The Mystery of Banking

Micro 
and
macro
are not
mysteriously separate worlds; they are both plain economics and
governed by the same laws. 
Money and Overall Prices
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IV.
T
HE
S
UPPLY OF
M
ONEY
T
o understand chronic inflation and, in general, to learn
what determines prices and why they change, we must now
focus on the behavior of the two basic causal factors: the
supply of and the demand for money. 
The supply of money is the total number of currency units in
the economy. Originally, when each currency unit was defined
strictly as a certain weight of gold or silver, the name and the
weight were simply interchangeable. Thus, if there are $100 bil-
lion in the economy, and the dollar is defined as 1/20 of a gold
ounce, then M can be equally considered to be $100 billion or 5
billion gold ounces. As monetary standards became lightened and
debased by governments, however, the money supply increased as
the same number of gold ounces were represented by an increased
supply of francs, marks, or dollars. 
Debasement was a relatively slow process. Kings could not
easily have explained continuous changes in their solemnly
defined standards. Traditionally, a new king ordered a recoinage
with his own likeness stamped on the coins and, in the process,
often redefined the unit so as to divert some much needed rev-
enue into his own coffers. But this variety of increased money
supply did not usually occur more than once in a generation.
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Since paper currency did not yet exist, kings had to be content
with debasement and its hidden taxation of their subjects. 
1. W
HAT
S
HOULD THE
S
UPPLY OF
M
ONEY
B
E
? 
What should the supply of money be? What is the “optimal”
supply of money? Should M increase, decrease, or remain con-
stant, and why? 
This may strike you as a curious question, even though econ-
omists discuss it all the time. After all, economists would never
ask the question: What should the supply of biscuits, or shoes, or
titanium, be? On the free market, businessmen invest in and pro-
duce supplies in whatever ways they can best satisfy the demands
of the consumers. All products and resources are scarce, and no
outsider, including economists, can know 
a priori 
what products
should be worked on by the scarce labor, savings, and energy in
society. All this is best left to the profit-and-loss motive of earn-
ing money and avoiding losses in the service of consumers. So if
economists are willing to leave the “problem” of the “optimal
supply of shoes” to the free market, why not do the same for the
optimal supply of money? 
In a sense, this might answer the question and dispose of the
entire argument. But it is true that money is different. For while
money, as we have seen, was an indispensable discovery of civi-
lization, it does not in the least follow that the more money the
better. 
Consider the following: Apart from questions of distribution,
an increase of consumer goods, or of productive resources, clearly
confers a net social benefit. For consumer goods are consumed,
used up, in the process of consumption, while capital and natural
resources are used up in the process of production. Overall, then,
the more consumer goods or capital goods or natural resources
the better. 
But money is uniquely different. For money is never used up,
in consumption or production, despite the fact that it is indispensa-
ble to the production and exchange of goods. Money is simply