by Thomas Allen

One of the debates that economists had during the era of the gold-coin standard[i] was whether the monetary value of the gold coin determined the value of gold bullion or gold bullion determined the value of the gold coin. Is the value of each unit of money determined by the value of the bullion in each unit? Or, is the value of bullion in each unit of money determined by the value of the monetary unit? In other words, is the monetary unit the independent variable, or is gold bullion the independent variable?[ii]

In his book Money (1882), George Weston argues that the value of bullion is determined by the value of coin, the monetary unit. The value of coin is determined by the quantity of coins and paper money. Weston is a proponent of the quantity theory of money. Other things being equal, the quantity of money fixes the value of the monetary unit, which he usually seems to mean its purchasing power. This is true not only for inconvertible fiat government paper notes, it is also true of full-weight gold coins and other types of money. According to him, governments can keep their government notes from deprecating by properly controlling their quantity. Moreover, he seems to prefer fiat paper government notes to full-weight gold coin. (A full-weight gold coin is a coin whose monetary value equals the value of its gold content.)

Weston believes that a parity between full-weight coin and paper money can be permanently maintained by limiting the quantity of paper money. Moreover, he contends that controlling the quantity of paper money is more reliable than redeeming paper money in coin on demand, which he considers to be “hopelessly treacherous as it is costly and clumsy.” He adds that using the requirement to redeem bank notes in gold coin on demand to regulate the issue of bank notes is “false and fraudulent . . . and had proved itself in practice one of the worst scourges which has ever afflicted mankind.” Such a system causes the quantity of money to fluctuate too much. A superior system is to use the price of gold to regulate the issue of inconvertible paper money. Perhaps, he is correct, but no government has ever achieved the goal of maintaining parity or near parity of paper money with coin or bullion for more than a few years without redemption. Furthermore, rarely does a government use the price of gold to regulate the issue of inconvertible paper money. Such methodology is too restrictive and obviates the purpose of resorting to inconvertible paper money, which is to issue money based on politics and not on economics.

Weston prefers a static supply of bank notes as the banking systems of England and most other European countries had where nearly all bank notes were backed by gold coin. A major problem with this static money supply is that to fit periods of high demand for notes, such as around Christmas, a large quantity of notes has to remain unused in vaults for most of the year. European countries overcame this inelasticity problem with checkable deposits, which Weston rejects as money. By expanding checkable deposits when demand was high and contracting them when demand was low, banks satisfied the markets’ monetary needs.

Moreover, Weston believes that the law gives gold its value. Furthermore, the value of gold as merchandise is not an element constituting its value as money. This monetary value of gold can be regulated by varying the quantity of paper money in circulation. Increasing the quantity of paper money decreases the value of gold coin. Here he seems to confuse value with purchasing power. The two are different. Besides, increasing the quantity of paper money does not always lead to a decline in purchasing power of gold coin. In the United States, during the last quarter of the nineteenth century, the purchasing power of gold coin rose while it was accompanied by a rising supply of paper money (some fiat like the U.S. note[iii] and some not like national bank notes[iv]) and legal-tender silver dollars.[v] However, fiat paper money and fiat silver dollars may have prevented prices from declining more than they did.

Also, Weston seems to believe that gold and silver are not money (Murray Rothbard strongly disagrees; he declares that gold is money, whatever its form.) People desire them because of ease of converting them to money — presumably, he means coin and possibly bullion as reserves for paper money. However, gold bullion has been used as money, and not merely as backing for paper money, before and after coinage.

According to him, civilized people today (1884) do not desire gold for ornamentation but solely for its use as money. If true, the manufacturing of gold jewelry would be an unprofitable undertaking.

Weston claims that silver coin can be kept at parity with gold coin by limiting the quantity of silver coins. He cites several examples in Europe. Silver coins in the countries that he mentions were either subsidiary coins to gold coin or soon became subsidiary coins. These countries were on the gold standard, and their silver coins were convertible to gold either directly or indirectly. This convertibility — not their quantity — kept the monetary value of these coins at par with gold coin, although the silver content of these coins was worth less than the monetary value of the coin. (If the monetary value of a coin fixes the value of its bullion content as Weston contends, why did not the value of silver rise to match the monetary value of the silver coin?)

