Joseph Salerno (b. 1950) is an American economist of the Austrian School. In 2010, he wrote Money, Sound and Unsound, where he provides a wide-ranging application of Austrian monetary theory across history. I read this book for a course with Saifedean Ammous: The Bitcoin Standard I. What follows are my notes.
chapter 1: two traditions in modern monetary theory: john law and a.r.j. turgot
- John Law (1671–1729) was a Scottish economist who created one of the first national central banks in France and nearly destroyed the country’s monetary system in four year (1716-1720).
- Law’s ideas are still prominent in the U.S. monetary theory and policy, with parallels to Keynes.
1.2. john law’s monetary doctrines
- 1705: Law published Money and Trade Considered: With a Proposal for Supplying the Nation with Money
- Two core assumptions about money
- Money’s best use is as a tool that belongs to the government. The State has the right to determine the composition and quantity in the public’s interest.
- Money is just an “exchange token,” with no value in itself (no store of value).
- Since money is just an exchange token, if should be spent quickly. “Hoarding” (saving) for the long-term damages the economy.
- Hoarding decreases money circulation and spending, which reduces trade and employment.
- Money is simply a policy tool that can increase the national income and wealth, but is not the store of wealth itself (consistent with modern view).
- The market economy is inherently unstable and tends to create unemployment.
- Expanding the money stock (supply) ➡ lower interest rates ➡ stimulus to investment in import/export trades + manufacturing ➡ expansion of employment
- Money shortage ➡ high interest rates ➡ prevents investment ➡ price deflation ➡ contraction in import/export trades + manufacturing
- Implication the assumption that money is an “exchange token” is that its value should remain perfectly stable.
- Precious metals (gold, silver) don’t make good “exchange tokens” because they are useful as commodities whose value goes up and down in the market
- So Law advocated for replacing market-chosen money with government fiat paper money … backed by land.
- Law saw banks as the best way to establish fiat paper money that the government could inflate.
- Fractional-reserve banking becomes essential to creating money and expanding loans
- (However, there is potential instability in fractional reserve banking due to a mismatch between the loans and underlying deposits.)
- Law envisioned a Commission that could issue notes in three ways:
- Lending notes at an interest rate
- Collateralized loans (e.g. a loan equal to the price of lands. When the loan is repaid, the lands are redeemed.)
- Purchasing land directly with newly printed notes
- The Commission would also be able to sell the its own mortgages (debt) and lands in exchanges for its notes.
- Today, the Federal Reserve does something similar (but different) when it buys Treasury securities from the public and the banks ➡ creates new bank reserves and checkable deposits in the economy.
1.3. law’s ideas in the modern world
Three modern schools of economics share most of Law’s ideas about money: neo-Keynesians, monetarists, and supply-siders
1.3.1. Money as a Policy Tool
- All three schools view money primarily as a tool for the government to pursue policy goals.
- Neo-Keynesians: Money is a tool alongside taxing, spending, & borrowing (monetary + fiscal policy). This toolset enables the government to manage total spending (or aggregate demand) to balance inflation and unemployment.
- Neo-Keynesians (wrongly) see inflation + unemployment as permanent traits of a free-market economy.
- Modern monetarists are descendants of the pre-World War Two Chicago School
- Keynesians don’t like the gold standard because it offers no flexibility for discretionary monetary policy.
- Monetarists don’t even believe a monetary system can work without government control and management.
1.3.2. money as an exchange token
- Most modern economists regard hoarding as a potentially serious source of macroeconomic instability.
- Early Keynesians saw hoarding not just as a drag on spending and economic output, but also as unruly and antisocial.
- Instead of seeing the money stock as important, they emphasized the flow of payments (see stock-flow ratio).
- Under the spending-output connection, Keynesians believe government should manage the flow of spending.
- Monetarists believe a key concept is the “velocity of circulation of money,” which refers to the rate a unit of money is “turned over” through spending in the economy.
- Hoarding ➡ decrease in velocity and spending ➡ recession (unless money supply increases)
1.3.3. stabilization of the price level
- Neo-Keynesians, monetarists, and supply-siders believe the stable value of money is one of the most important goals of macroeconomic policy (just like Law).
