3 posts tagged “federal reserve system”
(The Financial Boom was Bad [An Example of Not Allowing the Market to Work!])
The prophetic Mr. Peter Schiff, author of Crash Proof: How to Profit from the Coming Economic Collapse (2007), talks at the Mises Institute's Austrian Scholars Conference.
I hope you have some gold under your mattress.
Oh,
by the way, I wonder. Who has a better track record: Mr.
Greenspan----or, maybe I should call him, Mr. Monopoly Man----or, say,
the Austrian economists?
Hmm. What did Greenspan say in 2003 about housing and what did the Austrians say? Why, let's time travel back and read, how about, "Housing Bubble: Myth or Reality?" by Dr. Frank Shostak.
Or, even more generally, who has a better track record: The typical Keynesian economists you see on TV----who say they have the answer, even though they did not see this coming----or the Austrians?
***
Without Mr. Monopoly Man there would not have been any bubble in housing, as Dr. Thomas Woods says:
The housing bubble could not have arisen without the Federal Reserve. Had people started buying houses at unusually high rates, banks' loanable funds would have begun to deplete, interest rates would have shot up, and that would have been the end of it. That would have discouraged any additional speculation in real estate. But Alan Greenspan and the Fed could create money out of thin air, thus giving the banks more to lend and driving interest rates down, thereby perpetuating the destructive bubble in housing.
***
Despite the earnest intentions of those who call for a return to a "gold standard," perhaps they do not realize how severe this economic crisis is and is becoming (thanks to those in power who will not allow the market to rid itself of the various malinvestments that occurred in the artificial "boom"). Government with the gold standard abused it, more or less, from day one. Given its top-down and centralized nature, it was a system that was waiting to be abused. As a matter of fact, the prerequisite to have a gold standard is abuse, fraud, and anti-market interventionism! Because of this, nothing will suffice but the complete privatization of money production.
As Woods points out in his excellent book Meltdown, F. A. Hayek argued that this is exactly what needs to be done (read Hayek's "Toward a Free Market Monetary System"): "I am more convinced than ever that if we ever again are going to have a decent money, it will not come from government: it will be issued by private enterprise, because providing the public with good money which it can trust and use can not only be an extremely profitable business; it imposes on the issuer a discipline to which the government has never been and cannot be subject. It is a business which competing enterprise can maintain only if it gives the public as good a money as anybody else. . ."
(At the end of my blog essay "Money and Civilization" I give a quick outline on how this can be done.)
And, do I really need to type this? (OK. I guess I do, given what President Bush on steroids Obama is doing.) Economic progress comes from capital accumulation; not spending. Read Dr. George Reisman's brilliant essay on that here.
***
A Note on Deflation and Inflation.
We all have to be careful with the terms inflation and deflation because they are defined differently by different people. But the best definitions are, as is usually the case, the classical definitions: Inflation is nothing but an increase in the money supply via fiduciary media (put bluntly: counterfeiting). Deflation is nothing but the decrease in the money supply. In this very specific sense, therefore, deflation is practically always a statist phenomenon. A recession or depression often sees some fiduciary media extirpated. (This is not a bad thing, for both ethical and economic reasons.) On the other hand, deflation qua the overall fall in prices (we'll call it: "definition 2") is more generally and often a free market phenomenon. (Though, definition 2 often follows definition 1 in a recession or depression.) For instance, imagine that we have a robust economy with a free market money that is by and large gold as its medium of exchange, with no fiduciary media, and thus a banking system based on 100% reserves. Naturally, then, man would see overall deflation in this very specific sense. Gold would of course increase, but extremely slowly as compared to the increase in the amount of goods being produced. Hence, purchasing power would go up, prices would go down, and saving and investment would be encouraged. This would be a magnificent thing. Deflation is not evil. In contrast, inflation qua the overall increase in prices is, ultimately and generally, a statist phenomenon. It would not be something we would see in a free society.
Mr. Justin Raimondo at Anti-War.com writes about "The Bubble Boys."
“The Greenspan bubble benefited the banks, the real estate moguls, and, most of all, the war profiteers.”
***
Monetary socialism is an evil not only because it generates----through the Federal Reserve's artificial lowering of the interest rate via credit expansion----chaotic booms-and-busts in the economy, but is also an evil because it's an essential part of the military-industrial complex and the U.S. Empire. They rely on the Fed for sustenance.
This is why I believe it is very important for those of us who value liberty and, as a corollary, peace to point out to the public the need to eliminate the Fed and unbacked fiat money. We must all show the public the importance of a 100 percent gold dollar (or other equivalent free market money).
Ending monetary socialism is the only way to severely limit the State in its war making powers. If there is something the peace movement should rally around, it should be this. It would take away what feeds Leviathan's wars. It would help extirpate the fascistic influence of neoconservatism. Future neocon (and left-liberal) elective wars would not be an option as easily as they are today.