Weston seems deceitful about subsidiary coins and uses them to support his contention that the metal content of a coin does not determine the value of the coin, but the value of the coin determines the value of its metal content. Subsidiary coins are token coins used for transactions so small that full-weight gold coins cannot be used without receiving change in token coins. Moreover, token coins can be redeemed in gold coin. If a subsidiary coin is to circulate, the value of its metal content has to be less than its monetary value or else it will be melted for its metal.

Nevertheless, his comments on the European silver coins fit the silver dollar in the United States at that time. The silver dollar was fiat money whose quantity was fixed by Congress and the Secretary of the Treasury. According to Weston, it was kept at par with the gold dollar by limiting the quantity of silver dollars manufactured. Although the value of the metal content of the silver dollar was worth less than a dollar, Congress declared the silver dollar to have a legal-tender value of one dollar. Although the silver dollar could not be directly converted to gold, it could be converted indirectly to gold. One means of achieving this conversion was to deposit silver dollars in a bank and then withdraw the money in gold coin. This indirect conversion to gold kept the silver dollar at par with gold.

Historical examples argue against Weston’s position. As shown below, the value of bullion controls the value of the coin, and not the monetary value stamped on the coin.

In 1985, Congress authorized the minting of a one-ounce gold coin with a legal tender value of $50 and a one-ounce silver coin with a legal tender value of $1. This action occurred 14 years after gold had ceased having any formal part of the world’s monetary systems. Likewise, it occurred decades after silver had any formal part of the world’s monetary system except as subsidiary coins, which use ended in the mid-1960s.

If the monetary value of gold coin determined the value of its gold bullion content, which was $327 at end of 1985, then the gold coin should have pulled the value, price, of bullion down to $50 per ounce. Instead of the coin pulling the value of bullion down, bullion raised the value of the coin up. Likewise, silver bullion in the one-ounce $1 silver coin raised the value of the coin instead of the silver coin pulling the value of bullion down to $1 per ounce.

Under the Bretton Woods system, the US government guaranteed the US dollar to have the value of one thirty-fifth of an ounce of gold and exchanged one ounce of gold at the rate of $35 per ounce when a foreign government or its central bank redeemed its dollars. During the 1960s, the value, price, of gold bullion rose above $35 per ounce. If Weston were correct in that the value of the monetary unit determines the value of bullion, such a dichotomy could not have occurred. The price of gold could not have risen above $35 per ounce. As a result of the divergence between the monetary unit and bullion, the Bretton Woods system was abandoned in 1971.

The same effect occurred in Weston’s day when Congress authorized the issuance of government notes called US notes and nicknamed greenbacks. Soon after issuance, the $10 US note began trading at a discount to the $10 gold coin. Although the magnitude of the discount varied, the US note did not exchange at par with gold coin until it became redeemable in gold. If the monetary unit determines the value of bullion, then the $10 US note should have remained at par with the $10 gold coin. Moreover, if the monetary unit determined the value of bullion, then subsidiary silver coins should have remained in circulation. They did not. For several years subsidiary silver coins ceased circulating because their value as bullion exceeded their value as money.

According to Weston, the value of the dollar is determined by the quantity of coin and paper money. As S. McLean Hardy’s statistical study shows, during the War, the value of the dollar had more to do with Confederate victories and defeats than with its quantity. Confidence, not quantity, gives inconvertible paper money its value, although its quantity affects confidence. Convertibility gives paper money its value whatever its quantity.

Weston does acknowledge that paper money can depreciate against gold coin and cause gold coins to cease circulating. How can this be if the value of money determines the value of gold bullion in the coin? How can the value of the bullion content of a $10 gold coin rise above the $10 monetary value stamped on the coin, if the monetary value of the coin determines the value of its bullion content? The experience that he witnessed with the US note proves that the value of the monetary unit does not fix the value of its bullion content.

Centuries before the first precious metal coin was ever minted, people bought and sold goods and services with gold and silver bullion. Genesis 23:16 records such an event when Abraham bought a burial plot for his deceased wife by weighing out silver.

More proof that a coin’s bullion content governs its monetary value is that well-worn coins exchange by their weight rather than by the monetary value stamped on them unless the law prohibits such discounting. In which case, the law is often ignored by refusing to accept the worn coin in trade at its full monetary value. (Unfortunately, creditors often had to accept worn coins in payment of debt.) Some countries under the gold standard allowed by law exchanges of well-worn coins by weight rather than by tale. Even in some countries that prohibited such discounting guaranteed the full-weight of their coins by exchanging new full-weight coins for worn coins.

