What Has Government
Done to Our Money?

Few economic subjects are more tangled or more confused than money.

Debates abound over "tight money" versus "easy money," over the role of the Federal Reserve System and the Treasury, and over how to deal with a financial crisis.

Perhaps the confusion stems from humanity's propensity to study only immediate political and economic problems. If we immerse ourselves wholly in day-to-day affairs, amplified by political tribalism and the instant gratification of social media,  we cease making fundamental distinctions or asking the really basic questions. 

This is particularly true in our economy, where interrelations are so intricate that we must isolate a few important factors, analyze them, and then trace their operations in the complex world.

As always, it is the objective of a good economist to not simply analyze what is seen, but to compare it to alternative possible outcomes.

Of all the economic problems, money is possibly the most tangled, and perhaps where we most need perspective. Money, moreover, is the economic area most encrusted and entangled with centuries of government meddling. In fact, most that are considered "experts" never think of state control of money as interference in the free market; a free market in money is unthinkable to them.

The result has been a century of central bankers and financial elites increasing their power over society, decade after decade.

Historically, money was one of the first things controlled by government. Manipulating the currency was always one of the easiest ways to extract revenue from the public, allowing the state to spend and control far more than they could through taxation alone.

Generations of Americans have only known a global economy fueled by fiat money without any commodity backing. 

This complete politicization of one of the most important tools in human society has directly resulted in devastation and human misery to a degree many cannot understand.As Congressman Ron Paul has noted, "It is no coincidence that the century of total war coincided with the century of central banking."

We will also see how many of the alleged failings of a capitalist economy raised by critics on both the left and right are not the result of markets, but of the socialization of money.

So, it is high time that we turn fundamental attention to the lifeblood of our economy—money.

Can money be organized under the freedom principle? Can we have a free market in money as well as in other goods and services? What would be the shape of such a market? And what are the effects of various governmental controls?

If we favor the free market in other directions, if we wish to eliminate government invasion of person and property, we have no more important task than to explore the ways and means of a free market in money.

First, let's start at the beginning. What are the origins of money?

Before money, there was barter—a direct exchange of goods or services between humans. It is this economic behavior that is the foundation of civilization. 

If no one could exchange, and if we were forced to be completely self-sufficient, most of us would starve to death, and the rest would barely remain alive.

Exchange is the lifeblood, not only of our economy, but of human existence.

A barter system has two basic problems: indivisibility and lack of coinciding wants.

Imagine that a farmer wants to buy a pair of shoes, but the cobbler does not want eggs. He may want beef, but the farmer is not willing to slaughter his cow for shoes. A trade where both are happy is now difficult.

Any sort of advanced economy is impossible with simple direct exchange.

But humanity adapted. How? Indirect exchange.

Consider our farmer. Instead of offering eggs, he finds what the cobbler really wants—butter. He now exchanges butter for shoes. If enough people also want butter, our farmer may buy more—not to use it, but to exchange it for other goods and services.

Many goods have played this role in the past: tobacco in colonial Virginia, sugar in the West Indies, copper in ancient Egypt. Historically, gold and silver emerged as a widely accepted medium of exchange in a free market. This is not only because metal can be converted into durable and transportable units, like coins, but also because both have long been desired for their beauty and practical use.

This process—the cumulative development of a medium of exchange on the free market—is the only way money can become established from barter. 

This market process allows for prices to emerge between a medium of exchange and other goods and services—without this, it would be impossible for money to be properly valued. As we will see, government can manipulate the value of money—but it is powerless to create it from nothing.

As such, money did not begin as an abstract unit of account; it was not a useless token only good for exchanging; it was not a "claim on society." It was simply a commodity. Like commodities, its "price"—in terms of other goods—is still determined by supply and demand today.

When there is a high demand for money—perhaps because people are uncertain about the future and save more—the price of money goes up, which means the prices of goods and services go down. When the demand for money drops—perhaps because it is feared it will be worth less tomorrow—consumers will be more willing to spend, which means prices go up.

