Money is a fascinating and complex topic that often leads to heated debates. Some argue that the money supply needs to grow along with the economy, while others claim that limited money like gold or Bitcoin is sufficient. In this article, we’ll explore whether the total amount of money in an economy can be too little and cause deflation.
The Concern Over Limited Money
Most modern economies have central banks that control the money supply. They can print more fiat currency or digitally create it to match economic expansion. The rationale is that more money is needed to facilitate growing transactions and reflect new value creation.
Otherwise, the thinking goes, there would not be enough units of money to properly intermediate between buyers and sellers. As a result, the value of money would increase, causing prices to fall across the board. This condition is called deflation and feared by many economists.
But is this concern justified? Can there really be “not enough money” in an absolute sense if the quantity is limited? Or does stable or decreasing money supply simply lead to adaptation in prices?
The Praxian Thought Experiment
To better illustrate the dynamics of limited money, let’s consider a thought experiment on the distant planet Praxis. The Praxians discovered a unique asteroid metal called misesium that became the basis for their money due to suitable properties. The supply was limited because the metal did not occur naturally on their planet.
At first, minted misesium coins circulated alongside notes redeemable for a certain weight of misesium. But eventually, the asteroid metal ran out and lost all non-monetary uses. The question emerged – can misesium still work as money if the supply is forever fixed while the economy keeps growing?
Some Praxians proposed leaving the misesium standard and printing paper notes without backing to avoid looming “deflation.” But is their worry substantiated in this situation?
The Misesian View of Money
To shed more light on this debate, let’s examine what economist Ludwig von Mises wrote about the nature and role of money. In his seminal book Human Action, Mises notes that money is valued not for its physical form but for its purchasing power.
Money serves as a medium of exchange to acquire real goods and services. According to Mises, “The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.”
Changes in the money supply affect prices and redistribute wealth, but do not determine whether sufficient money exists in absolute terms. From this perspective, increasing production does not require an increase in money quantities.
Society enjoys all the economic benefits from money regardless of the total amount in circulation. As long as prices can adjust freely, limited money presents no hurdle to an advancing economy.
How Would Limited Money Work?
Applying this Misesian lens back to Praxis, we can conclude their concern about misesium causing deflation is likely overblown. The supply of money needs to facilitate trading, not match the value of all goods proportionally.
Let’s say the initial 100,000 tons of misesium allowed buying one praxee-sheep for 1 kg misesium. As productivity grew on Praxis, the same sheep would cost only 0.1 kg after ten years and 0.01 kg after fifty years due to the money’s appreciating purchasing power.
While the misesium units would not be practical to divide indefinitely, the paper notes could represent smaller weights like grams or milligrams. This is not fundamentally different from dividing a currency like dollars down to tiny fractions of a cent.
In other words, limited money supply leads to natural price deflation, but this does not impede economic coordination or make money insufficient. The purchasing power adapts to the volume of trade. As Mises stated, “For each individual and for all individuals together the advantages attainable by the use of money are always exactly sufficient to the extent that they are warranted by the money’s purchasing power”.
Overall, the key insight is that money aims to facilitate transactions, not measure total production. Money is neutral and desired for its exchangeability into goods rather than its physical quantity.
A limited money supply does not constrain society’s prosperity. It simply results in a dynamic process where the purchasing power of money rises as productivity and output expand. Therefore, concerns about money shortages or insufficient deflation are largely unfounded according to notable economists like Ludwig von Mises.
The thought experiment on Praxis illustrates how non-inflationary money could hypothetically function and adapt in an growing economy. While unfamiliar at first, limited money presents no inherent economic limitations.