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By Ludwig von Mises
http://www.mises.org/story/2660
Why have a monetary system based on gold? Because, as conditions are today and for the time that can be foreseen today, the gold standard alone makes the determination of money's purchasing power independent of the ambitions and machinations of governments, of dictators, of political parties, and of pressure groups. The gold standard alone is what the nineteenth-century freedom-loving leaders (who championed representative government, civil liberties, and prosperity for all) called "sound money."
The eminence and usefulness of the gold standard consists in the fact that it makes the supply of money depend on the profitability of mining gold, and thus checks large-scale inflationary ventures on the part of governments.
The gold standard did not fail. Governments deliberately sabotaged it, and still go on sabotaging it. But no government is powerful enough to destroy the gold standard so long as the market economy is not entirely suppressed by the establishment of socialism in every part of the world.
Governments believe that it is the gold standard's fault alone that their inflationary schemes not only fail to produce the expected benefits, but unavoidably bring about conditions that (also in the eyes of the rulers themselves and most of the people) are considered as much worse than the alleged or real evils they were designed to eliminate. Except for the gold standard, governments are told by pseudo-economists that they could make everybody perfectly prosperous. Let us test the three doctrines advanced for the support of this fable of government omnipotence.
1. The Fiction of Government Omnipotence
"The state is God," said Ferdinand Lassalle, the founder of the German socialist movement. As such, the state has the power to "create" unlimited quantities of money and thus to make everybody happy. Intrepid and clear-headed people branded such a policy of "creating" money as inflation. The official terminology calls it nowadays "deficit spending."
But whatever the name used in dealing with this phenomenon may be, its meaning is obvious. The government increases the quantity of money in circulation. Then a greater quantity of money "chases" (as a rather silly but popular way of talking about these problems says) a quantity of goods and services that has not been increased. The government's action did not add anything to the available amount of useful things and services. It merely made the prices paid for them soar.
If the government wishes to raise the income of some people, for example, government employees, it has to confiscate by taxation a part of some other people's incomes, and then distribute the amount collected to its employees or favored groups. Then the taxpayers are forced to restrict their spending, while the recipients of the higher salaries or benefits are increasing their spending to the same amount. There does not result a conspicuous change in the purchasing power of the monetary unit.
But if the government provides the money it wants for the payment of higher salaries by printing it or the granting of additional credits, the new money in the hands of these beneficiaries constitutes on the market an additional demand for the not-increased quantity of goods and services offered for sale. The unavoidable result is a general tendency of prices to rise.
Any attempts the governments and their propaganda offices make to conceal this concatenation of events are in vain. Deficit spending means increasing the quantity of money in circulation. That the official terminology avoids calling it inflation is of no avail whatever.
The government and its chiefs do not have the powers of the mythical Santa Claus. They cannot spend except by taking out of the pockets of some people for the benefit of others.
2. The "Cheap-Money" Fallacy
Interest is the difference in the valuation of present goods and future goods; it is the discount in the valuation of future goods as against that of present goods. Interest cannot be "abolished" as long as people prefer an apple available today to an apple available only in a year, in ten years, or in a hundred years.
The height of the originary rate of interest,[1] which is the main component of the market rate of interest as determined on the loan market, reflects the difference in the people's valuation of present and future satisfaction of needs. The disappearance of interest, that is, an interest rate of zero, would mean that people do not care a whit about satisfying any of their present wants and are exclusively intent upon satisfying their future wants, their wants of the later years, decades, and centuries to come. People would only save and invest and would not be consuming.
On the other hand, if people were to stop saving, that is, making any provision for the future, be it even the future of the tomorrow, and would not save at all and consume all capital goods accumulated by previous generations, the rate of interest would rise beyond any limits.
It is thus obvious that the height of the market rate of interest ultimately does not depend on the whims, fancies, and the pecuniary interests of the personnel operating the government apparatus of coercion and compulsion, the much-referred-to "public sector" of the economy. But the government has the power to push the Federal Reserve System, and the banks subject to it, into a policy of cheap money. Then the banks are expanding credit. Underbidding the rate of interest as established on the not-manipulated loan market, they offer additional credit created out of nothing.
Thus they are inescapably falsifying the businessmen's estimation of market conditions. Although the supply of capital goods (that can only be increased by additional saving) remained unchanged, the illusion of a richer supply of capital is conjured up. Business is induced to embark upon projects which a sober calculation, not misled by the cheap-money ventures, would have disclosed as mal-investments (over-investment in capital). The additional quantities of credit inundating the market make prices and wages soar. An artificial boom, a boom built entirely upon the illusions of ample and easy money, develops. But such a boom cannot last. Sooner or later it must become clear that, under the illusions created by the credit expansion, business has embarked upon projects for the execution of which the real savings are not rich enough. When this mal-investment becomes visible, the boom collapses.
The depression that follows is the process of liquidating the errors committed in the excesses of the artificial boom; it is the return to calm reasoning and a reasonable conduct of affairs within the limits of the available supply of capital goods. It is a painful process, but it is a process of restoration of business health.
Credit expansion is not a nostrum to make people happy. The boom it engenders must inevitably lead to a debacle and unhappiness.