When competing currencies exist, prices may also change between different monies. In the past, consumer demand could change the value of silver to gold. Today it may change the exchange ratio of dollars to euros. These exchange rates can shift freely on the market.

But how did we go from money as gold and silver to the dollars and euros we have now?

To understand that, we must first understand the service that emerged as the result of money: banking.

The rise of monetary economies assisted two significant changes to society:

First, since the fruit of one's labor was now monetized and so could be exchanged freely, it allowed for the specialization of labor.

Second, thanks to monetization, individuals could more easily save for the future.

By allowing for savings and capital formation, human societies were able to advance beyond subsistence farming. But with savings came another critical issue: security.

The banking industry allowed consumers to keep their gold or silver in protected vaults, and in return, they received paper receipts, which are easier to carry than heavy metal coins. The receipt entitled the owner to claim his goods any time he desired, like keeping personal items in a warehouse. Since any holder of the receipt could claim the gold, convenience inevitably led to the transfer of these paper notes instead of the metal itself.

The receipts for money become money substitutes.

So long as the bank had as much gold as it does banknotes—which is called full-reserve banking—there would be no increase in the money supply.

What if, however, the bank realized that money kept in the bank is not needed all at once? A bank could lend out a customer's money, profit from the loan, and then return the money to the customer's account before it is withdrawn. If a customer closed their account unexpectedly, the bank could borrow from another account to make up the difference.

This is fractional reserve banking, and this is how almost all banks operate today. In doing so, big banks have become very profitable—but the economic consequences complicate the issue of money.

For example, let us say that a hundred gold coins enter a bank account. 

The bank account only keeps 10 percent reserves in an account, so it lends out ninety gold coins. 

Fifty of those ninety gold coins end up in another customer's account at the bank, and now the bank lends out forty-five of those coins.

From that first deposit of one hundred coins, the original customer currently has a receipt for one hundred coins, another customer has a receipt for fifty coins, and there are an additional 135 coins' worth of loans on the market. The result is an expansion of paper receipts—money substitutes—in the market, without any increase in gold to support it. This arrangement is also different than if the original customer directly loaned out fifty coins instead, because with such a loan, the lender would have no expectation of being able to access the borrowed money.

These unbacked banknotes, like counterfeiting a coin, are an example of inflation, which may be defined as an increase in the economy's supply of money that is not due to an increase in the monetary base–actual gold coins, in this case. These "fractional reserve banks," therefore, are inherently inflationary institutions.

Whether this additional money is created by the direct printing of new money, or through multiplication in a fractional reserve system, the result is an increase in the money supply not reflected in an increase of wealth in the real economy. This will create additional issues we will explore later.

Another issue with fractional reserve banking arises if customers lose confidence in the bank: they rush to take their money back. Bank panics are devastating, not only because a large withdrawal of money from an overleveraged bank hurts other customers, but because it can lead to better-managed banks being similarly stressed in ways they did not anticipate.

As such, many of the criticisms of "instability" prior to the Federal Reserve have little to do with gold as money and everything to do with the lending practices of banks themselves. Many of the problems, as we will see, resulted directly from government policy designed to increase control over money and banking.

To understand money as it exists today, far removed from any sort of commodity, we must understand why control over money is so important to the state.

Governments, unlike all other organizations, do not obtain their revenue as voluntary payment for their services.

Consequently, governments face an economic problem different from that of everyone else.

Private individuals who want to acquire more goods and services from others must produce and sell more of what others want.

Governments need only find some method of expropriating more goods without the owner's consent.

One way is theft, which in a monetary economy is called "taxation."

But taxes are unpopular, and too much of them can spark rebellion from the public.

As a result, governments discovered another way to enrich themselves: counterfeiting—creating new money out of thin air, rather than earning it through exchanging goods and services.

While much has changed throughout history, government's dependence on counterfeiting goes back thousands of years.

