What Is Money? Part 6: What Makes Money Different?

Recently by Gary North: Refuting Keynes, Line-by-Line

When someone announces the discovery of a new oil field, most people rejoice. There are exceptions. Owners of existing oil wells don’t. Growth-hating environmentalists don’t. But for most people, a new oil field means an additional supply of a scarce resource. It means slightly lower prices for the resource. What is good for the person who owns the oil field is good for almost everyone else.

What about the discovery of a gold mine? The person on whose land the gold has been discovered is happy. People who want to buy circuit boards with gold plating are happy. People who own shares in the firm that discovered the gold are happy. But should anyone else be happy?

Today, yes. Gold is not money, except for central bankers. It has not functioned as money since 1933 in the United States and 1914 in Europe. So, an increase in the supply of gold will benefit users of gold as an industrial metal or as jewelry.

What about fathers in India? Are they happy? Probably those who can now afford extra gold for their daughters’ dowries are happy. Perhaps married women will not be, since the value of their dowries will fall slightly. But probably no one will care about the new mine, one way or the other.

What about in 1848? In those days, gold was money. The discovery of gold in California benefitted those people who owned land in the gold fields. It helped those few people who were located nearby and went out and dug up a lot of gold in the first year. It helped owners of real estate in San Francisco. It helped the tiny number of gold miners who later hit pay dirt. But did it predictably help anyone else? No. It increased the money supply. It raised prices. It lured gold-seekers to California, where they dug in the earth fruitlessly for years.

Someone might argue that the gains to the minority of gold country land owners and the early gold-diggers were greater than the losses sustained by existing gold owners and existing money holders, whose net worth fell as the price of gold fell and the value of money fell. But to argue this way, someone would have to be able to measure everyone’s subjective value on an objective scale, and then compare gains and losses. No such scale exists. No such comparison is scientifically possible.

Still, we can make a crude estimate. The beneficiaries in the California gold fields were in the tens of thousands. Those who lost purchasing power were in the tens of millions worldwide.

This discovery was unique in history. The gold fields of South Africa, Australia, and Alaska did not have a comparable effect on prices.

For most of history, the net increase in gold each year has been minimal. There has been very little effect on prices. The cost of extracting gold rises. The quantity extracted is a small fraction of the gold already serving as money directly or indirectly. Also, gold is used for jewelry and other consumer goods. These uses confer benefits to buyers. The existing owners of gold jewelry are barely aware of any decline in the price of their goods. Labor costs as a percentage of gold jewelry are high for most gold-related goods.

Here is a strange conclusion. An increase in the money supply conveys no verifiable social benefit. Early owners and early users gain benefits. Late-users experience losses. There is no way of knowing whether there are net gains or losses from an addition of money. But in times of mass inflation and then hyperinflation, the losses become obvious. The increased money supply forces a society back to barter, which is inefficient compared to a money economy where the money supply is stable. Zimbabwe has experienced this. That nation has been impoverished.


An increase in the supply of consumer goods conveys a benefit to consumers. There is a greater variety of goods to choose from. Put another way, there has been an increase in choices with the same money supply. This is the best way to define economic growth: increased choices.

In contrast, an increase in the money supply cannot be shown to increase the number of choices. Those with early access to the new money do increase their available choices. Prices have not yet risen. But the advantages gained by the initial users of newly created money are offset by those participants who face rising prices without a comparable increase in money. The new money spreads: from the fortunate few who gain early access to the large number of those who get their hands on this new money later.

This is an argument against counterfeiting. The counterfeiters gain great advantages if their money is accepted by early sellers of goods and services. But there are not many counterfeiters. The mass of citizens find that the counterfeiter has bought up goods at yesterday’s lower prices, while they face a market with fewer goods still available for purchase and more money in circulation.

The case against counterfeiting is the case against wealth-redistribution by fraud. The counterfeiters did not offer goods and services for sale, thereby benefitting society because they made more choices available to society’s members. They merely bought paper and ink and then produced pieces of paper with politicians’ pictures on them. The additional supply of pictures of politicians conveyed no net benefit to society. Given the political education effects of passing along pictures of politicians, dead or alive, society is probably poorer. (This is an argument for digital money: no pictures.)

Then there are the distorting effects of unanticipated new money on the allocation of capital: the boom-bust cycle. The new money lets users think that others have saved money — reduced their consumption — thereby providing new capital for the economy. But there has been no increase in thrift, no increase in capital goods. Entrepreneurs will be lured into starting new projects — the boom — that future consumers will not validate by purchases: the bust.

This leads to a counter-intuitive conclusion: society cannot be said to benefit from an increase in the money supply. We cannot make scientific interpersonal comparisons of subjective utility. We cannot measure subjective gains and losses. But we can make informed guesses about the net effects. The more fiat money that is spent into circulation by counterfeiters, the more obvious the net social loss is. Think “Zimbabwe.”

Unlike an increase in the supply of consumer goods, an increase in the money supply does not make society richer. Why not? Because it does not add to people’s array of choices. Early printers and users add to their range of choices, but this reduces the number of choices for late users.

Society penalizes counterfeiters. It also penalizes anyone who is taken in by counterfeiters and then gets caught. I know of no legal system that says that once counterfeit money comes into existence, it should be kept in circulation. Counterfeit bills do appear from time to time. The person who is caught trying to buy something with a counterfeit bill loses wealth, whether or not he is charged with counterfeiting. Society has determined that, if a holder of the counterfeit bill was so naïve as to accept it in exchange, he is out whatever it was that he surrendered to the previous holder. The store’s manager does not honor the transaction. Neither does the banking system. The system does not reward ignorance. It makes users of paper money responsible.