And ending monetary socialism is the only way to cure our credit addiction. It is the only way to promote the conservative work ethics of thrift. It is the only long-term solution to our current financial crisis. To paraphrase Mr. Lew Rockwell: We must all stop living in and believing in an illusion and a lie.
Government bailouts and other regulatory interventions can only result in prolonging and deepening today's recession. But the recession is not the problem. We should not be getting angry about that. The problem was the bubble that was created by the Fed in the first place. It was that creation that made the recession inevitable. And it is the recession that leads us out of our current mess. This is how the market is trying to correct the economy. The market must bring man back to reality and away from the unreality of the Keynesian fairyland of bubbles.
I thought this for many, many months now (actually, maybe longer), and I very much hope I am wrong, but I think it is 50-50 in terms of some kind of depression developing. My fears seem justified. Today's politicians appear to be copying what Hoover and FDR did. They tried to stop the market from correcting the socialist distortions, as readers of the late Murray Rothbard know. But by continually not allowing the market to fix the economy, it resulted in the Great Depression.
All of you one or two regular readers of The Paleo Blog know the economists of the Austrian school predicted this entire mess. There is a library of scholarly and popular work on this subject available at Mises.org for all to read. Correct ideas do not spread on their own. They need educated men to spread them.
I think it is about time to listen to those who have been right all along, like the Austrian economists and like Dr. Ron Paul. They all say that the bailouts and regulations are a wrong move. The default reaction by the statist establishment to "prevent" any kind of recession is a wrong reaction. What the politicians are doing now will be felt in the future, and it will not be pretty. Hopefully the politicians will not do any more destructive intervening. If they do implement more socialist schemes, well, the Austrians can say "We told you so" ...again.
Watch, Read, and Listen:
- Ron Paul on what the State is Guaranteeing.
- Read Ron Paul's Statement.
- Put the Time & Effort into Reading American's Great Depression by Murray Newton Rothbard.
- See The Bailout Reader at Mises.org.
- See The Recession Reader at LewRockwell.com
- Mr. Charles Goyette on Anti-War Radio. (Charles, please come back to radio soon.)
- Listen to Dr. Frank Shostak at Mises.
- Listen to Dr. Joseph Salerno at Mises.
Debates between Democrats and Republicans in the mainstream media are subterfuge. It is largely a distraction from the more fundamental issues. It divides men up and pins them against one another into some kind of binary, partisan debate of "Republican good" and "Democrat bad" or vice versa.
And it feeds on emotions. Perhaps it is just a sad fact of human nature to become emotionally attached in a partisan way to "one's team," so to speak. Watching political debates is often like watching a debate between two sports fans of opposing teams.
Emotions are so strong, also, because man has invested so much of his energy into the political world. With a democratic and super-centralized government micromanaging society in a multitudinous of ways, men invest less and less of their energies in voluntary civil society and more and more of their energies into political plunder. Surely, the upshot of this is a degeneration of men as they put more effort to develop their political personalities.
Against such pusillanimous and daft men is to be a "radical." To be radical, in its etymological sense, is to strike at the root; it is to boil things down to their essence. To be radical is to see things for what they really are; it is to ignore the thought police and the current taboos. The only thing that politics today promotes is the status quo and the ignoring of giant problems, such as the current monetary system. Such problems become so big that men become blind to them. It requires a man to step back, see the big picture, and to analyze. Apparently, the traits to do this most men don't have, as they are conditioned by public education and their boob tube. The masses don't think; they follow current trends and current elites.
So, as a replacement for getting caught up in the trivialities of the daily political circus, we will be looking at more fundamental issues in a radical way. However, because of the fragility of today's faulty monetary system, this subject will become increasingly important in open debate in the coming years. This concise overview of some of the issues concerning money and politics is written for those who can rise above the common man. It is only those who can lead that shape future direction. If future conditions go the way they have been going, then we can expect much financial trouble ahead. It is those who are prepared for such conditions and who understand what brought about those conditions that can lead society in the correct direction.
This essay is appropriately enough dedicated to the Remnant.
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Money and Politics
I.
The most important thing to understand, as M. Rothbard would say, is that money is just a commodity. In this sense it is no different than any other commodity on the free market. It exists with a certain finite supply and there exists a definite public demand for it. The difference is that this particular commodity is most often used as a general medium of exchange. Men use it so as to participate with others in trade and division of labor. It is not independent of the market (or have a "neutral" affect on the market), but is derived from it as a solution to overcome the many problems and limitations of a barter (non-money) system.
