The goal of this unit is to:
Self–owning human beings, free to do as they please, will normally choose to interact with others so as to enhance their lifestyle, and do so under terms of contracts which are explicit and voluntary, even if they are not always written down. That is a “market” and it is what a free society would be.
So as to make it easy to exchange things and services, it was shown that “money” would normally be used — but but no time was taken to define or examine money.
Ease of exchange is important, because if it is not easy it involves a cost, of time or effort; call that a “transaction cost.” Someone might want to acquire a pair of shoes, but the shoe retailer accepts only tenderloin beef that day, and the customer happens not to own any beef. So both of them have to make calls and negotiate to see how to solve the dilemma and get the shoes on the customer’s feet and the beef in the retailer’s freezer. Much simpler if there were a medium of exchange which is universally acceptable; the transaction can then be completed in a few seconds and at negligible cost.
That medium is “money” and in history it has taken many forms; early trading between English colonists and Pequot Indians in the 1600s was done with wampum, a variety of bead. Money can consist of anything which is valued by everyone in the market; “valued”, for everyone trading will be handing over something of value — the product of a day’s labour, perhaps — so they must feel assured that the token they are receiving in exchange will, in due course, be exchangeable for something else they may want to buy. Thus, whatever is used for money must be:
If the second were not true, the holder would need to spend it at once, which would usually not be what they wished to do.
Wampum did not last, because it was too easy to counterfeit; it took less labour to forge a set of beads than to produce something truly valuable like a coat or a bushel of wheat. That reveals the third requirement for sound money: It needs to be rare and therefore unprofitable to counterfeit; the cost of producing it must be comparable with its value in exchange.
The most frequently chosen medium of exchange, in five thousand years of recorded human history, has been gold. Gold has had a couple of disadvantages, as money: It is a dense metal and so rather heavy to carry around, and so rare and valuable that it is difficult to divide into small portions, to exchange for small items such as a loaf of bread. Those shortfalls have been handled by using silver for such small purchases — but then complexity arises, as it did in late nineteenth century America, which used both metals, when the exchange rate between the two changes, as it will do in obedience to the natural law of supply and demand in a free market. Another way to overcome the difficulty has been to issue gold certificates in small denominations — though there the problem of counterfeitability resurfaces. Today, thanks to the internet, neither of those partial solutions is needed because gold–based accounts can be run with high precision and even tiny quantities can be exchanged.
Those shortfalls having now been overcome, nothing — except government! — obscures the outstanding natural advantages of gold as money:
No wonder gold has entered the language as a “standard.” It is almost certainly the form of money that a freemalleablemarket society would choose, even though it is important to note that the choice of a medium of exchange would be a free choice, in no way dictated! The market would choose whatever it wanted for the purpose; the prediction that gold would be picked is just that, a prediction and nothing else.
We have seen above something never taught in government schools: A brief account of what money is, what purpose it serves, what requirements lie upon it, and why gold has been and probably will continue to be the favourite form of money in human society. Now turn to what prevails today throughout the world; for what is everywhere seen as ‘money’ is: Paper!
No society in its right mind would choose paper for money:
And yet here society stands, with little practical alternative for money but pieces of colourful paper. How did this happen? Government wanted to control the supply of money for its own purposes. In most countries the government prints ‘money’ directly, with its central bank; in the United States, the same thing happens but with a thin disguise, called the ‘Federal Reserve’, technically independent of government control. The Federal Government then forces the universal use of these pieces of paper with its ‘legal tender’ laws; those do not make it permissible to use the money, they make it mandatory! And yes, control over money is very important to government.
The process took place gradually. There was a move in 1791 to establish a United States Central Bank, but happily that was nixed by Congress in 1811 and a cunning substitute — a nominally independent private club of bankers called the ‘Federal Reserve’ — was not established until 1913. Since 1913, the United States Dollar has lost well over ninety–five percent of its value. Gold has, in contrast, kept its value constant.
