Ludwig von Mises Institute

Chapter 36
Of the True and False in Money and Banking

Two elements determine the value of money, as the true measure of price; one is the volume of currency, estimated in gold, in relation to the quantity of circulating capital; the other is the rapidity of circulation. Obviously, if money does not circulate, it has no effect upon prices; and it has more or less effect as the circulation is more or less rapid. To the average trader it is all the same whether he receives twice as much money for his sales in a given time because the volume of currency is doubled, or because the rapidity of its circulation is doubled. He has no occasion to know why the money comes; all he cares to know is that he gets it. Keeping a certain quantity of goods on hand all the time, by buying and selling, he will discover the varying proportion of his money to his goods and raise his prices the same in the one case as in the other. On the other hand, he will reduce his prices the same when he finds but half as much money offered, whether because of a contraction of the currency or because of a contraction of its circulation.

The rapidity of circulation is a somewhat awkward phrase, but it is the best that political economy affords to express the idea, and it is perfectly intelligible to anyone who desires to understand it. It explains significantly the present condition of money and trade. A contraction, not of the currency, but of the rapidity of its circulation, has raised the value of money in the fall of prices almost to the specie level; it has crippled trade, sunk assets, ruined debtors, destroyed enterprises, thrown labor out of employment, and caused widespread misery in society. But it is a cause within a cause; it is itself a consequence of inflation with false money, and only the pain of getting sober after the pleasure of getting drunk. It is but the revolt of commerce against the violation of its laws. Commerce requires money, the commodity, the product of labor, as the equivalent of other commodities, and we feed the money channel with debt, the equivalent of nothing, and the very opposite of money. Commerce depends upon capital, and we expel capital to substitute embarrassment, and force the exchanges of commodities through a ramification of debt and credit as utterly needless as a fifth wheel to a coach. Were the currency money, it would be borrowed, as capital, for trade as for any other enterprise, legitimately when needed, and buying and selling would be for cash on delivery of the goods, almost without exception. Ten thousand dollars thus borrowed and employed would support a business of $100,000 a year in the sale of goods, on an average, with ordinary enterprise and industry, and require no indebtedness beyond the $ 10,000. Whereas the same amount of business, under our discount system of making currency, requires the trader on borrowed capital to owe $50,000, and have $50,000 owing to him, besides his profits, which, if he makes any, are almost sure to be unrealized for a long time among lagging and more or less doubtful receivable debts. Moreover he will involve, and be involved with, his friends in the indorsement of discounted paper for probably twenty or thirty thousand dollars on each side at a moderate estimate. And the business of the country, in the aggregate, will be so much the less as there is less capital to do it with in the absence of money.

Instead of permitting money to remain in the country, or flow in from other countries, maintaining its normal value by noninterference, and exporting merchandise, we degrade its value by interference, and export it under such degradation, by paying our own false prices for foreign goods, in absolute loss. Instead of using it as the common equivalent to buy and sell for cash, we entangle ourselves in debt, which, being organized into currency by discounting, occupies and obstructs the money channel, and drives the money out. And this we call the "Credit System." It is a miserable fallacy; more properly, it is the counterfeit system. Money is the product of labor, never of credit. Credit borrows capital legitimately, not by producing currency; when it produces currency it produces false money and is but legalized counterfeiting. Money is naturally in repletion; by no possibility can it be sent out or kept out of the country, till it is in natural excess, but by adulterating it in the currency with false money, so as to make it cheaper than merchandise.

The French economists and bankers understand this, and France has a paper currency issued against, and covered with, specie, but no "paper money." Napoleon the First understood it. On his return to Paris from Austerlitz, "he drove directly to the Tuileries," says Abbot,

and ascended the stairs, with hasty strides, to his cabinet. Without undressing, or even throwing himself upon a couch for a moment of repose, he sent for the Minister of Finance. The whole of the remainder of the night was spent in a rigid examination of the state of the Bank of France. The eagle eye of the Emperor immediately penetrated the confusion in which its concerns were involved. Writing from the camp of Boulogne, in the midst of all the distractions of the march to Ulm and Austerlitz, Napoleon had thus addressed his Minister of Finance: "The paper of the bank is issued in many, perhaps a majority of the cases, not on real capital, but on a delusive supposition of wealth. In one word, in discounting in this manner the bank is coining false money. So clearly do I see the danger of such a course, that, if necessary, I would stop the pay of my soldiers rather than persevere in it."