Why is barter filled with problems and limitations? Imagine Bob has good "x" and Mike has good "y." Bob wants "y" but Mike does not want "x." In this case Bob is stuck. No direct exchange can take place. This is why indirect exchange develops. Bob starts to think about how he could get "y." He could run all over town to see if someone has "y" and wants "x." He could also ask Mike what he desires and would be willing to trade "y" for. Say Mike answers "z." Bob could then, using this indirect method, look for someone who has "z," buy it from him, and then sell it to Mike for "y." Bob would then value "z" only insofar as it facilitated a trade with Mike. But in any case a double coincidence of wants still needs to occur. That is to say, for Bob to accomplish his objective, it will only happen if and only if he finds someone who is willing to trade for "x." This is a very disorganized and inefficient system, as we can see. Another problem that can often develop is a problem of indivisibility. Say that "x" is an object that cannot be divided. Bob this time wants "b," "c," and "d." Say that he finds three people that offer these things separately. Again, Bob is in trouble.
In a barter economy it is almost instantaneous, as we can reason based on the analysis of the above paragraph, that men will be trading via indirect methods. This is what sets into motion the adoption of money, i.e., a generally used medium of exchange. For wanting to engage in many trades, entrepreneurial men look for goods that are highly marketable. These are goods that are greatly desired in the community. These goods have a high demand as a consumer good. But these entrepreneurial men value the acquisition of these goods as just a facilitator of trade. This adds a new "layer" of demand for these goods. In turn, this increases their marketability even more. An accretion of men will thus shift to this commodity as a medium of exchange. In turn, the marketability will go up even more. This process is what brings to life moneys that are used as general and universal mediums of exchange. The problems of barter disappear. Practically all trades start to take place with money. And owing to this development of money: more interactions between men can and will take place; all men will have a common "store of value;" and all men will have the ability to calculate monetarily their finances.
The incipient purchasing power of money relies upon the purchasing power yesterday (y) and the purchasing power yesterday relies upon the purchasing power yesterday minus one day (y-1) and so on. Money originates on the free market as a commodity with a pre-money barter demand and "price." So, not only has no money ever developed as fiat paper in any of recorded human history, but it is a priori impossible. A nascent money, shown with a regression proof, must have had a high non-monetary value on which to base its purchasing power.
Rothbard writes:
Economic analysis is not concerned about which commodities are chosen as media of exchange. That is subject matter for economic history. The economic analysis of indirect exchange holds true regardless of the type of commodity used as a medium in any particular community. Historically, many different commodities have been in common use as media. The people in each community tended to choose the most marketable commodity available: tobacco in colonial Virginia, sugar in the West Indies, salt in Abyssinia, cattle in ancient Greece, nails in Scotland, copper in ancient Egypt, and many others, including beads, tea, cowrie shells, and fishhooks. Through the centuries, gold and silver (specie) have gradually evolved as the commodities most widely used as media of exchange. Among the factors in their high marketability have been their great demand as ornaments, their scarcity in relation to other commodities, their ready divisibility, and their great durability. [Man, Economy, and State: A Treatise on Economic Principles, p. 164, emphasis has been removed.]
Clearly, then, a free market production of money is natural because that is where money originates. This selection process of money is also by nature competitive. Commodities which better serve as money will out compete and replace commodities that do not. It moreover gives men financial security since they have the freedom to pick and reject moneys they want and do not want. The competition in money production will thus produce the best moneys that men desire. Under a monopolistically managed money, though, this market mechanism is absent. Monopoly money, backed by legal tender laws, that is being debased and abused, for instance, cannot be replaced by a competitor's production of better money. Cheating, coin-clipping, and counterfeiting can only be much more intense than it otherwise would be under such monopolistic conditions.
Now we have a simple and straightforward reason governments have always tried to take control of the monetary system: They want to obtain more revenue. Cheating, coin-clipping, counterfeiting, and the like serve this purpose. What better way then to take control of the supply and management of the "lifeblood" of the economy, i.e. money? And in contrast to all forms of direct taxation, the bonus of appropriating revenue via monetary means is that it is indirect and unseen.
II.
It is now appropriate to go into a bit more extensively the economics of money production.
As already touched upon, money is basically like any other good that is being produced right now. It is a "hard" and "real" thing that needs to be produced. It is a commodity and hence has a "price." This price is shown daily in a man's financial transactions at the store. The man buys some bread and the store buys some money. The price of money is accordingly seen in the countless arrays of exchange ratios. Money's supply is the quantity of money in existence. And the demand for money is how much or little men are willing to give it up in exchange for other things or how willing or unwilling men are to forgo this action to save instead.
To repeat one more time: the difference between money and a "normal" good is that it is primarily used as a medium of exchange. Thus, this difference implies that once money is established in society, an increase or even a decrease in the supply does not give any social benefit or social loss per se. Therefore the production of money will be limited and slow. The supply will be more constant and steady than all other goods.
