Those in power have always made efforts to control of the money supply; this is an historical fact. From antiquity, kings and governors have claimed monetary control as a right, as a “royal prerogative,” which the people have come to accept. Kings knew they must control the money supply to withdraw revenue without raising taxes or borrowing from merchants or other countries.
By having behind-the-doors access to the money supply, kings and royals created new money to spend by debasing precious metal coins, mixing copper into the gold or tin into the silver.
Unlike the people, who had to mine, purify, and mint precious metals or trade goods and services for them, those in power forged new wealth. Kings drank freely from the money stream as through it were a bottle of rum whose deficits could simply be replaced with water. Fortunately for the people, coins have physical limits to which they can be debased. Gold and silver can only be diluted so far before the people will reject them as worthless. But leave it to those in power to stretch these limits to their utmost. Murray Rothbard describes the situation:
“Rapid and severe debasement was a hallmark of the Middle Ages, in almost every country in Europe. Thus, in 1200 A.D., the French livre tournois was defined at ninety-eight grams of fine silver; by 1600 A.D. it signified only eleven grams. A striking case is the dinar, a coin of the Saracens in Spain. The dinar originally consisted of sixty-five gold grains, when first coined at the end of the seventh century. The Saracens were notably sound in monetary matters and by the middle of the twelfth century, the dinar was still sixty grains. At that point, the Christian kings conquered Spain, and by the early thirteenth century, the dinar (now called maravedi) was reduced to fourteen grains. Soon the gold coin was too light to circulate, and it was converted into a silver coin weighing twenty-six grains of silver. This, too, was debased, and by the mid-fifteenth century, the maravedi was only 1.5 silver grains, and again too small to circulate.”
All of the talk about “coin clipping” and “Royal prerogatives” sounds archaic – a problem of primitive people and primitive governments. Would it surprise you to discover that these practices have carried into our modern day and place? These practices are still alive and well in our very own central bank the Federal Reserve. The Federal Reserve monopolizes the printing and distribution of money, and forces all citizens to accept the dollar as payment.
When ancient governments debased and destroyed the value of their currency, they would simply demand that people trade it at its original value. But the people would not stand for this forever. People stopped trading the worthless coins and began trading other things of value. Kings and governments were left longing for a currency that was easier to manipulate. Enter paper money.
Paper money was introduced as a claim to an object of value held by a bank, often a gold or silver coin. People trade goods and services; paper money was merely intended to represent a claim to these real things. Green pieces of paper with pictures of kings on them were not considered goods in themselves. Early banks allowed people to exchange paper notes and redeem them for the gold they represented.
Realizing that not everyone would withdraw all their gold at the same time, banks began to print and loan paper notes in excess of their gold reserves. As banks began to print and loan more paper notes against the reserves they held, they incurred the risk of experiencing a run. A run occurs when more people attempt to reclaim their gold than the bank holds in its reserves. Runs have occurred many times throughout history.
Due to their own interest in the banks, during the threat of a run, governments would often intervene and allow banks to “suspend specie payment” to avoid bankruptcy. Banks often lent to government, and power over money is power over politics. Banks quickly became a privilaged industry protected by government: any other business that could not return their customers’ money or property was prosecuted, but banks were protected by government. Now, banks were protected from having to lend within prudent lending standard. They began to leverage credit beyond its natural limits. When paper notes were finally extended so far beyond the gold reserves held by banks that they could not pay their obligations, the U.S. Government simply allowed banks to go off the gold standard.
Our U.S. dollar was backed by gold as recently 1971, when its ties to gold were officially severed. When the public finally accepted paper money unbacked by any commodity, governments removed the last physical barrier to unlimited money creation. Money could now be created out of thin air. Governments could simply print huge sums of money to purchase real goods. Since the U.S. cut its monetary ties to gold “…the Federal Reserve – has already, at this writing, increased the M-2 money supply 11-fold ($686 billion to 8.2 trillion) since August of 1971…”
The “quantitative easing” of the last 5 years has continued this trend, and there is no sign that money creation will end soon.