Weston asserts that suspension of the gold standard, i.e., the suspension of convertibility of paper money, in one country adds to the number of gold coins in other countries. The resumption of the gold standard, i.e., returning to convertibility of paper money in gold coin, draws gold coins from other countries. He ignores the large sink of hoarded coins, gold bullion, jewelry, ornamentation, plate, and other gold products that can absorb the excess gold under suspension and can return it under resumption. Thus, according to him, the abandonment of the gold standard in one major commercial country causes the value of gold in other countries to fall. Resumption of the gold standard causes the value gold in other countries to rise.

When a country suspends species payments, Weston claims that its coins flow to other countries and reduce the value of money, and by that, the value of gold, in these countries. If so, the effect is only temporary. The value of gold as bullion and in coin is nearly equal worldwide. Moreover, the global quantity of gold available for monetary use is so massive compared with what may flee one country that the effect of the fleeing gold would be small or even insignificant. Weston would counter that this new supply of gold is sufficient to lower its value worldwide.

If Weston is correct in that whatever gold that flees a country that has suspended the gold standard flows into the monetary system of other countries, only a small part will end up in circulating gold coins. Most will go to banks as deposits and become the basis for credit expansion. Most of the money created by this expansion will be as checkable deposits while some will be as bank notes. This credit expansion is what causes monetary inflation and the resulting rising prices. Its contraction results in deflation and decline in prices. However, many problems associated with credit expansion can be avoided by using sound banking practices (not fractional reserve banking practices, which allows multiple parties to use the same money simultaneously). Sound banking practices include not borrowing short and lending long and backing all checkable deposits 100 percent with full-weight coin or commercial money.[vi] (Commercial money is a real bill of exchange that is self-liquidating usually within 90 days or less; it can only function under a commodity standard like the gold standard.)

The decline in purchasing power, Weston contends, results from a reduction in demand for gold as coin when the gold standard is suspended. However, he claims that the loss in purchasing power results from a loss of the value of gold coin. The reverse occurs when the gold standard is resumed and paper money is again convertible in gold. Purchasing power of coin and paper increases because the value of gold increases. He ignores the quality of money theory, which explains the fall and rise of money’s purchasing power, which he calls value. When the gold standard is suspended, low-quality inconvertible paper money, which has less value and purchasing power than gold, replaces gold coin. When the gold standard is resumed, a high-quality money, gold coin and paper money convertible in gold, replaces low-quality inconvertible paper money.

Moreover, he seems to credit the rise and fall in prices mostly on changes in the supply and demand for monetary gold. He sees the changes in prices being caused by changes in the value of gold. He ignores changes in credit money, except bank notes, which he considers to be real money and not credit money,[vii] have much more effect on prices than changes in the supply of gold.

Weston fails to explain how the monetary unit gets its initial value. Under the gold standard, the monetary unit gets its value from gold. The monetary unit is defined as a specific weight of gold and the monetary unit has the value of that weight of gold. For example, the Gold Standard Act of 1900 defined the dollar as 23.22 grains of gold. Therefore, the dollar had the value of 23.22 grains of gold. This is more proof that the monetary unit derives its value from its metal content as the value of bullion precedes the monetary unit.

This notion Weston rejects. He claims that the value of the monetary unit, the dollar, gives the 23.22 grains of gold its value. The dollar may give 23.22 grains of gold its price, but it does not give the gold its value. Value and prices are not the same things. Value is subjective; price is objective. Moreover, not everything that has value, has a price; for example, love of one’s mate and children has great value but no price.

An example of the difference between price and value is that, under the gold standard, when a person buys a shirt for $10, the shirt has the value of 232.2 grains of gold and a price of $10. (Today, when one buys a shirt with a $10 federal reserve note, what is the value of the shirt? Without defining the dollar in terms of itself, which is a poor and unsatisfactory definition that should be unacceptable and not used, such as the value of the dollar is a dollar’s worth of goods, no one can definitively define the value of the dollar.)

