The Theory of Money and Credit

The principle of sound money that guided nineteenth-century monetary doctrines and policies was a product of classical political economy. It was an essential part of the liberal program as developed by eighteenth-century social philosophy and propagated in the following century by the most influential political parties of Europe and America.

The liberal doctrine sees in the market economy the best, even the only possible, system of economic organization of society. Private ownership of the means of production tends to shift control of production to the hands of those best fitted for this job and thus to secure for all members of society the fullest possible satisfaction of their needs. It assigns to the consumers the power to choose those purveyors who supply them in the cheapest way with the articles they are most urgently asking for and thus subjects the entrepreneurs and the owners of the means of production, namely, the capitalists and the landowners, to the sovereignty of the buying public. It makes nations and their citizens free and provides ample sustenance for a steadily increasing population.

As a system of peaceful cooperation under the division of labor, the market economy could not work without an institution warranting to its members protection against domestic gangsters and external foes. Violent aggression can be thwarted only by armed resistance and repression. Society needs an apparatus of defense, a state, a government, a police power. Its undisturbed functioning must be safeguarded by continuous preparedness to repel aggressors. But then a new danger springs up. How keep under control the men entrusted with the handling of the government apparatus lest they turn their weapons against those whom they were expected to serve? The main political problem is how to prevent the rulers from becoming despots and enslaving the citizenry. Defense of the individual’s liberty against the encroachment of tyrannical governments is the essential theme of the history of Western civilization. The characteristic feature of the Occident is its peoples’ pursuit of liberty, a concern unknown to Orientals. All the marvelous achievements of Western civilization are fruits grown on the tree of liberty.

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the nonobservance of old customs by kings. The postulate of sound money was first brought up as a response to the princely practice of debasing the coinage. It was later carefully elaborated and perfected in the age which—through the experience of the American continental currency, the paper money of the French Revolution and the British restriction period—had learned what a government can do to a nation’s currency system.

Modern cryptodespotism, which arrogates to itself the name of liberalism, finds fault with the negativity of the concept of freedom. The censure is spurious as it refers merely to the grammatical form of the idea and does not comprehend that all civil rights can be as well defined in affirmative as in negative terms. They are negative as they are designed to obviate an evil, namely omnipotence of the police power, and to prevent the state from becoming totalitarian. They are affirmative as they are designed to preserve the smooth operation of the system of private property, the only social system that has brought about what is called civilization.

Thus the sound-money principle has two aspects. It is affirmative in approving the market’s choice of a commonly used medium of exchange. It is negative in obstructing the government’s propensity to meddle with the currency system.

The sound-money principle was derived not so much from the Classical economists’ analysis of the market phenomena as from their interpretation of historical experience. It was an experience that could be perceived by a much larger public than the narrow circles of those conversant with economic theory. Hence the sound-money idea became one of the most popular points of the liberal program. Friends and foes of liberalism considered it one of the essential postulates of a liberal policy.

Sound money meant a metallic standard. Standard coins should be in fact a definite quantity of the standard metal as precisely determined by the law of the country. Only standard coins should have unlimited legal-tender quality. Token coins and all kinds of moneylike paper should be, on presentation and without delay, redeemed in lawful standard money.

So far there was unanimity among the supporters of sound money. But then the battle of the standards arose. The defeat of those favoring silver and the unfeasibility of bimetallism eventually made the sound-money principle mean the gold standard. At the end of the nineteenth century there was all over the world unanimity among businessmen and statesmen with regard to the indispensability of the gold standard. Countries which were under a fiat-money system or under the silver standard considered adoption of the gold standard the foremost goal of their economic policy. Those who disputed the eminence of the gold standard were dismissed as cranks by the representatives of the official doctrine—professors, bankers, statesmen, editors of the great newspapers and magazines.

It was a serious blunder of the supporters of sound money to adopt such tactics. There is no use in dealing in a summary way with any ideology however foolish and contradictory it may appear Even a manifestly erroneous doctrine should be refuted by careful analysis and the unmasking of the fallacies implied. A sound doctrine can win only by exploding the delusions of its adversaries.

The essential principles of the sound-money doctrine were and are impregnable. But their scientific support in the last decades of the nineteenth century was rather shaky. The attempts to demonstrate their reasonableness from the point of view of the Classical value theory were not very convincing and made no sense at all when this value concept had to be discarded. But the champions of the new value theory for almost half a century restricted their studies to the problems of direct exchange and left the treatment of money and banking to routinists unfamiliar with economics. There were treatises on catallactics which dealt only incidentally and cursorily with monetary matters, and there were books on currency and banking which did not even attempt to integrate their subject into the structure of a catallactic system.1  Finally the idea evolved that the modern doctrine of value, the subjectivist or marginal utility doctrine, is unable to explain the problems of money’s purchasing power.2

It is easy to comprehend how under such circumstances even the least tenable objections raised by the advocates of inflationism remained unanswered. The gold standard lost popularity because for a very long time no serious attempts were made to demonstrate its merits and to explode the tenets of its adversaries.

• 1See Mises, Human Action (New Haven: Yale University Press, 1949), pp. 204-6.
• 2See pp. 117-123.