From the nature of fiduciary media—as titles to nonexisting quantities of money property (gold), titles to money covered by things other than money, or plain counterfeit money—it would seem to follow that fractional reserve banking cannot possibly effect anything but a continual wealth and income redistribution. As the uncovered money substitutes ripple from the issuing bank and its borrower clientele outward through the economy, and thereby successively raise the price of increasingly more goods, real wealth (property) is transferred and redistributed in favor of the issuing bank and the initial and early recipients and sellers of this money, and at the expense of its late or never receivers and sellers. Explains Rothbard,
the first receivers of the new money gain the most, the next gain slightly less, etc., until the midpoint is reached, and then each receiver loses more and more as he waits for the new money. For the first individuals’ selling prices soar while buying prices remain almost the same; but later, buying prices have risen while selling prices remain unchanged.
According to Selgin and White, however, fiduciary media can accomplish far more. Rather than only redistributing existing property, the issue of fiduciary media can, under certain conditions, lead to an increase in real wealth (property). We have already quoted them stating that “benefits accrue to bank borrowers who enjoy a more ample supply of intermediate credit, and to everyone who works with the economy’s consequently larger stock of capital equipment.” They refrain from putting it this bluntly, yet what they claim is that, under specific circumstances, an increase of titles to an unchanged fund of goods will somehow make this fund grow or prevent it from shrinking.
When and how can such a miracle be accomplished? According to Selgin and White, (unanticipated) changes in the demand for money lead to “temporary” or “short-run monetary disequilibrium” involving “serious misallocations of resources”—that is, unless such changes are accommodated by fractional reserve banking practices. They write:
In the long run, nominal prices will adjust to equate supply and demand for money balances, whatever the nominal quantity of money. It does not follow, however, that each and every change in the supply of or demand for money will lead at once to a new long-run equilibrium, because the required price adjustments take time. They take time because not all agents are instantly and perfectly aware of changes in the money stock or money demand, and because some prices are costly to adjust and therefore “sticky.” It follows that, in the short run (empirically, think “for a number of months”), less than fully anticipated changes to the supply of or demand for money can give rise to monetary disequilibrium…. It is therefore an attractive feature of free banking with fractional reserves that the nominal quantity of bank-issued money tends to adjust so as to offset changes in the velocity of money.
If the banking system fails to increase the quantity of bank-issued money and the price level does not promptly drop, an excess demand for money arises (assuming also that the quantity of base money does not immediately increase). A corresponding excess supply of goods arises: unsold consumer goods pile up on sellers’ shelves (this is of course what proximately puts downward pressure on prices, until at last goods prices have fallen sufficiently). Business is depressed until the purchasing power of money gets back to equilibrium.
From the outset, one must wonder about the very existence of the problem of monetary disequilibrium (not to speak yet about the solution). In the just-given quote, one can substitute any other good for money: televisions, steel, beer, or pretzels. The quantities of goods such as these are also rigidly fixed (as is the quantity of gold), and yet (unanticipated) changes in the demand for televisions, steel, beer, or pretzels do not lead to temporary disequilibria involving serious misallocations of resources. Or, in any case, they do not cause problems that would require the invention of a special new device (such as fractional television or beer production).
Nor is it clear why we are supposed to believe that “it is important to distinguish between short-run and long-run implications of changes in the demand schedule for money or in the stock of money,” 31 or, in any case, why this distinction should be of different importance or significance in the case of money from that of everything else. To be sure, it takes time before an unexpected increase in the demand for televisions and beer, for instance, will have exhausted all of its effects on the system of relative prices and a new adjusted production structure will have been established. But this does not mean that price adjustments take any time (meanwhile causing short-run problems). On the contrary, price adjustments occur immediately and without any delay. Every change in the supply of or demand for anything affects prices instantly. This fact is overlooked because of an un-Austrian concern for macroeconomic artifacts such as the general price level, long-run equilibrium, and the velocity of money. However, viewed from the proper individualist perspective, there can be no doubt about the immediacy of price adjustments and the praxeological integration of the short and the long run.
