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What Is Money?

Economics / Economic Theory Sep 29, 2009 - 02:10 PM GMT

By: Gary_North


Diamond Rated - Best Financial Markets Analysis ArticleThis question divides economists even more than it divides voters. Voters do not think much about this question. Economists think about it throughout their careers. They do not agree with each other regarding the answer.

The problem is, about half of American economists who specialize in monetary theory and banking policy are either on the payroll of the Federal Reserve System or sell their services to the FED on a piece-rate basis.

Most of the others are trying to get in on the deal. Through the FED, economists set policy for American banking, and, through banking, just about everything else.

The economists are not agreed. Federal Reserve policy is therefore not consistent. It is mostly a system of trial and error – these days, very large errors. Through the influence of the FED among foreign central banks, and through the influence of the top dozen American graduate schools, the confusion over what money is has spread to the entire world.

In the area of monetary policy more than any other area of modern life, the self-certified, self-policed, and self-confident experts are making it up as they go along. Then the rest of us have to go along.

In my forthcoming series of articles, you will learn the following:

  1. The experts do not know horse apples from apple butter about monetary theory.
  2. Monetary theory should be an integrated part of a general economic theory of how the world works.
  3. Whenever an economic theory of how the world works makes an exception for monetary theory, the proposed monetary theory is incorrect, or the general theory is incorrect, or both are incorrect.
  4. Fiat money is always a form of counterfeiting.
  5. Counterfeiting produces bad results for almost everyone except the counterfeiters.
  6. Fractional reserve banking is legalized counterfeiting.
  7. Government fiat money is counterfeit.
  8. Those who trust government money will lose wealth more surely than those who do not trust it.
  9. There are ways to escape bad monetary policy.
  10. The worse the policy, the fewer the avenues of escape.

If you stick with me through this series of articles on monetary theory and policy, you will have a much better idea about where modern society has gone wrong. You will also have a better idea of how to protect yourself against the inevitable consequences, all of which are negative, of the government's violations of sound money principles.

It boils down to this question: If you don't know what money is, how will you obtain more of it? This is another way of saying that if you don't understand the modern violations of monetary theory, you will not understand the extent to which you are vulnerable to bad policies which are going to produce disastrous consequences, just as they have in the past.


What is money? These three words introduce one of the most baffling areas of economic thought. I can think of no other area of economics in which there is greater confusion, leading to greater economic disruptions, than this one.

A characteristic feature of all systems of economic thought except the Austrian School is a failure to integrate monetary theory with general economic theory. With the exception of the Austrian School, all schools of thought create exceptions to the laws of economics that they say apply in all of the other areas of the economy. They insist that the government is necessary to intervene into the free market in order to bring order to monetary affairs.

They argue that money is not part of a system of economic practice and theory. They also imply that monetary theory is not part of an integrated system of economic cause-and-effect. The explanations given for economic causation in every other area of the economy are not accepted as valid in the realm of money.

Monetary theory, when coupled with an explanation of how banking works, provides a case study of the unwillingness of economists to pursue the logic of economic causation. This should be a tip-off to the fact that there is something fundamentally wrong with either their theory of money or their general economic theory.


The confusion regarding monetary theory and practice has several aspects. First, there is conceptual confusion. There is a lack of understanding of how the free market works. The two fundamental rules governing free-market pricing are these:

  1. Supply and demand
  2. High bid wins

When you apply these two principles to any area of the economy, you have the conceptual tools necessary to understand the basics of economic causation. All deviations from free-market economic theory invariably involve the abandonment of one or both of these two principles of economic analysis. This certainly applies in the area of monetary theory and monetary policy.

Second, there is the confusion over the origin of money. How did money come into existence? What motivated people to make the decisions that led to the institution of money? What interference with people's motivation did the state imposes in order to gain certain advantages for itself? How do these interventions reduce economic liberty and the smooth functioning of the monetary system?

