Mises Daily

The Dangers of Monetary Reform

Austrians have long called for a reform of the monetary system. The current, Fed-driven, fiat-money system is on the verge of collapse. But however bad the current system is, a new system won’t necessarily be better.

Many libertarians would favor a return to the gold standard, while others would be content with simply repealing legal-tender laws and allowing competition in currencies. However, even in a great collapse like the one looming now, these reforms may still seem too extreme to the general public. This is especially true if they have an alternative that seems reasonable and gives total control over the monetary system to the state. One such alternative is the 100-percent-reserve solution advocated by Stephen Zarlenga, director of the American Monetary Institute, and author of the book “The Lost Science of Money.”

I caught an interview with Mr. Zarlenga on Gnostic Media, in which he discusses his book with host Jan Irwin. The first part of the interview was broadcast on August 30, the second part on December 20, 2009. Neither Zarlenga nor Irwin are economists, but both have strong opinions about economics and economists.

On several occasions, Zarlenga singles out the Austrian School and makes unfounded claims about Austrians, their methodology and their approach to monetary theory in general. In this article, I will attempt to correct Zarlenga on the issues he has with the Austrian School and his ideas on monetary theory in general.

The Definition of Money

Zarlenga claims that Austrians define money as gold, a definition that according to Zarlenga has its roots in the classical economics of Adam Smith. I’m not sure on what he founds this claim, but, obviously, it is not true.

Generally, Austrians define money as a good that is commonly or universally accepted as a medium of exchange. It was the invention of money that allowed the transition from the ineffective barter economy to the dynamic indirect-exchange economy. The Austrian focus on gold is mainly due to the fact that over time the market has selected gold as the primary medium of exchange. This means that while gold can be said to be money, money is not necessarily gold.

Zarlenga misses this completely. He also disagrees with the Austrian notion that money is something that arises naturally on the market. The Austrian position is supported by the fact that many things have been used as money throughout history in various parts of the world: commodities such as salt, clamshells, and animal skins. Zarlenga will have none of this.

Instead, he advocates what he calls the Aristotelian view, which is that money doesn’t come about by nature, but by law. In short, the market can’t produce a monetary system; only the state can do so. This view is of course refuted by the very existence of the various money commodities mentioned earlier. Zarlenga does not address this issue, however, nor does the host raise the question.

The mistake Zarlenga makes is that he confuses state intervention in the monetary system with state provision of a monetary system. To be sure, the state has injected itself into the monetary system for centuries. But this does not mean that the market is unable to provide a monetary system. On the contrary, when the state injects itself into a monetary system, it in fact injects itself into a system provided by the market.

The American Monetary Act

What is the 100-percent-reserve solution Zarlenga advocates? It is set out in a bill sponsored by Democratic representative Dennis Kucinich called the American Monetary Act. It has three key elements:

  1. The Federal Reserve must be nationalized and brought into the US Treasury, making it part of the government.
  2. Private banks must be stopped from creating money through fractional-reserve banking. Only the government should create money.
  3. Government would then print money and spend it into circulation on various programs, such as infrastructure.

The aim of the bill is to transfer the money power, as Zarlenga puts it, from the private Federal Reserve System directly to the government. It would be government who creates all the money, not the banks. Instead of the government issuing bonds and paying interest, it would be receiving interest from anyone it lent money to.

This would also reduce taxes, as the government could print the money it needed to fund various programs instead of taxing it away from the public. For instance, universal healthcare and education could and should be funded by government-printed money, according to Zarlenga. In addition, the government would spend money on infrastructure.

This solution is, as Zarlenga also points out, not a new one. The idea of having the government print money directly has been tried several times in history. Zarlenga claims that these experiments have by and large been successful — certainly more successful than private issuing of money (by which both Zarlenga and I mean private banks creating money out of thin air).

Even though I very much agree with Zarlenga that such private issuance of money has caused disaster after disaster, I challenge his thesis that government-printed money would be better.

Nationalizing the “Private” Central Bank

The natural first step in implementing the 100-percent-reserve solution would be to nationalize the formally private Federal Reserve. Like many other critics of the Fed, Zarlenga is diligent to point out that the Fed is in fact private and not a government agency. I’m not sure whether it was Dennis Kucinich himself who invented the phrase “The Federal Reserve is no more federal than the Federal Express,” but he certainly has made it his own.

The private member banks formally own the Fed. Many libertarians point this out too, and it is sometimes difficult to judge whether they actually agree with Kucinich’s slogan or not. Because the private ownership of the Fed is often used as an argument against free-market solutions to the problems of the financial sector, I feel compelled to discuss the nature of the Fed.

While it is undoubtedly true that the Fed is owned by private banks, the notion that it is a private company, as private as Federal Express, is wrong.

First, the Fed was created through an act of Congress. Not only that, a separate constitutional amendment was added in order to create the central bank. What other private company can claim the same? Certainly not Federal Express.