Before any commodity became money, a medium of exchange, it had to have value independently of its monetary use. Its monetary use adds to its value as a commodity, but does not create it. Weston acknowledges that gold had value as ornamentation, etc. before being coined, and its uses as coin add to that value and even gives gold its highest actual value. If true, no gold coin would ever be melted for use as ornamentation, for the highest value of gold is that in the form of a coin. However, as gold coins were often melted for their gold and that gold was used for other purposes, gold as coin is not always its highest use.

Moreover, Weston is unclear about how paper money gets its value other than the government limiting its quantity. How this limitation initially gives paper money, especially inconvertible paper money, its initial value, he does not explain. Convertible paper money derives its value from the gold that it represents. Inconvertible paper money derives its value from the gold coin that it replaces. Quantity has nothing to do with this initial value.

In his argument to prove that coin fixes the value of bullion, Weston shows that government can easily manipulate their monetary systems and the purchasing power of their money — usually to the detriment of the people. However, he fails to identify or to describe a governmentally manipulated monetary system that works better than, or even as well as, the gold-coin standard accompanied by a well-functioning credit system, although as an example, he offers Brazil, which used the price of gold as an index to regulate its fiat paper money supply.

Under the gold-coin standard, the government does not regulate the quantity of gold coins produced. However, it often intervenes to restrict the quantity of bank notes issued, although such intervention is not necessary and probably undesirable as it can distort the markets. Market forces decide the quantity of gold coins minted and gold coins melted. When the government does not intervene, and to some extent, even when it does, market forces regulate the quantity of bank notes issued.

Whether bank notes and government notes[viii] are convertible or inconvertible to full-weight gold coin, Weston argues that they are money in their own right. They are real money and are not merely forms of credit money. True, they are used as a medium of exchange. Also, when they are inconvertible, they nearly always become the unit of account, especially if the government makes them legal tender. However, real money like full-weight gold or silver coin performs one monetary duty that these notes cannot perform. That is, full-weight coin not only discharges debt, it also extinguishes debt because it is no one else’s liability. Bank notes and government notes can only discharge debt. They do so by passing the obligation to another, which is ultimately the person or entity responsible for the note.[ix] For example, the US government is the responsible party for today’s federal reserve note. Contrary to Weston’s assertion, bank notes and government notes are not real money; they are credit money and cannot extinguish debt.

Weston rejects the notion that bills of changes and checkable deposits are money. According to him, they do not have the effect as bank notes and do not increase the quantity of money. Today, as checkable deposits far exceed bank notes as money in industrialized countries, most monetary disturbances like inflation comes from changes in checkable deposits than fluctuation in bank notes.

Therefore, Weston’s quantity theory of money ignores commercial money, real bills of exchange, as part of the quantity of money. Like bank notes, commercial money is a form of credit money that can be used to purchase goods and discharge debts. Unlike bank notes, commercial money has a specific life, usually 90 days or less, before it expires. Commercial money often exceeds bank notes in quantity and even exceeds the quantity of coins and paper money. If the quantity of money is the sole determinant of the value of money, other things being equal, as Weston asserts, or even the primary determinant, then how can he ignore commercial money? Nevertheless, Weston rejects the notion that bills of exchange are money and, therefore, need no consideration as part of the quantity of money or any quantity of money theory.

Likewise, Weston’s quantity theory of money also ignores checkable deposits, checkbook money, as part of the quantity of money. Like bank notes, checkable deposits are a form of credit money that can be used to purchase goods and discharge debt. Unlike bank notes, which can pass through many hands before returning to a bank, checks usually pass through only one or two hands before returning to a bank. The major difference between a bank note and checkbook money is that a bank note is an order drawn on a bank to transfer gold from the bank’s account to the bearer and a check is an order to transfer gold from the drawer’s account to bearer. In Weston’s time (1884), in the United States, checkable deposits exceeded bank notes and coin in purchasing goods and discharging debt. He acknowledges that checks are used for most transactions. Moreover, under fractional reserve banking, which was practiced in his day as it is today, checkable deposits exceed species, commercial money and in Britain bank notes and in the United States silver dollars and US notes held by the bank; thus, they exceed what Weston considers real money. Any quality of money theory that ignores checkable deposits is a highly deficient theory. Nevertheless, Weston rejects the notion that checkable deposits are money and, therefore, need no consideration as part of the quantity of money or any quantity of money theory.

