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Monetary Stability

Money long preceded the existence of government. Grain and cattle have long been used as money, and still are, but it is a bit hard to make change for a ram, so valuable metals have been more popular.

Real money does not need to be enforced. It is either something of inherent value, such as gold or silver, or, more conveniently, promises to pay by someone whose credit rating is well known to be good. The bills of exchange issued by merchants in medieval times were effectively paper money. Indeed money was mostly issued privately until the twentieth century. In America the revolutionary experience with the “continentals” (revolutionary fiat paper money) was so disastrous that the constitution was for a long time interpreted in a way that restrained the federal government from taking a large role in the issue of money, leading to the “free banking era”.

Paper money started with the goldsmiths: people would ask them to keep their gold in their safe, and the goldsmith would give them a piece of paper saying how much was deposited. But then people started using these notes as money: “here's a goldsmith credit for 1 ounce of gold, so next time you go there you can get the gold I owe you for this horse”, then after a while the goldsmiths realized that they could give out more credits than they had gold in the safe, as not everyone claimed back their gold at the same time.

The reason we call banknotes “banknotes”, and not “government notes” is that they were originally issued by banks, and only later did governments take them over.

At the end of the nineteenth century, and the beginning of the twentieth century, it was widely argued that the government should more fully control money and the issue of money, supposedly because fluctuations in the volume of money caused economic instability, booms and busts, though arguably it was more a matter of debtors demanding government intervention to ensure inflation, and creditors demanding government intervention to ensure deflation.

The problem was that banker's tended to issue money denominated in gold against debts backed by against assets other than gold. Thus it came to pass that a rather small amount of gold circulated, and a rather large amount of  paper money circulated.  The amount of gold tends to remain pretty stable, for the gold that Agamemnon looted from Troy is still circulating, but the amount of paper tended to fluctuate with people's confidence in the banks, and in the assets securing mortgages.   When the volume of money increased, there was lots of demand for labor, goods, and assets, and prices tended to rise, or, equivalently, gold fell. When the volume of money fell, there was high unemployment, a bust, prices and wages tended to fall, including the price of assets securing loans, loans backed by land, but denominated in gold. This often resulted in shaky loans going under, hence shaky banks going under, hence loss of confidence in banks, hence further reduction in the volume of money.

This sounds like an open and shut case for regulation by wise and good government. Obviously wise and good government will do a better job of managing the money supply than greedy, short sighted investors and crooked bankers, right?. — Yes, quite right. — Unfortunately wise and good government tends to be in short supply. Will dishonest short sighted politicians flattering greedy special interest groups do a better job of managing the money supply than greedy, short sighted investors and crooked bankers?

In 1915, the federal government took over the money supply, intending to regulate it wisely, so as to avoid random fluctuations, and thus minimize booms and busts. The result was disastrous, in America, and around the world. In time, government regulation of money improved, but until the 1980s, government manipulation of the money supply was consistently worse than the market fluctuations under the gold standard, and it is far from clear that those market fluctuations were market induced, rather than induced by heavy handed government intervention.

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