On the free market, money producers will produce money to the degree that it turns in a profit. Meaning in this case, it will be produced to the extent that men demand more money and less consumer goods that could have been produced with the same factors of production.
Private coinage will be the primary business of these producers. They are more costly to produce than bullion but they are also more valuable to consumers because they economize. Weighing and melting down to figure out quality becomes less needed with trusted private coins. In the past there have also been private insured coins. Naturally, these coins are more valuable than uninsured coins.
It is important to keep in mind that in a free market man is free to choose his money. Therefore, if a given money becomes unusable because, for example, it is later found to exist in an almost unlimited supply, man is able to shift to another money. Furthermore, even though the scarcity of a supply of money above a certain threshold in no way limits the facilitation of trade because money is only a medium of exchange relative to the things it is bought with, for purely practical reasons a given money supply might stop being used for the reason that the purchasing power has become far too high. It would then become unpractical to carry around and use microscopic coins. Man might use property title substitutes for this money, but he might also switch to another money altogether. Incidentally, as economist J. G. Hülsmann has explained, this is why if we today had a free market in money silver, versus gold, might be the primary money in use.
Man lives in a world of scarcity. His time is limited, he has only one body that has a temporarily finite existence, and most of the things he desires have a finite supply. Not everything that a man wants can be gotten. He must therefore make choices in what objectives he seeks to obtain, and these choices imply the cost of curtailing other possible objectives that he could have alternatively aimed at. Man thus aims at objectives which he (subjectively) perceives as more valuable than other possible objectives. So, obtaining an additional homogeneous unit of a good (g+1), all other things being equal, will be put to use only to ends less valuable than what the previous unit (g) was. Harmoniously, an increase in the supply of a man's money will make it less valuable than otherwise. And it will be less valuable vis-à-vis other goods than otherwise. Hence, all other things being equal, the purchasing power will go down and the buying and selling prices of goods will go up.
A redistribution of wealth will occur as the supply of money increases. Those with higher cash balances will spend their new money. They (men A) will be able to buy more than they otherwise could. And those who receive this new money (men B), from the first users, will also have higher cash balances. They, as the second users, too, will be able to buy more than they otherwise could from other market participants (men C). As a consequence early receivers will benefit and late receivers will lose. Step-by-step prices will be bid up until the economy as a whole has been adjusted to the larger supply of money.
The Catholic Spanish Scholastic Luis de Molina---a member of the founders of economic science---explained in the 1550s as follows: "Just as an abundance of goods causes prices to fall (the quantity of money and number of merchants being equal), so does an abundance of money cause them to rise (the quantity of goods and number of merchants being equal)."
Just as the supply is important, the demand is important, he also said:
Wherever the demand for money is greatest, whether for buying or carrying goods, ... or for any other reason, there its value will be highest. It is these things, too, that cause the value of money to vary in the course of time in one and the same place. [Quotes from Faith and Liberty: The Economic Thought of the Late Scholastics by A. A. Chafuen, pp. 64-5.]
All human action implies changes in society's distribution of wealth. E.g., the increase in the supply of television sets or the decrease in the demand for fax machines implies a change in wealth distribution. These changes are hardly bad per se. And, from a practical point of view, it would be impossible to regulate society in such a way that no one lost value in their respective properties. Ex ante, we do not know if our actions will negatively affect the (subjective) value of someone else's property. This cannot possibly be controlled from an ex ante point of view. For these kinds of reasons private ownership can not be said to include the ownership of "value." Instead, ownership can only be ownership in the physical-objective integrity of "real" and "tangible" things. In this case, we do know (or can know) ex ante if our actions trespass or do not trespass against the physical-objective integrity of someone else's property.
Hence, the shifting of wealth through the private production of money is not per se bad or wrong. A shifting of wealth in money production, however, is bad and wrong if it is done through violations of private property rights. This, for example, is implied when one is forced to stick to a certain money because of legal tender laws. Man cannot protect himself and move from one money to a better money in such a case. In addition, even if one is to reject the vital and unambiguous distinction between ethical and unethical money production, from the point of view of someone that wants to minimize such shifts of wealth one must conclude that the private production of money would be vastly superior to government production. Monopoly money, which can be turned into pure fiat paper money, can be more easily debased and expanded in supply than competitive money, which can only last in competition because it is scarce and costly to produce. Paper money can drop down to a value of zero whereas a commodity cannot. (Which, then, is a safer and better money? The answer is obvious.) Besides, being a monopolist in paper money production gives one incentive to be more and more inflationary (i.e., expansionary) through time. Just imagine being a money monopolist, where money grows on trees! Only the possibility of hyperinflation curtails those in this position.