A bank note is merely a check that a bank writes on itself. (Under the system advocated by Weston as modeled after the British system after 1844, this is not the case. Under the British system, what were called bank notes were similar to gold certificates issued in the United States. Whereas gold certificates were fully backed by gold, a fraction of the British notes was backed by nontradable government securities. Like gold certificates, they were warehouse receipts promising to pay the bearer in gold. Unlike US gold certificates, which were not legal tender, British notes were legal tender. Although Weston implies that making bank notes legal tender makes them real money, he seems to accept gold certificates as real money though they were not legal tender.) A bank note, even if it is merely a warehouse receipt, is a credit instrument because it is someone else’s liability. Weston rejects the notion that bank notes are credit instruments: a check that the issuer writes on itself to pay the bearer money, i.e., gold coin. To him, bank notes are money in their own right and are not promises to pay money, i.e., gold coin.

An interesting note cited by Weston is that John Stuart Mills mused that under the right conditions, deposits and checks might replace currencies altogether. Weston thought that such a replacement was absurd. However, today, most countries are moving to eliminate currency and to force people to use bank deposits and checks, preferably with debit cards instead of paper checks. If this happens, the quantity of money, according to Weston’s theory, goes to zero: Money would cease to exist by his definition of money. Then what would fix the value of gold bullion?

Weston displays inordinate confidence in the government to manage the country’s monetary system. As the history of the last 100 years shows, governments are highly incompetent in managing their monetary systems if the objective is to avoid inflation, hyperinflation, panics, depressions, recessions, and other economic and monetary disturbances and disasters. If the objective is to transfer wealth and power from the common people to the rich and powerful, they has been highly successful.

When his quantity theory of money fails, Weston has an out, which is “everything else being equal.” When it fails, it is because “everything else is not equal.”

In conclusion, Weston argues that the value of gold bullion does not control the value of gold coin or paper money kept at par with it. To the contrary, the opposite is true: The maximum value of gold bullion fluctuates with and is regulated by the value of gold coin and paper money at parity with gold coin. Moreover, the value of the monetary unit depends, other things being equal, on the quantity of monetary units, both coin and paper money.

Weston errs when he claims that the value of the monetary unit gives gold bullion its value. To the contrary, the value of gold bullion gives the monetary unit its value. The value of gold preceded its use as money, and its use as money preceded its use as coin. Weston confuses value with price. The monetary unit gives gold its price, which is objective, but it does not give gold its value, which is subjective.

Endnotes:

[1]. See “What is the Gold Standard” by Thomas Allen.

[1]. See “Is the Price of Gold Fixed Under the Gold Standard” by Thomas Allen.

[1]. See “The U.S. Note, 1862-1879″ by Thomas Allen.

[1]. See “National Banking System” by Thomas Allen.

[1]. See “The Silver Dollar 1873-1900″ by Thomas Allen.

[1]. See “Real Bills Doctrine” by Thomas Allen.

[1]. See “Differences Between Real Money and Fiat Money” by Thomas Allen.

 

[1]. See “Difference Between Bank Notes and Government Notes” by Thomas Allen.

[1]. See “Extinguishing Debt” by Thomas Allen.

[i]. See “What is the Gold Standard” by Thomas Allen.

[ii]. See “Is the Price of Gold Fixed Under the Gold Standard” by Thomas Allen.

[iii]. See “The U.S. Note, 1862-1879″ by Thomas Allen.

[iv]. See “National Banking System” by Thomas Allen.

[v]. See “The Silver Dollar 1873-1900″ by Thomas Allen.

[vi]. See “Real Bills Doctrine” by Thomas Allen.

[vii]. See “Differences Between Real Money and Fiat Money” by Thomas Allen.

[viii]. See “Difference Between Bank Notes and Government Notes” by Thomas Allen.

[ix]. See “Extinguishing Debt” by Thomas Allen.

by Thomas Allen

Inconvertible paper money is money that is not convertible into full-weight metallic coin, such as gold and silver coin, on the demand of its holder in spite of its promises or guarantees. Proponents of inconvertible paper money consider it the “ideal money” as it has no intrinsic value and it represents no metallic coin, which they believe to be inferior to paper money.

