How Central Banks Destroy Money’s Purchasing Power

How Central Banks Destroy Money’s Purchasing Power by  for Activist Post

Most economists hold that a growing economy requires a growing money stock on grounds that growth gives rise to a greater demand for money that must be accommodated. Failing to do so, it is maintained, will lead to a decline in the prices of goods and services, which in turn will destabilize the economy and lead to an economic recession, or even worse, depression.

Since growth in money supply is of such importance, it is not surprising that economists are continuously searching for the optimum growth rate in money supply. For instance, followers of Milton Friedman—also known as monetarists—want the central bank to target the money supply at a fixed percentage. They hold that if this percentage is maintained over a prolonged period, it will usher in an era of economic stability.

The whole idea that money must grow in order to sustain economic growth gives the impression that money somehow sustains economic activity. If this were the case, most Third World economies by now would have eliminated poverty by printing large quantities of money.

According to Rothbard in Man, Economy, and State,

Money, per se, cannot be consumed and cannot be used directly as a producers’ good in the productive process. Money per se is therefore unproductive; it is dead stock and produces nothing.

Money’s main job is simply to fulfill the role of the medium of exchange. Money doesn’t sustain or fund real economic activity. The means of sustenance, or funding, is provided by saved real goods. By fulfilling its role as the medium of exchange, money just facilitates the flow of goods and services. Historically, many different goods have been used as the medium of exchange. On this Mises observed in The Theory of Money and Credit that, over time,

there would be an inevitable tendency for the less marketable of the 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.

Through the ongoing process of selection people settled on gold as the general medium of exchange. Most mainstream economists, while accepting this historical evolution, cast doubt on the idea that gold can fulfill the role of money in the modern world. It is held that, relative to the growing demand for money as a result of growing economies, the supply of gold is not adequate.

If one takes into account that a large portion of gold mined is used for jewelry, this leaves the stock of money almost unchanged over time. It is held that the free market, by failing to provide enough gold, will cause money supply shortages. This, in turn, runs the risk of destabilizing the economy. It is for this reason that most economists, even those who express sympathy toward the idea of a free market, endorse the view that the money supply must be controlled by the government.

People Want Purchasing Power, Not Just Money

When we talk about demand for money, what we really mean is the demand for money’s purchasing power. People don’t want a greater amount of money in their pockets but rather want a greater purchasing power in their possession. On this Mises wrote in Human Action,

The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of money or a definite weight of money; he wants to keep a cash holding of a definite amount of purchasing power.

In a free market, in similarity to other goods, the price of money is determined by supply and demand. Consequently, if there is less money, its exchange value will increase. Conversely, the exchange value will fall when there is more money. Within the framework of a free market, there cannot be such thing as “too little” or “too much” money. As long as the market is allowed to clear, no shortage of money can emerge.

Consequently, once the market has chosen a particular commodity as money, the given stock of this commodity will always be sufficient to secure the services that money provides. Hence, in a free market, the whole idea of the optimum growth rate of money is absurd. According to Mises in Human Action,

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