We can also conclude that under a free market "the norm" would be prices falling through time versus rising through time. A robust economy would be producing lots of goods. Market money would only be expanding slowly and predictably. As a result, the purchasing power of money would increase as it is being used for a larger amount of goods. Although today we see just the opposite, this is the result of a monetary system that is socialistic and fascistic. We would not see it in a freer and more moral society. Though, this no doubt begs questions concerning deflation and hoarding.
Defining deflation as simply the overall fall in price levels is something that much of history has seen during periods of tremendous growth and prosperity. Empirically speaking, then, we can refute the notion that deflation is necessarily "bad." Even today we can see industry-specific "deflation," e.g., in computers. These industries refute the notion that deflation leads to the stoppage of consumer purchases or the stoppage of wealth production. Men often buy an expensive computer despite the fact that they know that in a year that same computer will be less expensive. This can easily be explained. Man, all things considered, prefers present goods over future goods. In his actions, he acts through time towards the fulfillment of his objectives. Man works to get closer and closer to enjoying his goals. His actions show that he would rather get to his goal sooner rather than later. While the intensity of one man's preference for present goods over future goods differs with another man's (and differs with respect to himself at different points in time), all men have this preference----that is, time preference----given man's finite temporal existence.
Money not spent on consumer goods is saved and invested or hoarded. It is generally more profitable to save and directly invest than to hoard, even in a deflationary depression. Since we save for something in the future, this activity is in no way a net loss to the economy. On the contrary, more production and wealth will be present in the future than there otherwise would be. There will be more transactions between savers and entrepreneurs, a decreased interest rate with a larger supply of savings, and more investment. Only a readjustment in the "structure" of the economy would be required to adapt to the increased savings. In place of a market economy that relatively panders to the selling of present consumer goods (e.g., the electronic store), the market economy will relatively pander to the production of areas (e.g., research and development) remote from such selling and remote from stages of production close to such selling. The future result will be an even larger amount of consumer goods than otherwise. This is why such processes are undertaken. Capital accumulation, after all, is the road to prosperity. This will be explored more in Section IV.
Hoarding is a "withdraw" of money from market interactions. In and of itself it has no net macro consequences because, recall, economically speaking any amount of money is equally servable. A decrease in the amount of money being "used" results in an increasing purchasing power. Plus keep in mind as well that money is always "sitting" in one's cash balance. It just moves from one man's cash balance to another man's. In doing its "sitting" it's doing its job, so to speak. Additionally speaking, man is not a hermit. And a man who becomes one does not "rob" society.
It is true that deflation has often followed depressions. But this deflation is the result of shrinkage in the money supply which is partly or fully based on paper money and fractional reserve banking. When a man takes out his money from the bank he also takes out the money that the banks pyramid off of that via fractional reserve banking. For example, banks might have a reserve ratio of ten percent. The man that takes out $100 to hoard in actual practice gets "rid of" a total of $1,000 (which is equal to his $100 plus the $900 created via fractional reserve banking) from the economy. This is because when this man deposits the $100, the central bank will be sent $10 as reserves, and the $90 it will lend. The borrower with this $90 spends it and this hence goes into another bank which then puts $9 into reserves and lends out $81. Etc. When thinking about it in terms of money as gold it is straightforward: more property titles exist than actual property with fractional reserve banking. This is fraud. Secondarily, another reason for deflation is the increased financial uncertainty. It is uncertainty, specifically, that explains why man holds any cash at all. It is the uncertainty of knowing if one, for example, is able to trade with another due to a double coincidence of wants. In an economy where everyone knew exactly what everyone wanted and so forth, then everyone could engage with each other without money. (At the very least there would be no reason to hold additional cash in one's balance.) The real world is not like this. When times of uncertainty increase, men want more protection and this protection logically wants the most salable good available; that is, money. As H. H. Hoppe explains: "Because money can be employed for the instant satisfaction of the widest range of possible needs, it provides its owner with the best humanly possible protection against uncertainty." ["'The Yield from Money Held' Reconsidered."] Accordingly, the demand for money cash holdings increase, the purchasing power goes up, and overall prices fall ("deflation"). Increased certainty results and men are better off.
The only group that needs to be fearful of deflation----as a shrinkage in the supply of money by the extirpation of fiat paper money----is the power establishment. As Hülsmann writes:
Political entrepreneurs are ... right to fear deflation. For deflation takes away the source of their illegitimate income and puts them finally back on equal footing with all other members of society, whose incomes are based on efforts and services provided in a competitive environment. ["Deflation: The Biggest Myths."]
III.
Monopolization of minting operations has often gone hand-in-hand with having the face of government officials imprinted on coins. Weight and quality start to decrease, as officials enrich themselves at the expense of the public at large. Legal tender laws are put into place to force all contracts to accept such debased money on par with un-debased money. Of course under free market conditions, in direct distinction, such activity would be considered fraud and even if it did occur (man being what he is----imperfect), it would be harshly limited to a complete stop because of competition. Competitive conditions would allow men to seek honest and high quality companies. Such a possibility is, by definition, not possible under governmental management. Moreover, no legal tender laws would exist, by definition, to force men to accept such inferior money.