- When unemployment and inflation coexisted under Keynesian policies, Keynesians proposed a stable “Phillips-curve tradeoff” (inverse relationship between inflation and unemployment).
- In the 1970s/80s, though, the Phillips curve was not stable – inflation and unemployment rose upward together.
- Monetarists, however, don’t think full employment means giving up price stability.
- (Law + monetarists make money into a stable-value token (or measuring rod of value). They ignore money as a medium of exchange, which must fluctuate in value according to market supply & demand conditions. Stable-value medium of exchange = Oxymoron)
- Monetarists like Milton Friedman: unstable price level = disorderly money.
- Interestingly, these economists think the market efficiently adapts to changes in relative prices of goods/services, but the market can’t adjust smoothly to substantial changes in the overall price level.
1.3.4. the resource costs of a commodity money
- Friedman wrote: “The fundamental defect of a commodity standard, from the point of view of the society as a whole, is that it requires the use of real resources to add to the stock of money. People must work hard to dig gold out of the ground in South Africa—in order to rebury it in Fort Knox or some similar place.”
- Gold emerged as money because it maintains scarcity relative to demand.
- Under gold, the increased demand for money increases the purchasing power ➡ fall in prices (does not require mining more gold)
1.3.5. the supply of money as a political monopoly
All three schools believe money needs to be centralized under a political monopoly.
1.4. Turgot and the Anti-Law Tradition
- Anne Robert Jacques Turgot (1727 – 1781) was a French economist and critic of Law.
- Turgot say money’s key features as medium of exchange + unit of account.
- Money emerges from widespread barter with these properties: general demand in barter, natural scarcity, high value/weight ratio, divisible, durable, homogeneous, purity easily verified.
- (does not require central political authority fixing an exchange rate because the market self-organizes around the weight of gold as the unity of account)
- Money is a product of natural market process
- Gold stock as money supply does not become deficient, there is no “shortage”: “any quantity of money always provides the full utility of a medium of exchange to society.”
- Money, as the most saleable commodity, does not remain fixed in prices, but varies in response to market conditions. Price fluctuations are natural and essential to avoid excess demand or supply.
- Central bank attempts to stabilize prices by expanding money supply distort interest rates and relative prices ➡ malinvestment of capital ➡ economic recession or depression.
- Entrepreneurs must accumulate capital to pay for enterprises. Resource prices fluctuate according to competitive bidding from all entrepreneurs. Profit calculations adjust in response to prices. Accumulation (savings) and investment guided by monetary calculation.
- Under Turgot, the “circulation of money” is the process of saving and investment that drives productive activity. (without distortions and malinvestment)
- Turgot focused on money’s role as a “tool of economic calculation which serves the entrepreneurial function of allocating capital and coordinating the uses of productive resources in light of anticipated consumer preferences.”
- Carl Menger influenced by Turgot, Richard Cantillon, Abbé Condillac, Ferdinando Galiani, and J.B. Say.
- Menger’s contributions to monetary theory
- The origin of money is a spontaneous outcome of natural markets.
- Demand for money = Sum of individual demands to save cash to finance future enterprise.
- Menger saw capital as tied to monetary calculation – it is “the productive property, whatever technical nature it may have, so far as its money value is the subject of economic calculation, that is, if it appears in our accounting as a productive sum of money.”
- Eugen von Böhm-Bawerk, an Austrian economist, planted the idea of “price coordination.”
- Price coordination: the competitive market, guided by monetary calculation, free from political interference, finds the best allocation of scarce resources as viewed by entrepreneurs responding to the needs of consumers.
- Mises’s “Regression Theorem”: Money can never be decreed by government, it always evolves from a natural market.
- Mises + Rothbard: only way to denationalize money is to go back to gold.
- Austrian view deflation as a natural market response to an increased demand for money (could be due to uncertainty about the future).
- There is no way for central banks to stabilize money without completely distorting monetary calculation and the market economy.
- Fractional reserve banking: An insidious form of expanding the money supply.
- Austrians also oppose gold-backed money, as in the gold standard in Great Britain before 1914. One paper money is printed on top of gold, there is very little to stop governments from printing more.