The Value of Real (sound) Money vs. Fiat Money (unsound) Money

Today's worldwide Paper or Fiat-, money regime is an economically and socially destructive scheme, one with far-reaching, harmful economic and societal consequences that extend beyond what most people can imagine.

Fiat money is inflationary; it benefits a few at the expense of many others; it causes boom-and-bust cycles; it leads to over indebtedness, it corrupts society's morals, and ultimately finishes in depression.

This should not come as a surprise because the purpose of policy makers and their experts who serve as opinion makers is to keep the Fiat Money regime going, whatever it takes.

The Fiat Money regime rests on central banking, meaning that a government-sponsored central bank holds the money-production monopoly, and fractional-reserve banking, denoting banks issuing money created ex nihilo or out of thin air.

In The Mystery of Banking, Murray N. Rothbard discusses the Fiat-Money regime, with central banking and fractional-reserve banking, as a form of embezzlement and thievery (evil)..

Rothbard's conclusion might need some explanation, given that mainstream economists consider the concept of fiat money as an economically and politically desirable, acceptable, and state-of-the-art institution.

An understanding of the nature and consequences of a fiat-money regime must start with an appreciation of what money actually is and what it does in a monetary exchange economy.

In Y 1953, Ludwig v Mises wrote: The sound-money principle has two aspects. It is affirmative in approving the market's choice of a commonly used medium of exchange. It is negative in obstructing the government's propensity to meddle with the currency system...and; It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of right.What that means,

1. free choice of currency, meaning that money is chosen and produced by the free demand for and free supply of money in the market place, and

2. a line of defense against government violations of individual property rights.

With the above in mind, one can conclude that if money does not comply with the sound-money principle (if it is unsound), it will erode and eventually destroy civil liberties as directed by the government.

There can be no question about this being true, as it comes from the sound-money principle, and the sound-money principle is based on a true axiom of human action, which is at the heart of praxeology ( the logic of human action, as Mr. Mises described it.

One of Mises's main achievements is that he reconstructed the science of economics along the lines of praxeology. At the heart of praxeology is the axiom of human action.

The axiom of human action is a special quality: it meets the requirements of an a priori synthetic judgment, as the German-Prussian philosopher Immanuel Kant (1724-1804) called it.

To explain, a priori here means knowledge that comes to us before, or irrespective of, sensory experience. A priori knowledge is within our minds, so to speak. It is knowledge about the real world (reality), and for obtaining it one does not have to take recourse to observation, it is embedded knowledge.

Example: if this thing is 1 ft long, it is not, and cannot be, 2 ft long.

The above is a priori true, as one would not have to test it to prove it.

Synthetic means adding a predicate to a concept that is not thought in the concept before.

Example: all bodies (the concept) are heavy (the predicate).

One has to learn from experience that bodies are heavy; one does not know this a priori. Synthetic judgments are a posteriori.

Mr. Kant maintained that there is the possibility of so-called a priori synthetic judgments: judgments that neither repeat the meaning of concepts tautologically nor express new information about the subject term on the basis of experience.

According to Kant, a priori synthetic judgments must meet two requirements.

1. They must not be derived from experience but from reflection.

2. They must be self-evident, that is, their truth value cannot be denied without running into an intellectual contradiction.

Mises's axiom of human action meets both of these requirements. The axiom of human action is not derived from sensory observation. To understand that humans act stems from a reflective understanding, not from observation.

So it is self-evident.

The truth value of the axiom of human action cannot be denied, as such a denial would be a form of action and thus contradict the very statement that there cannot be such a thing as human action.

Praxeology, therefore, provides us with true knowledge about the outer world, and the truth of knowledge derived from praxeology is valid independent of sensory experience. It is in this sense that we can speak of praxeology as a priori theory.

An a priori economic proposition informs us about the relationships between observable events and the counterfactual alternatives to these events; it does not concern relationships between various observable events.

An a prioristic proposition allows us to name the outcome of a certain action with certainty. For instance, if the stock of money is increased, we know for sure that it will lower the exchange value of a money unit.