Second, the Fed has been given the governmental authority to control the nation’s money supply and direct monetary policy. As a rule, private companies don’t enact and enforce national policy. That is the function of government. Any entity authorized to enact and enforce policy is a de facto government agency.

Third, one of the Fed’s main functions is to fund government expenditures. The same can be said for almost all other central banks in history. Obviously, the private bankers reap huge profits from this partnership with the state, but that does not negate the fact that the state itself benefits hugely as well.

Since the creation of the Fed, all the of the United States’ wars and all of its major welfare programs have to a very large extent been funded by the Fed’s printing presses. Ron Paul has been pointing this out for decades. The Fed makes even Halliburton look like a beacon of free-market capitalism.

Of course, the authority given to the Fed by Congress was never Congress’s to give, as the Constitution does not allow Congress to issue paper money, and certainly not to enact legal-tender laws making paper notes the only legal money of the nation. If Congress does not have a certain power, it certainly cannot delegate that power to a private entity. If it does so anyway, the recipient of this unconstitutional monopoly cannot be compared to an ordinary private company.

This being the case, the outright nationalization of the Fed would not change much. However, as Zarlenga’s goal is to completely nationalize the “money power,” even the formal ties to private ownership must be severed.

Abolishing the Fractional-Reserve Banking System

“If Congress does not have a certain power, it certainly cannot delegate that power to a private entity. If it does so anyway, the recipient of this unconstitutional monopoly cannot be compared to an ordinary private company.”

The second key element of the plan is certainly something the Mises Institute and the American Monetary Institute can agree on, albeit with completely different objectives. Zarlenga is correct when he points out that private banks presently create money (or credit) out of thin air through fractional-reserve banking. The 100-percent-reserve solution calls for a government monopoly on creating money, which is why Zarlenga advocates the abolition of such banking. That way, the government won’t have any competition.

Presently, the banks have only a fraction of their deposits in reserves. How does Zarlenga propose to solve the problem of the transition from fractional reserves to full reserves? He proposes to lend government-printed money to the banks, thus increasing their reserves to cover all outstanding claims on them. This solution has a few flaws.

First, the government-created paper currency is no more real than the credit issued by the banks, as neither represent actual resources accumulated from real savings. For this purpose, it makes no difference who issues the phony money, the banks themselves or the government.

If banks can create credit that is then converted into money lent from the government, they have every incentive to keep creating credit. This situation would also encourage the government to keep lending money to the banks, not only for the interest they can charge, but because the ever-increasing supply of money leads to more and more taxable consumption, not to mention that the government itself can fund its own vote-buying programs so much more easily. Runaway inflation would be nigh on unavoidable.

Second, the bank’s equity is not enhanced by the government loans. When the bank has lent out 90 percent of its deposits, it has, say, $1,000 in reserves and $9,000 in loan receivables on its asset side, and $10,000 in deposits on its liability side. The infusion of a $9,000 loan would increase its reserves to $10,000, thus covering all of its deposits, but it would also increase its indebtedness by the same amount.

If every depositor withdrew their money, the bank would be left with $9,000 in debt on the liability side, but with $9,000 in loan receivables it is not allowed to have on the asset side. If the bank were forced to write off the loans because every depositor withdrew his money, the bank would be left with $0 in assets and $9,000 in debt to the government.

The solution presented is thus no solution at all, only a mechanism by which the same type of continuous inflation of the money supply could be carried on under the guise of full reserves, leaving both the government and the banks to continue to create money out of thin air. This would debase the currency and cause boom-bust cycles, all the while enriching government and the banks.

So while we can agree on the abolition of fractional-reserve banking, Zarlenga’s solution to the transition problem is deeply flawed.

Spending Money into Circulation

The 100-percent-reserve solution has government running the printing presses itself and spending the newly created money into circulation. By spending the money on “productive” projects and programs, such as infrastructure, healthcare, education and so on, Zarlenga claims that the money won’t lose its value over time. The inevitable rise in prices would be offset, he claims, by the increased production the government spending leads to.

“When this economic crisis evolves into a currency crisis, which it most probably will, reform will become inevitable. The question then is what ideas for reform are lying around for the people and the politicians to choose from.”

I argue that the 100-percent-reserve solution would drive up prices. The government would always find new programs to spend money on. The more money the government spends into circulation, the more it debases the value of the previously printed money, causing the purchasing power of each existing dollar to fall.

This also shows the fallacy in the argument that a dollar’s value can be set by government, which is one of Zarlenga’s key underlying arguments. Money is a function of law, as he claims in good Aristotelian fashion, which means that its value can be set and enforced by the government.

However, because the printing of money is so much easier than the production of actual goods and services, the production of new money is likely to far surpass the production of new goods and services. So in order to keep prices from rising, the government would eventually have to impose price controls. This has been done several times before, most recently by Nixon in the 1970s.