Inconvertible paper money derives from two sources. First, and the most common today, are bank notes that become inconvertible because of a suspension of redemption in specie. Today’s federal reserve note is an example of this type of inconvertible paper money. When bank notes are no longer convertible to specie, they begin to behave like inconvertible government notes — especially if the government makes them legal tender and if the government controls their issue either directly or indirectly. Government notes are the second source of inconvertible paper money. That is, the government issues its paper money directly. Examples of government notes are the Assignat, the Continental and the U.S. note between 1862 and 1879. This type of inconvertible paper money was much more common before World War I than it is today. (Today, most inconvertible paper money is bank notes issued for  governments by their central banks, which often have the appearance of independence, but which are really subject to governmental control. Although this money is usually labeled as bank notes, functionally, and for all practical purposes, they are government notes.)

Promoters of inconvertible paper money based their assertion of the superiority of inconvertible paper to metallic coin on several principles. A discussion of the chief ones follows.

1. Medium of exchange. According to the adherents of inconvertible paper money, it is superior to metallic money as a medium of exchange. Paper money is a convention and does not have any “intrinsic value.” However, by general consent, it may become the medium of exchange of a country. It may become so acceptable that it cannot be distinguished from the acceptance of gold. This is true as long as custom or law forces people to use the paper money. If gold coin is allowed to circulate, its circulation will cease as people prefer to hoard the more valuable money, gold, and spend the less valuable money, paper. If gold coin does circulate, it will trade at a premium to the paper money.
2. Common denominator in exchanges. Adherents of inconvertible paper money claim that it functions as well as, if not better than, metallic money as a common denominator in exchanges. Producers want an article of uniform quality that can be easily divided to serve as a common denominator in exchanges. Thus, money is a mere convention to facilitate exchanges. Inconvertible paper money can serve this purpose as well as, if not better than, gold.

What is called “a common denominator in exchanges” is called “a measure of value” by most economists. Gold coin is superior to inconvertible paper money as a measure of value as its value as money is independent of itself. Inconvertible paper money is inferior to full-weight gold coin in that its monetary unit does not measure anything tangible that is independent of itself. For example, the Gold Standard Act of 1900 defines the dollar as 23.22 grains of gold, which means that it has a value equivalent to 23.22 grains of gold. When the redemption of federal reserve notes in gold coin ceased, federal reserve notes had a value of 23.22 grains of gold. However, as federal reserve notes were no longer convertible to gold, the dollar ceased having the value of 23.22 grains of gold. It ceased having an independent unit of measure. Its measure of value became what a dollar could buy, which is a highly inferior measure of value.

3. Standard of deferred payment. Adherents of inconvertible paper money assert that it can function better than metallic money as a standard of deferred payment. The better a money can ensure the same purchasing power during the duration of the contract or loan, the better it functions as a standard of deferred payments. Advocates of inconvertible paper money claim that it maintains its purchasing power better than metallic coin.

Inconvertible paper money can perform as a standard of deferred payment (it does so today) as long as it has popular acceptance. How well it performs this function depends on the regulation of its quality — so assert its proponents. Gold often proves inadequate in performing this function. Nevertheless, gold has historically done a better job of preserving value and, by that, its purchasing power than has inconvertible paper money. Eventually, inconvertible paper money loses popular acceptance. Gold never has although governments have often intervened to prevent its use, as occurred in the United States between 1933 and 1974.

Moreover, the advocates of inconvertible paper money seldom admit that depreciation, as revealed by a premium on gold or silver, is proof that the paper money has failed as a standard of deferred payment. They argue that the value of paper has not fallen; the value of gold and silver has risen. Whenever they do admit to depreciation, the fault is not with inconvertible paper money itself. It is with the government’s failure to use the correct formula or technique, which they are ready to provide, to regulate the quantity of money. If the depreciation occurs during wartime, the argument is that the enemy is flooding the country with counterfeit notes.

4. Natural limitations on quantity. Adherents of inconvertible paper money argue that it is superior to metallic money because it is not subject to natural limitations as is metallic money. Unlike gold, inconvertible paper money is not subject to any natural limitations. Coins, hoards, ornamentation, plat, and the like along with mines limit the quantity of gold available for monetary use. The only limitation to the quantity of paper money is the speed at which printing presses can run and the speed at which printing presses, inks, and papers can be manufactured. These limitations can be overcome by putting an ever larger number on the paper notes.

