Title: What has Government done to our Money?
Author: Murray N. Rothbard
We’re already well in the first few days of the New Year, and I thought that I might kick the year off with this book. Partly because it’s been waiting to be read on my desk for a while now, but another reason was because it is perfect for the current times we are facing.
Not because it tells a story of a pandemic going on, well not the health one we’re facing, but in some way it is telling the story of the money issues we are living through in today’s times.
Stimulus packages, government deficit spending, all these programs relate to government spending money. More money in circulation, with the number of goods/services being created remaining unchanged will ultimately result to one thing; inflation. Although we might not be feeling it yet, it is probably a logical outcome when we have managed to get the health pandemic under control once again. To give some reasoning for this, I’d like to tell a story of what happened in Germany just before the end of World War I:
- During the war people had saved all the money they could afford to save, due to the uncertainty of what would happen afterwards
- Also, the people bought government bonds, which the government used to finance the war
- Before the wars had broken out, the world economies each operated on a Gold Standard
- This meant that people had confidence in the amount of currency that they had could be redeemed for a fixed amount of gold
- For this to be possible, the amount of fiat currency in circulation had to be a fixed amount i.r.t. the amount of physical gold held in storage
- After the war had ended, Germany was handed a massive reparations bill by the other nations
- Germany wanted to pay off the money that its people had lent it to finance the war, and also pay their neighbouring nations, but wouldn’t be able to finance this with the amount of gold they held in storage
- Thus, they started to print more money (in the Weimar Republic) in order to have the paper and settle their obligations
- More money in circulation meant all the other money had to lose some value (ie. purchasing power), and ultimately this printing action of the government brought the government into a hyper-inflation
Now, we are in different times, under different circumstances, but the above extract from history was meant to show how bad something can end up for a country when the government decides to run the printing presses.
Getting back to the book, the book is split into three sections:
- Money in a Free society
- Government meddling with Money
- The Monetary break-down of the West
It starts off in part 1 to explain how money (ie. a medium of exchange) came about, until it reached the final form of gold and silver coins.
Then it steps into part 2 where it tells the story of how government became more and more involved in the economy, taking over control over what may be traded and used as money, and gaining control over how much money can be supplied and how much inflation should be allowed to roam.
Part 3 then closes off where it describes the different monetary standards that were in place from 1815 – present, which the author has broken down into 9 phases.
Part 1: Money in a Free Society
Value of exchange
The author supports the argument that humans are better off when we engage in trade, because if we didn’t engage in exchange we would all need to be self-sufficient.
If we wanted to enjoy a multitude of different goods & services, we would need to apply our own skills and resources, in the available time to generate all those goods. This is considered rather inefficient, and wouldn’t be a popular lifestyle choice to most people.
After establishing that exchange is the better alternative, the only means available to acquire a variety of different goods & services was to exchange what you had for something that someone else had.
However, the flaw with barter (ie. direct exchange) was that the goods you may want are with a person who doesn’t want your goods, but who wants something else. Therefore, the difficulty lay with finding all the right buyers just so everyone gets what they want.
Secondly, the other flaw with this was that the goods had to be exchanged immediately since some of the goods were perishable.
Hence, to solve the above two dilemmas and inconveniences, humans needed a medium of exchange, ie. a yardstick. Something that someone would accept to hold value, and they recognize that this item would enable them to buy the goods they want themselves. Furthermore, this item, not perishable, would solve another problem. It allowed the user to delay his purchase until when they wanted to buy, and didn’t force them to make the exchange immediately.
A variety of different resources were used in different parts as that medium of exchange, but ultimately we ended up with gold and silver. Gold, being scarcer than silver was then valued higher due to that scarcity.
Thus, what gave an item its value, was the limited supply thereof, and its acceptability by the population as a fair medium of exchange.
Soon, everything became priced i.t.o. gold and silver, that the values of different goods were comparable with the value of other goods. Further, gold and silver could be broken down into smaller pieces, enabling this medium of exchange to make multiple transactions of different sizes possible. And the way this divisibility was governed was by the weight of Gold and Silver.