The Bank of France no longer "coins false money"; it no longer discounts an evidence of debt out of itself, and therefore does not increase the currency, the notes it issues being merely instruments to circulate the pre-existing currency of specie in its vaults, or credits and vouchers unused for money absolutely and honestly borrowed and lent. It is immaterial whether a bank issues notes or inscribes credits in its books for its demand debt. The notes are but items of an account current in principle, the same as the book credits. Debit a bank to the value loaned on its note when the same is received, and credit the bank by the value received when the note is disposed of, and you demonstrate the principle of an account current; but there is nothing of the nature of money in it. You simply lend to the bank for nothing the value of the capital you dispose of for the note; it may be dry goods or groceries or any sort of commodity or labor. The note has nothing to do with money, it does not represent money, unless it is covered with money held in reserve against it; in which case it serves as a certificate to circulate the ownership of the money so held, as a storage certificate serves to circulate the ownership of merchandise. If there is no money received and held, in the one case, or merchandise in the other, the respective certificates or promises are equally false.

The French have a habit of hoarding, and they hoard bank notes as well as specie. A commercial bank is not required or expected to cover its liabilities for borrowed money with specie, any more than a savings bank. Such liabilities are not current deposits; they are invested by their owners and earning interest; there is no principle or effect of currency in them; of course, they do not affect the value of money or general prices. But the deposits in daily use, offered in market as merchandise in store is offered, and liable to be drawn upon as freely as the gold in one's counting-house safe, are current deposits; they constitute, usually, the chief item of running cash in the accounts of merchants and men of business; they are potentially currency, and if they are not money actually in the bank vaults they are a swindle. The true theory of such deposits is safekeeping; they are not lent to the bank nor borrowed by it on any honest principle; and they cannot be lent by it without inflating and debasing the currency, or, in the words of Napoleon, "coining false money." This evil principle the Bank of France avoids, but the commercial banks of England, and of Europe and America, in general, do not. Here in the United States it is the one great temptation to the establishment of banks; it is the very principle on which banking is supposed to depend for its profit and its existence, and, in the long run, it is the ruin of the business. It is ignorantly and generally believed here that without this paradox of holding while lending—having your cake and eating it too, in the bank deposit—there would be no such business as banking. It is owing to this principle that Germany has been financially ruined, almost, by receiving the war indemnity of $1,100,000,000 which France paid without feeling it. Germany used this money to increase the capital of her old banks, and more than double their numbers in chartering new ones, and the false money they produced was used, as such money always is used, in creating debt, and in promoting extravagant enterprises and wild adventures, that have fallen to ruin. And England is suffering cruelly from the operation of this principle to-day.

The Bank of France, including the branches, held on the 14th November, in coin and bullion, $400,000,000; a sum undoubtedly exceeding its liabilities for the running cash of its creditors, such being all that come within the category of currency. Everything it owes, beyond this, is for capital borrowed in the pre-existing currency, on the principle of a savings bank, to be loaned out without the ridiculous theory of cash on hand to be checked upon at sight, when there is no such cash in existence. Hence, as the bank does nothing to increase the currency, it does nothing to degrade money and drive it away; so that France maintains a metallic system as pure as if there were not a bank in the nation. No one estimates the specie in France at less than $1,300,000,000; some place it as high as $1,600,000,000. She suffers more or less, as every commercial nation must suffer, from the perturbations of commerce and financial mismanagement elsewhere; but her trade is better conducted, more equal and reliable, and less disturbed by defalcations and bankruptcies, than that of any other nation outside of Asia. One would think, at times, that her bad politics would ruin her; but her sound money system outlasts her kingdom, her rotten empire, the crazy commune, and all the wild fancies of the most unpractical and fanatical set of politicians that ever tampered with human government. To-day, if her government should ask for a loan, the requirement would be promptly and far exceeded in offerings of capital by her own people.

I commend to our banks, and our government, the example of the Bank of France, with its devotion to the true principle of banking; in other words, refraining from the making of false money.