The production of gold can vary significantly over the years. However, the quantity of newly mined gold entering the market is extremely small when compared with the aboveground stock of gold available for money. This high stock-to-flow ratio stabilizes the value of gold and prevents it from changing significantly. With no restriction other than governmental fiat placed on the production of inconvertible paper money, its quantity can increase without limit — or at least increase until it becomes worthless and no one accepts it.

According to the advocates of inconvertible paper money, another advantage that it has over metallic money is that the cost of manufacturing paper money is extremely low. Mining gold is expensive.

5. Not exportable. Adherents identify the inability of inconvertible paper money to be exported to other countries as an advantage that it has over metallic money, which is easily transported. Inconvertible paper money is limited in its circulation to the country of issue. (This may have been true in the past, but it is not true today. The U.S. dollar circulates worldwide. Other fiat inconvertible paper moneys also circulate outside their country of issue.)

Under the gold standard, an overissue of money is halted by the exportation of gold. No such mechanism exists to halt the overissue of inconvertible paper money.

Moreover, unlike gold under the gold standard, inconvertible paper money is independent of the actions and monetary policies of other countries. Advocates of inconvertible paper money consider this independence to be a great benefit.

6. Overissue. Adherents of inconvertible paper money firmly believe that if the government follows the correct formula or technique in issuing it, overissue is impossible. So far, no one has found the correct formula or technique, although fiat money reformers have come forth with several techniques to use to issue the right amount. However, the temptation to issue ever more notes is often too great. Governments find issuing new notes easier and more acceptable than raising taxes. One of the few exceptions is the U.S. note: The government reduced the quantity in circulation and eventually redeemed them in gold.

Under the gold standard, overissue is a self-correcting, short-lived problem. Any excess gold coins will be exported or converted to bullion. Excess convertible bank notes will be converted to gold coin, which will then be exported or converted to bullion. Thus, the overissue is quickly halted and reversed.

7. Overissue leads to more issue. Adherents of inconvertible paper money who believe that it may be overissued are convinced that the overissue can be halted instead of leading to more issuance. However, the overissue of inconvertible paper money is seldom halted; the overissue nearly always leads to evermore increases in the money supply.

When gold is the money, supply and demand applies. Demand creates supply; supply satisfies demand. Excess monetary gold is exported or converted to bullion.

However, paper money is seldom exportable; it can only be used in the domestic markets. (Today, the U.S. dollar is a notable exception. Being the primary reserve currency of the world and the primary currency for buying and selling goods on the world markets, it is highly exportable. This exportation has spared Americans an enormous rise in prices.) When prices begin to rise because of excessive issuance, the government has to issue more notes just to maintain its current level of consumption. This new issuance leads to more rising prices, which leads to more issuance. Thus, a vicious cycle is created. Soon speculators enter the markets to buy goods before their prices rise to sell them at a higher price later; thus, prices begin to rise even more rapidly. A prime example of this phenomenon is the Assignat of the French Revolution.

In spite of all the historical evidence to the contrary, advocates of inconvertible paper money are convinced that no government can issue more notes than the real necessities of the government require. Unlike banks, governments cannot issue notes for profit. Therefore, the issue of government notes is limited to the absolute wants of the government. Most often governments under issue their notes — so assert some advocates of inconvertible paper money.

8. Stability. Adherents of inconvertible paper money claim that it is more stable, i.e., maintains constant purchasing power, than is metallic money. An abstract paper monetary unit is more likely to be less variable in value, purchasing power, than gold. Yet, history has shown that the value of inconvertible paper money is much less stable than the value of gold under the gold standard.

Historically, gold’s purchasing power tends to rise for a decade or two and decline for a decade or two. However, over decades, its purchasing power is fairly constant. (See Roy Jastram’s study on gold’s purchasing power.)

On the other hand, inconvertible paper money’s purchasing power tends to decline at varying rates. Moreover, the decline accelerates as the currency approaches its death.

Depreciating paper money fluctuates primarily for two reasons. First, the demand for money varies. Under the gold standard, this variation in demand is smoothed by gold moving into and out of the country. However, inconvertible paper money remains in the country; thus, its value fluctuates with changing demand. Second, the depreciation of inconvertible paper money impairs its circulation. Depreciation affects confidence in the currency. Inconvertible paper money depreciates more rapidly when confidence is falling and less rapidly when confidence is steady or rising. A rise in confidence may lead to a rise in purchasing power for a while. Political events affect confidence more than the volume of money in circulation.