- However, due to transactions not taking place with coins in the beginning, but by nuggets and other shapes, gold and silver always had to be weighed, and checked for their purity
- Then, a new form of medium of exchange came about, coins of equal shapes and sizes.
- This invention solved two problems: First, gold from traders would no longer need to be weighed, because all coins had the same weight. Second, the coins were marked by the kings, which ensured the purity it promised to hold.
However, when an empire grew to big (ie. it had many social programs it needed to fund) or when the empire needed to go to war, the leadership always needed money to fund this project/war. Due to the quantity of gold in circulation being limited, the kings had two choices, levy more in taxes, or dilute the value of the coins via debasement.
Debasement happened when the king took 10 true coins, melted them down and mixed them with a alloy compound. The result was that he now could mint 15/more coins. The additional coins would then be the kings profit and used to fund the additional expenses.
- To get away with this scheme, it was vital for the king to be in control of the coin mints, so that they alone knew the total amount of coins that were in circulation, and that this was taking place.
- Over time, people will figure this out that their money is no longer what it was, and then they will gradually use their diluted coins to acquire legitimate coins, and hold them in reserve. (Gresham’s Law)
The law of supply and demand will then take this into account (ie. higher supply of coins, without any change to the quantity of goods to be exchanged) and ultimately this will lead to higher prices of goods – rebalancing of the value of money i.r.t. goods.
Skip ahead a few pages and we gradually move towards the centuries just before paper currency was invented.
When gold coins were solidly established to be money, it sometimes could be difficult to carry all your gold with you, where you deem it safest. Thus, a business establishment was created where people held on to other people’s gold for them, and giving you a receipt so you may claim them whenever you would want them. However, in order to engage into a transaction, you would then first need to go and collect your coins, update your receipt, and then only buy some goods. The recipient may then go and deposit the coins at the same bank. This was considered to be rather inefficient, and therefore eventually paper currency made its appearance (probably by a trader called Marco Polo on his travels to Asia where paper money has started first). Now, your gold was deposited at a bank, who held on to the coins for you, in exchange for paper money, fully redeemable in gold.
By solving the first problem, now came the next. The bank may have issued its own paper currency, and another bank its own. When people of different banks transacted with each other, effectively the banks receiving the paper money would need to deposit the gold from their client with the bank of the other party, and that piece of paper should be eliminated from the first bank, and the second could print another of their own.
Fast forward to 1913 when the Federal Reserve Bank was created in USA, which issued the only currency that was allowed to be used for trade in the USA district. Thus, the creation of a central bank, who issued the sole currency that was allowed to be used for trade, eliminated the problem of different currencies that were issued by different banks.
Part 2: Government meddling with Money
What is government’s role?
Like the responsibility of the king in an empire, it will promise to provide more and more for social programs (ie. health care, retirement, education, etc). The way the government provides these services is through tax collections. However, as its programs become more and more, more funding is needed in order to provide what it promised to its people. The way to do this would be to collect more taxes. However, when the taxes of people become higher and higher, people might become fed up and decide to leave to another place where they are treated better.
So, the government uses its second power. The silent form of taxation, inflation. The way this is done is illustrated below:
- The government controls the institution that is printing the money that is the legal tender in the economy
- It makes a law that this form of currency is the sole form of currency permitted to be used as money (ie. medium of exchange for different goods and services)
- It prints more money (incurs deficit spending), and spends that money in the economy. However, you should realize something has happened here. The supply of currency has increased, without an equal increase in the quantity of goods. Therefore, to align the new total quantity of money in circulation with the available goods, prices start to increase, until the new equilibrium of supply and demand has been reached.
- Not only is it able to create the money, and declare it to be money. The central bank has created it out of thin air, and used it first to acquire goods and services at the prices before the new equilibrium has been reached.
