Hayek Grasps Endogenous Money

There is an interesting passage from Hayek’s Prices and Production:

“There can be no doubt that besides the regular types of the circulating medium, such as coin, bank notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money. Now while for certain practical purposes we are accustomed to distinguish these forms of media of exchange from money proper as being mere substitutes for money, it is clear that, ceteris paribus, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money.

In particular, it is necessary to take account of certain forms of credit not connected with banks which help, as is commonly said, to economise money, or to do the work for which, if they did not exist, money in the narrower sense of the word would be required. The criterion by which we may distinguish these circulating credits from other forms of credit which do not act as substitutes for money is that they give to somebody the means of purchasing goods without at the same time diminishing the money spending power of somebody else. This is most obviously the case when the creditor receives a bill of exchange which he may pass on in payment for other goods. It applies also to a number of other forms of commercial credit, as, for example, when book credit is simultaneously introduced in a number of successive stages of production in the place of cash payments, and so on. The characteristic peculiarity of these forms of credit is that they spring up without being subject to any central control, but once they have come into existence their convertibility into other forms of money must be possible if a collapse of credit is to be avoided.” (Hayek 2008: 289–290).

That is an insightful passage: it describes the endogenous money supply that capitalist systems have had for centuries.

A major aspect of the elastic, endogenous money supply historically was, and still is to some extent, the negotiable debt instruments we call (1) promissory notes and (2) bills of exchange.

Both are freely and voluntarily created by private agents – there is no fraud involved. Free agents on the market create money at will by both these debt instruments. If modern Western capitalism has any “natural” or normal characteristics, it is the endogenous money supply.

The Rothbardian, anti-fractional reserve banking Austrians are guilty of two-fold intellectual incompetence, as follows:

(1) fractional reserve banking (FRB) is not fraudulent. FRB is an exchange of present for future goods, and is a mutuum contract, not a bailment. FRB does not involve two parties owning the same property because fractional reserve accounts (which we normally call demand deposits, checking accounts, transactions accounts, etc.) are nothing but debt instruments (just like promissory notes and bills of exchange): you transferred legal ownership of the money when you signed the contract and your FR account is actually just a record of the debt owed to you by the bank, re-payable on demand.

(2) even if FRB was banned, capitalism would still have an elastic, endogenous money supply via promissory notes and bills of exchanges. In order to stop the elasticity of money production by negotiable debt instruments, Rothbardian Austrians would have to violate private freedom and ban promissory notes and bills of exchanges. By its own self-proclaimed standards, the Rothbardian system is nothing but a tyrannical ideology violating liberty and free contract.

BIBLIOGRAPHY

Hayek, F. A. 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, Ludwig von Mises Institute, Auburn, Ala.