Engelhardt wrote an interesting analysis of possible monetary arrangements: Fully Dependent National Central Banks, Independent National Central Banks, Independent, Discretionary, International Central Banks, Monetary Policy Rules, and Market-Based Money.
‘Fully Dependent National Central Banks
Let’s start with the worst case — a central bank that is fully dependent on the political system. In effect, in such a system, the Treasury would have the power to create money at will. Economists generally agree that such a system would lead to very high rates of inflation. Government spending is popular — the left loves their social welfare programs, while the right likes funding a large military. However, taxes are politically unpopular — especially with those that have to pay them. So, it is unsurprising that governments typically run deficits. If the government were given direct control over money creation, one can expect that deficits would be funded largely by the creation of new money, as the effects of money creation are much easier to hide than the effects of taxation or decreases in spending.
The end result that economists expect with this framework is that hyperinflation becomes a very real possibility. Historically, hyperinflations tend to occur when large deficits are funded with money creation. This isn’t shocking — a $1 bill costs just about $0.07 to print, so money production is quite profitable. It’s a cheap way of raising funds for the government, and zeros are cheap. So, as prices go up and the money loses value, the Treasury can maintain their profits simply by adding zeros. Eventually, we end up with a Zimbabwe scenario. I have 180 trillion Zimbabwe dollars that I bought on eBay for $15 — and that included protective plastic sleeves. I suspect the sleeves are more valuable than the money inside them, but the point is: zeros are cheap. That being the case, there is virtually no limit to the inflation that a Treasury could create if it were giving the power to create money directly. For this reason, most economists now suggest that central banks should be independent.‘
Our final stop in the spectrum of monetary independence is a truly independent currency — that is, a money that has no legal advantages or disadvantages when compared to other goods. In short: a free market in money where moneys are free to compete with one another to attain the favor of users. Anyone who wishes may introduce their own money — so I could print Engelhardt dollars in my basement — and try to convince people to use them. The only restriction would be that fraud would be banned — so no one else could mimic my Engelhardt dollars.
In such a system, I would expect that moneys would be governed by the normal, everyday actions of entrepreneurs that do so well satisfying so many of our desires. As they respond to demand and competition from other suppliers, the supply of money would grow at the pace that the market determines. If more of a particular money is demanded, that money will rise in value — increasing the profitability of producing it — leading those entrepreneurs that produce it to produce more, and drawing other entrepreneurs toward producing money that is similar — and therefore competitive — with that money.
As entrepreneurs respond to demand, one would expect that the value of a winning money is likely to be fairly stable over long periods of time — not perfectly stable, of course, as there is often a delay between a change in demand and changes in production to meet that demand. But, the market will reward those money producers that do the best job providing a money that people actually want to use.
As Sennholz observed in many of his writings, there’s something about gold that makes it a particularly good money. And that something is not just some undefinable “X Factor.” It’s a list of traits. As laid out in Sennholz’s Money and Freedom, gold is useful, but unessential, easily divisible, highly durable, storable and transportable. So, the fact that gold — in many cases operating alongside the remarkably similar, but somewhat less valuable silver — was, historically, what emerged as money on the free market. Like Sennholz, I also agree that it seems fairly likely that, if people were left to their own devices, they would again use gold as money.
The question then is: what would it take for us to establish a market-based money? When I first read Sennholz’s Inflation or Gold Standard? I read his plan for reform — and on nearly every step, I said to myself “Well, we’ve already done that.” Only a couple points remained. When Sennholz wrote Money and Freedom in 1985, his original intent was just to update Inflation or Gold Standard? — but he realized that the world had changed enough in the ten or so years since Inflation or Gold Standard? was written that a new book was required. So, he laid out a new plan for reform. It ends up very little has changed in the past thirty years — so Sennholz’s plan from 1985 is mostly still relevant to us today.‘