The question can be asked, how free is trade when a government controls the money supply? Money is the lifeblood of any economy. No matter how free trade appears, it occurs through a fiat currency. When government manufactures money, it buys existing goods without returning anything into the social stock of goods except green pieces of paper. This is the essence of counterfeiting – to print unearned money to buy real goods and services. Government has simply monopolized the ability to counterfeit and made it illegal to the layperson. Nobel laureate Friedrich von Hayek describes the situation most eloquently:
“There is no justification in history for the existing position of a government monopoly of issuing money. It has never been proposed on the ground that government will give us better money than anybody else could. It has always, since the privilege of issuing money was first explicitly represented as a Royal prerogative, been advocated because the power to issue money was essential for the finance of government – not in order to give us good money, but in order to give the government access to the tap where it can draw the money it needs by manufacturing it. That, ladies and gentlemen, is not a method by which we can hope ever to get good money.”
Historically, one of the biggest reasons government needs access to the money supply is to finance war. Throughout the history of almost every country, wars were always accompanied by massive inflation of the currency. American history is no different. From the Continental Congress’ issuance of the “continental dollar” during the Revolution, to Lincoln’s “greenbacks” during the Civil War, to the inflation of the dollar during World War I, war is largely financed by government’s ability to simply produce more money. If one were opposed to war, perhaps one would want to deprive government of the tool by which they finance it.
Another problem we experience as a byproduct of government control of the money supply is inflation. The term inflation means an increase in the supply of money. One of the effects of an ever-increasing money supply is rising prices. The more money enters the market, the lower its value. The media misuses the term inflation to mean rising prices, which distracts from the cause of rising prices: increases in the money supply. Since there is only one entity who can increase the money supply, if the term was used properly we would know who to blame for rising prices. When inflation is used to mean price inflation, people confuse the cause with the effect and mistakenly blame businesses and markets for the rising cost of living. Once the term inflation is properly understood as an increase in the money supply, inflation no longer seems like some strange problem that happens of its own accord. It can be seen for what it is: a direct consequence of government manipulation.
One of the most insidious effects of government inflation is that it does not harm everyone equally. The first person to spend the newly printed money, the Fed or one of its favored agencies, benefits most. It buys goods at current prices. The first recipient of the money uses it to buy from others and so on, and the money is disbursed into the economy. Since more money is now in circulation, the value of money drops and prices rise to compensate. As prices rise, wages and savings stay the same. The working class is the last to receive increases in pay, all the while they have been paying higher prices for goods. Increases in wages always lag behind rising prices, making the poor poorer by the year. Inflation impoverishes the lower class and those on fixed incomes by keeping them behind the rising cost of living. Those at the top of the money chain get richer, those at the bottom get poorer – all at the hand of a government agency.
Not only do wages lose value; savings do too. When a person saves to have five hundred thousand dollars for retirement in twenty years, he is calculating the amount to be adequate based on its purchasing power now. He will be ruined when he arrives in the future to find his money worth only a third of its projected value. Imagine if our great grandparents had saved for today in anticipation of nickel subway rides and penny candy. Inflation removes saving as an option; people are forced to speculate and invest to keep the value of their money. Even a savings account with a modest interest rate may not outrun inflation. People are thrust between a rock and a hard place: save and lose value or invest in markets which you may know nothing about and can ruin you if you make the wrong choices.
Beyond assaulting freedom, funding war, and de-valuing wages and savings, central banks and fiat currency create boom and bust cycles. Consider the following:
Supply and demand intersect to form a price. When the supply goes up and demand stays the same, prices must fall to prevent a surplus. When supply goes down and demand stays the same, prices must rise to prevent a shortage. This is Econ 101. Supply and demand for borrowing money intersect to create a price known as the interest rate. When banks hold lots of money savings, the supply is high and they can lend at low interest rates. When the supply of savings is low, banks must raise the interest rate accordingly. So what happens if interest rates are artificially lowered? This is where the Fed steps in.