- Effectively, if you created counterfeits and bought something with them, you have gained assets without having worked for real money
- This is the exact same picture, only when the central bank created money, it does it legally
- Through this money-creation process, all existing money loses some of its purchasing power, and the people who are influenced by this are the very people who have voted for the political parties to govern them
- The central bank gets some money
- And your money loses some of its value
Personally, I have considered the following question:
- If new money is created, wouldn’t the fair thing be to distribute the %-share to each person of their current holdings of the existing value in circulation?
- This way, your current $100 loses some of its value, but you receive the coinciding new currency to bring the total purchasing power back to $100.
- This way, you may have more currency in your hands, but the purchasing power is the same as before.
- However, if someone found this to be the equitable approach, how would one determine the value of all things that are in your possession?
- You wouldn’t only want your current bank account holdings to be used, but everything that you own that could be sold
- Problem with this is that the price at which some assets were acquired were at inflated prices in bubbles, or depreciated prices in others
- The reasonable conclusion would be to have a list of all things that could be included in this evaluation, get a fair market price for all those assets, and use that when new money is distributed into the economy.
In the modern economy, how did the government gain ultimate power through a central bank:
- They needed to seize an absolute monopoly of the minting business, so they can gain control of the coinage supply
- This control would allow them to supply whatever denominations of coin it, (and not necessarily the public) wanted
- As a result, the variety of coins (previously issued by different mints) is now reduced to one kind of coin
- Government then change the name of the monetary unit so we no longer value a coin based on its weight in ounces/grains/grams of gold, but rather only know the monetary unit by the name of the country
- Here people lose track of how much a dollar is worth i.r.t. a ounce of gold, but only know the name of the currency used in a country
- Therefore, they value things i.t.o. the currency, not gold, and therefore don’t see the impact of inflation immediately
- This shift made it thus possible for the government to continue with its secret tax of debasement
- this is possible because they can print a lot of paper currency (whereas the supply of gold couldn’t be replicated the same way)
- After setting their official currency, they write into legislation (legal tender law) what may be used as money to acquire goods/services in the region
When coins (pure gold and silver) were used as money in a country, the governments ability to engage in money printing was limited only by the fact that gold and silver couldn’t be created as quickly as paper money. When money-substitutes (ie. fiat/paper currency) were introduced, this became ever more easier for kingdoms and governments to do.
When the central bank was first created, it promised to bring stability in the economy through balancing inflation. People had huge faith in this central banking system that they deposited their gold with their banks, and received notes that were backed by their gold. The banks in turn had to deposit the gold with the central bank, and have a positive balance with the central bank. The central bank issues to the bank the ‘true’ money that (according to legal tender law) may only be used to engage in business. However, by having people deposit their money (gold) in exchange for the notes, the central bank gained more and more control over the supply of ‘true’ money.
- The reason why people made these deposits was because they had faith the central bank would act in good faith, and because of patriotic propaganda that was circulated at the time, denouncing people who held on to their gold as being hoarders, and selfish
Initially when the central bank was established, the currency was backed by gold, and this was stamped on their currency.
However, due to later pressures from war and other political reasons, the USA decided in 1971 to finally go off the gold standard, and no longer make currency redeemable into gold.
Fractional reserve banking
Another process that makes this deficit spending possible is the concept of debt.
Banks were permitted by law to not hold 100% of the money of their customers’ deposits in their vaults, but only (example) 10%, and may lend out the other 90% to someone else. The borrower buys something for the borrowed $90, and the seller deposits the full $90. The bank in turn keeps $9 on hand, and lends out $81 to the next person. This process is repeated until eventually $900 new money was created from the initially deposited $100.
Due to deficit spending (of paper currency) and debt (from paper currency) one can clearly see how inflation is created.
What have we learnt?
Step by step, governments have removed gold money (which couldn’t be manipulated) from circulation and replaced it with fiat money (paper money that can be inflated at tremendous speeds) and holds complete control over how much money is in the economic system.
This control, the author calls a socialistic control.
Part 3: The Monetary break-down of the West
I will give a brief break-down of the nine phases that the author mentions of where our monetary system was in 1815 and where it has come to now.
