How Much Money Should There Be?
Frank Shostak | Posted on 10/8/2001
What about removing the central bank altogether and keeping the current stock of paper money unchanged? Would that not do the trick? No, it would not. An unchanged money stock will cause an almost immediate breakdown of the present monetary system. After all, the present system survives because the central bank, by means of monetary injections, prevents the fractional reserve banks from going bankrupt.
It is therefore not surprising that the central bank must always resort to large monetary injections when there is a threat from various political or economic shocks. For instance, to prevent possible disruptions to the monetary system due to the September 11 terrorist attack, the Fed pumped out over $100 billion in one week.
Observe that the same fate is likely with other schemes. The only difference, of course, is that in other schemes it will take some time before the final breakdown will occur. How long the central bank can keep the present system going is dependent upon the state of the real pool of funding. As long as this pool is still growing, the central bank is likely to succeed in keeping the system alive. Once the real pool of funding begins to stagnate-or, worse, shrink-however, then no monetary pumping will be able to prevent the plunge of the system.
In a true free market, if people raised their demand for gold as a result of a major upheaval, this would lift money’s purchasing power, and that would be about it; no further disruptions would emerge. The monetary system would remain intact. Also, as opposed to the present monetary system, money can’t disappear in a true free market and set in motion the menace of the boom-bust cycles.
In fractional reserve banking, when money is repaid and the bank doesn’t renew the loan, money evaporates. Because the loan has originated out of nothing, it obviously couldn’t have had an owner. In a free market, in contrast, when the gold is repaid, it is passed back to the original lender; the money stock stays intact.
Since the present monetary system is fundamentally unstable, there cannot be a “correct” money supply rate of growth. Whether the central bank injects money in accordance with economic activity or fixes the rate of growth, it further destabilizes the system. The only way to make the system truly stable is to permit the free market to take over.
In a truly free market, there is no need to be concerned with the issue of the “correct” rate of money supply growth. No institution is required to regulate the supply of money in a free market. Furthermore, while the free-market money is associated with rising real wealth, the present monetary system is inherently inflationary and leads to economic impoverishment.