Ludwig von Mises Institute

Chapter 4
Money and Banking

In the discussions relating to the currency that commonly arise among businessmen who have not paid any particular attention to the science of political economy, the prominent idea advanced in favor of paper money, and bankers' credits, called "deposits," and used as money, is that there is a great addition to the currency and to the facilities of business in these fictitious dollars. It is not so. If, however, it were true that money is permanently increased thereby, it would be precisely the reverse of the true policy, for the less the volume of the currency, the greater will be the value of the dollar, the lower will be the prices of commodities, the greater will be the exports, and the consequent employment of navigation, the more the employment of the people in the production of property, and in fine, the greater will be the prosperity and wealth of the nation. The wealth is in the commodities and property, not in the money which determines their price. Their value is quite independent of their price, and would be precisely the same with one-tenth of the currency we now employ in their exchange, as with the whole of it, only at one-tenth of the name in money; which would be an advantage, inasmuch as the bulk of the precious metals would be less cumbrous. It would save nine-tenths of the trouble and expense of their transportation for the settlement of balances. The world gains nothing by the increase of gold, but the trouble of handling more of it for the transaction of business at higher prices, except in plate and trinkets.

Money, it should be remembered, is not the leader of commerce, but the follower. It comes, legitimately, only to the individual or to the community as the result of industry and good management; industry and good management do not result from the possession of money.

The fact of paramount importance relating to this subject, of which even our merchants and bankers seem to be almost profoundly ignorant, is distinctly stated, and clearly demonstrated, by Adam Smith, that "the whole paper money of every kind, which can easily circulate in any country, never can exceed the value of the gold and silver of which it supplies the place, or which—the commerce being supposed the same—would circulate there, if there was no paper money."

He appears to have been the discoverer of this important truth, and the following is his illustration:— Let us suppose that the whole circulating money of some particular country amounted, at a particular time, to one million sterling, that sum being then sufficient for circulating the whole annual produce of their land and labor. Let us suppose, too, that some time thereafter, different banks and bankers issued promissory notes, payable to the bearer, to the extent of one million, reserving in their different coffers two hundred thousand pounds for answering occasional demands. There would remain, therefore, in circulation, eight hundred thousand pounds in gold and silver, and a million of bank notes, or eighteen hundred thousand pounds of paper and money together. But the annual produce of the land and labor of the country had before required only one million to circulate and distribute it to its proper consumers, and the annual produce cannot be immediately augmented by those operations of banking. One million, therefore, will be sufficient to circulate it after them. The goods to be bought and sold being precisely the same as before, the same quantity of money will be sufficient for buying and selling them. The channel of circulation, if I may be allowed such an expression, will remain precisely the same as before. One million we have supposed sufficient to fill that channel. Whatever, therefore, is poured into it beyond this sum, cannot run in it, but must overflow. One million eight hundred thousand pounds are poured into it. Eight hundred thousand pounds, there fore, must overflow, that sum being over and above what can be em ployed in the circulation of the country But the paper cannot go abroad; because at a distance from the banks which issue it, and from the country in which payment of it can be exacted by law, it will not be received in common payments. Gold and silver, therefore, to the amount of eight hundred thousand pounds, will be sent abroad, and the channel of home circulation will remain filled with a million of paper, instead of a million of those metals which filled it before.

This is plain and easy reading, and the doctrine, inculcated, undeniably true. I commend it to the careful attention of the reader; for the paper money system, as I have already suggested, rests upon, and is wholly sustained by, the idea—the delusion, in fact—that the wants of trade require more money than can be supplied in gold and silver, and that this additional supply is obtained by the fabrication of paper money.

But the truth, which escapes public attention, is that the real wants, under such circumstances, are lower prices of property, and a consequent higher value to money. The want of money, among an intelligent, enterprising, and a laborious people, cultivating the arts of peace, if left to its natural remedy, will supply itself at the cost of other communities, less productive, or burthened with more oppressive consumption, with the absolute certainty of the law of gravitation. What better business can we desire than selling goods for money, when money is worth more than merchandise? This we do when we import specie in exchange for merchandise; and this we should be sure to do, by giving utility to the precious metals in the currency, until the withdrawal of the whole sum of the fictitious money, now usurping their office. The common notion of the want of money, or bank capital, or of the true method of supplying it, is a mere chimera—a most profitless and absurd conceit. This country needs no law but the natural law of distribution left to itself to secure an abundant supply of real money.