Third, there is the financial issue. That which individuals want for themselves personally, namely, more money, is bad for the economy when either the state or the banking system interferes with private contracts. What we want to achieve for ourselves individually we had better avoid corporately: more money. This is not understood by virtually all schools of economic opinion, with the exception of the Austrian School.

Fourth, there is the political issue. There is great confusion over the proper relationship between civil government and monetary policy. Economists insist that the monetary system should not be autonomous; civil government must interfere in some way to provide stability and predictability to the monetary order. In rare instances, this is limited simply to the enforcement of contracts. In most cases, the principle of necessary government regulation is extended to mandate broad intervention by political authorities.


There is a familiar phrase in the American conservative movement: ideas have consequences. This phrase comes from the book title of a 1948 book by English professor Richard Weaver. This principle certainly applies to monetary theory. Mistaken ideas have disastrous consequences.

Mistaken ideas in the area of monetary policy have produced more disasters than mistaken ideas in any other area of economic thought. There is a reason for this. Money is at the heart of the modern economy. Mistaken policies in the realm of money and banking spread to the entire economy. There is a kind of multiplication effect. The worse the idea in economic theory, the more widespread and devastating its consequences when the idea is applied to the monetary system.

There are five analytical categories in which mistaken ideas lead to bad economic policy. I summarize them as follows: sovereignty, authority, law, sanctions, and continuity. These five categories are crucial for economic analysis. They are exceptionally crucial in the realm of monetary policy, as I will demonstrate. They are violated constantly in modern society. They have been violated constantly ever since 1914: the outbreak of World War I. National governments and private banking came close to honoring the truth in these five categories for a century: 1815 to 1914. During that century, there was considerable monetary stability for Western Europe, leading to greater economic growth than any other period in the history of man.

Because of the violation of nineteenth-century monetary policy, we have seen the rise of world wars, hyperinflation, and depression. None of these would have been likely apart from fiat money, which is a violation of the law of property. This violation leads to terrible consequences in the real world.


Let us return to the original question: What is money? The best answer to this continual question was provided in 1912 by the Austrian economist, Ludwig von Mises. In his book, "The Theory of Money and Credit," he provided an answer in six words: money is the most marketable commodity. He had in mind gold and silver coins, but his theory encompassed any commodity that can or has served as money in history.

By defining money as the most marketable commodity, Mises integrated monetary theory with general economic theory. His theory of money was an extension of his theory of the free market. He rested his case for the free market on the right of private ownership.

I have said that there are five analytical categories in which mistaken ideas lead to bad economic policy: sovereignty, authority, law, sanctions, and continuity. Now I must explain what I mean.

1. SOVEREIGNTY. Property rights are the foundation of money, Mises argued. Property rights provide the legal setting for voluntary exchange. He argued that the development of money was an unplanned outcome of the decisions of individuals who sought to increase their wealth by increasing their productivity.

Individuals have always sought to specialize in those areas of production in which they have a competitive advantage. This advantage may be due to personal skills. It may be due to geographical location. Whatever the origin of the advantage, the individual seeks to exploit this advantage. He specializes in one area of economic production, so that he will have an increased quantity of goods and services to exchange with other individuals, who specialize in those areas in which they have a competitive advantage. Mises argued that out of the barter system came money. A monetary commodity was originally valued for something other than exchange. It may have been sought because it was beautiful. It may have been sought because it had religious significance. Whatever the reasons that people sought to accumulate a particular commodity, this led to the discovery that this particular commodity could be used to facilitate voluntary exchange.

Instead of having to find a buyer for the particular commodity or service that an individual produced, he could exchange his output for a commodity that was widely desired by other members of society. As these exchanges grew in number, this commodity began to attain value as a result of its ability to serve in the process of exchange. What had originally been a commodity valued for some other characteristic increasingly was valued for the purpose of facilitating exchange. In other words, this commodity became money.