We know that the law of diminishing marginal utility is implied in the axiom of human action.

This law says that the marginal utility of a unit, that is the utility of an additional unit of the good, declines if the supply of the good increases all other things being equal.

An additional money unit in one's possession can only be employed as a means for removing an uneasiness that is deemed less urgent than the least urgent one that has so far been satisfied by the unchanged size of money units in one's possession.

We can then say with certainty that a rise in the money stock necessarily reduces the exchange value of a money unit when compared to a situation in which the money stock had remained unchanged.

This is not to say that a prioristic propositions allow us to make exact forecasts in a quantitative sense.

For instance: we do not know when and by how much the exchange value of a money unit declines if and when the money stock rises.

The a priori theory tells us in advance (without having to run a social experiment) whether or not a given action, or policy measure can or cannot bring about the desired and promised effects.

For instance: we know with certainty that a rise in the money stock will never be neutral in the sense of leaving market agents' income and wealth positions unaffected. A rise in the money stock will always benefit some at the expense of others. It is impossible to think otherwise.

As action requires time, with time being a category of human action, a rise in the money supply benefits the early receivers of the newly created money at the expense of the later receivers of the new money or those who don't receive any of the new money (known as the Cantillon effect ).

What follows explains that the sound-money principle can be traced back to the axiom of human action.

To do so, one has to start with stating some true propositions that can be logically derived from this axiom.

The irrefutably true axiom of human action tell us that human action is purposeful action: means are employed to achieve ends.

We also know that means are scarce with regard to the services for which man wants to use them. Where man is not restrained by the insufficient quantity of things available, there is no need for any action, and this is impossible to think, and because of the scarcity of means, we also know that man prefers more goods over fewer goods.

So, assuming that people realize that the division of labor yields a higher productivity than self-sufficient production (an assumption), they will engage in specialization and trade.

Trading becomes most efficient if people make use of an indirect means of exchange.

Exchanging goods against a good that has a higher marketability expands actors' markets, allowing them to take full advantage of the productivity gains provided by the division of labor.

The commodity with the highest marketability will be chosen as Money.

Mises described the process this way: 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.

The Big Q: why is money chosen by the unhampered market necessarily commodity money, as Mises and Carl Menger maintained?

The Big A: in Y 1912, Mises had shown with his regression theorem that money must have emerged, for a prioristic considerations, from a commodity.

People demand Money because there is uncertainty, which, in turn, is a category of human action, and Money helps to deal with uncertainty: It can be exchanged against other vendible items most conveniently, as it has purchasing power.

The purchasing power of Money is determined by the supply of and the demand for money.

But isn't such an explanation circular? If the purchasing power of money is determined by the supply of and demand for money, how can this explain the demand for money, which is, in turn, determined by the purchasing power of money?
Mises with his regression theorem found the answer to this question. He explained that the demand for Money in the present is explained by Money's purchasing power experienced in the (immediate) past.
He saw that the purchasing power of Money can be regressively traced back to the point in time when a commodity, which had previously been used only for non-monetary purposes, is used for monetary purposes for the 1st time.

From a praxeological viewpoint one concludes that in a free market, one where people are assumed to be governed by self-interest and have the ability to appreciate the higher productivity resulting from a division of labor, Money must emerge in the form of commodity Money, and that free-market Money means sound Money.

Against this backdrop the following Big Questions come up:

How can it be that today's Moneys, the USD, the Euro, the Chinese RMB (Yuan), the GBP or the Swiss franc are no longer commodity moneys?

How can it be that they are not produced freely in the sense of complying with free-market principles?

Today's moneys are so-called Fiat Moneys: Moneys that represent intrinsically valueless paper tickets or bits and bytes on computer hard disks; they are not redeemable into anything. These Fiat Moneys are produced by government-sponsored central banks, which hold the Money production monopoly.

We know from history that the Gold Standard was replaced by Fiat Money. Mainstream economists maintain that this happened because the Gold Standard failed, as it did not allow for a flexible, or politically motivated, increase in the money supply.

