Robert P. Murphy does not understand fiat money


In “Let There Be Money” Robert P. Murphy shows that he does not really understand money. And he gets fiat money specially wrong.

He states that “the market’s classic commodity moneys have been displaced by unbacked State-issued paper”. State-issued paper is not unbacked: it is inconvertible or irredeemable, but it is backed by the assets in the Central Bank’s balance sheet; the quality of the backing may be low, but it is not zero. And paper notes are only a fraction of State-issued liabilities used as money: there are also private bank deposits at the Fed.

Unfortunately, the complaints against State fiat money can be imprecise at times, leading libertarians to form a faulty understanding of how money works. “Fiat money” is not unique to a coercive State. Neither does the State have the power to force its citizens to use something as money.

Here Murphy is right and he himself proves it: his analysis of fiat money is incorrect and he has a faulty understanding of how money works.

Fiat money is unique to a coercive State because that is what fiat means: by State order, decree, law or sanction. It helps to know some latin.

Commodity money is not the opposite of fiat money, and vice versa. A commodity can be fiat money it the State so decrees and manages to enforce that legal tender law.

When gold was embraced the world over as the market’s money, an ounce of gold was an ounce of gold.

And before that and after that, an ounce of gold was, is and will be an ounce of gold. That is not saying much.

When a State printing press takes paper and ink and creates new currency notes, those particular pieces of paper (covered with ink) become additional units of money because of the minting process.

The minting process is not the essential phenomenon. The production of liabilities of a central bank, whatever their form, is.

Privately issued, voluntary fiat monies are theoretically possible.

No, they are not, because they imply a contradiction.

Friedrich Hayek imagined private-sector financial institutions issuing competing currencies. I would also argue that bitcoin is a private-sector fiat currency (though in my view it is not a “money” yet).

Hayek did not call private currencies fiat money. Bitcoin is not fiat.

The term “fiat money” sometimes leads critics to declare that the State can turn something into money “by fiat.”

Fiat implies that the coercion of the State is essentially involved somehow. It does not imply that the State has infinite powers and can always achieve what it intends.

Murphy quotes Mises, who does not get it right either:

In order to avoid every possible misunderstanding, let it be expressly stated that all that the law can do is to regulate the issue of the coins and that it is beyond the power of the State to ensure in addition that they actually shall become money, that is, that they actually shall be employed as a common medium of exchange. All that the State can do by means of its official stamp is to single out certain pieces of metal or paper from all the other things of the same kind so that they can be subjected to a process of valuation independent of that of the rest…. These commodities can never become money just because the State commands it; money can be created only by the usage of those who take part in commercial transactions.

Actually, legal tender laws can do more than that: they can decree that a certain kind of money must or may be accepted for all or some payments (like taxes). Maybe the State is not powerful enough to have that law be respected, or maybe it is. And maybe the State does not need to be omnipotent, perhaps it only needs to provide a marginal advantage to some means of payment.

The existence of legal-tender laws and other regulations complicates the issue, but nonetheless it is possible that next Tuesday, nobody will want to hold US dollars anymore and so their purchasing power will collapse, with prices quoted in US dollars skyrocketing upward without limit. This has happened with various fiat currencies throughout history, and these episodes did not occur because the State in question repealed a regulation that had previously ensured its currency would be the money of the region. Instead, the people using that currency simply abandoned it in spite of the government’s desires, resorting either to barter or adopting an alternative money.

So legal tender laws complicate the issue, and the issue is so complicated that Murphy seems not to understand it. Some Austrians love arguments of the type of “it is possible that”: they do not specify how probable it is “that next Tuesday, nobody will want to hold US dollars anymore”. Fiat currencies do not fail randomly: they fail when they are badly mismanaged and when the State loses all or part of its coercive power.

We can at least imagine privately issued fiat money.

If we have a deeply defective illogical imagination, then yes we can!

Murphy does not even mention one of the main differences between moneys or means of payment: whether they are assets that are nobody’s liability (like a physical commodity or an abstract entity like bitcoin) or if they are assets that are somebody’s liability (credit money, someone’s promises to pay money, debt used as money).

It is possible to consider fiat central bank notes as non-liability money, but it must be done in a way that they can also be considered liability money. In order to understand this apparently paradoxical issue you need good knowledge of money, debt and banking.

Robert P. Murphy does not understand banking


In his article Banks Can Perform Their Two Functions With 100% Reserves, Robert P. Murphy writes:

Let’s start with the basics: There are two functions that banks serve:

(1) They act as credit intermediaries, in which the banks take funds from savers and channel them to borrowers.

(2) They act as warehouses, in which the banks store their customers’ deposits in huge vaults and provide services such as check-clearing and ATMs.

Murphy does not get the basics of banking right. Actually banks perform two main functions: payment managers and financial intermediaries (debt or credit intermediaries). Banks are not money warehouses; deposit contracts are not warehousing contracts. Banks perform their payment management function by issuing their own liabilities (bank notes and demand deposits) and ideally backing them with very short term and very low risk assets. Only a small part of those assets is money proper, therefore banks naturally operate with fractional reserves. Bank liabilities are not money in the strict sense (outside money, probably some commodity) but money substitutes, promises to pay money, fiduciary media (inside money). They are used by their clients because they can be more convenient than using only money. The problem with banks is not fractional reserves, but maturity and risk mismatch between their liabilities and assets (borrowing short and low risk and lending long and high risk).

According to Murphy:

100% reserve banking is possible in a market economy.

It is possible in the same sense that less efficient and competitive agents are possible: in principle they are not impossible, but competition tends to expel them from the market.

100% banking could work, yes: badly.