Is the Supply of Money a Natural Monopoly?

In conventional microeconomics the monopoly is associated with inefficiency. Under perfect competition there are no deadweight losses. This means that resources are efficiently allocated. The monopoly, on the other hand, provokes inefficient production by choosing a low level of production. This inefficiency could be reduced by the involvement of the government; that is, by regulation. The monopoly then, can become regulated or even a public company rather than private company. The argument sustains that while a private company will try to maximize its benefits, the public company will try to maximize social welfare by minimizing inefficiency.

Not all monopolies are originated similarly. A firm may become a monopoly, for example, because the government legally forbids competitions. In this case the solution is straightforward: remove the institutional benefits to allow for competition. But another possibility is the natural monopoly. This is a case where the structure of costs in the market results in one supplier only. If the average cost of production is decreasing as output increases, then only one producer will subsist in the market. If there were, for example, two producers, each one of them could reduce their costs by increasing production and then lowering the prices of their production. If average cost decreases continually, then only one producer will remain active in the market. This is the case of the natural monopoly; a common examples is the supply of utilities.

If supply of base money is a natural monopoly, then a case may be raised for the government to take under its scope the supply of money. As long as base money is a commodity, like gold or silver, it is not evident that supply of these commodities are natural monopolies. There are not, at least, historical cases of monopolies in the mining and minting of commodity money when competition was allowed to take place. The same occurs with the production of banknotes as money substitutes, the result was not a monopoly when competition was allowed.

But because money is the other hand of every transaction that takes place in the market, the more people use a particular money as a medium of exchange the better for each individual. This standardization suggest that money may be a network good. The more people use the good, the more likely other will use it as well. Common examples are fax machines and telephones. There is no use in having a fax or a telephone if I’m the only one having one of these goods. A more modern example could be social networks like LinkedIn, Facebook, etc. If money is a “network good” or has “social economies of scale in use,” is not this a case of a natural monopoly?

This is still not the case for base money (i.e. gold) or money substitutes (i.e. banknotes). It is true that for any individual to interact with another in, say, Facebook, he needs to have an account or belong to the same network. But this is not a requirement for the case of money. Any individual does not need to have an account in the same bank than another to perform an exchange. Similarly, in any given exchange it does not matter from which gold mining company the gold used in the exchange came from. The difference is that a social network good requires the participant to belong to the network, but this does not hold in the case of money. The fact that all exchanges are ultimately performed against base money, this does not require the base money to come from one supplier only. This case does not hold, then, neither for base money (i.e. gold) nor for money substitutes (banknotes).

A different question is what is the optimum number of suppliers of base money and optimum suppliers of money substitutes. This is not a different question of what is the optimum number of producers of cars, computers, or any other good.

A different situation is when the base money rather than being a commodity is fiat money. As White (1999, pp. 133-135). There are no historical cases of a competitive market of suppliers of fiat money to guide an answer to this problem. A key work on currency competition is Hayek’s Denationalisation of Money (1976). Hayek argues that each issuer of fiat money would try to stabilize the purchasing power of its currency to a price index of their choice. If all banks refer to the same price index then this may become a natural monopoly scenario; although a preference for diversification may counter act this tendency. Because fiat money is not convertible to a commodity money like gold, there is a benefit in accepting fiat money with high market share; similarly to the benefit of accepting a liquid commodity money like gold against a another with low level of acceptance. However, if as Hayek suggested, each bank will target a different price index, then the scenario of the natural monopoly may not arise.

The natural monopoly argument does not hold in the case of money. On the contrary, it is clear that the case is that money is a legal monopoly. If one of the principles of sound money is to increase efficiency, and is accepted in conventional economics that competition is more efficient than monopoly, then institutional privileges to central banks should be eliminated and let the forces of market competition give us better money.

Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.

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