For example, in ancient Rome, emperors would shave off bits of metal from coins—or replace them entirely for inferior metal. In doing some, the government would create new coins for it to spend—at the expense of the citizens whose money was now less valuable.

Governments today do not inflate the currency by cutting coins, but they continue to expand the money supply at the expense of everyone else.

How? Two ways.

One is by creating it directly.

One consequence of using paper was that it became easier to print new money into the system. Every new dollar that the government created, not backed by any commodity, had the same effect as shaving off metal to create new coins.

In today's world, it is even easier. Now that most transactions are done electronically, central banks—like the Federal Reserve—can create trillions of new dollars with a keypad. This can then be pumped through the banking system with the central bank buying assets—like government debt or mortgages—in exchange for the newly printed money.

The other way is by regulating how banks can issue loans. With a fractional reserve banking system, the government can increase the money supply by changing the requirements for reserves in bank deposits. Requiring a 90 percent reserve means only 10 percent of a bank account can be loaned out. Changing that to a 10 percent reserve would allow for an exponential increase in the money supply, given the way money can multiply in such a system.

This increase in the money supply can give the economy the appearance of increased wealth in an economy. More money means its price—also called the interest rate, or the cost of borrowing money—goes down, which means that it is cheaper to invest in a new project that an individual may believe to be profitable.

Without an increase in money, this would require an increase in real savings—which would reflect a change in consumer preferences. Instead, this artificial boom leads to investments in projects and industries that would not have appeared profitable with real market prices.

A short-term boom becomes a bust as there is not enough profit to justify the debt.

A government that controls the money and banking systems in an economy can use it to confiscate wealth through inflation, monetize its debt, and interfere with general investment activity. It can do all of this without the brutality of police forces or militaries.

How do governments achieve this power?

To help understand that, let us look at the history of our Federal Reserve.

The battle over a central bank is an issue that goes back to the beginning of America.

The Federalists, led by Alexander Hamilton, wanted the new American government to resemble the British Empire—with their own Bank of England. They were opposed by Jeffersonian Republicans, who understood a central bank to be a dangerous institution of corruption that would benefit a politically connected minority.

Both sides saw their share of victories and defeats, leading to the establishment of the First Bank of the United States under Washington, ended by Jeffersonians in 1811. A Second Bank of the United States was created in 1815, and then ended by Andrew Jackson in 1836.

Older than any American central bank, however, was the dollar—which began as a Spanish silver coin widely used in the colonies. During the Revolutionary War, America tried its hand at paper currency not backed gold or silver. The result was the Continental Congress acquiring resources and military service from Americans in exchange for an unstable currency that collapsed in value.

The result was, in 1792, the establishment of a national currency based in gold and silver. The new US mint would mold coins in a patriotic design, but the weight of silver remained the same as the Spanish dollar.

With currencies around the world all backed by gold and silver, global trade benefitted from what is called the classical gold standard. This international gold standard provided an automatic market mechanism for checking the inflationary potential of government. If a country, like Mexico, inflated their paper pesos, the inevitable result would be gold leaving the country when foreign banks redeemed their Mexican paper money for the proper amount of gold and silver.

While the ability to redeem gold internationally imposed a level of discipline on national governments, interventions in domestic economies still managed to create the booms and busts we see in business cycles. Often, through some sort of government privilege, banks would be legally protected to print money not backed by gold—which would spur investment into projects that otherwise would not be profitable, resulting in a bust.

After a particularly bad financial crisis in 1907, the result of bad banking policies first imposed during the Civil War, major Wall Street banks decided to promote the creation of a new central bank that could be depended on to bail them out during a financial crisis.

The Wall Street bankers and their allied politicians understood that it would be difficult to get the American public to create such a powerful and dangerous government tool. In planning the creation of this new bank, they met in secret locations—like Jekyll Island, Georgia—using fake names. They plotted a national propaganda campaign to sell the public and elected officials on the plan by any means necessary.

In 1912, Woodrow Wilson was elected president in a three-way race with less than 42 percent of the vote.