Paper appeared as a convenient form of money much earlier than 1913 — but only in the form of certificates for gold or silver, issued by banks which placed their reputations and businesses on the line when they had them printed, and which the holder could exchange for metal upon demand of the issuing bank’s teller; the United States Treasury issued some too. So people got used to carrying paper as money for more than a century, and most Americans did not notice or understand what was happening when gradually the connection between paper and metal was broken. Roosevelt savagely attacked it in 1933 by prohibiting individuals to own gold other than jewellry but it was not completely severed until 1971, when President Nixon declared that the value United States Dollar was no longer even nominally guaranteed in terms of gold.
In the thirty–five years following 1971, the paper United States Dollar lost seventy–seven percent of its purchasing–power value.
Obviously, nobody would volunteer to use such a flimsy excuse for money; its use had to be compelled, as well as to be introduced gradually so as to deceive the population into supposing it represented something real. The key is the innocent–sounding ‘legal tender law.’ On its face, any United States bill — or rather, ‘Federal Reserve Note’, as it says at its head — declares “This note is legal tender for all debts, public and private.” Many suppose that to mean, it is okay — you can go ahead and use it, the government guarantees it is good.
That law means no such thing. It really means “Sucker, you are legally forced to accept this in payment, like it or not.” Hence the term “fiat currency”, meaning “money is what we say it is.” Bad ‘money’, by force of government law, has excluded good money.
It is worth pausing to notice the importance of this, for there are many good people who mistakenly blame the Federal Reserve alone for the debasement of the United States Dollar, as if its whole cause was the participation of that private association. The very opposite is the case!
Imagine that as a large club of private banks, the Fed issued its Notes as today, without any pretence that they certified anything such as exchangeability with gold, but that there was no legal–tender law — no government force, to make creditors accept them. Would they accept them then? Not in a million years. Especially not when they saw that the notes lost value every year!
It gets worse. Part of the scheme that binds the Fed to the government is a sweet deal called ‘fractional reserve banking.’ This means that it is quite okay for a bank to lend out money it does not have, and earn interest on it. If it receives a deposit of $100, it is free to lend out $90 and when that is re–deposited, a further $81, and so on to a total of $900 — to borrowers who might pay five percent a year in interest on the $900, which — with the full knowledge and approval of the Fed and the United States Treasury — it ‘created’ out of nothing. That would be $45 per year, or forty–five percent on the original $100 that it does have, on deposit. The deeper we look, the deeper the fraud!
That is a ‘fraction’ of one ninth, or about eleven percent — it varies from time to time. In essence, banks can keep in reserve only one ninth of the money they lend out. Now, absent government — that is, in a free market — would one deposit their money in an institution that loaned out nine times what it held? No way, José!
Take it a step further, and assume that in such a free market, Bank B noticed an individual’ reasonable reluctance and advertised that they loaned out only five times their deposits, instead of nine. They would find that much safer, so they might make a deposit; Bank B would compete effectively with the first bank. Then along comes Bank C, announcing a fractional reserve of fully two thirds of its loans; they would probably switch to that one, as being safer yet. Finally comes Bank D and does it right: One hundred percent in reserve! It lends out nothing it does not possess — though it may make some charges for its service of keeping your money in its vault. That is about as safe as one can get. So they and everyone else would prefer Bank D, and all those practising fractional reserve would go out of business. In a free market, good banking practice would drive out bad.
By that logic is proven the proposition that fractional reserve banking, with all its attendant evils, can operate only when the market is not free — when government controls it. The hands of the Federal Reserve are hardly clean; but the essential ingredient of the fraud is the set of government laws that force the population to interact with it in ways the free market would not touch. The Fed is an accessory; government is the master criminal.
The reason governments love paper and force its use upon those they control is that it is so easy to print. And why is that so attractive to them? Having printed some, before the new ‘money’ passes into circulation it is first spent by government, on projects that will bring votes. As the new ‘money’ circulates, it reduces the average value of all money and therefore causes prices to rise and previously–agreed loans like mortgages to become cheap to repay. Government can therefore in one simple move benefit one sort of person — borrowers — and destroy another sort — lenders. That is power!