But, a priori theory offers a different explanation of why the Gold Standard (Sound Money) was replaced by a Fiat-Money standard (unsound Money). The central element in this a priori theoretical explanation is the concept of the State.

Murray N. Rothbard ( a new Austrian theory of the State, defining it as follows: the State is that organization in society which attempts to maintain a monopoly of the use of force and violence in a given territorial area; in particular, it is the only organization in society that obtains its revenue not by voluntary contribution or payment for services rendered but by coercion.

Rothbard not only explained that the state is incompatible with the free-market society; he also outlined in What Has Government Done to Our Money? how and why Commodity Money was replaced by Fiat Money, namely, because of the continual expansion of the state.

Hans-Hermann Hoppe ( ) has explored in great detail the logical-ethical-economic implications of public ownership of government, as represented by Democracy-Republicanism, showing that once public ownership of government is put into place, ever-greater violations of individual property rights will be the logical consequence.

Three interrelated factors explain this: 1. Under public ownership of government there will be temporary caretakers of government power; so-called politicians, or the ruling class. Assuming self-interest on their part, the caretakers of government will use their temporary government power to their own advantage, 2. The caretakers of government will maximize their current income rather than the present value of all future government revenues. For what the temporary caretaker of government does not consume when he holds government power, he will not be able to consume in the future, and 3. Public ownership of government means that those who want to be among the ruling class need the support from the majority of the people. The latter, also assumed to be driven by self-interest, will support those who will provide them with the desired monetary and non monetary benefits.

The caretakers of government will have to win over as many voters as possible to get into and stay in power. This can only be achieved by promising, and providing, potential voters with benefits they otherwise would not, or could not, obtain. These benefits will have to be expropriated, and necessarily so, from others.

Assuming that voters prefer more over fewer goods, a logical implication of the axiom of human action, it becomes obvious why public ownership of government will necessarily result in progressive violations of individuals' property rights.

Some forms of private-property violations are more advantageous for bringing about a coercive redistribution of income and wealth than others, both from the viewpoint of the rulers and the ruled.

The using of Fiat Money is, politically speaking, more attractive than other forms of expropriation such as raising taxes. Having recourse to Fiat Money, Mr. Rothbard noted, government can then appropriate resources slyly and almost unnoticed, without rousing the hostility touched off by taxation.

Mr. Rothbard described the various steps through which Commodity Money is replaced by Fiat Money, including; monopolizing the minting business, giving money a name rather than defining it as a weight of the commodity it represents.

The last step in replacing Commodity Money by Fiat Money is allowing banks to suspend the redemption of outstanding bank notes and demand deposits in money proper which was in practice, Gold.

This happened on 15 August 1971, I remember it clearly, in the United States, when Richard Nixon, the then President, closed the Gold window. In his television address, President Nixon said, I have directed US Treasury Secretary Connally to suspend temporarily the convertibility of the American Dollar except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.... The effect of this action, in other words, will be to stabilize the Dollar.

Mr. Nixon's order meant that the US Dollar was no longer redeemable in Gold. The measure was not temporary, as it is still in place, plus it did not stabilize the US Dollar: between August 1971 and July 2011, the Greenback lost 82% of its purchasing power, based on consumer prices.

Under the Bretton Woods system ( ), all major currencies; the GBP, the French Franc, the Japanese Yen, to name a few were linked to the USD.

With the suspension of the redeemability of the Greenback in Gold, all these currencies were also cut loose from Gold. Commodity Money became Fiat Money.

That said, replacing Commodity Money by Fiat Money, that is, replacing the sound-Money principle by the unsound-Money principle is, from a praxeological viewpoint, the logical consequence of public ownership of government.

Another Big Q: what has a priori theory to say about the question of whether Fiat Money can last, or whether it will have to collapse?

The answer can be found within Austrian trade-cycle theory, or with 2 important implications, which may escape attention: 1. Ongoing injections of Fiat Money produced through bank-circulation credit to fight the crisis caused by Fiat Money expansion in the 1st place prevent unprofitable investments from being liquidated, as they can be refinanced at lower interest rates and appear to be profitable, and 2. Artificially suppressed interest rates, brought about by an expansion of bank-circulation credit, encourage investment projects that would not have been undertaken if the market interest had not been pushed down by central-bank policy.