If it were really possible to substitute credit expansion (cheap money) for the accumulation of capital goods by saving, there would not be any poverty in the world. The economically backward nations would not have to complain about the insufficiency of their capital equipment. All they would have to do for the improvement of their conditions would be to expand money and credit more and more. No "foreign aid" schemes would have emerged. But in granting foreign aid to the backward nations, the American government implicitly acknowledges that credit expansion is no real substitute for genuine capital accumulation through saving.
http://www.mises.org/story/2660
The eminence and usefulness of the gold standard consists in the fact that it makes the supply of money depend on the profitability of mining gold, and thus checks large-scale inflationary ventures on the part of governments.
The gold standard did not fail. Governments deliberately sabotaged it, and still go on sabotaging it. But no government is powerful enough to destroy the gold standard so long as the market economy is not entirely suppressed by the establishment of socialism in every part of the world.
Governments believe that it is the gold standard's fault alone that their inflationary schemes not only fail to produce the expected benefits, but unavoidably bring about conditions that (also in the eyes of the rulers themselves and most of the people) are considered as much worse than the alleged or real evils they were designed to eliminate. Except for the gold standard, governments are told by pseudo-economists that they could make everybody perfectly prosperous. Let us test the three doctrines advanced for the support of this fable of government omnipotence.
1. The Fiction of Government Omnipotence
"The state is God," said Ferdinand Lassalle, the founder of the German socialist movement. As such, the state has the power to "create" unlimited quantities of money and thus to make everybody happy. Intrepid and clear-headed people branded such a policy of "creating" money as inflation. The official terminology calls it nowadays "deficit spending."
But whatever the name used in dealing with this phenomenon may be, its meaning is obvious. The government increases the quantity of money in circulation. Then a greater quantity of money "chases" (as a rather silly but popular way of talking about these problems says) a quantity of goods and services that has not been increased. The government's action did not add anything to the available amount of useful things and services. It merely made the prices paid for them soar.
If the government wishes to raise the income of some people, for example, government employees, it has to confiscate by taxation a part of some other people's incomes, and then distribute the amount collected to its employees or favored groups. Then the taxpayers are forced to restrict their spending, while the recipients of the higher salaries or benefits are increasing their spending to the same amount. There does not result a conspicuous change in the purchasing power of the monetary unit.
But if the government provides the money it wants for the payment of higher salaries by printing it or the granting of additional credits, the new money in the hands of these beneficiaries constitutes on the market an additional demand for the not-increased quantity of goods and services offered for sale. The unavoidable result is a general tendency of prices to rise.
Any attempts the governments and their propaganda offices make to conceal this concatenation of events are in vain. Deficit spending means increasing the quantity of money in circulation. That the official terminology avoids calling it inflation is of no avail whatever.
The government and its chiefs do not have the powers of the mythical Santa Claus. They cannot spend except by taking out of the pockets of some people for the benefit of others.
2. The "Cheap-Money" Fallacy
Interest is the difference in the valuation of present goods and future goods; it is the discount in the valuation of future goods as against that of present goods. Interest cannot be "abolished" as long as people prefer an apple available today to an apple available only in a year, in ten years, or in a hundred years.
The height of the originary rate of interest,[1] which is the main component of the market rate of interest as determined on the loan market, reflects the difference in the people's valuation of present and future satisfaction of needs. The disappearance of interest, that is, an interest rate of zero, would mean that people do not care a whit about satisfying any of their present wants and are exclusively intent upon satisfying their future wants, their wants of the later years, decades, and centuries to come. People would only save and invest and would not be consuming.
On the other hand, if people were to stop saving, that is, making any provision for the future, be it even the future of the tomorrow, and would not save at all and consume all capital goods accumulated by previous generations, the rate of interest would rise beyond any limits.
It is thus obvious that the height of the market rate of interest ultimately does not depend on the whims, fancies, and the pecuniary interests of the personnel operating the government apparatus of coercion and compulsion, the much-referred-to "public sector" of the economy. But the government has the power to push the Federal Reserve System, and the banks subject to it, into a policy of cheap money. Then the banks are expanding credit. Underbidding the rate of interest as established on the not-manipulated loan market, they offer additional credit created out of nothing.
Thus they are inescapably falsifying the businessmen's estimation of market conditions. Although the supply of capital goods (that can only be increased by additional saving) remained unchanged, the illusion of a richer supply of capital is conjured up. Business is induced to embark upon projects which a sober calculation, not misled by the cheap-money ventures, would have disclosed as mal-investments (over-investment in capital). The additional quantities of credit inundating the market make prices and wages soar. An artificial boom, a boom built entirely upon the illusions of ample and easy money, develops. But such a boom cannot last. Sooner or later it must become clear that, under the illusions created by the credit expansion, business has embarked upon projects for the execution of which the real savings are not rich enough. When this mal-investment becomes visible, the boom collapses.
The depression that follows is the process of liquidating the errors committed in the excesses of the artificial boom; it is the return to calm reasoning and a reasonable conduct of affairs within the limits of the available supply of capital goods. It is a painful process, but it is a process of restoration of business health.
Credit expansion is not a nostrum to make people happy. The boom it engenders must inevitably lead to a debacle and unhappiness.
If it were really possible to substitute credit expansion (cheap money) for the accumulation of capital goods by saving, there would not be any poverty in the world. The economically backward nations would not have to complain about the insufficiency of their capital equipment. All they would have to do for the improvement of their conditions would be to expand money and credit more and more. No "foreign aid" schemes would have emerged. But in granting foreign aid to the backward nations, the American government implicitly acknowledges that credit expansion is no real substitute for genuine capital accumulation through saving.
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