Book Review: Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown, by Detlev Schlichter

“The US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost.”

Such was the observation of Ben Bernanke during his time as an academic before he became chairman of the Federal Reserve. Although Bernanke was speaking with reference to the response of policymakers in the face of a deflationary environment, there was essentially nothing radical about his prescription; the Fed had already been steadily increasing the money supply for some time. In fact, during the 50 years up to the onset of the recent financial crisis, the amount of dollar notes and coins in circulation increased by a factor of 26, while the level of industrial output increased by a factor of only 5.

The constant injection of new money into the economy by the central bank lies at the heart of the secular inflation that industrial economies have experienced ever since they left the gold standard. Policymakers would have us believe that steady, modest inflation is good for the economy, so long as it is managed responsibly by them. In what could be poised to become his seminal study, Detlev Schlichter contends that the system of ever-expanding paper money is in fact a disaster waiting to happen, and a central cause of our current economic malaise.

Far from creating the stable economic conditions so sought after by central bankers the world over, Schlichter argues that the ongoing expansion of the money supply artificially lowers interest rates which in turn allows misallocations of capital to build up in the economy, thereby exacerbating the gyrations of the boom-bust business cycle – gyrations which are getting worse. In Paper Money Collapse, elastic money is likened to a Ponzi scheme, which by definition requires ever increasing injections of new money in order to perpetuate the illusion of sustainability. And like all Ponzi schemes, it is only a matter of time before this one unravels.

The solution?

Unfortunately there is no easy way out other than to allow the emperor to realise that he’s not wearing any clothes. As Ludwig von Mises, a chief proponent of the Austrian school of economics – and a major influence on this book – observed: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved”.

Schlichter, an investment manager by trade, sets out his case with systematic logic and is almost clinical in his analysis. Indeed, some would be put off by what is undoubtedly not an ‘easy’ read, but in truth I have hardly been able to put this book down. One by one, the fallacies of the supposed superiority of elastic money fall prey to Schlichter’s intellectual juggernaut. In fact, it is remarkable that the public are so accepting of the status quo given the historical record: Of the 30 hyperinflations recorded by history, 29 were in the 20^th century (i.e. when elastic money was in the ascendant).

By the same token, Schlichter explodes many of the myths surrounding commodity-based money – to which he urges a return – chief of which is the assumption that the secular deflation associated with commodity money is necessarily harmful to the economy. On the contrary, history shows that economic and social progress was facilitated rather well during the thousands of years that the world used commodity money, which provided remarkable levels of price stability; major financial crises were usually due to some attempt by the authorities to impose elastic money on the public.

Although Schlichter is remarkably sparing with his criticism of individuals, he is clear that the main beneficiaries of the current system are the state and its agents – including the banks, which are considered to be little more than extensions of the monetary policy of the state. Indeed, the concept of the free market is now almost anathema when applied to these institutions, which are fed a limitless supply of fresh reserves from the central bank. This in turn creates a situation where it is no longer in the interests of commercial banks to run a prudent lending policy through the maintenance of reserve levels – essentially precipitating the moral hazard which led to the financial crisis of 2007-09.

A compelling, albeit rather alarming critique of contemporary economic doctrine, I am disturbingly convinced that Paper Money Collapse will prove prescient. The last words are reserved for Schlichter himself: “The present fiat money economy is ripe for some Schumpeterian ‘creative destruction. In the meantime, the debasement of paper money continues.”