21 September 2008

Reining in Government: Sound Money

The United States Constitution is a marvel to behold for its clarity, brevity and limitations on government power. Some of its unfortunate compromises, like the protection of slavery, are understandable given the context in which it was written, but others are perhaps less comprehensible. In the case of money, the founders understood intimately the dangers of issuing paper money, stating that, "No State shall...emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts." Such restrictions were unfortunately not placed on the federal government, allowing the Congress the vague rights to "To coin Money, regulate the Value thereof, and of foreign Coin," which have become (mis)interpreted in conjunction with the elastic "necessary and proper" clause to allow for the creation of fiat paper money.
While it is understandable that the founders were frustrated with Britain's restrictions on coinage in the new world and the general shortage of coin that resulted, they neglected the market alternative of allowing private mints to competitively create coinage. In a competitive currency environment where merchants have the freedom to accept or reject any form of currency, there is a natural incentive for mints/banks to create reliable, quality currency so as to not have their currency rejected.

In any monopolistic currency regime, the temptation to use the monopoly to tax users of the currency via inflation and debasement of the money supply is irresistible for the monopoly issuer. The main restrictions on such inflation, revolution, emigration and foreign currency competition, have delayed and muted effects proportional to the size of the domestic economy. Large economies, like that of the United States, can force domestic acceptance of the national currency, thereby taxing the substantial domestic wealth. Debtors, who benefit from inflationary monetary policy, then provide democratic support for the perpetuation of such policies, along with the largest debtor of all, the government.

Sound money favors prudence and saving, punishing excessive risk-taking and debt with bankruptcy and failure. While sound money does allow for periodic fluctuations in the value of currency, be it through changes to the supply of precious metals, wars or other exogenous events, such fluctuations are minor in comparison with the rampant inflation caused by fiat money. Small fluctuations are even healthy because they can be both inflationary and deflationary, rewarding the prudent and punishing the over-extended.

Without access to the ability to monetize debt, governments are unable to bail out industries as the U.S. government recently did with Fannie Mae, Freddie Mac, AIG and the bad debt purchases. Indeed, such industries would never have been allowed to become so insolvent without the rampant encouragement of debt possible in a fiat monetary system.

Unfortunately, rather than calls to return to private, competitive money, the general cry is for more government inflationary and regulatory intervention. Regardless of the outcome of the upcoming U.S. elections, the resulting regime will surely comply, inhibiting market forces in the financial markets until such time that the necessary re-alignments lead to depression and revolution. Is there an alternative route?

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