9. Benefits the working class. Adherents of inconvertible paper money are adamant in that the primary beneficiary of inconvertible paper money is the working class. They present it as benefitting the working class and gold standard as harming the working class. As with most claims of these advocates, the opposite is true. Inconvertible paper money is an egregious tax on production and labor. It leads to speculation, which benefits sharpies at the expense of workers. Initially, depreciating paper money increases the profits of businesses at the expense of consumers, most of whom are workers. However, these excess profits are short-lived as they attract more businesses. Moreover, inconvertible paper money leads to wasteful habits. As it is nearly always depreciating, its loss of purchasing power causes prices to rise. Moreover, prices rise before wages do and faster than wages. Thus, workers must pay more for goods and services with the same amount of labor. Also, most workers lack the means to hoard goods to sell in the future at much higher prices, or even for their own use. Worse, inconvertible paper money undermines the virtues needed to support the social system of the community. It destroys industry, frugality, and economy while promoting extravagance and speculation. Inconvertible paper money is the most effective means to cheat workers as it transfers the wealth of workers to the rich and the government.
10. Gold is not essential to the monetary unit. Adherents of inconvertible paper money argue that gold is not essential to defining the monetary unit. They

assert that gold is no more essential to the monetary unit than brass or wood of a ruler is to the yard or meter. The yard and meter are not defined by the material of which a ruler is made. They are defined by the distance that light travels in a specific fraction of a second. Likewise, the value of the monetary unit is not defined by the material of which money is made. Under the gold standard, it is defined by the value of a specific weight and purity of gold. For example, the dollar was defined as 23.22 grains of fine gold, and, thus, had a value equal to 23.22 grains of gold. Under today’s monetary standard, the dollar is a nebulous abstraction whose value cannot be defined except in terms of itself.

Defining the value of the monetary unit, such as the dollar, peso, pound, or euro, as equal to the value of what the monetary unit buys gives the illusion of stability. The dollar always buys a dollar’s worth of goods. However, the quantity and often the quality of goods that a dollar buys declines over time. Anyone who has lived during the permanent suspension of the gold-coin standard and later the suspension of the gold exchange standard has personally witnessed the instability of an abstract monetary unit and its constant deterioration and loss of value.

Inconvertible paper money may be as bank notes for which redemption has been suspended, such as federal reserve notes after 1932, or forced government notes, such as U.S. notes before 1879. No matter which, both derive their initial value as money from the commodity money, e.g., gold coin, that they replace.

Unlike gold, which has value both as money and as bullion for ornamentation, etc., inconvertible paper money has only one use and that is as money, purchasing medium, a unit of account, and payment of debt and taxes. Therefore, it is low quality money. Lacking quality, it is a poor store of value. Likewise, its poor quality as money makes it a poor standard of exchange value, that is a standard of prices and accounts, or a measure of value.

Inconvertible paper money does have value, but that value is derived from its use as money, and that value depends on the confidence that people have in it. Also, it depends to a limited extent on the authority and power of the government to force it on the people. Once the value of money degenerates beyond a certain point, the power of government can no longer force the people to accept it, even with the death penalty. Examples are the Assignat and the Continental. Unless the government gives a believable promise that the paper money will soon be convertible on demand in full-weight metallic coin, that confidence declines. Declining confidences leads to declining value, purchasing power, of inconvertible paper money.

As the value of inconvertible paper money declines, so does the demand for it. When demand declines, its value declines. Therefore, more is needed to make the same quantity of purchases, Thus, its supply must increase to maintain the same level of purchases. Increasing supply leads to further loss of confidence and decline in demand for the money. As a result, general prices continue to rise.

Inconvertible paper money does function as money although inferior to gold coin. It can serve as a medium of exchange, a standard for the payment of debt, especially when it is legal tender, a measure of value, and even a store of value. However, it swindles creditors and impoverishes workers as it generally loses value over time. Moreover, as it loses value at varying rates, it is a poor measure of value and a poor standard of value. However, unlike gold coin, inconvertible paper money cannot extinguish debt. It merely discharges debt by transferring it to the issuer of the paper money.

Copyright © 2017 by Thomas Coley Allen