A year later, he would sign into law the creation of the Federal Reserve.

Shortly after, the costs of World War I would force governments around the world to begin massively inflating their currencies—which would result at the end of the gold standard.

So, if the classical gold standard worked so well, why did it break down?

It broke down because governments were entrusted with the task of keeping their monetary promises, of seeing to it that pounds, dollars, francs, etc., were always redeemable in gold as they and their controlled banking system had pledged. Governments were incentivized to allow banks to print far more paper money than gold on hand than they could in a free market.

It was not gold that failed; it was the folly of trusting the government to keep its promises.

At the start of the Federal Reserve, very little changed for average Americans. Over time, an ounce of gold had become valued at $20, which itself was still worth an ounce of silver.

The eruption of World War I changed the world forever.

As we have seen, governments have viewed the printing of money as a convenient means to raise government revenue—particularly in times of war. The incredible costs of World War I quickly forced European central banks to end currency exchanges to gold.

As a result, after the war, European currencies found themselves being valued far less than they were previously. The British pound, for example, was traditionally defined at a weight that made it equal to $4.86. After the war, it was valued at $3.50.

The proper solution to this issue would have been to readjust the pound's peg to gold at this new postwar level. Instead, the British government tried to force the pound to its prewar strength, which would have required a massive reduction of the money supply. Given that prices—including salaries—had now adjusted to the current pound, this was highly disruptive.

The result was global economic instability, contributing to the financial crisis around the world in the twenties and thirties.

In America, President Franklin Delano Roosevelt's response to the Great Depression was an aggressive use of government power. The creation of new government programs, bureaucracies, and public works required levels of spending far beyond anything seen during World War II. Since the government does not create anything on its own and taxing is difficult during a depression, the Federal Reserve was a major tool of the state.

This was made easier in 1933, when FDR announced Executive Order 6102, which said Americans would no longer be able to trade in their dollars for gold and that all privately owned gold was to be confiscated. This allowed FDR to immediately devalue the dollar—an unprecedented transfer of wealth away from Americans and into government.

Agents of major central banks gathered in Bretton Woods, New Hampshire, and adopted a new gold exchange standard.

This Bretton Woods system worked as follows.

The US remained on the classical gold standard, redeeming dollars in gold. British pounds and other currencies were not payable in gold coins, but only in large-sized bars, suitable only for international transactions. This prevented the ordinary citizens from using gold in their daily lives and empowered governments to accept a wider degree of paper and bank inflation—which they did.

The following decades saw many of FDR's radical expansions of government power made permanent and then expanded. This was coupled with a growing American military footprint, with wars in Korea and Vietnam—and military bases established around the world.

This continued increase in spending both domestically and abroad resulted in severe inflation beginning in the 1960s. This led foreign countries to consider exchanging their dollars for gold, as was still allowed. In response, the American government cut the dollar from its last tie to gold in 1971, under Richard Nixon.

For the past fifty years, the world government has been engaged in a radical experiment with global currencies backed by nothing but the credibility of their issuing central bank. Understanding the consequences of this modern fiat money system is one of the most important economic issues in the world today.

As was the case with the original creation of the Federal Reserve, cutting the final connection to gold had little impact on the day-to-day life of the average American. The dollar did not change; the inflation that began to impact Americans in the mid-1960s continued.

It was foreign governments that were the most affected, as the collapse of the Bretton Woods system created a new era of uncertainty. The result was a new monetary system, with the American dollar—unbacked by gold—replacing gold as the global reserve currency.

Without hard money to back their currency, governments had to identify how to instill confidence in it. Some failed to do so, falling into the same mistake of relying on money printing to justify government spending. For example, Zimbabwe ended up printing 100-trillion-dollar bills as the result of the hyperinflation that resulted from reckless government policies.

Many smaller countries tied their currency to the dollar—which meant their monetary policy was dictated by the Federal Reserve. Europe—except for the United Kingdom—created a continental currency—the euro—and central bank, with the idea that no one country's government would be in a position to abuse the printing press. Other global governing institutions—like the World Bank and the International Monetary Fund—were also created to assist developing countries in this global economy.  

