What Has Government Done to Our Money?

What a great little gem of a book - Rothbard, with his pithy wit, concisely describes the origin and development of money, and briefly chronicles various government interventions in the free currency market and its inflationary effects.  This is the first LvMI book I've read (after frequenting the site) and what a great introduction to the work of economist-philosopher-historian Rothbard.  It's a quick read, but worthy of an at-length discussion.

 

I just finished reading this just three days ago, incidentally. It really is a great work worthy of anyone's attention. Rothbard's work never fails to both captivate and educate alike.

This is the first LvMI book I ever read also -  a perfect one to start with, in retrospect.  Rothbard had such a great talent for illustrating economic theory clearly, so that any person could follow.  Not that I support the concept of state-run education, but if I did, I think this book should be a must for every student.  It really is incredible how many people have no concept at all of monetary theory.

In Part II. Section 8. entitled The "Proper" Supply of Money (page 41 of the LvMI edition), Rothbard writes:

"We come to the startling truth that it doesn't matter what the supply of money is.  Any supply will do as well as any other supply."

This conclusion comes after a discussion about how the addition of newly-mined gold (as money) into the market will simply dilute the value of existing money supply, and prices will adjust (upward) accordingly.  This seems to describe inflationary activity that would naturally occur in a free currency market.

It occurred to me, though, that proponents of central banking might apply Rothbard's conclusion to the supply of paper money.  That is, if mining companies' activities could potentially inflate the supply, and dilute the value, of gold as money, they would in a sense be acting as state banks Rothbard describes elsewhere, inflating the supply of paper money and diluting its value.  Obviously, the effects of paper inflation are well-described in Part III. Section 2. The Economic Effects of Inflation.  But might the naturally-occurring inflation (the introduction of newly-mined gold as money) also have (some of) these economic effects?

 

cold hard cash:

"We come to the startling truth that it doesn't matter what the supply of money is.  Any supply will do as well as any other supply."

Block and Barnett disagree with this position.  Look here.

For fiat they agree, but not for commodity.  For commodity, they believe whatever the market chooses is the optimal money supply.  Obviously, 1 oz of gold would be an inadequate money supply, given the number of transactions per unit of time that gold needs to conduct.  On the other hand, the additional transactions a new supply of gold could facilitate might not be worth as much as an alternative use for the gold, if the money supply is already sufficient.

Rothbard doesn't strictly disagree with Block and Barnett's position. For example, he says, "gold is not only money, but is also, inevitably, a commodity. An increased supply of gold may not confer any monetary benefit, but it does confer a non-monetary benefit ---i.e., it does increase the supply of gold used in consumption. [...] Gold mining is, therefore, not a social waste at all." (Murray Rothbard, What Has Government Done to Our Money? (Auburn, Alabama: Ludwig von Mises Institute, 2005), pp. 42). Therefore, we can quite easily see that this non-monetary benefit to an increased supply of money is indeed beneficial, as Block and Barnett recognize.

But what of the other main part of their argument? They say that "1 oz of gold would be an inadequate money supply, given the number of transactions per unit of time that  gold needs to conduct." However, this statement ignores the fact that the commodity serving as money at the time need not necessarily be involved directly in exchange. For example, we could quite easily have gold as the basis for the money supply if we only had 1 oz: the solution would be for the ounce to remain deposited in a bank or divided among several banks and have claims to a certain fraction of that gold ounce printed. We would see anything like a 1/20 of a gold ounce claim, however, we would see something more like a 1/10,000,000,000 of a gold ounce claim. This doesn't mean that exchange would be hampered at all, nor does it mean that gold would not be the money; money substitutes would simply be used in virtually every transaction.

It is improbable, however, for gold to emerge in a world where there exists only 1 oz, for relatively obvious reasons: for money to emerge it has to be valued on the market previous to its emergence as a medium of exchange, and if someone exists in such a small quantity, there would hardly be any market for it and no demand for it. Something else would emerge as a money, with a more reasonable quantity. I do not know if Block and Barnett elaborate on any ideas of this kind, but it is not so that gold has to be directly exchanged in monetary transactions.

We could continue to think about a world with only one ounce of gold that used gold as money, and it is possible that we could conceive of a different reason why a single ounce of gold would create problems. The thing that comes to my mind is that it would be absurdly easy to confiscate, devalue the money by printing fiduciary media, and there would be little physical check on these actions. However, those potential objections rely on events that do not necessarily have to happen.

