Title: The Mystery of Banking

Author: Murray N. Rothbard

Hi all,

this week marks a second book of the Rothbard series.

The first book talked about how money came into existence and then how a government’s intervention can cause the quality of money to deteriorate.

This version talks about how the banking sector works and how modern banking in the 19th and 20th century panics were a result of the works of banks. However, it doesn’t just give the history of the American banking sector, but also gives an intro on how every day people could do something against a central bank’s inflationary efforts.

Practically, it is an advocate of hard money.

It covers the following topics and therefore offers the reader a broad insight into a variety of topics of money so the reader may familiarize themselves very well with money:

1. Money: It’s importance and origins
2. What determines prices: Supply and Demand
3. Money and overall prices
4. The supply of money
5. The demand for money
6. Loan Banking
7. Deposit Banking
8. Free Banking and the limits on Bank Credit Inflation
9. Central Banking: removing the limits
10. Central Banking: determining the total reserves
11. Central Banking: the process of bank credit expansion
12. The Origins of central banking
13. Central Banking in the United States I: the origins
14. Central Banking in the United States II: the 1820s to the Civil War
15. Central Banking in the United States III: the national banking system
16. Central Banking in the United States IV: the federal reserve system
17. Conclusion: the present banking situation and what to do about it

Even before money came into the picture antiquity communities would apply barter to trade amongst each other. The worth of something was determined by the available quantity and the size of the demand for it.

Today, even with fiat currency and technology, the process of determining supply and demand is not significantly different than before. However the medium we use to ‘barter’ (exchange) has made trade much more efficient.

Before modern banking took hold people would use gold and silver coins in their daily transactions. However, carrying them around or having them at home exposed them to being stolen and therefore people would leave the coins with smiths and receive a receipt to collect their gold whenever they wanted. Later, people would trade these receipts instead of collecting the coins and then engage in trade because these receipts were accepted to be true. However, to make more money some smiths would issue more receipts/gold and then retrieve their returns before the original owners reclaimed their gold. This practice would expand until people didn’t trust the receipts and would then reclaim their gold, only to find out that there wasn’t enough gold in storage.

• This could be identified banking/ central banking in its infancy

How we think banking works:

The general understanding that we grow up with about banking is that a bank will take some people’s money and give you an interest rate for borrowing it to them. Then, that money is lent to someone else at a higher rate and the bank makes their money from the difference in interest rate.

Also, we believe that there is a fixed quantity of money in existence and therefore just leaving your money in the bank will retain its value. Your money is safe and you can reclaim it at any time.

How banking really works:

Banks take your money and sometimes offer an interest rate, but occasionally also charge a negative interest rate (i.e. punishing you that you have money in your account and not spending it in the economy). The bank doesn’t hold enough reserve money in the bank to pay holders back when they want it but have issued a majority to borrowers. They might hold 40%, 20%, 10%, 5% or even less of actual cash and the rest was issued out to borrowers. Effectively, they say that your money exists, but the money lent out also exists and therefore have created new money.

More money means more currency supply is chasing the same quantity of goods in circulation, which results in prices increasing.

How central banking works:

The Central Bank is the sole issuer of the currency that may be used for trade in the economy. Other banks need an account with them and deposit some assets with the so they may acquire some of the currency. The banks need to hold a certain % of reserves on hand for all the money that was deposited with them. The other % is issued out. By promising that your account holds the deposited funds, but having actually lent that money to someone else it has created new money so that both exist. When banks aren’t trusted people will engage in a bank run, whereafter the central bank will create the new currency to fulfil the peoples demands for money. Through this process more paper currency is created for the fractionally-reserve-currency that was newly created (i.e. bailing out the bank that didn’t have enough cash on hand).

How real money is removed from circulation:

• At first, the economy starts with sound (gold & silver) money.
• Then people start depositing their money with a bank and receive a receipt that confirm their paper currency is redeemable in gold. To support this move it is advertised that paper money is more convenient and it is patriotic to support your banks and government.
• Once people are happy with accepting money over gold, propaganda is sent out that money is the currency of the country not gold or silver and people therefore only associate currency with being real money not gold (i.e. they accept xx dollars, and don’t ask what the price is i.r.t. gold).
• Once this is accepted as general practice the bank (central bank) engages in inflationary printing, which causes prices to increase. People accept that there may be a shortage or that it simply costs more to acquire some goods, but don’t compare what the prices of the goods are in relation to gold and thus don’t realize that there is more money in circulation that has reduced their purchasing power.
• Next the redeemability of currency to gold is cut off and is advertised as being unpatriotic.
• People have now lost the link to gold (real money) and those in charge of the printing press can print as much as they need to finance the projects they wish to bring out.

(roughly this way is explained how we move from quality money to quantity money)

Who gets this new money created through fractional reserve banking?

If new money is created and distributed to each holder for their proportionate share we would know that each unit of paper was less valuable, however you received your proportionate share so that your purchasing power in absolute hasn’t changed.

However, this is not how this is done in real economies. When new money is created the government may use the new money and spend that money on goods and services at its pre-inflation prices, before the rest of the economy catches on there is more money. Once the rest find out there is more money than supply (i.e. the demand for their goods has gone up at their current price) they will increase their selling prices to make a higher profit (or increase prices because their goods are more expensive from their suppliers). This ripples to the end consumer who has the same amount of money as before, except that they can now buy less than before.

Effectively, the only winners are those that have created the new money because they can spend it on products and services at their pre-inflationary level before the rest. Further, salaries do not grow at an equal pace as inflation and therefore this inflation is a hidden tax.

What happens when there is too much currency?

When people realize their money is buying less and less every year (or month or week, depending how quick the printing press is moving) people will consider putting their money into assets that are outside of the financial system (i.e. buying stocks or a home, etc.) so that they can get rid of the currency.

Consequently those prices rise significantly and we move into a bubble.

Who has caused inflation?

Some may argue that people have caused the inflation of asset prices because all at once everyone wants a piece thereof. However, the ultimate cause is the one who sent more currency into circulation. They have added more money supply than was necessary and bought some goods/services for themselves. The markets have simply reacted to the new money supply.

What to do?

The best way to protect your wealth is to understand how the financial system works and then recognizing whether your economy is currently at the stage of inflation or deflation (seldom) and then make a plan into what assets you could hedge yourself in if this would get out of hand so that the excessive money printing doesn’t cause you to lose your wealth.

Best way to enhance your education is to read up and learn from those who teach ways to improve your wealth.

Summary:

Great insight into the origins of money and banking and how central banking has developed throughout the centuries, specifically in America. The author also gives examples to explain how the process of banking works and why the inflationary banking practices (i.e. fractional reserve) are a symptom of the business cycles in our economies. All that is written above was what I learnt from the book and how my earlier thinking of banking was not up to date. The rating for the book is set at 4.6/5

Happy reading!!! 🙂