New coins introduced into the market via government that have a real weight of Z start to be labeled with a weight value = to Y, where Y is > Z. Y is the weight of the old coins which are labeled properly. Because of legal tender laws these old and new coins become legally equal to each other. Mathematically, so to say, we know that this is unmistakably impossible from the outset. Men will discriminate between coins. The old coins (which have a weight of Y = to their label) start to be hoarded and the new artificially overvalued coins in circulation (which have a real weight of Z which is < Y despite their label saying it is > Z and = to Y) start to become the only coins traded. In trading and contracting it only makes sense to trade with the inferior money. In a way, one can say that this makes robbery legal. One man's contract with another can be fulfilled using this new money. Matching this, bimetallism----in comparison to freely floating parallel standards----is a vivid illustration of this kind of interventionist policy. Here a fixed exchange ratio is set by law between two moneys, say, gold and silver. But, clearly, this form of price control will only sooner or later conflict with reality. Supplies and demands are not constant. How one exchanges into another will change.
"Gresham's Law"----[tells us] that an artificially overvalued money tends to drive an artificially undervalued money out of circulation----is an example of the general consequences of price control. Government places, in effect, a maximum price on one type of money in terms of the other. Maximum price causes a shortage----disappearance into hoards or exports----of the currency suffering the maximum price (artificially undervalued), and leads in circulation by the overpriced money. [What Has Government Done to Our Money? by M. Rorthbard, p. 72.]
Flip-flops will take place, too, in terms of what is being undervalued and overvalued. The market will become chaotic----all in the name of public officials saying that they are making moneys "stable" vis-à-vis each other! When one money is driven out of the market, another effect will be produced. This will be artificial deflation. As a massive readjustment process takes place to handle the price control's sudden effect of taking money off the market, business calculations will be massively thrown off. Many bankruptcies and readjustments will thus take place. Moreover, the incentive to use fractional reserve banking will increase so as to stabilize this process. Such bimetallism, therefore, has an indirect result of shifting man to use more and more notes that are not 100% covered by what it is meant to represent, viz., a "hard" commodity.
Juan de Mariana, another Late Spanish Scholastic, called these kinds of debasements and manipulations "systematic robbery" and "barbaric," and that they are a "plague in the republic." He said that it additionally produces "distrust" in commerce and the thus the reduction of interaction. He wrote:
I understand that any alternation of money is dangerous. It can never be good to debase currency or to fix its price higher than its natural valuation and common estimation. [Quotes from Faith and Liberty, pp. 66 & 68.]
As is always the case, one interventionism leads to another. Government comes in and all of these bad consequences and unintended consequences occur. Next the call for more government involvement is asked for. Then more bad consequences occur. Next more government is called for. ... Etc. From the point of view of the government and its allies, this is generally wonderful. Those who consider the welfare of the public at large as more important, though, see this as something else entirely. Government obtains its revenues parasitically from those who actually produce wealth and improve society. Production is logically prior to government. Hence, government can only be viewed as a parasite. All of its activities are based on this parasitism. Its interest in expanding its wealth is more or less like any other man's, but it can expand its wealth not by serving voluntary consumers (which proves it is actually serving them well versus competitive alternatives) but by expropriation and exploitation (which proves that it is obstructing consumers by destroying their "sovereignty" and by destroying competitive alternatives).
This interventionist road led to banks increased use of fractional reserving banking (FRB). This pestilence played the key role in the devolution of money. FRB is inheritably unstable because it opens up the possibility of a bank run. A bank will not be able to fulfill its contracts in such a case. And the bank run of one bank leads to a chain reaction that will generally cause the run of another bank and another. In some sense, then, all have a collective incentive to prevent such a thing. This gives an impetus to form a cartel-----a central bank. In actual practice, the formation of one requires the protection of government. Government, motivated by self-interest, agrees because this will increase its revenue and control over men. Inflation as a way to increase its income starts to have essentially no limitations. Printing up more money or, even better, adding more money electronically has a cost of almost zero.
Another advantage, from the point of view of government, of fiat paper money is its constant homogeneity in comparison to commodity coins because men cannot evaluate and discriminate between the newer and older money. An increase in fiat paper money therefore does not lead to artificial deflations, as has been covered above.
Now it is often complained that before the Federal Reserve System there was "wildcat banking." In several different periods of American history this is basically true and is what led to the formation of the Fed (and its short-lived predecessors). However, it was only the logical step resulting from previous interventions. Not only did the government legitimatize FRB, it tremendously encouraged its practice, and it often allowed banks to "suspend species payments" when a bank run occurred. As far as the last thing is concerned, this gave a given bank the ability to cancel its contractual obligations, at least for a period of time. This set a precedent and encouraged more and more reckless behavior on the part of banks. In fact, FRB combined with government protection creates moral hazard on a massive scale. It is only through the power of government and its violations of the free market that allow FRB to reign.
