Home Business & Finance Money, Markets, and Democracy: Politically Skewed Financial Markets and How to Fix Them
Money and Government
Lydia’s coins were originally introduced by private merchants. Yet in whatever form it happens to be comprised, money is always an enticing object for governments to command and regulate. It became especially so with coinage and even more so several millennia later when paper replaced it. It should be no wonder, then, that Lydia’s king at the time, Gyges, seized control of coin production and made it into a state monopoly. With few exceptions, that has since been the approach toward money taken by governments. A commonly stated rationale for this is that leaving it to private individuals and firms would provide incentives to issue false money as a way to increase profits. In the case of coins, an unscrupulous minter could embed a lower mass and purity of metal than the face value, while pocketing the difference. With paper, an institution, usually a bank, will have an interest in maximizing the amount of notes it can issue through its lending activities so as to augment its interest income. That this does not necessarily align with the interests of the community is something that becomes evident where the amount of the note issuance reaches a point at which these cannot all be redeemed for species or the boom created by the excess lending turns into a bust. Another oft-cited justification for the state’s regulation of money is that it is uniquely positioned, by virtue of its legitimacy and authority, to certify that certain pieces of metal and paper are actually worth as much as indicated on the currency. Otherwise, transaction costs would be markedly higher, with sellers forced to scrutinize the authenticity of the coins and notes handed to them. The leading argument, though, in favor of government control is that money is a public good, its quantity and circulation impacting the economic environment whose condition and fluctuations all the members of society inescapably share. Like national defense and the administration of justice, money is reckoned to demand an agency capable of superintending it with a view to the public good.
Indeed, there is a school of thought that goes further than saying that money works best under government oversight, declaring it to be a state construct. This is the thesis put forward by Georg Friedrich Knapp, whose The State Theory of Money drew thoughtful consideration from Max Weber and influenced Keynes in accepting the position known as chartalism. To students of philosophy, the debate surrounding chartalism is reminiscent of the realism versus nominalism question—that is, whether general terms such as “bird” and “tree” refer to a set of qualities that are discovered by the mind existing independently of human will or rather to phenomena that we, as members of a particular linguistic community, have decided to isolate for our own cognitive convenience in making sense of the world. The first is the realist stance, while the second is the nominalist perspective.
Chartalists like Knapp apply the nominalist view to the concept of money by observing that the state defines its basis as a unit of account through its power to define the contractual terms of debt and tax payments. By this means, the chartalists seek to explain the mystery of how a certain piece of paper, having virtually no value in itself to meet human wants, is nevertheless treasured as money. Their answer is that the government wills its value through legislation. For even where the money has been defined in terms of a specific weight of metal, history has repeatedly demonstrated that states treat that amount as a nominal matter by subsequently establishing, for example, that a debt specified as a pound of copper shall henceforth be equivalent to a stated amount of another metal. “The state”, Knapp writes, “accordingly regards the former unit of payment (a pound of copper) as if it meant only the name of the former unit without attaching any importance to the material of which it was composed”. Buttressing this power to determine what counts as money, according to the chartalists, is the government’s capacity to stipulate what items it will accept in payment of taxes.
The chartalist argument runs into problems by not directly referencing money’s role as a medium of exchange. From the first moment it was invented up to the present day, this has been a defining feature of money. The chartalist is forced to account for this feature by assuming that the government’s specification of a given set of objects for the legal fulfillment of tax and debt obligations invariably causes those objects to be used in everyday transactions. But that is not necessarily the case. No doubt, as a sizable player in the economy, the government can markedly influence what gets commonly accepted for payment among buyers and sellers, if only because people will typically find it more convenient to operate in the same currency in which they are required to pay their debts and taxes. Still, individual and firms do sometimes opt for other currencies, with a mind to exchanging it when necessary to meet state-enforced obligations. This could transpire because their industry demands it as a result of international activity, or because they believe they would be shortchanged in regularly giving up the relevant coins in exchange for goods, or simply because they lack confidence in the local government notes.
Best exemplifying this are the various failures of governments in the past to successfully enforce a bimetallic standard at the legally prescribed rate. The ratio between silver and gold might be established at 15 to 1, but if the market diverges from that ratio, as it inevitably does, Gresham’s law—according to which undervalued money will tend to disappear from circulation and be replaced by that which is overvalued—will ensure that only one metal will remain in use. This is precisely what happened in the USA as a result of the 1792 Coinage Act. Once silver prices subsequently fell due to increased production, and the ratio consequently rose above 15 to 1, gold was hoarded and the USA effectively went to a silver standard in the early nineteenth century.  A more recent instance in which people have resisted the government’s choice of money was in Africa. The governments of Angola, Mozambique, and Ghana sought to cajole firms to use their respective national currencies instead of US dollars. In Zambia, the government went so far as to threaten users of foreign currency with a ten-year prison term.3 3 That the state occasionally must go to these lengths indicates that there is more to the essence of money that what the government’s will defines as the means of payment for debt and taxes.
Also damaging to the chartalist thesis is that, for much of history, the movement of different monies has not respected the geographic boundaries of states. During the Renaissance, Venice’s ducat and Florence’s florin both circulated widely throughout Europe, while in colonial North America, the British guinea, French Louis d’or, and the Spanish doubloon, among others, greased the wheels of commerce. What Benjamin J. Cohen calls the Westphalian model of monetary geography, wherein states successfully monopolize currency issuance within their territories, only emerged in the nineteenth century. In part, this was due to the legislation that the chartalists cite, but it was also owing to the monopolization of currency issuance achieved by the establishment of central banks. Indeed, we are currently witnessing the de-territorialization of money, a dynamic that has acquired momentum over the last several decades of globalization in which a few currencies have emerged dominant in international market share, as manifested in FX trading, export/import invoicing, and financial claims. That the Japanese yen, European Euro, and US dollar have attained this status points to the market’s decisive role in deciding the identity of money.
