uses and abuse of money
...ore material goods, rather than being some alien imposition from without. Even so, the latter notion is probably more widely held than the former. A part of the popular misunderstanding about money is the belief that money is the tangible form which it sometimes takes - notes and coins. Money is in fact wholly conceptual and definable only as a widely accepted medium of exchange. It is a good example of a wholly subjective feature of human society, as described by Hayek [2]. At different times people have chosen to use different items as money, such as seashells and cigarettes, while metal coins have sometimes ceased to be money. What remains the same, whatever the form it takes, is that money is a medium of exchange. GOVERNMENT INTERFERES Most people think of money as something administered by the government. It is true that government has assumed control over the issuance of currency, and has usually forbade the use of other currencies, through the use of legal tender laws. [3] Ultimately, however, government does not control money. It is people in their transactions accepting a certain good as a medium of exchange that allows money to exist. If that acceptance is withdrawn then money ceases to be, whatever exhortation the government may use. There are cases of people rejecting the government's decreed currency. In Israel, for example, when inflation raged in the 1970s, people chose to recognise dollars as money and used them instead of the official tender. In the former Soviet Union the legal tender ruble has at times plunged in value and been shunned by many, while dollars, sterling, deutsche marks and Marlboro cigarettes are more acceptable as exchange media. Historically, government attempts to control money have often been disastrous. The biggest problems have arisen when governments have used money for political ends rather than to ensure the smooth functioning of the economy. Sometimes this has been purely cynical but at other times it has been the result of the misconception described above, that money has some intrinsic value, and hence that the more of it there is the richer a country becomes. The mercantilists - economists who preceded Adam Smith - held that a country's wealth was measured by the amount of gold and silver it owned. The more modern version, usually labelled Keynsianism, says that while a larger quantity of money does not of itself represent greater wealth it will bring forth more production. The consequence of these doctrines has been inflation, an expansion of the supply of money that leaves each unit of a currency worth less. A symptom of inflation has been the suspension of convertibility of fiduciary money into its (once) underlying commodity. Paper monies originally arose as receipts for deposits of precious metals, which were considered the real money. These receipts became acceptable as exchange media, but each note was still backed by an amount of gold or silver. Later the deposit holders would issue more receipts than were backed by metal, in the knowledge that only a minority of holders at any one time would ask for the notes to be redeemed. Until 1889 the Bank of England redeemed notes with full gold coins. Now we have a currency which is backed by nothing. Its supply is determined by whichever rules of issuing policy are being pursued. This obviously allows far more scope for abuse by governments than a metal-backed currency. If the government's central bank flooded the economy with notes of a metal-backed currency it would very soon face the exhaustion of its metal deposits by note-holders seeking redemption. Inflation is a way for governments to achieve a short-term boost to economic activity, but an illusory one. A surge in the supply of money will be felt by different individuals at different times and with different intensity. The businessman is likely to discern the first results in new orders, to which he responds by raising production and employing more staff and by upping the prices of his goods. Later he realises that the prices of his inputs have also risen and that the increase in demand was purely monetary. His production increase is reversed, and the extra staff are laid off. Inflation also has a drastic impact on the capital goods sector through the effect it has on interest rates. Interest rates essentially express the ratio of preferences between present and future goods. An increase in the supply of money will depress short-term interest rates (or this may be engineered directly by the central bank lowering its lending rates, or by prices of. other goods rising while nominal interest rates remain unchanged). This implies a heightened preference for future goods relative to present goods and will lead to greater investment to produce those future goods. It will lead to a lengthening of the process of production, that is, it will make more ambitious processes feasible when before they weren't. However, input costs for the capital goods sector then rise. At the same time, the increased money supply begins to be manifested in higher consumer demand, and consumers hold the same preferences between present and future goods which are not reflected in the prevailing exchange rate. It becomes evident that more future goods are not being demanded. At the same time, credit markets begin to factor in the higher inflation, so that interest rates rise. The result of this monetary expansion is therefore to cause 'malinvestment' - greater capital investment than is merited by the current state of demand. This is why capital goods industries suffer particularly during recessions. [4] The boost to production caused by inflation can only be sustained with larger and larger increases in money supply. Ultimately this will lead to so-called hyper-inflation and possibly to demonetization when individuals revert to barter. [5] BAD POLICY EXPORTED Commercial banks have often been complicitous in abusing the monetary system. With the encouragement of Western Governments, for example, banks in the 1970s and 80s made huge loans to corrupt and incompetent governments in the developing world. Predictably, the recipient governments proved poor credit risks. With their economies smothered by regulation and bureaucracy, they were unable to generate the returns even to meet interest payments, let alone to repay the capital sums lent. The problem was compounded where recipient governmen...