In individualistic terms, an increased demand for money is the result of the purposeful actions of individuals; that is, people intent upon increasing their individual cash balances. To do so, a person must restrict his purchases and/or increase his sales. In either case, the outcome is an immediate fall of some prices. As the result of restricting one’s purchases of x, y, or z, the money price of x, y, or z will be lowered immediately (as compared with what it would have been otherwise), and likewise, by increasing one’s sales of a, b, or c, their prices will fall instantly. No one is concerned about the general price level or the generalized purchasing power of money. Instead, everyone is always concerned about specific prices and the purchasing power of money regarding specific items (and everyone is interested in his very own and different specific array of prices and purchasing power). In restricting his specific purchases and/or increasing his specific sales, each actor accomplishes exactly and immediately what he wants: certain prices that he deems too high are lowered, the purchasing power of a unit of money increases, the real value of his cash balance rises, and his demand for and supply of money is immediately brought back into equilibrium (and he wishes to hold neither more nor less money than he actually does).
The adjustment of the praxeologically meaningless general price level necessitated by an increased demand for money is nothing but the summation of a series of countless immediate and purposeful individual cash-balance adjustments. If the increased demand for money is accommodated by the issue of fiduciary media, as Selgin and White advocate this adjustment process will not be facilitated but delayed. 33 The speed of the adjustment of prices depends on the market-participants’ expectations concerning the given quantity of money. If it is reasonable to assume that fractional reserve banks will increase their fiduciary issues in response to an unanticipated increase in the demand for money, then the adjustment will take more time. Production would adjust and begin earlier without the additional influence of inflation.
Moreover, the proposed solution to the alleged problem of short-run monetary disequilibrium displays a fundamental confusion regarding the concept of demand (and supply), and the relationship between the demand for money, saving, and investment in particular. First, an increased demand for money (as for televisions, beer, or pretzels) is not just a wish to have more money (or televisions, beer, etc.), but effective demand. That is, an increased demand for money (as for anything else) can be satisfied only if the demander is willing to increase his market-supply of and/or reduce his demand for something else. Likewise, the supplier (seller) of money can only increase his supply of money if he reduces simultaneously the supply of (or his reservation demand for) something else. The authors have overlooked Say’s law: all goods (property) are bought with other goods, no one can demand anything without supplying something else, and no one can demand or supply more of anything unless he demands or supplies less of something else. But this is here not the case whenever a fiduciary note is supplied and demanded. The increased demand for money is satisfied without the demander demanding, and without the supplier supplying, less of anything else. Through the issue and sale of fiduciary media, wishes are accommodated, not effective demand. Property is appropriated (effectively demanded) without supplying other property in exchange. Hence, this is not a market exchange—which is governed by Say’s law—but an act of undue appropriation. Or would it be an efficient solution to the problem of unanticipated short-run television, beer, or pretzel-shortages if television, beer, and pretzel producers were to accommodate such increased demand “temporarily” by issuing and selling additional titles to televisions, beer, and pretzels but not these goods themselves?
Second, Selgin and White further misconstrue the nature of money and demand for money held in making the extraordinary claim that the issue of fiduciary media “matched by an increased demand to hold fiduciary media” is not only not disequilibrating, but will actually afford the economy a “larger stock of capital equipment,” because
[t]he act of holding fractional-reserve bank-issued money not only (like holding base money) defers consumption for a longer or shorter period, but also temporarily lends funds to the bank of issue in doing so. The period of the loan is unspecified … but if the bank can estimate with a fair degree of accuracy the lengths of time for which its demand claims will remain in circulation … it can safely make investments of corresponding length.
Following the lead of Rothbard, Hoppe criticized this essentially Keynesian view concerning the relationship between the demand for money and savings (loanable funds) 36 by pointing out that
[n]ot-spending money is to purchase neither consumer goods nor investment goods…. Individuals may employ their monetary assets in one of three ways. They can spend them on consumer goods; they can spend them on investment; or they can keep them in the form of cash. There are no other alternatives…. The consumption/investment proportion, i.e., the decision of how much … to spend on consumption and how much on investment, is determined by a person’s time preference; i.e., the degree to which he prefers present consumption over future consumption. On the other hand, the source of his demand for cash is the utility attached to money; i.e., the personal satisfaction derived from money in allowing him immediate purchases of directly or indirectly serviceable consumer or producer goods at uncertain future dates.
Accordingly, if the demand for money increases while the social stock of money is given, this additional demand can only be satisfied by bidding down the money prices of non money goods. The purchasing power of money will increase, the real value of individual cash balances will be raised, and at a higher purchasing power per unit money, the demand for and the supply of money will once again be equilibrated. The relative price of money versus non-money will have changed. But unless time preference is assumed to have changed at the same time, real consumption and real investment will remain the same as before: the additional money demand is satisfied by reducing nominal consumption and investment spending in accordance with the same pre-existing consumption/investment proportion, driving the money prices of both consumer as well as producer goods down and leaving real consumption and investment at precisely their old levels.
