Explore the nature of money, including its use and composition.
Discuss government control over the supply of money.
Discover the problems of inflation and the dollar empire.
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:
Valuable upon receipt.
Able to keep that value over time.
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:
It has a high value, being beautiful and malleable and popular in jewellry.
It has proven over thousands of years to keep a remarkably constant value.
It is very rare and quite hard to extract from the earth and impossible to counterfeit.
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:
It is almost worthless.
Again and again, it has proven to lose its nominal value over time.
It is quite easy to counterfeit.
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.
Inflation and control
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.
The dollar empire
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?
No, that is impossible. In the case of the United States, all of them have always promised to uphold and defend the Constitution, with its clear definition of the 'dollar' as a specified weight of pure silver and its tight restrictions on government power with respect to coining money. All of them made the promises under oath. Every one was broken. They are all habitual liars. So this answer will not do.
In the United States, no such nationwide plebiscite is provided for by the Constitution, and that fact would certainly be used by government to prevent it ever taking place. Perhaps in some countries, but not in the United States. Please try again.
Sorry, this was a trick question! It has been shown that real money is what a free market chooses; there is to be no imposition of any 'standard' at all, not even a gold standard. Even if by some means unknown government were separated from money, a decade or two down the road it would succeed in getting back that power. Government is a cancer; there is no alternative but to root it out altogether. Review the other answers, then continue with the remaining questions.
At first sight, that might do the job. But all known of government says it will relentlessly work to break down all barriers to the expansion of its power; if somehow control of money were removed from its hands, a few years later it would be back again. Theoretically, the government does not have power today to control money in any way. In the United States, the Constitution allows them only to 'define' a dollar and to 'coin' such metal as is brought to a mint. It has burst through those restrictions like a Mack truck. So — please try again.
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?
No, and you can check this by inventing a game for a few players. Give each player one hundred money–tokens and 'buy and sell' some articles in turn. Note the prices paid. Then hand everyone an extra one hundred tokens, and note what happens to the prices bid.
That is correct! Milton Friedman showed that the rise normally follows twelve to eighteen months later, but it is inevitable and tightly related to the rise in the supply of money. It is also related to the supply of goods, so is a bit hard to measure in a real society where that too is changing — if twenty percent more goods were to be produced, their prices would stay about the same — hence the assumption that their supply is constant. Government, issuing the new money, gets to use it first — before the prices rise. That is why they do it, and why it is so wicked.
No, there is no reason to expect a price drop, on the assumption given. That could only happen if the quantity of goods circulating were to increase, by about thirty–five percent. Try again.
True, they would rise, but not just by fifteen percent. The hike would not happen overnight but when it was all done, it would be higher than fifteen percent. Try again please.
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?
No, try again. The increase in money supply will tend to increase prices, but then the increase in supply of goods will tend to lower them; it will be a 'buyers market'.
No, try again. The increase in money supply will tend to increase prices, but then the increase in supply of goods will tend to lower them; the two trends will partly offset each other.
No, the sellers of the more abundant goods will lower prices more rapidly than the miners produce more money. Try again.
Correct! If the supply of goods and services were constant, there would be an annual two percent inflation, due to the increased availability of money; buyers would bid prices up. But since five percent more goods are being produced, sellers will lower prices to attract buyers and the two trends will compete and the larger trend will prevail, hence a three percent fall in prices. During the one hundred years following 1811, that is exactly what did happen in America; goods and services increased by about three percent a year while about two and one half percent more money — gold and silver — was mined and minted each year so the net effect was an almost–steady decline in prices, of about one half percent a year. Review the other answers and continue with the remaining questions.
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?
That is what it seems to do, and what will appear in the book of accounts. But the question asked about its real value, and one must remember that four percent extra money would push prices up about four percent — so its real, purchasing–power value is less. Try again.
That is what would result from the four percent inflation rate if no interest were being earned. But it is, at three percent. So no, please try again.
No, the math got in a twist here. The inflation rate is higher than the interest rate, so the purchasing power of the account must decrease. Try again.
Correct! The passbook will say $10,300 but by then prices will have risen four percent so that will only buy $9,900 worth of goods and services. Check the other answers and continue.
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 “fractional reserve” principle underwritten by government. What was the gross interest rate it earned on the money actually deposited?
Oops! Try again. That was its rate earned on the $10,000 — $9,000 of which it did not really have.
No, figure how many dollars were paid to the bank in interest. 10000 x 6 / 100 is $600, right?
Correct! $600 was received, and $1,000 had been actually placed on deposit — at some cost, perhaps three percent, paid to the depositor. So the gross rate earned was sixty percent, and the net would be (600-30) $570 or fifty–seven percent. Perfectly obvious why Main Street banks are so happy with government and its paper!
Good answer! Not what was expected though, and not quite accurate; it did earn $60 gross on the $1,000 it actually had on deposit. But please try again.
Why is it that paper money distorts financial decisions, commercial and domestic?
Yes. 'A' plan can be formed, but only with raw guesswork about the future value of money. Or worse: Perhaps a businessperson is so close to government that their 'guess' is better than their rivals'; that would give them a vital advantage and turn them into a supporter of paper money. Check the other answers.
Yes, they are. When money is 'too easy' to borrow, the business risks taken are foolish; too great. Real money is lost, and everyone suffers. Government manipulation of money, in this and other ways, creates such 'easy money' and produces boom–bust 'business cycles' that make the economy run on square wheels.
Correct. Ordinary people cannot know for sure what to buy or when best to buy it. When the German government of 1923 hyperinflated its currency workers were wise to take the barrow–load of their week's wages and spend it immediately on essentials for living, before prices rose another fifty percent. That distortion was so massive as to make Hitler's promises of order and stability very appealing, and they elected him a few years later; with consequences all too well known. Such are the massive and unpredictable, perhaps unintended consequences of government control of money.
Yes. There are of course many uncertainties in business, and no way to remove them; but government money and the worldwide dollar–domination that it has permitted adds some that need not and should not be present.
Would average prices be predictable in a free–market society? Why, or why not?
True, it is possible that new forms of money would be tried out and that would make prediction tricky. However such changes would tend to be slow, and almost certainly gold would predominate; and the supply of gold money is not at all hard to predict. So no, this answer is much too pessimistic.
Correct, and for just those reasons.
Innovation and invention would certainly increase as regulation was removed, and yes, that would make price prediction harder. At the same time it would make it easier; better mousetraps always bring prices down!
About those “unhappy foreign investors” — how will they be handled?
They may be angry, and they may so ask. Whether those governments take such foolish action, however, will depend on how they rate their chances of success given that nobody here will be authorised to surrender. Additionally, their own populations — the big investors excepted — will be very interested in imitating the free society forming in the former nation state, and their governments will have their hands very full keeping control at home. So no, almost certainly not; try again!
Anyone in the free society will be free to contribute to any distressed foreign supporter of the former government.
Correct! Supporters of the former government whether foreign or domestic will get everything they agreed to buy. No injustice will be done by leaving them sink or swim.
Yes, that will probably be so, depending on how well the rest of the world predicts what will happen in the new free society. Either way, no individuals would owe them a cent.