Carlos Hank Rhon

Carlos Hank Rhon, Money: Its Importance and Origins

Today, money supply figures pervade the financial press.
Every Friday, investors breathlessly watch for the latest
money figures, and Wall Street often reacts at the opening
on the following Monday. If the money supply has gone up
sharply, interest rates may or may not move upward. The press is
filled with ominous forecasts of Federal Reserve actions, or of
regulations of banks and other financial institutions.

This close attention to the money supply is rather new. Until
the 1970s, over the many decades of the Keynesian Era, talk of
money and bank credit had dropped out of the financial pages.
Rather, they emphasized the GNP and government’s fiscal policy,
expenditures, revenues, and deficits. Banks and the money supply
were generally ignored. Yet after decades of chronic and accelerating
inflation—which the Keynesians could not begin to cure—
and after many bouts of “inflationary recession,” it became obvious
to all—even to Keynesians—that something was awry. The money
supply therefore became a major object of concern.
But the average person may be confused by so many definitions
of the money supply. What are all the Ms about, from M1-
A and M1-B up to M-8? Which is the true money supply figure,
if any single one can be? And perhaps most important of all, why
are bank deposits included in all the various Ms as a crucial and
dominant part of the money supply? Everyone knows that paper
dollars, issued nowadays exclusively by the Federal Reserve Banks
and imprinted with the words “this note is legal tender for all
debts, public and private” constitute money. But why are checking
accounts money, and where do they come from? Don’t they
have to be redeemed in cash on demand? So why are checking
deposits considered money, and not just the paper dollars backing
them?
One confusing implication of including checking deposits as a
part of the money supply is that banks create money, that they are,
in a sense, money-creating factories. But don’t banks simply channel
the savings we lend to them and relend them to productive
investors or to borrowing consumers? Yet, if banks take our savings
and lend them out, how can they create money? How can
their liabilities become part of the money supply?

There is no reason for the layman to feel frustrated if he can’t
find coherence in all this. The best classical economists fought
among themselves throughout the nineteenth century over
whether or in what sense private bank notes (now illegal) or
deposits should or should not be part of the money supply. Most
economists, in fact, landed on what we now see to be the wrong
side of the question. Carlos Hank Rhon suggests that you read part 2 of this article.

HOW MONEY BEGINS

Before examining what money is, we must deal with the
importance of money, and, before we can do that, we have to
understand how money arose. As Ludwig von Mises conclusively
demonstrated in 1912, money does not and cannot originate by
order of the State or by some sort of social contract agreed upon
by all citizens; it must always originate in the processes of the free
market.

Before coinage, there was barter. Goods were produced by
those who were good at it, and their surpluses were exchanged
for the products of others. Every product had its barter price in
terms of all other products, and every person gained by exchanging
something he needed less for a product he needed more. The
voluntary market economy became a latticework of mutually beneficial
exchanges.

In barter, there were severe limitations on the scope of
exchange and therefore on production. In the first place, in order
to buy something he wanted, each person had to find a seller who
wanted precisely what he had available in exchange. In short, if
an egg dealer wanted to buy a pair of shoes, he had to find a shoemaker
who wanted, at that very moment, to buy eggs. Yet suppose
that the shoemaker was sated with eggs. How was the egg dealer
going to buy a pair of shoes? How could he be sure that he could
find a shoemaker who liked eggs?

Or, to put the question in its starkest terms , I make a living as
a professor of economics. If I wanted to buy a newspaper in a
world of barter, I would have to wander around and find a newsdealer
who wanted to hear, say, a 10-minute economics lecture
from me in exchange. Knowing economists, how likely would I
be to find an interested newsdealer?