The legal system acknowledges that there is no right to use counterfeit money. There are winners and losers from counterfeiting. The legal system tries to make potential losers more alert to the risk. It rewards those sellers who spot the phony money early and call a halt to the continuing circulation of this money. The seller of goods is not only rewarded for not accepting the phony money, he is expected to call the police.

Are we agreed? First, counterfeit money does not benefit society as a whole. Second, society rightly establishes penalties against counterfeiters. Third, in order to reduce the spread of counterfeit money, society penalizes those people who unwisely accept counterfeit money. The legal system concludes that, in order to reduce the spread of fraud, the last user of a counterfeit bill loses.


Our attitude toward counterfeiting should govern our attitude toward fractional reserve banking, which is the most widely accepted form of counterfeiting. The same economic objections to paper-and-ink private counterfeiting apply to the digital-entry private counterfeiting. First, fractional reserve banking does not benefit society. Second, society should establish penalties against fractional reserve banking. Third, in order to reduce the spread of counterfeit money, society should penalize those people who unwisely accept counterfeit money. The legal system should conclude that, in order to reduce the spread of fraud, the last user of a counterfeit digit loses.

With the exception of the followers of Murray Rothbard, no economists accept these conclusions. Every school of economic thought refuses to apply the economics of counterfeiting to fractional reserve banking. There is universal agreement on the following:

First, counterfeit money does not benefit society as a whole. Second, society rightly establishes penalties against counterfeiters. Third, in order to reduce the spread of counterfeit money, society penalizes those people who unwisely accept counterfeit money. The legal system concludes that, in order to reduce the spread of fraud, the last user of a counterfeit bill loses.

First, fractional reserve banking does benefit society. Second, society should not establish penalties against fractional reserve banking. Third, in order to further the spread of counterfeit digital money, society should never penalize those people who unwisely accept counterfeit digital money. The legal system should conclude that, in order to further the spread of digital counterfeit money, the last user of a counterfeit digit should not be penalized.

In other words, the economist’s logic against counterfeiting by unlicensed private counterfeiters does not apply to counterfeiting by government-licensed counterfeiters.

Why not? They never say. They never write about fractional reserve banking as counterfeiting, just as they never write about the central bank as the enforcing agent of a bankers’ cartel. In short, they are intellectually schizophrenic. Ludwig von Mises had a word to describe this phenomenon: polylogism.

All modern schools of economic opinion except the Austrian School believe in the central planning of money. All major schools support quasi-private central banking as the proper agency of central planning. They debate over which plan the central bank should adopt. Some argue for targeting interest rates. Others argue for targeting the consumer price index. Others argue for a fixed increase in the money supply, though there is no agreement on what rate of increase. Ever since October 2008, most economists have thought that the central bank has only one goal: keeping the largest banks in operation.

Think of a gang of counterfeiters. The head of the gang is known as Leftie. (Note: gangs are never led by someone named Rightie.) Leftie oversees Milt, who sits at a ditto machine, which cranks out pieces of paper with politicians’ pictures on them. Leftie has a B.A. in economics from an Ivy League school. He tells Milt, “Consumer demand is about to get a much-needed shot in the arm.” Leftie is a Keynesian.

Milt, however, got his B.A. in economics from the University of Chicago. “I don’t know, Leftie. Maybe we should limit ourselves to a steady 3% to 5% increase in the money supply per annum.” Leftie then shoots Milt in the back of the head.

This is what happens with University of Chicago economists who get into advisory positions at the Federal Reserve’s Board of Governors or the New York FED. Either they keep their mouths shut or else it’s cement shoes, career-wise.

Milton Friedman was successful in persuading his peers of only one idea: that the Federal Reserve System caused the Great Depression because it did not expand the money supply fast enough. This is universally believed, except by Austrian School economists. Summarizing his position:

“Once the official counterfeiter and its local operatives successfully flood the economy with fiat money, it must do everything it can to make sure than this money supply grows. If this means flooding the commercial banks with fiat money reserves, so be it. The money supply must not be allowed to shrink to its pre-counterfeiting level.”

This is why Bernanke was universally praised by economists and investment advisers.

Counterfeiting is universally regarded as scientific money management, when done by Ph.D.-holding bureaucrats who have no direct economic stake in the outcome of their policies.


The economics profession is as committed to the expansion of fiat money as Congress is. To maintain this position, economists must avoid applying the standard treatment of counterfeiting to the banking system.

They praise the increase of money. They condemn any policy that would allow the money supply to shrink as a result of large-bank bankruptcies. They conclude that banks are too big to fail, too important to fail.

No one calls the police when someone uses his credit card to pass along newly counterfeit money. And, when it comes to physical Federal Reserve Notes, the law is clear: “THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE.” A merchant who spots a counterfeit bill is expected to refuse the money and then call the police. In contrast, a debtor who pays his creditor with Federal Reserve Notes is supposed to call the police if the creditor refuses this payment.

This is the topsy-turvy world of central banking. Economists tell us that this is the best possible system. Gold is barbaric. Fiat money is rational. Fractional reserve banking’s digital fiat money is the best money of all. They agree with their boss: Leftie.

October 15, 2009

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2009 Gary North