The consequence of these 2 aspects is that the economy's overall debt load keeps growing at a faster rate over time than real incomes, leading to a situation of over indebtedness (sooner or later), in particular if and when government is in the hands of temporary caretakers.

A Fiat Money regime will finish logically in a situation in which borrowers will no longer be in a position or willing to service their debt, and lenders will no longer be willing to rollover the maturing debt. It is at this stage when the printing of ever-greater amounts of Fiat Money will be seen as the policy of the least evil.

This too, is a praxeological inference.

To explain: public ownership of government reduces the economic incentive to limit aggression against individuals' property rights. It reduces peoples' encompassing interest in the market economy by increasing their interest in transfer incomes. It increases the societal time preference, thereby lowering savings and investment and thus economic progress.

Government beneficiaries, such as those employed by government or firms receiving orders from the public sector will increasingly be in favor of an expanding government, as big government will give them the opportunity of bigger business and higher monetary and non monetary income, thus setting into motion a process where ever-greater numbers of people team up with government.

Frederic Bastiat ( describes the underlying logic briefly and to the point : Government is that great fiction, through which everybody endeavors to live at the expense of everybody else.

It was actually in accordance with praxeology when Mr. Mises concluded as early as in Y 1923, before he put forward praxeology, that under public ownership of government, Fiat Money will be progressively debased, or completely destroyed: if a government is not in a position to negotiate loans and does not dare levy additional taxation for fear that the financial and general economic effects will be revealed too clearly too soon, so that it will lose support for its program, it always considers it necessary to undertake inflationary measures. Thus inflation becomes one of the most important psychological aids to an economic policy which tries to camouflage its effects.... By deceiving public opinion, it permits a system of government to continue which would have no hope of receiving the approval of the people if conditions were frankly explained to them.

In summary: Mr. Mises's sound-Money principle can be logically deduced from the axiom of human action, that which is at the heart of praxeology; the sound-Money principle is axiomatic in nature.

This is all the more important as the sound-Money principle has been replaced by the unsound-Money principle the Worldwide now: 1. money production is monopolized by government, and 2. government's power over money production is leading to ever-greater violations of individuals' private-property rights.

It is in this way that Fiat Money is instrumental in eroding the fundament of the Free Market order, increasingly transforming it into a Socialist order.

The way back to the sound-Money principle is theory dependent. Mr. Mises wrote: the belief that a sound monetary system can once again be attained without making substantial changes in economic policy is a serious error. What is needed first and foremost is to renounce all inflationist fallacies. This renunciation cannot last if it is not firmly grounded on a full and complete divorce of ideology from all imperialist, militarist, protectionist, statist, and socialist ideas.

To Mises, a return to the sound-Money principle must start with unmasking the false theories. This is because theories are at the heart of human action: Actions are preceded by thinking.... He who thinks a causal relation thinks a theorem. Action without thinking, practice without theory are unimaginable.

A priori theory is a powerful intellectual tool for classifying theories as true or false. In fact, a priorism allows for the unmasking of false economic theories exante, theories that make false promises, resulting in detrimental and/or disastrous consequences if put into practice.

Making use of a priori theory shows that free-market Money is sound Money, and that deviating from the sound-Money principle leads to disastrous economic, social, and political damage.

To return to sound Money, the a prioristic nature of the sound-money principle must be understood, and so Mises's work on the methodology of the science of Economics deserves attention.

Paul A. Ebeling, Jnr.

Paul A. Ebeling, Jnr. writes and publishes The Red Roadmaster's Technical Report on the US Major Market Indices, a weekly, highly-regarded financial market letter, read by opinion makers, business leaders and organizations around the world.

Paul A. Ebeling, Jnr has studied the global financial and stock markets since 1984, following a successful business career that included investment banking, and market and business analysis. He is a specialist in equities/commodities, and an accomplished chart reader who advises technicians with regard to Major Indices Resistance/Support Levels.