Ultimately, the international monetary system transformed from one backed by hard currency to one based on the whims of university-trained experts.

Of course, powerful bankers and government officials have always been the catalysts for the inflationary policies that have created the great economic crises of the past.

Governments are always the primary benefactors of inflationary monetary policy, and inflation is always an easier means of financing government spending than direct taxation. As long as money is controlled by the state, the incentive will be for central banks to expand the money supply at the expense of the rest of the population.

The result has been economic crises becoming larger and more global. The booms and busts of business cycles are created by the expansion of money and credit unbacked by real wealth. Without any tie to gold, governments, central banks, and large financial institutions have created more money and credit than ever before. From stagflation in the seventies to the financial crisis of 2008, central bank policy continues to sow the seeds of economic crises with increasing severity.

Another consequence of this has been normalizing consistent inflation. From 1792 to 1932, an ounce of gold consistently cost roughly $20. Between FDR's closing the gold window in the US and Nixon's doing so internationally, the price rose from $32 to $45. In 2021, an ounce of gold cost more than $1,800 dollars.

In our next video, we will look at the impact of this inflation.

Often when we talk about inflation, what comes to mind is increased prices—but the consequences of politicizing money go far beyond what we see when making a purchase. Money is not simply a unit of account but is the lifeblood of the economy; manipulating it for political ends has ramifications that many will never understand—but are no less important for that.

The government's control over the production of money increases its control over the real resources in society. When inflation occurs, it does not happen evenly—like boats floating on rising water. There are winners and losers in an inflationary environment, and many of the criticisms about the consequences of "capitalism" can be traced back to the socialization of money.

As we've noted, the first winner in inflation is government—it increases the resources they can control without their having to increase taxes. This allows government to spend more than they otherwise would, which is why we've seen exponential increases in government projects, foreign wars, and welfare programs the more government has taken control over money.

The next winner is big banks, which central banks use to conduct money. In 2008, it was the Federal Reserve that purchased most of the bad debt from big banks, bailing them out for their bad decisions at the expense of everyone else who holds dollars.

But those aren't the only winners. The closer individuals or businesses are to the creation of new money, the more they benefit. So, if big banks desire to focus their investment on technology, for example, Big Tech firms win as well. And in fact, some major tech companies—Uber, Spotify, and Snapchat—have never been profitable on the market, but they continue to grow because they have access to cheap debt—subsidizes by Federal Reserve policy.

When one sector benefits from politicized money, other industries may be hurt—and not simply because of inflation. For example, in the 2000s, Federal Reserve policy subsidized the housing bubble that created a financial crisis. With the housing construction industry benefitting from monetary policy, it attracted workers away from sectors that use similar workers, like manufacturing. Pundits often ignore these secondary consequences, but a good economist looks at both the "seen" and the "unseen."

There are cultural consequences as well. When central banks push interest rates low, this changes the cost of money and encourages spending now while discouraging saving for the future. It impacts society's time preference. Since 2008, with interest rates near zero, Americans have received very little in interest if they saved money in a traditional bank account, but were rewarded for investing in the stock market. The result is more Americans owning risky financial assets rather than having dependable savings.

This disconnect between financial markets and real production has created an economy grounded in "financialization." The result has been major gains in the financial services industry but declining purchasing power among American workers. While many Americans claim to be concerned about rising income inequality, few connect this issue to one of its major causes—giving government bureaucrats complete control over the money. No one has benefitted more since Nixon closed the gold window in 1971 than the wealthiest 1 percent of Americans.

In recent years, concerns about the abuses of the Federal Reserve—and other central banks—have sparked innovation in money, notably cryptocurrencies. In our next video, we will look at what private money may look like in the future—and how governments may try to stop it.

