Mises Daily Articles
Our Money Madness
We flatter ourselves, in this technological age driven by financial innovation and mind-boggling efficiencies, that we know more than any previous generation. But there is lost knowledge, among which is the knowledge of what sound money feels and looks like, what it does, who makes it and why, and how it holds its value.
So let us revisit Robert Louis Stevenson's classic story, Treasure Island, and the climactic scene where the pirates and their companions have finally found their treasure and prepare to haul it away. The narrator reports as follows:
It was a strange collection, like Billy Bones's hoard for the diversity of coinage, but so much larger and so much more varied that I think I never had more pleasure than in sorting them. English, French, Spanish, Portuguese, Georges, and Louises, doubloons and double guineas and moidores and sequins, the pictures of all the kings of Europe for the last hundred years, strange Oriental pieces stamped with what looked like wisps of string or bits of spider's web, round pieces and square pieces, and pieces bored through the middle, as if to wear them round your neck -- nearly every variety of money in the world must, I think, have found a place in that collection; and for number, I am sure they were like autumn leaves, so that my back ached with stooping and my fingers with sorting them out.
There is more to learn about real money from this paragraph than in most money and banking texts. Here we discover that money is international. It matters not what nation-state or private party mints it. Money can come in all shapes and sizes. It has enduring value for hundreds of years. It can be put in a vault and found by anyone in the future and retains its value. Its merit as money is not dependent on the existence or persistence of any single government.
The regimes that minted the coins may be long forgotten but the money they made stays as a permanent part of the economic landscape until it is melted. What this suggests is independence for the people who have, hold, and use the money. They are not roped into any regime as such. They go about their economic affairs as independent people. Their money, which cannot be destroyed by the actions of a central government or a central bank, testifies to their status as free people.
And what is it made of? Gold, silver, or any precious metal, something or anything that will cause a back to ache and the fingers to hurt from sorting them out. Money is heavy, robust, durable, divisible, enduring. It is treasure. It worth hiding when one is in trouble and worth hunting for if one stumbles upon a map to guide you there. As to when it was minted and by whom, it doesn't matter. Money lasts. Money is true. It transcends the generations. It transcends the nation. It transcends the state.
As for any money minted or printed in the last fifty years, some of it may have value as a collectible but its value would vanish to near zero if it were melted. As for the paper, it would be truly worthless. One can imagine the scene in Treasure Island had they opened the trunk to discover wads of paper currency from defunct governments. Let's just say the story would have ended very differently. It might have looked more like that scene in Lawrence of Arabia where the warriors trek hundreds of miles across the desert for treasure only to find crates full of paper cash, which the plunderers promptly throw to the wind. Lawrence wisely departs the scene on a horse, promising to return with real money.
Incidentally, I do think there is a point to buying children coins for presents. Just to hold an older coin of gold and silver imparts a lesson of sorts. It illustrates the reality of a history that is different from our present. I've never seen a child disregard a nice gold or silver coin. They keep it in a safe box, show it to their friends, and reflect on the sense of personal empowerment they experience from owning it. Children know what treasure is, even if central bankers do not.
Today we think of money as something to possess for instrumental purposes but something otherwise created and managed by the government to keep the economy going.
The new Fed chairman, Ben Bernanke, was grilled at his Senate confirmation hearings as if he were a magician who could pull rabbits or squirrels out of his hat, depending on his mood that day. All the questions related to whether he would tend to prefer the rabbit of employment to the squirrel of inflation. The goal of these politicians was to prod him into admitting that squirrels are far to be preferred to rabbits, and if he would just admit it and swear to it, they would give him a free pass and let him perform, while Congress and president provide the necessary smoke and mirrors.
And by the way, Bernanke also promised to keep the Fed completely free from politics. "I assure this committee that, if I am confirmed, I will be strictly independent of all political influences and will be guided solely by the Federal Reserve's mandate from Congress and by the public interest."
When ex-Fed chairman Arthur Burns arrived at the Bonn airport as ambassador to Germany, a reporter asked him how he could have agreed to Nixon's desire to inflate so massively? The Fed chairman must do as the president wants, he answered, or the Fed would lose its independence.
Here is a rule of thumb. If an institution has a dot-gov in its web address, as in FederalReserve.gov, it is not independent and it is not free of politics.
One politician summed up the Fed's mandate this way: "guiding the economy to create broadly shared prosperity."
