An In-Depth Review of Paper Money Collapse

At the beginning of Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown, Detlev Schlichter provides a sweeping view of monetary history and of today’s place within it.

Mankind has used money for more than 2500 years. For most of history money has been a commodity and most frequently gold or silver. There are good reasons why gold and silver have held this unique position. These precious metals possess some characteristics that make them particularly useful as monetary commodities, such as homogeneity, durability, divisibility, and, last but not least, relative scarcity. The supply of these metals is essentially fixed. Gold and silver can be mined but only at considerable expense. Their supply cannot be expanded quickly and inexpensively. For most societies throughout history, the supply of money was therefore essentially inelastic.

Today we use money that is very different from what the vast majority of our ancestors used. Today, money is nowhere a commodity. It is everywhere an irredeemable piece of paper that is not backed by anything. We live in a world of “paper money,” although most money today doesn’t even exist in the form of paper. It exists only as a book entry. It is electronic money or computer money. It is immaterial money. And because it is immaterial money, its supply is entirely elastic. Those who have the privilege of legally creating this money can produce unlimited quantities of it.

As history, particularly that for the past 2500 years, all of this is true. But as some of you may want to ask, so what?

Schlichter’s thesis is primarily that this change has been for the worse and that a return to sound money, money that cannot be expanded at the whim of some bureaucrat, is exactly what the world needs right now.

Although the thesis itself is not groundbreaking, Schlichter stands apart from other commentators in both his defense of inelastic or commodity-backed money and in the power with which he demolishes every main argument for its non-backed and elastic opposite.

Schlichter’s wit in particular is sharp. A central banker could commit seppuku with these pages. And his logic is devastating, if only because readers can set the book down and see the truth of what he says playing out in the economy today. Take, for instance, the evolution of a paper money system that Schlichter provides:

[W]henever the dislocations created by easy money and artificially low interest rates begin to derail the economy, a credit correction is avoided by a renewed administrative lowering of rates by the central bank and, if required, further additional injections of money. The idea behind this is obvious: The boom is good and should just be enjoyed; the correction is bad and must be avoided at all cost. And with money being now fully elastic, why even suffer a credit contraction?

However, we know from the Austrian analysis that this cannot solve the underlying problems. Easy monetary policy in a recession simply obstructs or stops the adjustment process. The misallocations of capital from the previous boom do not get corrected and instead are carried forward into the next money-induced expansion in which additional misallocations are added to existing ones. The next time a recession occurs—and it will, of course, only be a question of time—the need for a cleansing correction will be even more intense, and it will consequently require an even larger injection of money and even lower interest rates than previously to postpone the correction again and to manufacture another boom with the help of artificially low interest rates. There can be no doubt that this is a process that must make the economy progressively more unbalanced. Recessions will get more protracted, recoveries will be more difficult to engineer and will be shallower and more fragile. As the distortions that need liquidating get bigger, it will be politically ever more difficult to allow the correction to unfold. And as the policy establishment has long maintained that ‘under a paper money system, a determined government can always generate higher spending and hence positive inflation’ (Bernanke), the short-term fix of paper money will be applied in ever larger doses.

If that doesn’t sound familiar, I’m pretty sure you haven’t been watching the news.

But Schlichter’s book does much more than show that our present system of fiat money is headed for collapse—just like every other such system across history has done. The book also nails so many crucial areas of economics that you can profit from reading it on that basis alone.

For example, Bernanke’s above statement about being able to “generate higher spending,” relies in part on what Schlichter calls “an irrational fear of savings” and in part on the view that consumption creates wealth. But Schlichter points out the truth that savings are the basis for prosperity.

No society has ever risen, nor could any society conceivably rise, out of poverty and into prosperity via consumption. It is saving and production that generate wealth. By shifting resources from meeting present consumption needs and by allocating them to productive uses to meet future consumption needs, that is, by saving and investing, society generates the capital stock that raises the productivity of labor and allows a larger supply of goods and services.

Schlichter likewise demolishes the myth that deflation is to be feared—something that advocates of loose money and inflation do their best to perpetuate. He shows that a growing economy does not need a growing supply of money, that a growing supply of paper money is in fact harmful—forcing people to squander, not save—and that a system of constantly expanding paper money has never ended well.

On that latter issue, one of Schlichter’s most timely points is that the latest attempt has nearly run its course and that readers should prepare for the endgame by purchasing real assets, assets that cannot be produced in unlimited quantities by central bankers.

Here, Schlichter suggests buying gold above all. But Schlichter recommends it not as an investment; he recommends it as sound money, money that will outlast and one day replace the paper money system of today.

Thankfully, Schlichter does all of the above while making important distinctions and keeping things in perspective. He notes, for example, that the collapse of paper money does not mean the end of the world.

Decades of constant paper money injections, of artificially low rates and high asset prices, have created an illusion of prosperity, but that does not mean that all our wealth is illusionary. Great advances have been made in the efficient uses of resources, technological progress has been phenomenal, and the international division of labor has expanded and intensified. Real prosperity and economic progress will always be the result of entrepreneurial initiative, of innovation and creativity, of voluntary saving and capital accumulation, all guided by unimpeded price formation in uninhibited markets, and not by paper money creation, artificially low interest rates, and artificially high interest rates.

This is crucial to remember, both now and in the coming years. The whole thesis is one of the most important of our times—in fact, as important as the need for a return to the rule of law. And Schlichter’s execution of it makes Paper Money Collapse one of the best works of economics in many years.