However, the price controls would simply lead to economic chaos and black markets, where people try to make exchanges at real market prices. Additionally, the chronic price inflation would encourage people to borrow and spend, since the value of their debts would steadily decline. The lenders would have to counter this with increasingly high interest rates, making long-term investing very difficult, which in turn would greatly disrupt economic activity.

Since Zarlenga intends to fund such things as healthcare and education with government-printed money, it becomes obvious how catastrophically inflationary the 100-percent solution would be. In the interview, Zarlenga says that one of the first spending projects would be revamping the nation’s infrastructure. According to the calculations of civil engineers, a complete overhaul of roads, bridges, and so on would cost $2.3 trillion. This could, according to Zarlenga, be paid for with the printing press.

The Moral Dimension

Zarlenga criticizes economists for many things. One of these is that economists have taken morality out of the science of economics. He also says that economists have tried to hide this exclusion of morality, because if people were told about this atrocity they would be outraged.

Of course, morality has no place in the science of economics. Science is, by its very nature, value-free. When you try to explain why action A had consequence B, you should examine theory and fact. It is only when you start to advocate certain actions or programs, such as the 100-percent-reserve solution, that morality comes into play. Let us therefore examine the moral aspects of Zarlenga’s monetary reform.

From the very outset, printing dollars out of thin air, declaring them legal tender, and purchasing goods and services with them is tantamount to theft. The printer acquires property without giving anything of real value in return. After all, the money is merely ink on paper with no value of its own except what it derives from the violent force of the government.

In addition, it is always those who get the new money first who benefit the most. In this instance, it would be the government. But those who are second in line will benefit too, while the new money still has most of its value. The recipients of the new money can turn around and again acquire something for nothing. The amount that can be acquired diminishes over time, so those who get the money last are the ones who pay for the early recipients’ gains.

Zarlenga explicitly mentions healthcare and education as being areas of government spending, as this would benefit the masses, who otherwise couldn’t afford such services. What he fails to understand is that it isn’t the students and patients who benefit, but the hospitals and universities. It is the medical professionals and academics who are the true recipients of the money. It is to them that the money is paid for the services they provide, and the constant influx of new money into these sectors will of course raise prices significantly over time.

Every bout of new money will draw value from the existing amount of money, which means that after the initial theft of property by the government and its preferred interest groups, the debasement of the currency will continue at an ever-increasing rate; the more devalued the dollar gets every year, the more dollars must be printed every year to pay for the same things. For people far away from the printing press, this means that the value of their savings and income is transferred to the money printers and first recipients of the new money, much as it is today.

Another obvious problem with having the government print money is that it creates rent-seeking behavior. With fresh supplies of money coming from the government at an increasing rate, it becomes more and more reasonable for private corporations to lobby for a part of the public-spending cake than to appeal to consumers. In the long run, this means that an ever-increasing part of the private sector will become dependent on the influx of new government money.

From a moral point of view, it makes no difference who counterfeits the money and acquires property for nothing. It is still fraud and theft.


There is no point in making the Austrian case for commodity money here. There are many easily read books that do that. The purpose of this article is to explain that no matter how bad a system is, it can always get worse. Not all reforms are improvements. As we have seen, the 100-percent-reserve solution is ripe with unintended consequences.

When this economic crisis evolves into a currency crisis, which it most probably will, reform will become inevitable. The question then is what ideas for reform are lying around for the people and the politicians to choose from.

The reform advocated by Zarlenga and introduced to the Congress by Dennis Kucinich may very well appeal to politicians and bureaucrats. Also, the increasing animosity toward both the Fed and the banking establishment as a whole will likely encourage ordinary Americans to support Zarlenga and Kucinich’s initiative. On the face of it, the solution sounds rather reasonable and has the support of a very popular congressman.

Just think about it. It would strip the banks of their privileges and put the money power back into the hands of the people through their elected representatives; it would break the bankers’ secretive monopoly racket, which enables them to pay out billions in bonuses while ordinary people suffer. Doesn’t that sound familiar? Isn’t that how the Federal Reserve system was sold to the American public following the Panic of 1907?

For Austrians, it is easy to dismiss Zarlenga as a crank, which, based on the ridiculous claims he makes, he undoubtedly is. So why should we pay attention to someone like him? Because if we don’t, we increase the risk of him being successful in making the American Monetary Act become law. After all, similar monetary systems have been tried before.

This is why Austrians need to expose the real dangers of such a system. It would be a mistake to simply assume that that everyone will recognize its inherent problems and reject it. If the government can pass a constitutional amendment to sign the Federal Reserve Act into law and thus create a private central bank, they can certainly do this too.

So in addition to making the case for the free-market solution in money and banking, Austrians need to take up the debate with all their intellectual opponents. Zarlenga is one of them, and he should not be taken lightly.

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