Herein we find the perfect summary of what is wrong with Washington's view of economic life. It imagines the economy to be guided by the Fed, and that prosperity is created by its printing press. Bernanke, however, was not in a position to correct the record, for he has himself spoken about the wonderful and limitless power of the Fed to create as much money as it wants to.
Thus spake Bernanke to those worried about deflation: "The US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."
What awesome power! Are we really supposed to believe that a government that possesses the ability to create unlimited amounts of money will wall off the institution that does the creating from any political influence? Surely not. The independence of the Fed is just a mask that the government uses so that it can avoid taking responsibility for any downside that comes about from the Fed's awesome power.
I suppose that if I had a counterfeiting machine, I too would want it kept out of the house and run by someone I could appoint who would nonetheless swear to be completely independent if caught in the act.
The Bernanke hearing was a despicable display in more ways than we can count. That there is a direct relationship between inflation and employment was never questioned, even though that relationship does not exist as a matter of history or economic law. To use the printing presses to drive down unemployment is to risk not only inflation but also radical economic instability and business cycles that can end in the worst of all worlds. And the idea that low unemployment — as a symbol of a growing economy — needs constant infusions of paper money inflation from the Fed is belied by the whole of the 19th century, as well as by economics.
What did Bernanke and his examiners agree on? They agreed that the Fed should be all-powerful in matters of macroeconomics. They agreed that there should not be any ironclad rule for the conduct of monetary affairs, but rather that smart guys ought to wing it day by day to achieve the right mix of policy options. And they all agreed that the prevention of deflation, meaning a fall in the general level of prices, ought to be the number one priority. So when you hear that Bernanke favors "low inflation," remember that the emphasis is on the noun and not its modifier. It means that he prefers any amount of inflation to a condition of deflation.
Why the hysteria against deflation? We are faced with a real puzzle here. In the whole of the private sector, the number one focus of retailers these days, particularly those dominant retailers such as Wal-Mart and Home Depot, is low prices. This they emphasize above all else because they know that this is what consumers want.
And yet in the public sector, we find exactly the opposite: an ironclad promise that prices will not be low but rather will be continually rising. So if Wal-Mart's slogan is "Always Low Prices," the slogan of the Fed and the government should be "Always Higher Prices."
The question is why. Why is it that Congress, the Fed, and the presidency all agree that deflation is something to be avoided at all costs? The experience of the Great Depression looms large but, as Murray Rothbard has shown, low prices were just about the only good economic trend that was happening throughout the 1930s. Imagine if you had all the same disasters occurring — all inspired by bad economic policy — but with high prices on top of it all! Here is a test. We all know people who lived through it. Ask them today if they would have been better off if all goods and services had been two or three or ten times more expensive.
No, the trouble with the Great Depression was not low prices. Nor were low prices and wages the cause of the economic downturn. As Rothbard further showed, the downturn was a correction of a previous inflation, a macroeconomic version of the dot-com bust, and one that was made ever worse by governmental attempts to fix the problem. As for the Fed, it did not pursue a policy of benign neglect but rather desperately attempted to inflate the money supply and was unable to do so.
The real blame for the Great Depression lies with precisely the policy that Bernanke favors, that is, a steady and relentless increase in the money supply to keep the economy humming while not sparking price increases that are politically objectionable. This inflation targeting is precisely the problem since it sends false signals to capital-goods investors and borrowers, skewing the production structure forward in time to a greater degree than underlying savings can support.
Not knowing what the Austrian School says, Congress and the Fed might believe that a policy of low-grade inflation is the best protection against depression. But I don't believe that this is why they favor such a policy. Nor do I think that the desire to boost employment is the reason, since there is no evidence for anything like a long-run tradeoff between inflation and unemployment.
The reason the government — and here I speak of Congress and the presidency — favors a loose monetary policy, a discretionary rule at the Fed, and ongoing low-grade inflation is the most obvious one of all. It pays the bills. In other words, the reason is no different from that of private counterfeiting. They like to have money without having to work to get it. That is essentially what the Federal Reserve provides the government. It doesn't have to worry about its bond rating collapsing or its credit standing falling. It doesn't have to bother with taxing people. It can hide the costs of government in the complications associated with monetary affairs.
Looking back at the history of inflations in the United States, we can detect a single event that, more than any other, prompts the government to engage in inflationary finance. I wish I could report to you that inflationary finance was a modern invention of the modern regime with its endless wars and welfare expansions. Sadly, America was born in monetary sin, so to speak. The Continental Congress financed the Revolutionary War with paper money, beginning in 1775.