As Rothbard pointed out, the printing of money by government need not be literally the cranking of a press. Huge blocks of ‘money’ are created out of thin air by a very sophisticated, fraudulent process: The United States Treasury offers to sell a ‘T-bill’ with a face value of, for example, ten billion dollars and the Federal Reserve Bank buys it, at a discount that provides part of the motive to do so. The trick is that at the instant of purchase — writing the check — the Fed does not have the money! Instead they ‘kite’ the cheque until the next day, when the T-bill is deposited in the account, so ‘balancing’ the books. The result gives the government cash to spend, while it gives the Fed an asset that it can use to lend out to borrowers such as home buyers and expanding businesses — at interest!
Everybody wins, especially borrowers who can pay back loans with cheaper “dollars” — such as government with its six trillion dollar debt — but not the holders of the ‘money’ with a value duly diluted by that chicanery; ordinary people, and especially those conned into buying government CDs earning less interest than the inflation rate. Government savagery is not always done by thugs in Ninja suits; sometimes the suits have pin stripes. But there is even more.
In stunningly beautiful Bretton Woods there met in 1944 delegates from forty–five nations — Germany and Japan were not invited — to agree what would replace the British Pound as the world’s ‘reserve’ currency. No prizes for the answer: It was to be the United States Dollar, since the United Kingdom and most other countries were nearly bankrupt due to the war still raging. The Feds promised to exchange gold for dollars at the rate of $35 per ounce; a promise that Nixon broke in 1971. But by then the dollar reigned worldwide.
By “reserve” and “reigned” is meant that the United States would act as the world’s banker; that capital goods and commodities would normally be priced in terms of the United States Dollar. Thus, if a Brazilian order was to be placed for a hydroelectric dam with contractors from Japan, money would flow in the form of dollars. The supply of dollars to be held for international trade has meant — ever since 1944 — that American ‘money’ has been the world’s currency. This has had two consequences for Americans.
First, it has brought prosperity they have not earned. Because of the special status of the dollar, foreign manufacturers are willing to export to buyers useful goods such as automobiles, oil, and television sets, and to accept in exchange pieces of green paper; or more accurately, electronic entries in an American bank account. They then invest those bank balances in United States government bonds — IOUs, to be repaid eventually by American taxpayers at the point of a gun — and in shares of American companies. The net effect is that United States residents enjoy a steady flow of useful goods with no corresponding export of other useful goods or real money such as gold, but also that foreign investors gain an increasing degree of ownership in those companies. That is the price Americans pay for such prolonged though artificial prosperity. When the government’s power to tax evaporates when all Americans, then better–educated, walk away from government, there will be a lot of unhappy foreign investors; perhaps a few truckloads of $100 bills will be printed up to satisfy their contracts, but nobody in America will accept them any longer in exchange for anything valuable. Those ‘legal tender’ laws will be no more.
Second, it has meant that to keep tabs on the ocean of United States currency that is circulating around the world, the Feds have had an excuse to probe in every country to see who owns what; their scrutineers do not just demand that American domestic banks deliver private bank–account information upon request, but that even foreign banks do likewise, if accounts are held in dollars. This has severely hampered the ability of Americans to place their own money out of reach of the tax–gatherers; financial privacy, worldwide, is but a sick joke. Cynics say the ‘golden rule’ is that whoever owns the gold, makes the rules; since 1944, the United States Government has proven that whoever prints the dollars makes the rules. America is increasingly detested worldwide as a result, giving motives for future wars. But the government’s gigantic thirst for power is slaked . . . for a while.
How would a gold standard best be restored?
Suppose in a closed society the amount of goods and services in circulation were constant, but the amount of money increased one year by twenty percent. What would happen to prices?
Suppose a free–market society chose gold for its predominant form of money, and that the supply of gold being mined increases by two percent a year. After a little while, what will happen to average prices if the supply of goods and services increases by five percent a year?
In a society whose money is managed by a government, prevailing interest rates on savings accounts are three percent a year, while the supply of paper ‘money’ printed is increased by four percent a year. What happens to the real value of a $10,000 savings account in the first year?
In 2005 a United States bank received a deposit of $1,000 and legally made loans shortly afterwards of $10,000 at six percent interest, using the &rlsquo;fractional reserve&rqsuo; principle underwritten by government. What was the gross interest rate it earned on the money actually deposited?
Why is it that paper money distorts financial decisions, commercial and domestic?
Would average prices be predictable in a free–market society? Why, or why not?
About those “unhappy foreign investors” — how will they be handled?