In order to keep interest rates low the Fed must keep loanable funds in high supply. It does this by “injecting liquidity” into the banking system – fancy talk for printing more money. Now banks can lend beyond the savings they hold at no risk: when they run out, they merely ask the Fed to keep their supply coming. This process institutionalizes the problem of moral hazard: banks have no incentive to stay within prudent lending parameters. They can rake in the profits by lending as much as possible and then simply call upon the Fed to print them the money they need when they cannot make payment to their clients.
By artificially lowering interest rates, the Fed fools entrepreneurs into thinking that greater savings exists than really do. This in turn creates a boom in the economy; entrepreneurs take out loans, expand businesses, invest in new projects, and create new jobs in anticipation of people being able to solicit this new business in the future. It is not until entrepreneurs finish projects that it is revealed that people do not have the savings required to solicit the new businesses. The low interest rate was not a signal of a high level of savings after all. Low demand for the projects ushers in the bust phases of the cycle.
The bust shows that capital has been improperly allocated. No one is buying from the new businesses or soliciting the new services, so the market self corrects. The mal-invested expansion projects get liquidated, that is, dismantled and sold to those businesses that the market still demands. Mal-invested labor is absorbed by those industries that the market still demands.
During these bust cycles, people get mad and blames the “flaw” in the free market. Entrepreneurs feel shaken, workers are angry about layoffs, and the public loses confidence in the economy’s ability to self govern. Little does the public know that our central bank, the Federal Reserve, which is not a free market institution, caused these errors by sending out false signals in the form of artificially low interest rates.
Boom and bust cycles can still occur without a central bank as a consequence of credit expansion. Local banks often extended credit at low interest well beyond the safe level. However, the booms and busts created by regional banks are much more limited in scope. The major difference between a business cycle caused by a regular bank and that of a central bank is that a regular bank cycle must self correct. Because a regular bank can only extend credit so far past its reserves, it cannot keep the false boom going for very long. By having direct access to the country’s money supply, a central bank allows a boom to extend long after the market would have corrected itself. Further, it allows multiple banks to unite in their credit expansion rather than compete in terms of prudence. The Fed operates through regular banks, allowing them all to lend beyond their means, rake in the profits and socialize the losses.
When the case is stated this baldly, it is hard to imagine why anyone would think that a policy of artificially low interest rates and inflation could work. But this is exactly what the popular and influential economist John Maynard Keynes recommended:
“Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us in a quasi-boom.” (The General Theory of Employment, Interest, and Money p322)
In order to keep banks lending at low interest, the Fed pumps money into the system. Rather than an immediate crash, we experience runaway inflation. A permanent boom is impossible; eventually printed money will find no goods to buy. When everyone is spending and consuming and no one is saving and producing, there is no way to avoid a crash.
Central banks and fiat currency assault freedom, fund war, devalue wages and savings, and cause business cycles: how could it get worse? The greatest slap in the face is that the Federal Reserve has no oversight: “The Federal Reserve System is accountable to no one; it has no budget; it is subject to no audit; and no congressional committee knows of, or can truly supervise its operations. The Federal Reserve, virtually in total control of the nation’s vital monetary system, is accountable to nobody…” (Murray Rothbard, The Case against the Fed). As Congressman Ron Paul put it, “if this sounds fishy to you, then you understand it exactly right!” Does this sound like an institution befitting a modern democracy, or does this sound like the behavior of the kings and monarchs of old?
Central banks and fiat currency are not without their apologists. But in the face of these apologies ask yourself, what reason did the kings of the Middle Ages give their people? Surely they sold such policies in terms of their benefits. We see historically that these policies have always been detrimental to the people. Have times really changed and the benefits are now suddenly real? Or have apologetics for such behavior simply become more sophisticated? In 500 years, when our progeny read the history of America, will they see us as clearly as we see our ancients and wonder – how did we ever believe that free people benefit from governmental control of the money supply?
History illustrates its danger, we experience inflation, and we witness the devastation of business cycles. I believe the case is clear for an audit of the Fed at very least, or at best, its abolition and a return to a monetary system of the people, by the people, and for the people.