Accordingly, Hoppe concluded, it is never warranted to accommodate an increased demand for money by issuing fiduciary credit. 38 In fact, to do so will either—insofar as the accommodating increase of fiduciary media is unanticipated and the market rate of interest falls temporarily below the natural rate of interest—lead to a boom-bust cycle; or else—insofar as the monetary change arising from the banking system is anticipated and the market rate of interest is bid up (in the expectation of higher selling prices) in accordance with the height of the natural rate—it will accomplish no more than a plain wealth and income redistribution among various members of society. It is praxeologically impossible, however, that the issue of fiduciary media can lead to an “enlarged stock of capital equipment.”
In their attempt to rebut this argument, Selgin and White first concede the central theoretical point: “We agree that time preference and money demand are distinct, and that a change in one does not imply a change in the other.”
[t]hat holding money is one form of saving does not imply that an increase in the demand for money is identically an increase in total saving. An increased demand for money may accompany a reduced demand for holding other assets, and not a reduction in consumption; hence it may be part of a change in the manner of saving with no change in total savings.
However, if an increased demand for money is not identically an increase in total savings, then it is impossible to maintain that it provides for a larger pool of loanable funds and increased capital formation (a lengthening of the structure of production). Hence, to rescue their economic-growth thesis, immediately following this concession Selgin and White try to take it back again by arguing that:
Nonetheless [the nonidentity of time preference and money demand notwithstanding] to hold money is to hold it for later spending, even though how much later is not signalled (and typically has not yet been decided by the money-holder). Holding money for later spending, rather than spending it on consumption now, does defer consumption to the future. As Hoppe himself points out, the demand for cash stems from the convenience it allows one in purchasing “consumer or producer goods at uncertain future dates.” So perhaps our disagreement here is merely over words.
Unfortunately, this suggestion is unfounded. Rather than a verbal quibble, the disagreement is a substantive one concerning the nature of money.
It is difficult not to interpret the two previous pronouncements as contradictory. Selgin and White try to escape from this conclusion by an ad hoc semantic shift, that is, in characterizing money as a future good. Essentially, their argument is that while increased money demand does not imply increased savings, it provides nonetheless for a larger loan fund, because money is held only to be spent “at uncertain future dates” (their emphasis), such that an increased demand for money is always and at the same time an increase in the demand for future goods. Yet money is demonstrably not a future good. In fact, when the money is spent—in the future—it loses all its utility for the present owner. It has utility only while and insofar as it is not spent, and its character as a present good stems from the omnipresent human condition of uncertainty.
The error in classifying money as a future good can be revealed in a twofold manner. On the one hand, negatively, it can be shown that this assumption still leads to contradiction. In support of their thesis, Selgin and White claim that “holding money for later spending, rather than spending it on consumption now, does defer consumption to the future,” implying that the holding of money involves the exchange of a future good (satisfaction) for a present one. In the next sentence they admit that money held is spent neither on consumer goods nor or producer goods. Yet they fail to notice that this implies also, as a further consequence, that holding money for later spending, rather than spending it on production now, does defer production (and hence future consumption) to the future. If the holding of money defers consumption and production, however, then it becomes impossible to maintain that the holder of money has thereby invested in a future good, because there are no future goods—whether consumer or producer goods—which result from the act of holding money and to which its holder could thus be entitled. Yet as claims to no future goods whatsoever, money would be worthless. By implication, if money is not worthless (and no one would hold money if it had no value), then its value must be that of a present good.
On the other hand, positively, the nature of money as a paradigmatically present good can be established by praxeological proof. As Mises and Rothbard have explained, in general equilibrium or, more appropriately, within the imaginary construction of an evenly rotating economy, no money exists. With all uncertainties by assumption removed, everyone would know precisely the terms, times, and locations of all future exchanges, and all exchanges could be prearranged accordingly and take the form of direct rather than indirect exchanges.
In a system without change in which there is no uncertainty whatever about the future, nobody needs to hold cash. Every individual knows precisely what amount of money he will need at any future date. He is therefore in a position to lend all the funds he receives in such a way that the loans fall due on the date he will need them.
While there is no place for money in the construction of an evenly rotating economy, however, there exists within its framework a present and a future, now and later, the beginning of an action and its later completion, immediately serviceable consumer goods (present goods) and indirectly serviceable producer goods (future goods), a structure of production, and savings and investment, that is, exchange of present against future goods governed by time preference. If anything, this proves again that money and the demand for money are systematically unrelated to consumption, production, and time preference, and that the source of the utility of money must be a categorically different one from that of consumer goods and producer goods. The source of the utility of a consumer good is its direct and present serviceability, and the source of the utility of a producer good is its indirect future serviceability.
