The Magic Coin

For Parents and Teachers:

WHAT HAS GOVERNMENT DONE TO OUR MONEY?

Murray Newton Rothbard wrote What Has Government Done to Our Money? in 1963. At the time, the US dollar still had some tenuous ties to gold under the Bretton Woods system. But the inexorable consequences of government spending enabled by money creation eventually led to the severing of those weak ties on August 15, 1971. President Richard Nixon announced a “temporary” suspension of gold redemption, scapegoating “international money speculators,” who were allegedly “waging an all-out war on the American dollar.” Of course, the true villain was the US government itself, for it had financed much of its spending on the Vietnam War, the Great Society programs, and other programs with newly printed money. At the end of World War II, the US government had promised foreign governments to maintain a ratio of $35 per gold ounce. By the 1970s, it had become impossible for the government to preserve this ratio without a total depletion of its stock of gold.

Rothbard understood that this event was not a sudden surprise but just another government intervention (albeit a big one) in the monetary arena. The Magic Coin takes Rothbard’s history of money, including the history of it being co-opted by the state, and turns it into a magical adventure. It’s What Has Government Done to Our Money? for kids.

Our story begins with Lily’s discovery that the price of candy has risen from one cent to twenty-five cents (a nod to Richard Maybury’s Whatever Happened to Penny Candy?). She finds a magic coin engraved with the image of a man named Newton, who takes her through the origins, evolution, and devolution of money. Let’s compare Newton’s destinations in The Magic Coin with Rothbard’s What Has Government Done to Our Money?

Lily and Newton’s first stop is Robinson Crusoe’s island, where Newton shows that Crusoe doesn’t need money. Crusoe was Rothbard’s first stop as well. His book begins this way: “How did money begin? Clearly, Robinson Crusoe had no need for money. He could not have eaten gold coins.” Crusoe needs food, shelter, and fresh water. He can only obtain these by laboring—he cannot trade with others. This means that money must somehow be the product of people trading with each other.

Next Newton takes Lily to a primitive village where direct exchange, or barter, is commonplace. We find Abigail and Joshua struggling to overcome the hurdle economists call a double coincidence of wants. In short, Abigail wants new clothes and Joshua wants eggs, but even though Abigail has eggs for sale, she can’t trade with Joshua because he doesn’t have clothes to sell—he only brought shoes to market. Abigail learns that Lauren wants shoes and is selling clothes, and then she has the bright idea to engage in indirect exchange. She decides to trade with Joshua even though she doesn’t want shoes, realizing that she can offer the shoes to Lauren in exchange for what she actually wants. Thus, a medium of exchange, in the form of shoes, is born.

Rothbard discusses the problem of the double coincidence of wants with the same kinds of goods: “If A has a supply of eggs for sale, and B has a pair of shoes, how can they get together if A wants a suit?” Later, Rothbard explains the emergence of indirect exchange: “Under indirect exchange, you sell your product not for a good which you need directly, but for another good which you then, in turn, sell for the good you want. At first glance, this seems like a clumsy and round-about operation. But it is actually the marvelous instrument that permits civilization to develop.”

Rothbard wasn’t exaggerating. It seems like a simple step for a primitive economy to take, but it actually opens the door for money, a widely accepted medium of exchange, to emerge in the market. Money allows the division of labor to expand and makes it possible to employ economic calculation (the use of profit and loss to guide production decisions). These conditions allow more productive and capital-intensive projects to be undertaken (the lengthening of the structure of production).

The development of civilization is depicted in The Magic Coin when Lily and Newton visit seventeenth-century London. There is a much greater quantity and variety of consumer goods available. Businesses and consumers also use money prices to make decisions.

Newton shows Lily a special kind of business: a goldsmith bank. They discover that a 100 percent reserve bank does not increase the money supply. Depositors come in with gold and silver and leave with banknotes. As long as people trust the bank to redeem these notes on demand, the notes themselves are used in exchanges. The banknotes become a money substitute. And as long as the bank keeps a one-to-one ratio of gold to banknotes, its reputation will remain intact and the money supply cannot expand.

But what happens when this gold warehouse decides to engage in what Newton and Rothbard refer to as “profitable hanky-panky?” Here’s Rothbard’s description from What Has Government Done to Our Money?:

More warehouse receipts are printed than gold exists in the vaults. What the bank has done is to issue gold warehouse receipts which represent nothing but are supposed to represent 100 percent of their face value in gold. The pseudo-receipts pour forth on the trusting market in the same way as the true receipts, and thus add to the effective money supply of the country.

Not only has the money supply expanded, but the bank has opened itself to a run. In The Magic Coin, Newton inadvertently starts a run, highlighting the fragility of such a bank (a fractional reserve bank).

Banks don’t like runs, but they also don’t want to miss out on the profits that can be earned by keeping fractional reserves. It turns out that if banks compete with each other freely (a system known as free banking), they check each other’s expansion of reserves, preventing overexpansion of pseudoreceipts (fiduciary media).

But the story of money and banking took a different path. Banks and the government became aware of the enormous benefits of central banking over free banking. Lily and Newton watch the politicians and bankers work together to cartelize the banking system by forming a central bank. Now the system is based not on gold and silver, but on paper. Now all the banks in the country are clients of the central bank, as Rothbard pointed out. Now banks can expand together without fear that a rival bank will bring them down. Individual banks no longer issue their own banknotes, just central-bank notes, like the US dollar. The central bank isn’t subject to a bank run because it doesn’t accept deposits from the public and because it has the authority to create more central-bank notes.

Governments also win with a central bank because they can spend as much as they want and the central bank will buy their debt with, you guessed it, new money. It’s no surprise, then, that once the US government finally severed all ties to gold in 1971, government spending increased even more. The national debt has increased astronomically since then. The government seems to grow and grow with no limit.

What has been the result of the government’s stewardship of money and banking? Business cycles (see Ludwig the Builder for a children’s book on that topic), financial crises, bank runs, price inflation, and all the other bad things we would expect from putting the government in charge of something so important.

While we haven’t (yet) seen hyperinflation in the US, this disastrous scenario has played out in other countries. Lily and Newton see a thief dump all the paper notes out of a wheelbarrow and then steal it. This is not fiction! This actually occurred in the famous Weimar hyperinflation of the early 1920s.

In What Has Government Done to Our Money? Rothbard explains how hyperinflation becomes a self-feeding spiral:

Soon, the country reaches the stage of the “crack-up boom,” when people say: “I must buy anything now—anything to get rid of money which depreciates on my hands.” The supply of money skyrockets, the demand plummets, and prices rise astronomically. Production falls sharply, as people spend more and more of their time finding ways to get rid of their money. The monetary system has, in effect, broken down completely, and the economy reverts to other moneys, if they are attainable—other metal, foreign currencies if this is a one-country inflation, or even a return to barter conditions.

Newton’s explanation about how to “fix the mess” conveys this wisdom to Lily.

At the end of her adventure, Lily reflects on what makes for sound money. The short answer is justice. The problems all come from dishonest banking practices that have been institutionalized via central banking. A sound money is a just money, and a just money is, well, just money. We need to regain what was taken from us: the money that originated on the market. That doesn’t necessarily mean gold or silver or bitcoin or shoes or any type of money in particular. It simply means that the market should decide, not the government.