One major factor to FRB has been war funding. The War of 1812, for example:
Most of the country's banks were located in New England, a section unsympathetic to America's entry into the war. These banks refused to lend for war purposes, and so the government borrowed from new banks in the other states. These bands issued new paper money to make the loans. These banks issued new paper money to make the loans. The inflation was so great that calls for redemption flooded into the new bands, especially from the conservative nonexpanding banks of New England, where the government spend most of its money on war goods. As a result, there was a mass "suspension" in 1814, lasting for over two years (well beyond the end of the war); during that time, banks sprouted up, issuing notes with no need to redeem in gold or silver. ... This suspension set a precedent for succeeding economic crises; 1819, 1837, 1857, and so forth. [What Has Government Done to Our Money?, pp. 78-9.]
To quickly skip ahead, 1913 saw the creation of the Federal Reserve System (Fed), with the help of major banks and businessmen (e.g., J.P. Morgan and John D. Rockefeller) seeking to enrich themselves at the expense of the public. Ultimately, it allowed all banks to expand their money supply more uniformly. It became the "bankers' bank" because all of the banks were forced to deal with it and only it. Banks could then only create deposits on top of these monopoly notes (based on the reserve ratio). The Fed additionally became the "lender of last resort."
Although this did not really solve the problems that previously existed. For instance, a bank run can still occur, in principle, on the Fed. It is only when the money in existence completely turned into pure paper money backed by nothing that this was absolutely prevented. Then the Fed can never go bankrupt. (This is exactly what happened in 1971 with the collapse of Bretton Woods. The U.S. central bank could not redeem its dollars to other central banks with gold. This was entirely predictable from the start because Bretton Woods allowed the Fed to get away with more inflation than it could before. And so it was later finally facing a run and thus cut its ties to gold.) On the other hand, it now has the ability to print up money with no technical or practical limitations that can result in hyperinflation and the complete break down of the economic system. Natural market checks on reckless behavior have only decreased more with this money devolution.
IV.
A Fed can bail out any bank or any business simply by printing money. Given the interconnection much of big business has with big government, such activities are to be expected. Big business by itself has no power. It becomes "big" by profiting voluntary consumers (who can boycott at any time).* Government has power (which no one can boycott without going to jail) and that is why big business comes to it seeking privileges. And government agrees because it can then expand its role in civil society.
More fundamentally, a large scale bankruptcy can have the result of bringing down the unstable, pyramid-based banking system. This is why the Fed has the incentive to bailout. But this is what creates moral hazard. Businessmen start to behave recklessly knowing that a bailout is likely if many of them fail consumers. The monetary system is ubiquitous; it should thus be expected that its negative consequences are economy-wide.
Furthermore, businessmen become more credit dependent and bank dependent, as the work of economists such as Hülsmann show. Credit will be cheaper and more abundant than otherwise, and hence this is the area competition will pressure businessmen to. Equity (real cash holdings) will thus decrease whereas liabilities (credit) will increase and make businessmen more fragile to any miscalculations on their part concerning future market conditions. Likewise, private men will become more debt orientated in their finances.
FRB and its centralized nature via the Fed will put the economy through violent swings of booms and busts as well.
We have already demolished, at least in rough form, the idea that saving is a "bad" thing for the economy. A society that moves from the position of saving little to saving much results in a change in the capital structure of the economy, as shown in Section II. The upshot of this shift will result in a society that will be more prosperous in the future than if this shift did not occur. We have also showed that money gets its primary value as a medium of exchange. So real wealth, as should be more than clear, is not created by growing money on trees, or printing it up. Producing desirable goods for consumers is wealth creation.
To further this process requires capital goods, which are used to create consumer goods. The growth thereof depends on technological innovation and the holding off of present gratification, to save and invest. Such production aims at a higher total of consumer goods in the future. Savings is what allows this to happen. It is a freeing up of resources to devote to such production instead of being used on present consumption. Man cannot logically consume X and invest X at the same time.