In the case supposed by Adam Smith, the coin, in the particular country, amounted to one million pounds originally. One million of paper being added, eight hundred thousand pounds of gold and silver are displaced and sent abroad. There appears then to be twelve hundred thousand pounds left in the currency; but it is not so. Two hundred thousand of the paper is issued against coin retained. The notes to that amount are virtually certificates of deposit, as all paper money ought to be. Both coin and paper cannot be kept in circulation for the same sum, at the same time. We must, therefore, deduct the reserve of two hundred thousand from the currency, and it remains one million pounds as before.

Thus it is that every paper note, put in circulation, is a "ticket of leave" to one of specie for the same amount, which must either go out of the country, or be absorbed in the bank hoards to meet the returning notes, and the same effect is produced by the inscriptions of bank credit. Not a farthing is added to the currency, except temporarily. The depreciation of the value of money is soon felt in the rise of prices, which stops the sale of exportable merchandise, brings in foreign commodities, and sweeps off the gold and silver.

To this the objector will probably say that a consequent increase of business will employ the paper addition to the currency. How will this be brought about? Let us inquire. He may never have reflected upon the great disproportion of other property to money in every country, which may be perhaps 25 to 1; therefore, property and business must increase twenty-five fold over the whole world, to employ each additional dollar, without reducing the value of money.

The first operation of the bank, on the credit system, is to discount a note, we will suppose, for Mr. Needy, obtained for flour, which—the currency having been before sufficient to circulate and distribute the products at the then ruling prices—he has sold at a remunerating advance on time. The net amount of the discount is entered to the credit of Needy, and thus becomes a substitute for money. He goes into the market for the purchase of wheat, with this substitute, in competition with his neighbor, who has gold in hand for the same purpose; the seller finding he has two customers instead of one to play upon, puts up the price. In short, Needy, and Hopeful, and Fuller, and a hundred others—buying and selling goods, and operating in the same way with bank money, as good as gold, according to the theory of our system, because promised to be paid in gold on demand—by their competition in the market, raise prices all round, exportable and imported commodities being affected alike, and what follows? Why, the community wanting our commodities, whether the next town, or State, or foreign nation, will not buy them of us if the same description of articles can be obtained at specie prices elsewhere—they will take our gold and silver, and set sail for the Baltic, or Black Sea, or White Sea, or some other sea, where no such folly, or less of it, enters into the money system, and there, where gold and silver have more utility and consequent value, they will exchange them for the wheat, or beef, or pork, or ashes, etc., which their wants require, at the lower prices of a stronger and better currency.

Is this an increase of business? No, it is directly the reverse. The producer, and the produce dealer, and the plow maker, and the harness maker, and the merchant's ships, the carpenter, rigger, and sailmaker, and all men and things through all the ramifications of commerce, depending upon the export trade, are shorn of their employment, and the profit to be derived from it, to the extent of this unnecessary export of gold and silver, and there is so much less capital in the country than there would have been, if "tinkering the currency" had not lessened the utility and consequent value of gold.

We cheat ourselves transparently in this matter. What we fancy to be a rise in value of our products is merely an alteration of the name in money that we exchange them by; they are not altered thereby, in their exchange value, with regard to each other—it is a rise of price. The additional money we obtain for them will buy no more of anything than the smaller amount bought before. The really effective thing we have done is absolute mischief; we have degraded gold, with paper alloy, and we sell it, without the paper, in its standard purity, at the degraded value. This is the consequence of not knowing the difference between value and price; value being the power of property to exchange for other property, and price its power to exchange for money only.

