As an economist, I am often asked how fast the money supply should grow. The answer is simple: it shouldn’t. In fact, once an economy has a money supply, any amount is optimal. This answer is often met with confusion because it is so far outside of their expectations. To build my case, let us make a simple argument.
Barter is the economic system that precedes a world with money. In a barter world, people directly trade goods. For example, people will trade apples for blueberries. Both apples and blueberries have “use value.” Use value is the subjective satisfaction one gains from a good or service, like apples and blueberries.
As any economist will tell you, barter is highly inefficient. The transaction costs are so high that many will endure hyperinflation rather than resort to a pure barter economy. To overcome these high costs, as Carl Menger illustrated, money naturally emerges from a barter economy. Imagine two people (A and B) who have apples and blueberries. Suppose person B (who has blueberries) does not want apples and would rather have cherries. Thus, person A finds person C (who has cherries and is willing to accept apples) and trades the apples for the cherries. Finally, A trades the cherries for the blueberries, and everyone is happier. Why did person A trade for the cherries? Person A might not like cherries. Person A might be allergic to cherries. So why did he trade? The answer is obvious: the cherries are a means to an end. Person A traded the apples for the cherries to get what he ultimately wanted, the blueberries.
In this example, the cherries have use value because Persons B and C value their use. However, they have also gained something else: exchange value. Person A was completely uninterested in the use value of the cherries and only valued them as a means to get his ultimate end. In other words, he only valued the cherries because he could exchange them for the blueberries. See Rothbard’s Man, Economy, and State (beginning with Chapter 2, section 2) for a detailed exposition of use and exchange values. As the goods with exchange value compete with each other in the marketplace, the victor is the good called money.
Fiat money is money that has pure exchange value. It has no use value. Most dollars are digital numbers recorded in electronic accounts. A curious point about the fiat dollars is that when they are used, they are not used up. When I use a dollar, it remains a whole dollar. It is not diminished by my giving or receiving it. In contrast, when I use an apple, it gets used up. The same is true about durable goods. They, too, are used up, albeit at a much slower rate. But money is different, and it is this difference that is important.
We do not need to add more dollars to replace used dollars. Furthermore, as we add more fiat dollars into the economic system, no additional use value is added to the economy. And, as we increase the supply of fiat dollars, we are not adding exchange value to the economy either. We are simply diffusing the total exchange value across more dollars. We are reducing each dollar’s purchasing power. In other words, there is no gain in either use or exchange value as we create new dollars. (For more details on how adding more dollars does not add value to the economy, see the classic article by Rothbard on the Austrian Theory of Money).
The takeaway is that dollars do not disappear as they are used, and creating more dollars does not add value to the economy. Therefore, there is no economic reason to change the money supply. Any amount of money is optimal.