The Morality of Money, 4: Manipulation by the State

By Thomas V. Mirus (bio - articles - email) | Nov 18, 2016

Fractional-reserve banking and inflation can happen on a free market, but only on the fringes. In The Ethics of Money Production, Hulsmann argues that it is government that allows inflation to become widespread, either protecting it by legalizing the falsification of money, or itself perpetrating it. The past few centuries have seen the gradual development of a complete government monopoly on currency, beginning with legal tender laws.

Legal tender laws force creditors and sellers to accept other moneys as substitute for what was stipulated in the original contract. They establish legal equivalence between two or more moneys, at the expense of creditors and to the benefit of debtors (including the government); this was known as bimetallism when it was done with silver and gold.

Even if the exchange rate is fixed at the current “market rate,” this will fluctuate over time so that one money is overvalued in terms of the other. The result is that the overvalued money drives the undervalued money out of the economy, a phenomenon known as Gresham’s Law. Hulsmann notes other consequences as well, such as stimulation of the use of fractional-reserve banknotes because there is a need for a currency to purchase cheaper goods than the overvalued currency can be divided to purchase. By forcing someone to accept payment in a form other than that which he stipulated, legal tender laws may also discourage certain exchanges and diminish trust and social cooperation.

Legalization of false money or even granting false money monopoly status might not do a great deal of damage if people are free to evaluate and reject it. But when granted legal tender status (i.e., when people are compelled to accept it in exchanges), Hulsmann deems it much more harmful. Nobody wants to pay a higher price for a genuine certificate if the other party has no choice but to accept the debased coin or fractional-reserve banknote, so in accordance with Gresham’s Law, everyone will switch to using the false money.

It is not difficult to see the social imbalance that results from granting legal tender status to fractional-reserve notes:

When the economy is flooded with legal-tender fractional-reserve notes, the whole economic body of society begins to cater excessively for the needs of those who control the banking industry. The American economist Frank Fetter once observed that the unhampered market economy resembles a grass-roots democratic process. One penny, one market vote. From this point of view, the imposition of fractional-reserve notes through legal-tender laws creates market votes out of nothing. The bankers and their clients (usually the government in the first place) have many more votes than they would have had in a free society. [Hulsmann, p. 139]

The medieval bishop and philosopher Nicholas Oresme stressed that inflation was “essentially unjust,” a means by which the ruler enriched himself at the expense of the people, even “if he should tell the tyrant’s usual lie, that he applies that profit to the public advantage” [cit. in Hulsmann, p. 100]. He went so far as to say that alteration of legal tender was worse than usury because usury, at least, was based on a voluntary agreement between creditor and debtor:

The usurer has lent his money to one who takes it of his own free will, and can then enjoy the use of it and relieve his own necessity with it, and what he repays in excess of the principal is determined by free contract between the parties. But a prince, by unnecessary change in the coinage, plainly takes the money of his subjects against their will, because he forbids the older money to pass current, though it is better, and anyone would prefer it to the bad; and then unnecessarily and without any possible advantage to his subjects, he will give them back worse money. . . . In so far then as he receives more money than he gives, against and beyond the natural use of money, such gain is equivalent to usury; but is worse than usury because it is less voluntary and more against the will of his subjects, incapable of profiting them, and utterly unnecessary. And since the usurer’s interest is not so excessive, or so generally injurious to the many, as this impost, levied tyrannically and fraudulently, against the interest and against the will of the whole community, I doubt whether it should not rather be termed robbery with violence or fraudulent extortion. [cit. in Hulsmann, p. 149]

The only exception Oresme made for inflation by the state was in the case of an emergency with no other recourse, such as a sudden invasion, and even in such a case inflation would not be permissible without the consent of the entire people. He declared that if the government needs to increase its revenue, it should do so openly and honestly by asking the people to pay more taxes.


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The Ethics of Money Production may be purchased in hardback from its publisher, the Mises Institute, at a third of the Amazon price, or, like all of the Institute’s publications, downloaded for free as a PDF or ebook.

Thomas V. Mirus is an administrative assistant and writer at CatholicCulture.org. A jazz pianist with a music degree, he often takes the lead in our commentary on the arts. See full bio.

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