake of economic calculation all that is needed is to avoid great and abrupt fluctuations in the supply of money. . . . Precision is unattainable in economic calculation quite apart from the shortcoming emanating from not paying due consideration to monetary changes.