Phase 1 – The Classical Gold Standard (1815 – 1914)
- Each currency was convertible to a fixed weight amount of gold
- When one country sold more goods to another it had a positive balance of payments and the other had a deficit balance of payments
- The country with the deficit had to settle its deficit with gold
- When one country had more gold, it could issue more currency (but the supplied goods remained unchanged) and therefore the local goods became more expensive and the foreign goods cheaper, they would now import more
- Their higher imports would result in a deficit balance of payments, and now their country would need to settle in gold to the other country
- And on and on this cycle would continue, as long as every country played fair and abided by the rules
Phase 2 – World War I and After
- Governments need money to fund their war, so they suspend the convertibility of currency into gold
- They also borrow money or create more to fund the war
- Everyone believes that the currency they receive for the goods sold has a backing in gold, and therefore, no one worries that it won’t become redeemable (this belief is further supported by the years preceding the war where this was true)
- After the war, the country has debts to pay. Also, everyone wants to get back on the gold standard. However, they have created more of their own currency supply (and number of goods remains unchanged), and their gold stock levels didn’t change
- The sensible thing would have been to restate the value of currency i.r.t. gold, so that the total currency in circulation is backed by gold once again
- However, Britain is against this and wants to go back to pre-war rates
Phase 3 – The Gold Exchange Standard (1926 – 1931)
- The British government doesn’t want to restate because it wants to retain its title as a strong power within Europe, and therefore makes the following recommendation in 1922 at the Genoa Conference:
- It created the gold-exchange standard (which removed gold from circulation, and melted them down to bars, making them less accessible to citizens, and only businesses or governments)
- Further, when less coins were in circulation, the government could engage in inflation much easier when only paper currencies existed
- This way other governments would go back to gold as well, but their currencies are overvalued i.r.t. Britain, which would make it more expensive for other countries to export their own goods, and induce them to rather import from Britain
- This was the plan by which Britain hoped to get back to its pre-war gold standard (without proper regard for the other countries)
- It created the gold-exchange standard (which removed gold from circulation, and melted them down to bars, making them less accessible to citizens, and only businesses or governments)
- Another criteria was that currencies in Europe could peg their currency to the strong British Pound, and the Pound in turn was backed by the US Dollar, which was also backed by gold
- What happened then was that the countries in Europe engaged in spending and buying with other countries, with one important difference, when their balance of payments ended as a positive they didn’t reclaim the gold from the other entity that incurred a deficit.
- Thus, they kept the pound on hand, and engaged more spending, and greater deficits.
- As more and more Pound Sterlings were piling up in different countries, the other countries were beginning to lose confidence that Britain would be able to settle the amount in gold, should they wish to redeem it
- In 1931, the bubble finally burst. Countries wanted to reclaim their Pound Sterlings in gold, but Britain went off the gold standard, and soon other countries in Europe followed
Part 4 – Fluctuating Fiat Currencies (1931 – 1945)
Countries had stopped redeeming gold for currencies, and in order to become competitive in international trade they had a number of devaluations (Germany’s hyperinflation), set exchange controls and trade barriers to become competitive once more.
The US entered into a depression, and had been the last country to be on a gold standard. Before, its exchange was $20 p/oz, then, after Franklin D. Roosevelt required citizens to give up their gold (via the New Deal laws and propaganda) the new exchange rate was set at $35 p/oz. The Dollar had been devalued significantly in the effort to save the US economy, and likely with it the world economy.
- The significant event that happened here was that people were required to surrender their gold and coins, to help the US and be patriots
- However, by giving up their gold, they would now receive only paper money, which was (from 1913) under the control of the Federal Reserve Central Bank
- They now had control over all the money, and could influence the supply thereof
Part 5 – Bretton Woods and the New Gold Exchange Standard (1945 – 1968)
After the second world war had ended, European countries had war debts they needed to settle with the US, who had borrowed them money and also supplied them with materials for the war. In return for those goods, countries had settled with their gold reserves.
