A Challenge to Banking

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SECTION TWO - Honest Money

The Requirements of Money

Major changes are obviously required if the collapse of the monetary system is to be averted. Before undertaking any change, however, it is vital that we have a clear picture of the requirements of sound money and a sound monetary system. We must know where we are heading. Honesty and accuracy must be the prerequisites.

Money serves three specific functions. It acts

1. as a unit of measurement of exchange value
2. as a medium of exchange, and
3. as a store of exchange value for future use

No commodity which continually loses value can be acceptable as a unit of measurement or as a store of exchange value for future uses. Any commodity which physically deteriorates, tomatoes for instance, will inherently lose value, and therefore will prove unacceptable.

The commodity used most successfully for money to date has been gold. By its very nature it is almost ideal. It is scarce. To produce a small amount of it requires a large expenditure of human energy. It is homogeneous and therefore can be divided into small amounts of identical size, quality and exchange value. It is inert: it does not physically deteriorate, so it does not inherently lose value. It passes the first hurdle. But there are other hurdles.

Supply and demand play a part in determining the exchange value of any commodity. Demand in the case of money must reflect the amount needed to service the numbers of and value of exchanges in the market-place. Where survival is dependent upon exchange, people will need money to buy food, drink and shelter. As a result there will be a minimum demand for money equal to the amount required to feed, house and clothe the total population.
Both the numbers and the value of exchanges will change as the size of the population and its expectations change. So increases in either the population or its expectations will produce increases in the demand for exchanges in the market-place and, consequently, increases in the demand for money.

Any commodity suitable for use as money must also meet the requirements of ordinary people for their normal use in the market-place. It must be available in quantities sufficiently small for an individual to carry enough on his person to use for expected daily exchanges. The product used as money should therefore be such that it can be divided into small equal and identical lots and that a small amount of it carries a relatively high exchange value. Thus a commodity which is scarce and homogenous would suit. Gold meets both these requirements.

Any commodity which is scarce will require a large expenditure of time or energy to locate and produce it. If the exchange value of money were to fall, those involved in its production should consider producing something else. The level of production would then decrease. It would fall until the demand sufficiently exceeded the supply, and then its exchange value would begin to rise. This rise would encourage more producers, and, as the supply increased, its exchange value would once again begin to fall. Over the course of time its level of exchange value would tend to fluctuate less and less, eventually leading to price stability. It is important to note here that the control of the supply of the commodity used as money is the willingness of people to expend their energy producing it.

Ideally, the product chosen as money would have a level of exchange value as near to constant as possible. To achieve constancy the product would have to be available in such quantities and in such conditions that each measurable unit of human energy would produce exactly the same amount of it, and each amount produced would have exactly the same level of quality. Gold does not have this quality. Nor has such a product yet been found. Therefore the ideal unit of money has not been achieved. There is nothing magical about gold which demands that it be used as a medium of exchange. It is true that gold has more of the characteristics that best serve in a medium of exchange than any other natural commodity. Over the course of time, people have come to recognise this fact. Should it ever be legitimised again as a medium of exchange, there is every indication that people will once more use it in that capacity.

Paper money, on the other hand, is not a natural commodity. It is manmade. Ian, therefore, ought to be able to control it. The weaknesses which need to be controlled are the following:

1. Paper money can be produced too easily.
2. It is subject to wear, damage and destruction.
3. There is no relationship between the cost of its production and its exchange value: its production is limited only by self-restraint.

We know that any increase in the supply of paper money will remove exchange value from the holders of previously existing notes, and transfer it to the recipients of newly created notes. We know that increases in the money supply under the paper money system will reduce the size of the unit of exchange value and produce all the distortions which were observed earlier.

It is clear that no production which will increase the existing supply can be permitted. Therefore, if we are to salvage the paper money system, procedures will have to be put in place which ensure that no notes can be minted except for the replacement of worn or damaged ones. In addition, the money-lending activities of the banking system will need to be brought to an immediate halt. The control procedures required will need to be very exacting and rigorously enforced.

When such procedures are firmly in place we will experience phenomena in the market-place which have been long forgotten. With any general population increases or with any increases in the level of expectation of the existing population, the level of exchanges will increase and so, accordingly, will the demand for money. Where it is not possible for the supply of money to increase, any increase in demand for it will lead to an increase in its exchange value. This means that prices will fall and the same amount of money will service an increased volume of transactions. So, we will discover that an economy can expand without requiring an expansion of its money supply.

Of course, there is a catch: as money's exchange value increases, some people will prefer to hang onto their money rather than use it in exchanges. Hoarding and dumping could then lead to artificially large swings in the level of exchange value of money, which in turn could seriously disrupt the market-place.

This is a hurdle which can easily be overcome. Increases in the exchange value of money will lead to people preferring to use something other than money in exchanges so that they can hold on to the money which is increasing in value. Buyers will offer sellers a choice of substitutes instead of money for the goods and services which they wish to purchase. Eventually exchanges will occur using substitutes acceptable to both parties. In due course some commonly acceptable substitutes will emerge. If these commonly acceptable substitutes were also made valid as legal tender or units of money, then the money supply would expand according to demand.

This time, however, the expansion of the money supply would be very different to that which we currently experience. Each money substitute would have its own previously existing level of exchange value, so it would not remove any exchange value from existing holders of paper money and the value of money would remain relatively constant.

Therefore, we can now see that it is possible to develop a programme which can maintain the existing paper money system, stabilise the level of exchange value of existing units and provide us with a total money supply which can expand naturally according to demand. This must be our goal.

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