As a free-market economist, Mises did not attribute the origin of money to the decision of a civil government. It was not that a particular king or group of nobles decided that it would be convenient if a particular commodity were adopted as money. On the contrary, governments began to extend their control over money because they recognized that they could increase their extraction of wealth from private citizens with greater efficiency if they taxed people's monetary income rather than taxing their individual output. It was easier to collect money and spend it for the purposes of civil government than it was to collect hundreds or even thousands of goods. It was not that the state was the origin of money; it was that money became a tool of the expansion of the state. The state claimed sovereignty over money because it was convenient for the state to gain control over this most central of economic assets.

In short, Mises argued that the free-market social order possesses original sovereignty over money. Any claim by the civil government that it exercises sovereignty over money is not grounded in economic theory or the law of contracts. It is grounded in the desire of civil rulers to extract greater wealth from those under their authority.

2. AUTHORITY. Mises argued that the authority over money originally came from the authority of individuals to exchange their goods and services voluntarily. There is a hierarchy of control that is based on individual ownership.

Civil government attempts to gain authority over monetary affairs because it is less expensive for the government to expand its authority over every other area of life when it controls the monetary system. In short, there are both competing sovereignty and competing authority – market vs. state – in the competitive arena of monetary policy.

3. LAW. There is a law of monetary affairs, but this law is not unique to money. The general law of contracts led to the creation of money. A legal order that enabled individuals to exercise control over their labor, their property, and the output of the combination of labor and property led to the establishment of a monetary system.

The law of pricing is no different from the law of any other asset. Again, there are two laws: first, supply and demand; second, high bid wins. As these two laws extend to the general society, the monetary order comes into existence.

Here is Mises' central point: the monetary system is the product of human action, but not human design. This is what is denied by all schools of economic opinion except the Austrian School. All the schools of opinion believe that, for the proper functioning of money, the civil government, because of its inherent sovereignty, must exercise control over money. So, it must have legal authority over money. This means that the law of money, as an extension of the law civil government, is different from the laws governing voluntary economic exchange.

4. SANCTIONS. Then there are sanctions. Government imposes sanctions for violating civil law. What are the comparable sanctions in the realm of monetary policy? The sanctions are simple: profit and loss. These two sanctions govern the realm of voluntary economic exchange. They therefore govern the realm of monetary policy. The sanctions of profit and loss, which apply to every other area of voluntary exchange, also apply in the realm of monetary policy, and therefore should apply in the realm of monetary theory. But, we find that this is not the case in any school of economic opinion except the Austrian School.

5. CONTINUITY. The fifth category of economic analysis that applies to money is the category of continuity. Continuity is the crucial factor in all ownership. Does an individual have the right to retain possession of his property through time? Do voluntary exchanges transfer ownership of property to other individuals? If the answer is yes, then the same degree of continuity must prevail in the realm of monetary policy. One of the central factors in all forms of money is continuity through time. If an individual does not believe that a particular asset will enable him to purchase scarce goods and services in the future, the value of the monetary unit will fall. It will fall to whatever value that consumers impute to it for their purposes. If gold or silver coins were expected to be abandoned by market participants who are seeking stability of purchasing power over time, the value of the two metals would fall to whatever they are worth in other areas of the economy.

It is more likely that pieces of paper with rulers' pictures on them will be subjected to doubts concerning their continuity of value than gold or silver coins that are used widely in exchange.

In summary, the original sovereignty over money was established by the free market, which is in turn was an extension of a particular legal order. Second, authority over money inheres in an individual's right to possess property. Third, the law of money is an extension of the law of private property. It is in no way different from the general legal order that governs ownership and exchange. Fourth, the sanctions of profit and loss apply to money, just as they apply to all the other areas of the free market economy. Finally, there is continuity of money over time because there is continuity of ownership over time.


Money is an extension of the free-market social order. To the extent that civil government interferes with money, it interferes with the operations of the free-market order. Interference in the area of money beyond the general application of laws governing contracts has more extensive consequences, all negative, than interference in any other area of the economy. This is because money is the universal facilitator of voluntary exchange. An error in policy in the realm of money extends to the entire society.

    Gary North [send him mail ] is the author of Mises on Money . Visit . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

    © 2009 Copyright Gary North / - All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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