How long will these higher prices remain to delude us? Not a moment longer than it requires the foreign producer to throw his commodities into our market and exchange them for gold. This inflowing of foreign products, and outflowing of gold, must infallibly continue, till the equation of international demand is established where it was before. Prices of imports must fall to the value of gold, when their supply will be checked—prices of exportable commodities must fall, in like manner, when they will go out in the place of gold; the true operation being, that gold, by the increased demand, rises to the value of merchandise. Meanwhile the product of the debt-factory we call "bank," will be nestled into the place of the gold it has expelled, and draw interest, for the proprietor, from the labor of the country, on capital not his own, for doing nothing but evil, in checking production, traffic, and the increase of wealth. There is also created a counter debt, from the people to the bank, which every contraction of the india-rubber currency, necessary to raise the gold to the value of merchandise, violently discharges, in bankruptcy, to the full amount of the contraction.

To this incubus of debt we owe the exorbitant rate of interest, so constantly prevailing in this country, and the constant scarcity of money for all the purposes of life. How few there are ready, and able, to pay cash to the butcher, or baker, or grocer, for their daily supplies; or to the church for the support of their spiritual guide. Even the crinoline, that occupies such breadth of pavement, goes on "tick." Every man, almost, feels that he had as much as he can do to raise money to meet his "Bills Payable" in bank, and all generous and philanthropic enterprises languish.

When, by the contraction of bank discounts, and the consequent scarcity of fictitious money, real money becomes again as valuable as merchandise, and can be kept at home; that is, when the specie export ceases, the banks by standing still, with the sum of the bank debt in the currency, huge as it is—$400,000,000 of immediate liabilities, beyond the coin in their coffers—might keep the exchanges in our favor, and secure a constant export demand for merchandise; but the whole profit of the business is in the creation of debt, to and from the people; and its nature—its very essence—requires the widest possible expansion of debt, and the utmost possible expulsion of money. As soon, therefore, as the export demand for specie ceases, and the exchanges of the world are in our favor, as during the past spring—when there is no wholesome want of money—the fictitious dollars multiply again, by the increase of bank loans, and we are put through the same round of misery as before. It is an unrighteous scheme, operating against all natural law—always inversely to our needs; and this its advocates call a beautiful equilibrium in the system! I am only surprised that any sensible man can entertain such an idea for a moment.

Every dollar of paper money is a certificate of mischief, and every inscription of credit for which gold or silver has not been deposited, and, on the undrawn loans, is not retained, is positive evidence that the same amount of merchandise, which otherwise would have been sold, is on hand or unproduced—that the same sum of money is not here that would have been here, and the same sum of debt, with its progeny of debt, is pressing upon the community without any legitimate right to an existence. The sum of this debt, in the currency—now $400,000,000—pressing upon all classes throughout the country, has been created in a series of years, by expelling coin once earned; and we are borrowing back from England a large portion of the amount for State uses, railroads, and other enterprises, and paying interest on capital of our own creation.

I believe this amount to have been utterly lost to the country in paying for imports the inflated prices of a mixed currency, more degraded than that of other nations. J. Stuart Mill says, very truly, that "the demand which affects money prices consists of all the money in the hands of the community destined to be laid out in commodities." The price of the imported commodity is thus determined by the amount of money here, while the exportable article must be sold by the measure of the foreign currency; that is, it must pay to export at the price to be obtained in the foreign market, or the exporter will leave it and take gold; as we see he does take all the gold we can possibly spare; for we never cease exporting it till the banks are driven to a pressure with the loss of specie. The exportable commodities are thus kept above the relative value of gold as long as gold can be supplied.

But by the law of value we must return from every inflation. After forcing off all the gold we can spare, by paying the inflated price for imports, the banks stop discounting, and make money valuable again, when our produce falls in price and is shipped instead of gold, as I have before stated.

I am not of those who think the imports can be essentially checked by any national policy short of nonintercourse or war. Labor is a necessity abroad as well as here:—the imports must come. But the bank dollar employs no labor in its creation; it is made by writing a promise on a bit of paper; it creates no value, and is no wealth. It expands prices, however, as much as the real dollar, and is the ready instrument of the speculator. It cannot be used in the currency without degrading the value of gold, to expel it and make room for itself. As prices rise here, the almost lightning speed of commercial intelligence transmits the news to the shipping markets abroad. Hides rise in South America, sugar and molasses in Cuba, and cloth in England to meet the rise here:—our fictitious dollars raise the prices of the world, and we pay in extra labor the expenditure of other nations.