Yes - the potential problem is that money substitutes really can't be redeemed for something that can be used as money by common people.  Thus, they are not money substitutes really.  If a bank note redeemable for 1/1,000th oz gold is used as a money substitute, this implies that 1/1,000th oz gold is money.  Think of the gold bullion standard.  Most "clients" never had enough money substitutes to be able to redeem them for the minimum bullion quantity.

Given that the market changes over time, I see no problem with the optimum money supply changing as well.  As the population grows, it needs more physical pieces of money.  Fiat would perform this feat by exchanging larger bills for smaller ones.  Commodity standards could perform similar measures - re-minting larger coins as numerous smaller coins.  However, it may be more efficient to mine new gold and make new coins.  While this would remove purchasing power from existing coins, this is not a huge problem considering whatever is chosen as money is unlikely to suffer large-scale expansions.

Also, the monetary additions are not made through the banking system, so it would not necessarily cause a business cycle.

As far as saying, "we can handle it with computers" etc, this implicitly admits that fiat is better than commodity monies.  Fiat COULD be completely non-inflationary.  The problem is with the administrator.  What if the handler went bankrupt or their system crashed, etc.?  What if it decided to create its money from thin air for its own use?  What about privacy?  There are reasons why people will always want cash.

A few thoughts to add here:

First, in regards to the magnitude of the money supply, if there were only one ounce of gold in the world, it is highly unlikely that gold would be used as money. Some other commodity would have come out on top. Gold emerged as the commodity of choice to be used as money for many reasons; I suspect that one of the criteria would be a quantity large enough to facilitate easy division and exchange.

Second, I suspect (though I'm admittedly guessing here) that gold is not prone to sudden, large spikes in discovery. Yes, these would be inflationary. However, resources have to be expended to bring the gold to market. For example, for every ounce brought to market, maybe 0.9 ounces is consumed in mining and minting costs. So diversion of economic resources in order to add to the money supply is actually a good thing, as it dampens the inflationary effect. If a mining company were to find a huge, unexpected deposit on their property, then they would expend much less for every ounce brought to market, perhaps 0.3 ounces. But only for a short time. It would kick off a "gold rush" in the immediately surrounding area, which would serve to bid up the mining company's cost (other startups bidding for the same heavy equipment, energy, labor, etc) to something higher than 30% of their revenue. Big profits are an imbalance that the market will find a way to adjust to.

I must admit, I don't agree with everything Rothbard says... but this book is straight to the point and I think 100% on target.  It should be a required read to understand basic economics.

My main beef with Rothbard is that he is adamant about how no one can own value, but is partially against fractional reserve banking because inflation takes value from existing money. He can't have it both ways. What did you disagree with?

I think its more about fraud and theft then it is about value. I can see where the confusion arises however. 

 

Maybe I'm putting words in Rothbard's mouth. I can't find a quote that clearly makes my point in this book. I may actually be thinking of Block or Hoppe from articles relating to fractional vs full reserve banking. The basic point was that FRB imposed externalities on not only those holding the bank notes but those holding gold or some other commodity money used as fractional reserves by banks. The increased claims to gold devalued gold's purchasing power. I don't believe such an externality constitutes a violation of libertarian ethics. Ultimately, the market has the ability to price gold and gold substitutes differently, and if it chooses not to, that is not the banker or its customers' fault.

I'm pretty sure that you are thinking of The Case Against The Fed.....I get these two books confused sometimes myself as they sort of flow into one another.

I tried to find the article, and I found this: http://mises.org/journals/qjae/pdf/qjae1_1_2.pdf Check out the second section. This is pretty much what I was talking about. I find Hoppe and Block's argument persuasive actually.

I read this a couple of weeks ago. I don't recall anything contradicting ownership, private property or anything like that. We all own things and their value is calculated by the pricing system, i.e what others are will to pay or exchange for any given item, service, action, thought, etc..(Subjective theory of value). He was clearly opposed to fractional reserve banking in the book. It was declared out right fraud as paper notes or tokens used to be deposit receipts or claims on gold stored (warehoused) in banks. This is a little funny to me as so many modern economists, including otherwise advocates of individual liberty (like Thomas Sowell) view fractional reserve banking as an innovation that has allowed vast amounts of wealth to be created that would not otherwise have been. Sowell's book Basic Economics from 2007 pretty much says that with some explanation of bank runs and how the FDIC and Fed have been able to prevent them. I love Sowell but I'm on Rothbard's side on this one. There would be more peace, honesty, prosperity and higher degree of civilization on a strict gold standard.