The currency was supposed to be retired in seven years with a pro rata tax levied by the states. But once the government got the hang of the magic of war finance, it forgot about the pledge and endlessly expanded the currency. Between 1775 and 1781, the Continental went from trading on par with one dollar in specie to being nearly worthless. It was a tragic incident because it benefited all the worst people in this young country, the very group that later pushed for the Constitution to replace the Articles, and backed the creation of the first central bank, to enrich themselves. In some way, this war, which was undoubtedly just and involved a meritorious secession from a distant government, was the beginning of the end, precisely because it unleashed a horrendous inflation and schooled a new governing elite in the benefits of inflationary finance.
It has been war that has been the driving force in monetary depreciation throughout history. If Bush had been forced to raise the hundreds of billions that he has spent on his Iraq caper through taxation, his supporters would be far less supportive, and his policy more honest. Instead, he has been able to count on the inflationary finance of his friends at the Fed to make it all possible. Monetary policy has been the handmaiden of empire in other ways too, as the dollar is used as political leverage against nearly every country in the world from Argentina to China to Russia.
Fiat currency engenders conflict of all sorts, unbalances the economic structure, and puts everyone's savings at risk. It is for this reason that Alan Greenspan once wrote that the cause of freedom is bound up with the cause of the gold standard.
Should our monetary system be reformed so that it is based on a pure gold coin standard? Yes it should. This would be the single best reform we could make for the cause of freedom. Its commercial benefits include stability, predictability, and honesty in finance. Its moral benefits include a financial system that does not reward living beyond one's means. From the point of view of government, a gold standard would tie the hands of the state. They could wish and long for wars, welfare, foreign aid, bailouts, subsidies, and graft, but unless they could raise the money by taxing, all their talk would be pointless. That is a country I want to live in.
For years I've heard people suggest that the Mises Institute come up with a detailed plan for how the conversion would work. In fact, there are many models to choose from, from Joseph Salerno's to Murray Rothbard's to George Reisman's to Ron Paul's own legislation, which has been before the House for some two decades. What is lacking is not a plan. It is the political will. It would require that the government recognize the error of its own ways, agree to limit its power and influence, abolish the Fed, and return the control over economic structures back to the people. And you wonder why the movement for a gold standard struggles!
But let me just clear up a few myths about gold. It is not the case that under a gold standard, we would all find ourselves in the position of that young man in Treasure Island, with aching backs and throbbing fingers. Banks would continue to exist and compete on a sound basis. All financial services would continue to exist just as they do now, from credit cards and bank cards to PayPal and stock portfolio checking and all the rest. Indeed, we would see an explosion of financial innovation under the gold standard because so many of the uncertainties associated with inflationary finance would be a thing of the past.
Money would become truly international, or would tend in that direction as more countries decided to make their currencies as good as gold. And if we managed the transition properly, government would have no monopoly on the production of money. This would be something handled by the private sector, as suppliers competed based on beauty and design and reliability. In an ideal world, all currencies in the world would be different names for precious metals, all interchangeable with each other based on weight and fineness.
If that sounds complicated or unreasonable, or even completely unviable, let us remember that all forms of freedom seem impossible in the midst of despotic control. Many intellectuals and officials in Russian and China couldn't really imagine how society would work if people were permitted to live and work and move where they wanted. To them it sounded like chaos. Germans can't imagine how society would survive without strict laws on when retail shops can open and close. And people in Britain went into a panic recently on the suggestion that pubs be permitted to stay open longer than usual.
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In our own country, we can't imagine the legalization of drugs, the elimination of the minimum wage, the abolition of Society Security, or not bombing someone every two years. These things seem crazy to us because we have adapted to statism. So it is with money. We are used to the idea that government should run the monetary system. And that's why when we say we favor the gold standard, people think we are nuts. But today in China or Russian, anyone who favors a return of travel and moving restrictions is considered dangerous and deranged — which is precisely how I feel about anyone who says that government ought to be given full control of a nation's monetary institutions!
So I ask you to imagine how the world worked before the advent of central banking and before our permanent state of inflationary paper currency. Imagine if the money you made and saved were as good as gold — a truly independent medium of exchange that was not subject to political manipulation, confiscation, or depreciation. The wizards at the Fed would not control our destinies, Congress's appetite for spending would be curbed, and the president would be a bit more cautious about embarking on wars that would cost political capital. It would be the world of Treasure Island, where the only criminals we would need to worry about owned ships, not fleets, and where the pirates sang ditties about rum, not national anthems to the glory of the state