As for the more modest view of government that sees it as facilitating the operation of the monetary system for the common good, we do well to remember that Gyges was probably not so high-minded in taking over Lydia’s coinage. This is a man, after all, who gained the throne as a result of killing the previous king, Candaules.  The Lydian state’s monopolization of money production was imitated by other rulers in the ancient Greek world during the seventh and sixth centuries when the region was dominated by tyrannical regimes. In any reckoning of money’s relationship to the state, the fact that the ruling groups use that coercive apparatus to pursue their own interests must never be overlooked. States benefit from having images of their symbols, traditions, leaders, and historical personages embossed on the currency. It continually reminds the people of the state’s presence in all our dealings, thereby gently, even if only imperceptibly, touching the fear that all political authorities, to one extent or another, must invoke to elicit obedience. True, since the governors are always outnumbered by the governed, as David Hume famously reminds us, states principally rely on opinion, rather than fear, in securing compliance to their edicts. З7 Yet having the regime’s signage on the money reinforces the opinion of its right to exercise authority by conveying its worthiness to exercise a hallowed trust—namely that of authenticating the community’s purchasing power. Since, in the popular mind, riches are often simply equated with money, the government’s stamp likewise strengthens the opinion that the maintenance of its rule is in everyone’s interests, it being in control over the elements of our financial well-being. This is the influence that Jesus, challenged by the Pharisees whether he was claiming immunity from having to pay taxes to the Roman state, pointed to in summoning a coin with Caesar’s image on it and declaring, “Render therefore to Caesar the things that Caesar’s, and to God the things that are God’s”.
Less subtle, if still obscurely obtained, are the government’s gains from seigniorage. Basically, this is income earned by the manufacturer of money on the spread between its actual and face value. Suppose an individual brings a bar of gold to the mint in exchange for coins. Suppose further that the mint takes that exact bar and uses it to make the requested coins. In order to cover its production costs and earn a profit, the mint will end up returning coins with less gold, in terms of both purity and weight, than that contained in the original bar. The profit thereby reaped is seigniorage—though by profit here, we are speaking of it in economic, as opposed to accounting, terms as a return in excess of all costs, including the use of equity capital. Accordingly, where mints find themselves operating in a competitive market—a situation that actually existed for low- value coinage during the late eighteenth and early nineteenth centuries in Britain—seigniorage would tend toward zero, as the battle for customers would drive prices toward marginal costs. Holding a monopoly, though, a government-controlled mint is able to charge a higher price (i.e. offer a lower real gold content in its coins relative to face value) and thus earn seigniorage.
With paper money not backed by any tangible asset, precisely the situation with today’s fiat currencies, the seigniorage which the government can garner is much bigger. The costs of producing an additional note, given an existing money press infrastructure, are virtually zero. Seigniorage here effectively equals the face value of the notes created. A government can literally earn an income to finance expenditures on goods and services by simply printing money. Granted, by increasing the money supply relative to goods, the purchasing power of the currency is thereby reduced. But the newly manufactured notes will almost always retain much of their value, as the devaluation affects not just the added stock, but is passed along to all existing holders of money. Nor do prices adjust instantaneously to additions of money. These funds must circulate through many hands in purchasing goods and services before the associated increase in demand raises the entire price structure. The first to receive the funds, the government and its closest allies, can obtain prices that largely, if not wholly, reflect the prior quantity of money. Not to mention that the price adjustment that eventually does occur lowers the government’s real debt burden, affording it extra borrowing capacity to fund its operations.
Even the most cursory overview of the past suffices to demonstrate how often and systematically the seigniorage privilege has been abused by governments. In the sixth century BCE, when Rome was still ruled by kings, the “as” coin was instituted and embedded with one pound of copper. Later during the Republican period, largely to finance the Punic Wars with Carthage as well as Rome’s conquests, the copper content was systematically cut down. By 250 BCE, the as was down to 1/12 of a pound, and by 130 BCE that fraction had dropped to 1/24 on its way to becoming a mere token. An analogous, though ultimately more destabilizing, depreciation took place later after Rome had become an empire. That political behemoth had to finance a growing bureaucracy, an extensive system of handouts and entertainments to mollify the populace, persistent trade deficits fueled by the import of luxuries from the East, and, most importantly, a considerable military force to defend its far-flung borders. To pay for all this, the Roman Empire continuously debased its denarii. At the time of Nero in the first century CE, these silver coins were made up of 99 % pure silver. But in 64, Nero lowered it to 93.5 %, beginning a series of debasements that over the next two centuries would see the silver content of Rome’s currency reduced to almost nothing (Fig. 2.1). 
Inflation thus began to ravage Rome’s economy, which arguably played a crucial role in the empire’s decline and fall.4 3 Subsequently, when a desolated Europe began to revive out of the Dark Ages, currencies with names denoting the weight of precious metals embedded in them were established, such as the English pound and French livre. Well before the widespread adoption of paper currency reduced the commercial relevance
Fig. 2.1 Silver content of Roman coins, 60-274. Source: Kenneth W. Harl
of the metal content in coins, these post-Roman monies were eventually stripped and adulterated to the point where we are now—that is, in which the names of those currencies serve merely as a historical reminder of the way money was once supposed to be worth its weight.
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