With a bank acting as an intermediary, men's savings can be transferred to entrepreneurs as a loan. It is the supply (savings) and the demand for such loans that determine interest rates. Consequently, the more savings, all other things being equal, the more to loan and thus the lower the interest rate is. Printing up money and creating "imaginary savings," to be sure, can lower the interest rate. But it is a lowering of the interest rate independent of true market conditions. It ignores the proportions men are saving versus consuming. Such artificial lowering of the interest rates through the banking system's centralized top-down nature will therefore push entrepreneurs to invest in long-term projects far removed from the consumer at the same time consumers are continuing their consumption versus savings activities. That is, men will be consuming, and, accordingly, a freeing up of resources (e.g., equipment and labor) will not be occurring to sustain these projects for the long-term. On top of this, men will actually be saving less than they would be because it will pay less to loan. An unsustainable boom has occurred which will go bust as soon as the new money flows through the economy reestablishing interest rates that reflect real market conditions. As a result, resources will become scarce for these investment projects and profitability will be destroyed. In addition, due to the location of the "boom," many investments and projects will even have to be completely abandoned. They will not be able to be moved to other areas of the economy because they are so capital-specific in their location.
Money calculation is essential when understanding this subject. Quoting D. Mahoney, money, as it allows for cardinal calculations so as to compare things based on a common medium, is a "'measure' of the amount of property available for production processes." ["Austrian Business Cycle Theory: A Brief Explanation."] Hence, an artificial lowering of the interest rate will bring the illusion of a larger pool of savings. There will be, in other words, a mismatch between time preference (as it is represented in the public at large) and investment. This in turn will distort entrepreneurs to start up more projects than can be temporally maintained. Now, keep in mind, to engage in capital production requires savings so that temporally lengthy roundabout methods of production can take place. So from the very outset, a greater amount of projects will be started than reality will allow; hence, a bust after the "boom."
L. v. Mises writes:
The whole entrepreneurial class is, as it were, in the position of a master-builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master-builder's fault was not overinvestment, but an inappropriate employment of the means at his disposal. [Human Action: A Treatise on Economics, p. 557.]
*[Put in another way: in a genuine free market, getting rich is dependent---versus independent, as under government---on getting others rich. The very rich man gets rich by making the masses rich. The market makes us think about how we can better serve our fellow man, since a man must use the goals of others as economic means to achieve his own goals. It is therefore untrue, as many dullards claim, that the free market promotes egotistical selfishness. The diminution of the division of labor would help to accomplish that. Increased statism, likewise, would do that. After all, under a voluntary system---where violence against the non-violent is viewed as unethical---you can always cancel your interaction with or membership to an organization. This is impossible under statism. States, for this reason, do not really have to directly serve their constituents well. They do not have any direct competition in the area they are monopolists. Nor are they directly dependent on changing and heterogeneous consumer demands, since they can easily expropriate property. No requisite exists, unlike free enterprise, for them to be cost-effective or to put maximum effort into improving the quality of their services. Hence a State enterprise often grows not because it is being cost efficient and is being ever better in its quality of services but despite it, as economist Hoppe has shown. Given that man is no angel, increased perversity should be expected as the outcome of increased government. Moreover, allocations of the State will always have to be arbitrary and wasteful with no profit - and - loss. When a true economic businessman fails, he then suffers a loss and perhaps disappears. It promotes correct allocations. On the other hand, when the State fails nothing often happens. There is nothing that helps divert resources into productive uses, which can only be done on the market with the pricing system. No continuous mechanism would exist so as to rationally and non-arbitrarily filter out bad lines of production and promote good lines of production. The State that does X activity necessarily does it at the expense of other things. It is absolutely impossible to judge if alternative Y or Z or A or B, or a combination of them, is more or less wanted by the public----a public that is heterogeneous. And its simplistic top-down nature cannot manage a complex world in an effective manner.]
V.
In this essay we have shown: (1) how and why money enters into society; (2) the superiority of competition in money production; (3) the redistributionist effects of changes in the supply of money; (4) that there is no reason to fear deflation; (5) why savings is the road to prosperity, even in a depression; (6) the non-problem of hoarding; (7) Gresham's Law; (8) the tendency of monetary interventions to lead to further interventions and further instability; (9) how the current monetary system leads to debt and enervates the economy; and (10) the economy-wide distortions of credit expansion in the structure of production.
We conclude, therefore, that there is a vital need to eliminate the current monopolistic system to allow a competitive market order as its replacement.
***
Notes and References: This essay was completely rewritten in Oct 2009 as the result of e-mail conversations I have had. My attempted answers to certain questions resulted, at least in part, in this essay. Now the essay itself has been greatly influenced not only by the late Murray Newton Rothbard but also Jörg Guido Hülsmann, a German economist teaching in France. He has written some outstanding essays on the economics and ethics of money production. Here are some of his essays, which have heavily influenced this essay:
- "The Political Economy of Moral Hazard"
- "Optimal Monetary Policy"
- "Legal Tender Laws and Fractional-Reserve Banking"
- "Deflation: The Biggest Myths"
- "Deflation and Liberty"
- "Toward a General Theory of Error Cycles"
- "Nicholas Oresme and the First Monetary Treatise"
- "The Cultural and Spiritual Legacy of Fiat Inflation"