The Fraction-reserve banking is my main beef with Rothbard as well. I have been on a search for satisfactory arguments against FRB for many months now after almost de facto taking the position because I had been in agreement with Rothbard on everything else. It was a good lesson for me. I do not consider FRB fraud and find most arguments against it to be very UNRothbardian. Externalities?

With separation of money and state and a truly free market(which I advocate) I would be willing to bet on FRB being common practice and not being viewed as fraud.

Dennis- Fractional reserve banking is very much fraud, because that means the bank, instead of having your money at any time available for withdraw on demand, they have loaned it out. That is one major issue. For a period like the Great Depression to come about, where there are runs on the banks all over the country, and the bank to NOT have everyone's money, even though they've promised to have it available on demand at ANY time, is the same as theft. But they get away with it. Another is, if you're familiar with the Austrian theory of the Trade Cycle, you'll see FRB plays an insurmountable role in giving people access to unwarranted easy credit. Credit expansion is another way of inflating the money supply in the end. Having 100% backing is in many ways the only way to healthy monetary system.

I agree with Kris and Rothbard. Fractional reserve banking is fraud and inflationary. The inflation of the supply of money/credit decreases the buying power of each individual holding money progressively as it filters through the system. This causes individuals time preferences to rise, causing a decrease in savings and increased risk taking. The housing bust is a prime example of the distortion this creates. So currently, fractional reserve banking is fraud, inflationary and therefore immoral in my opinion.

Now if there were free banking and privatization of money, there may be fractional reserve banks competing with full reserve banks. In this case the fractional reserve banks would have to be very honest about what they were doing or risk a business disaster for themselves. I suspect fractional reserve banks would operate as certificate of deposit banks where depositors would be prohibited from withdrawing their funds for a defined period of time as it would be made clear that it would be lent out and the depositor would be paid (interest) for this service to borrowers. Rothbard described this in the book. This is a more simple, sane and safe system of operation with lower time preferences and steady, sustainable growth.

Unfortunately with the rampant mindset of collective ownership, disrespect of private property and way out-of-proportion ego boundaries that have been propagated throughout world cultures as a result of religion and government education, the only way I foresee a more sane economy and civilization coming about is by the natural implosion of the unsustainable system that is currently in place. My worry is that the lows could be very low if one considers how long the soviet system continued after Stalin or China after the cultural revolution.

I agree also regarding FRB being fraud. It is not like the banks tell their customers that their money may not be available or that maybe 90% of it has been loaned out to third parties. That is what makes it fraud. If, on the other hand, the banks informed their customers of this practice, and the customers still deposited their money, that would, in my opinion, eliminate the fraud. But another issue is that the courts have looked on money deposited in FRB as not belonging to you, but rather is the banks to do, more or less, as they wish with it. In other words, your money on deposit with a FRB is not regarded as a warehouse receipt. This also, to me, constitutes fraud. Does anyone else have this understanding?

I ask, who doesn't know that banks lend deposited money? I have asked some of my acquaintances about banks and everybody seems to agree that banks lend the money that people deposit. They start looking perplexed when you point out that now there's a "deposit" of, say $100, $10 in the Central Bank and someone with $90 "borrowed". But I digress. My point is, most people know that banks lend the very same money that is deposited in them. They just seem confident regarding the security of bank deposits. That is, until something nasty happens and then you have bank runs. Now from this contradiction (of having your money in the bank and having it loaned out _simultaneously_) arises the contradiction you see in court, where they regard your money as at the bank's disposal.

I think the issue is not with "term" deposits, which are available to be used more-or-less at the bank's discretion until the end of the agreed term, at which time the bank and the customer are agreed that the bank must have the funds available to return to the depositor. Certificates of deposit would be like this. What is shaky is the "demand" deposits, which the bank contractually agrees to have ready to return to the depositor "on demand". If the bank loans out too much of this money, they are at risk of insolvency if anything triggers a high percentage of their depositors to demand their deposits back all at the same time.

Hello Bill. I once read in a magazine (I think it was The Economist) that banks lend money in longer terms but their deposits are short term. Here where I live (Uruguay) the longest deposit is one year (360 days to be precise), but the terms of payment for a car loan are 4 years and for a house up to 15 years. So even for term deposits there can be a problem if confidence starts going down the drain. A bank run happened here in 2003. I cashed out all my demand deposits one day before the bank holiday. When the ATMs stopped operating, some people didn't have money to put gas in their cars or buy groceries!