Money, by contrast, is neither consumed nor employed in production. It is neither directly serviceable (as consumer goods are) nor indirectly useful as a way station to future consumer goods (as producer goods are). Rather, the utility of money must be that of an indirectly yet presently serviceable good.
Outside the imaginary construction of an evenly rotating economy, under the inescapable human condition of uncertainty, when the terms, times, and locations of all future exchanges cannot be predicted with certitude, and when action is by nature speculative and subject to error, man can conceivably demand goods no longer exclusively on account of their use-value (present or future), but also because of their value as media of exchange (for resale purposes). Faced with situations where, due to the absence of double coincidences of wants, a direct exchange is impossible, man can evaluate goods also on account of their degree of marketability, and can consider trading whenever a good to be acquired is more marketable than that to be surrendered, such that its possession would facilitate the acquisition of directly or indirectly serviceable goods and services. Moreover, because it is the sole function of a medium of exchange to facilitate purchases of directly or indirectly serviceable goods, man will naturally prefer the acquisition of a more marketable and, at the limit, universally marketable medium of exchange to that of a less or nonuniversally marketable one, such that
[T]here would be an inevitable tendency for the less marketable of a series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.
Selgin and White are familiar with this Mengerian-Misesian reconstruction of monetary evolution, of course. They apparently fail to recognize, however, that this feature of money as the most easily and widely salable commodity far from rendering it a future good, qualifies money at the same time as the good best suited to alleviate presently felt uncertainty and, as such, the most universally present good of all. 46 Although only indirectly useful—in this regard like producer goods, and unlike any consumer good—money is precisely on account of its supreme saleability a uniquely present good—in this regard like consumer goods, and unlike any producer good. Because money can be employed for the instant removal of the widest range of possible needs (or the satisfaction of the widest range of possible desires), it provides its owner with the best humanly possible protection (insurance) against uncertainty; that is, against his uneasiness of not being able to predict—of not being certain about—all of his future needs and desires. In holding money, its owner gains in the satisfaction of being able instantly to meet, as they arise unpredictably, the widest possible range of future contingencies.
The keeping of cash holding requires sacrifices. To the extent that a man keeps money in his pockets or in his balance with a bank, he forsakes the instantaneous acquisition of goods he could consume or employ for production.
Accordingly, to the extent that he feels certain regarding his future, a man will want to invest in consumer and producer goods. Only to the extent that he feels uncertain about his future will he want to make the sacrifice referred to by Mises; that is, will he possibly want to invest in relief from any uneasiness felt concerning the uncertainty of his future consumption—production (income—expenditure) pattern. Hence, rather than indicating his increased willingness to sacrifice present satisfaction in exchange for future satisfaction, an increased demand for money demonstrates a man’s more intensely felt uncertainty regarding his future; and rather than being an investment in the future, an addition to his cash balance represents an investment in present certainty (protection) vis-à-vis a future perceived as less certain.
In light of this praxeological reconstruction of money as a singularly present good, Selgin and White’s entire positive case for fractional reserve banking is revealed as mistaken. If banks indeed accommodate an (unanticipated) increased demand for money through the temporary issue of additional fiduciary media (credit), as Selgin and White propose, this can have only disruptive and disequilibrating effects. If and insofar as the accommodating response on the part of the banks is unanticipated, the interest rate will be reduced temporarily below its natural height, investment will increase, and the structure of production will be lengthened. Yet this result is fundamentally at odds with the public’s demonstrated preference. The public perceives the future as more (increasingly) uncertain and, accordingly, in striving to increase the size of its cash holdings and thereby bidding the prices of nonmoney goods down and correspondingly increasing the purchasing power per unit money, is intent upon providing for more (increased) present protection against uncertainty. To commit additional resources to the future is the expression of less public uncertainty (rather than more), and thus stands at cross-purpose to the public’s actual wishes and implies a systematic misallocation of resources (to be revealed in a boom-bust cycle). And in any case, even if the banks’ accommodating money supply increase could be fully anticipated and the structure of production were not unduly lengthened, any such accommodation would still be disruptive, because—even apart from its inescapable redistributionist consequences—it can only delay the arrival of the desired goal. In order to be better protected against perceived uncertainty, prices must fall and the purchasing power of money must rise. With an additional influx of money, it cannot but take longer before this goal is accomplished