In 2009, an anonymous individual using the name Satoshi Nakamoto unleashed the first version of bitcoin—a private, peer-to-peer digital currency. In creating bitcoin, Nakamoto tried to give his creation similarities to the old gold standard—it was mined using increasingly difficult mathematical formulas, like mining gold. Bitcoins were easily divisible, like weights of gold, and government couldn’t create more of it out of thin air, like with other commodity-backed currencies. 

In the white paper announcing bitcoin, Nakamoto made it clear he was inspired to create bitcoin in reaction to the 2008 financial crisis, which highlighted the dangers of the Federal Reserve’s manipulation of money and the abuses of powerful Wall Street banks. With bitcoin, the hope was an alternative to politicized money and the privileges that it gave to tyrannical governments.

Since 2009, free exchanges on the market have seen bitcoin increasingly rise in value. In 2010, an individual purchased two large pizzas in exchange for ₿10,000. This was the first recorded transaction of bitcoin for a real economic good. The value of the pizza was $41. Eleven years later, the same amount of bitcoin was worth $365 million. All without any government support.

Concerns about the Federal Reserve have not only sparked interest in digital, private money. In recent years, US states have changed tax laws to make it easier to use gold and silver in exchanges. While the US Constitution always prevented states from printing their own paper money, the use of metal was always protected. The State of Texas even established its own gold bank in response to concerns about potential future inflation.

This rise of private money is a direct result of concerns about the Federal Reserve, foreign central banks, and large financial institutions. Since 2008, central banks around the world have engaged in historically unprecedented increases in the money supply and credit creation. While central bankers have regularly claimed that these powers will be short lived, and that they have the ability to return to “normal” monetary policy, every attempt to do so has risked starting a new financial crisis.

As governments take on more and more debt, new concerns arise. For example, if interest rates increase, it means the cost of government’s creating new debt goes up—meaning that more and more taxes will go to interest payments on past spending, and not toward new spending. Also, industries that are not profitable with higher interest rates may collapse. With Federal Reserve policy pushing more Americans to hold stocks, rather than save money in a traditional bank, the popping of an industry bubble could destroy the savings of countless US households.

As such, governments and central banks have looked to create new tools to increase their control over the financial system and attack private money it cannot control. For example, central banks are trying to create their own digital currencies while increasing regulation—or outright banning—private cryptocurrency in their financial systems. China, for example, has banned bitcoin—which can be used in ways it can’t control—and has pushed its own state digital currency, which can be used to track individual users.

Other central bankers have even discussed banning paper money, since using banknotes allows individuals to conduct transactions they cannot track. If they are able to force everyone to use central bank digital currency, central banks would have even more power to control interest rates, the money supply, and credit. This is good for those in power and bad for everyone else.

Multinational organizations—like the World Bank and International Monetary Fund—have also talked about using their own digital currency as an alternative to the dollar. Should this happen, the influence the US has over international finance will instead go to these powerful globalist institutions. For some, the ultimate goal is the creation of a global currency—such as when the European Union created a single currency for Europe.

As we saw in 1931, the response to the US government going off the gold standard was Washington confiscating the gold of average citizens—a major increase of the state’s power. In the future, we may see similar attempts to confiscate challenges to politicized money—like bitcoin or gold—in order to strengthen the power of globalist institutions, governments, and central banks.

For anyone interested in challenging the growth of the state and the abuse of power, one of the most important questions to ask is, "What has government done to our money?"

Want to learn more about money?

• This series was inspired by Murray Rothbard's classic introduction, What Has Government Done to Our Money?, available for free in PDF, HTML, and Audiobook, and for purchase from the Mises Bookstore.
• To learn more about the operations of the Federal Reserve, check out Bob Murphy's book, Understanding Money Mechanics, available for free in PDF and HTML, and for purchase from the Mises Bookstore.
• Please visit mises.org for Mises Wire articles (written and audio), Power and Market blog posts, downloadable books (in PDF, EPUB, and HTML), podcasts, seminars, lectures, and so much more. 
• For more animated content, check out Economics for Beginners at BeginEconomics.com.