In his second response, Mount Chapter 3, Nate provided four categories of money:
- Commodity money
- Fiat money
- Money certificates
- Credit money
He also answered my questions, which I shall summarize as follows:
- When they function like money, gold and silver are commodity money, as evidenced by the historical preference for them.
- Federal Reserve Notes are fiat money, with some characteristics of credit money.
- TMS2 does not represent his definition of the money supply, but serves as a useful tool for estimating it.
- All of the categories in TMS2 are fiat money; some may be credit money as well.
It was a strong and informed response, much better than one would likely receive from a professional economist or a central banker. Two of his answers were also incorrect, for reasons I shall presently demonstrate.
Nate’s first mistake is the identification of credit money as fiat money, even though he clearly has his suspicions concerning the problematic nature of the distinction as it applies to the US monetary system. That this distinction is false can be demonstrated in two ways, first with a legitimate appeal to authority and history, and second by the money creation process.
With regards to the first point, Mises writes:
“It can hardly be contested that fiat money in the strict sense of the word is theoretically conceivable. The theory of value proves the possibility of its existence. Whether fiat money has ever actually existed is, of course, another question, and one that cannot off-hand be answered affirmatively. It can hardly be doubted that most of those kinds of money that are not commodity money must be classified as credit money. But only detailed historical investigation could clear this matter up.”
– The Theory of Money and Credit, p. 61
So, we recognize that while fiat money can potentially exist in theory, the question of its actual existence, in the United States or anywhere else, is not settled. Nate himself notes that Federal Reserve Notes have some characteristics of credit money and that some of the categories in TMS2 may be credit money, but he fails to take the critical step, which is to recognize that the reason they have those characteristics is that they are credit money. Note in particular the statement that most kinds of money that are not commodity “must be classified as credit money”.
This leads us to our second point. The “fiat money” of TMS2 includes Demand Deposits, Other Checkable Deposits at Commercial Banks, Other Checkable deposits at Thrifts, Savings deposits at Commercial Banks, Savings Deposits at Thrifts, Demand Deposits, Time and Savings Deposits, and US Government Demand Deposits, among other things. But from whence do these deposits come? We know they are not simply printed by either the U.S. government or the Federal Reserve; there is simply not enough currency to account for them.
Clarity is established here via the the endogenous vs exogenous money debate. We’re not likely to get sidetracked here, because Nate ultimately comes down on the endogenous side, he simply hasn’t connected it to his conception of fiat money. Mises, too, comes down firmly on the side of endogenous money, as evidenced by the following passage:
“It is not the State, but the common practice of all those who have dealings in the market, that creates money. It follows that State regulation attributing general power of debt-liquidation to a commodity is unable of itself to make that commodity into money. If the State creates credit money – and this is naturally true in a still greater degree of fiat money – it can do so only by taking things that are already in circulation as money substitutes (that is, as perfectly secure and immediately convertible claims to money) and isolating them for purposes of valuation by depriving them of their essential characteristic of permanent convertibility. Commerce would always protect itself against any other method of introducing a government credit currency. The attempt to put credit money into circulation has never been successful, except when the coins or notes in question have already been in circulation as money substitutes.”
– The Theory of Money and Credit, p.78
The significance of endogenous money to us here is that it shows that deposits of the sort that make up the TMS2 are created by loans. They are, to the extent they can be considered money at all, quite literally credit money. As the market in commercial paper demonstrates, these loans, these future claims, whether created by the central bank, the member banks, or other corporations, have become a commodity in their own right.
And yet, although we can establish that M1, M2, TMS2 all consist of credit money, none of these various money supply measures can be considered money by our original definition, even with its stamp of fiat approval, because the credit money concerned is not directly convertible into commodity money on demand and has not been since 1971. Despite its use in exchanges, by our agreed-upon definition, this credit money merely represents claims to money rather than money proper, it is a money-substitute money surrogate, which Mises rather confusingly describes as “fiduciary media”.
(“We shall use the term Money Certificates for those money substitutes that are completely covered by the reservation of corresponding sums of money, and the term Fiduciary Media for those which are not covered in this way.” Mises, p. 133)
At this point, it is understandable if the mind shies away from the inescapable logical conclusion. The question of inflation and deflation of the U.S. money supply is a category error, because there is no U.S. money supply. This category error and failure to understand that what we have been taught to consider money is merely a money-surrogate is why all of the various quantity theories and complicated attempts to calculate the money supply and predict the consequence of changes in it go so reliably awry, because they are attempting to estimate something by looking at the derivative without realizing that it is a derivative.
To put it in more straightforward terms, while there is no U.S. money supply, there is a money-surrogate supply that consists of fiat-backed credit money. This was inevitable with the introduction of money-surrogates, given Gresham’s Law, which is popularly summarized as “bad money drives out good money”, and which I would modify as “surrogate money drives out genuine money when it is assigned exchange value by the State”. This has considerable implications that go well beyond the simple question of inflation versus deflation and merits serious contemplation, however, what concerns us is the three questions it raises that are directly pertinent to the current debate:
- What is the best measure of the money-surrogate supply?
- Is the money-surrogate supply growing or shrinking?
- To where has the genuine money been driven?
In conclusion, I will note that the great Austrian sage recognized and prophetically described the very process of transition from commodity money to credit money, from genuine money to money surrogate, that we have seen take place in American history, although he appears to have been more than a little naive concerning how the diminution of purchasing power might be considered desirable by those in a position to systematically benefit from it. In the chapter entitled “Influence of the State”, he wrote:
“The exaggeration of the importance in monetary policy of the power at the disposal of the State in its legislative capacity can only be attributed to superficial observation of the processes involved in the transition from commodity money to credit money. This transition has normally been achieved by means of a State declaration that inconvertible claims to money were as good means of payment as money itself. As a rule, it has not been the object of such a declaration to carry out a change of standard and substitute credit money for commodity money. In the great majority of cases, the State has taken such measures merely with certain fiscal ends in view. It has aimed to increase its own resources by the creation of credit money. In the pursuit of such a plan as this, the diminution of the money’s purchasing power could hardly seem desirable. And yet it has always been this depreciation in value which, through the coming into play of Gresham’s Law, has caused the change of monetary standard.”
– The Theory of Money and Credit, p.77