The US currency was identified to be a strong currency in the world, and therefore it was decided that all the currencies would be pegged to the US Dollar, and the Dollar was pegged to gold at $35 p/oz, which the other countries were allowed to redeem. Another criteria was that the countries should build up a reserve of funds, which they did in US Dollar.
- At first countries didn’t redeem their gold for the Dollars they had in excess, but used it as good as gold
- 1950s the US government was spending more money, inflating away, whereas the European counterparts were running “hard money” policies themselves
- The US was running more and more balance of payments deficits with its European counterparts, and this went all the way through to the 1960s
- The western European countries, led by France’s DeGaulle, were becoming ever more weary of the US’s excessive spending, and were becoming afraid the US might not be able to redeem gold repayments, and therefore started to redeem gold for their reserved US Dollars, at $35 p/oz
- After the second world war, the US had amassed $25billion stock of gold. Until the late 1960s, due to redemption calls increasing this reduced to $9billion in stock.
- Finally, the collapse of the Bretton Woods system was beginning to show its first signs of weakness in 1968 to the world economy
Phase 6 – The Unraveling of Bretton Woods (1968 – 1971)
The US found it ever more difficult to keep settling its debts with gold at the set exchange rate of $35 p/oz. Due to the sales of the US Dollar for gold, by both foreign governments and foreign residents, the US made an agreement with the foreign governments that they will set up a two-tier gold market. Foreign governments would continue to be permitted to settle their dollars at $35 p/oz, whereas the price on the private market would not be considered. (Therefore, a private citizen could possibly get less than 1oz of gold for his $35, depending the current supply and demand in circulation.
In addition, it wanted to set up a world currency (called SDR – Special Drawing Rights) via a future World Reserve Bank, which give control over world inflation to the world central bank.
Within the remaining years, the US had kept up its deficit spending, and finally confidence was lost in the US Dollar, that the US made the decision in 1971 to suspend “temporarily” the redeemability of gold for US Dollars, in an effort to halt the European governments from withdrawing all the gold.
Phase 7 – The End of Bretton Woods: Fluctuating Fiat Currencies (Aug – Dec 1971)
European central banks still held some of the US Dollars and wanted to redeem more, but the US had now called for the Dollar no longer being redeemable in gold.
The world currencies were now free-floating exchange currencies.
Phase 8 – The Smithsonian Agreement (Dec 1971 – Feb 1973)
The world economies came together to pledge that their currencies would be set at fixed rates i.r.t. their counterparts.
Phase 9 – Fluctuating Fiat Currencies (Mar 1973 – present)
Not very long after the Smithsonian Agreement, the system collapsed, and the world currencies were now once again set on a free-floating exchange rates.
The gold exchange standard was forgotten and this new system was in place to stay. One group of people that favoured this system (ie. not backed by gold, which limits money expansion) were the Keynesians. The next step would be to have a world central bank that has control over the world currency supply, and regulate the currency for the world economy, and thus control inflation.
The book goes into great detail of how money came about and finally settled at gold and silver being adopted by the free market as currency. It also goes into great length to elaborate how some challenges that were posed by physical gold were relieved with the introduction of paper currency and also a central bank that issued one currency, and not multiple from different banks. These changes definitely brought in efficiencies. However, with every new good thing comes a bad thing. The new system was abused, and is one of the factors that gives central banking and government a bad name.
While I hold that the option of gold as money would give some certainty over the retention of value for citizens, moving to a all-gold currency might not be beneficial. What needs to happen is that the people in control over our money should deal with our money more ethically. If inflation (ie. increase in money supply) is about to happen then it should happen in such a way that everyone should get their %-share of their current worth, so that when then supply of currency is increased, no one has lost purchasing power.
The book is a great read for anyone wishing to gain an understanding of currency, gold and how money is created and controlled in a modern economy. The book thus gets a rating of 4.9/5 🙂
This was quite long to write but I hope you learn as much as I have done from this!!!