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Our Disastrous Monetary System: A New Must-Read Book

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There is a long tradition in Austrian economics and libertarian thought of presenting ideas not only to academic peers and fellow intellectuals, but directly to the broader public. Hayek’s Road to Serfdom, and Rothbard’s What Has Government Done to Our Money? are prime examples. In the German speaking world it was Roland Baader, a student of Hayek’s at the University of Freiburg in the 1960s, who has from 1988 until his death in 2012, more than anyone else, popularized the ideas of the Austrian school of economics. Blind Robbery! How the Fed, Banks and Government Steal Our Money by Philipp Bagus and Andreas Marquart stands in that tradition. The German-language original has already been translated into Taiwanese, Korean, and Spanish, and it is now made accessible to a much wider audience in English.

The aim of the book is to shed light on a subject that far too many people spend too little time, if any at all, thinking about: the monetary system. Everybody knows about the importance of money, but what do we really know about the functioning of the monetary system? The authors invite the reader to think carefully and critically about central questions: What is money? How is it produced? And what effects does an excessive production of money have on the distribution of incomes and wealth, our ways of life, our culture, and the economic system as a whole?

In nine chapters Bagus and Marquart outline the most important and elementary insights of Austrian monetary theory without discouraging the layman with overly technical or formal language. In fact, readers will not even notice that they are holding a book on allegedly dry economic theory in their hands until the very last pages, on which the authors admit that the book could equally well carry the title An Introduction to the Monetary Theory of the Austrian School. With a self-deprecating sense of humor they ask: “Who after all wants to spend their spare time reading macroeconomics?” (p. 165)

Throughout the book, the interactions and relationships between the inhabitants of an imaginary city by the lake serve as vivid illustrations of how money emerged in the first place and how it was transformed over time. The analogies help readers understand the roots and consequences of the modern financial system and the underlying expansionary monetary policy.

What Is Money? 

The first chapter deals with the nature and origins of money. It is commonly assumed, if the question is considered at all, that money is a creation of the state, a convention implemented by government decree. This claim, however, has been challenged by the Austrians. Money as a commonly accepted medium of exchange originated from free and voluntary exchange on the market without government intervention. This of course is not to argue that modern money creation is not a government enterprise. Governments, or more precisely central banks, have indeed a legal monopoly over the production of money.

Traditionally, money was a commodity like gold or silver. Money production, the topic of the second chapter of the book, was organized like the production of any other good in a free market system. It was private and competitive. The use of money certificates instead of the actual precious metals, over time, led to the institution of fractional reserve banking. Depositary banks that were requested to safely store the precious metals of their clients could not resist the temptation of issuing more certificates into circulation than they held gold or silver in their vaults. As long as this scam went unrecognized, banks could multiply their profits. Yet, eventually the resulting economic problems such as bank runs and banking crises were politically exploited for the gradual cartelization and nationalization of the banking system under the auspices of monetary authorities, i.e., central banks. These developments led to the current monetary system based on legalized fractional reserve banking and immaterial fiat money that can be created at virtually zero costs and at the discretion of central banks.

It should come as no surprise that enormous amounts of new fiat money are put into circulation on a regular basis. We are told that these are measures to stimulate economic activity, to prevent or cure economic crises, increase employment, and soothe the financial markets. Bagus and Marquart explain why these are empty promises that we should resolutely reject. The excessive expansion of the money supply, which was impossible under a genuine commodity standard, has far reaching short- and long-term consequences which are explained in chapters three to seven.

How Fiat Money Increases Economic Inequality

Chapter three exposes the redistributional effects of fiat money creation. The new money enters the economic system through the financial markets, where it is lent to corporations, firms, and individuals. As it ripples step by step through the economy, it benefits the first recipients at the expense of the later recipients. Those who can spend and invest the new money first can do so for still relatively low prices. As they buy goods and services they gradually bid up prices. Those who receive the new money later or never are confronted with higher prices without receiving higher incomes. Typically, wage earners and people on fixed income such retirees pay the price. It is primarily the financial sector and the state, whose tremendous amounts of debt are financed through money creation, who benefit from the system, as do well-connected corporations and wealthy individuals. Bagus and Marquart state:

Monetary expansion (inflation) is partly responsible for the increasing schism in society between rich and poor. It is responsible for the fact that more and more people cannot live on the wages they earn and that families can no longer pay for their living expenses from the income of a single wage earner. (p. 66)

The authors also point out that this phenomenon is not dependent on actual price inflation. The redistribution of wealth takes place whether prices actually rise or not, due to other factors such as technological innovation that are at work at the same time. The Austrian insight is that prices are still higher than they would have been without the expansion of the money supply, and that fiat money creation therefore always occurs to the relative disadvantage of the late receivers.

But not only does the modern financial system unjustly redistribute wealth from bottom to top. Austrian business cycle theory, first presented by Ludwig von Mises and further developed by Hayek and Rothbard, explains how it can lead to an overall destruction of real capital and wealth, and hence to a general impoverishment of society. Contrary to the commonly advocated view according to which monetary expansion is an adequate tool for fighting economic recessions, Mises has pointed out that monetary expansion can indeed be the source of economic crises. Bagus and Marquart present the outlines of this theory vividly.

A Monetary System by the State and for the State 

The money monopoly of the state and its undemocratic character are treated in chapter five. The undemocratic element of a central bank controlled fiat money system lies not so much in the specific government activities that it finances. After all, most people are in favor of the welfare state in some form or another. Rather, it lies in camouflaging the actual costs of these activities through the creation of new money out of thin air. Direct taxation as a means of state finance is immediately felt by the tax payers, whereas the expansion of money and credit is only felt indirectly through price inflation and redistribution. Money creation and debt allow the state to engage in political projects, such as wars, without having the electorate feel the costs immediately (not to mention the disastrous consequences in the war regions). They are felt only as a slow and lingering expropriation as real resources are redistributed into the hands of the state and the purchasing power of money diminishes.

In the sixth chapter of the book, the authors incorporate some of the recent research on the cultural consequences of inflation. Redistribution, indebtedness, and business cycles are more or less immediate consequences of monetary expansion. There are much deeper consequences over a longer time horizon. Ongoing inflation systematically benefits the borrowers at the expense of the creditors. People therefore tend to be more heavily indebted. Private individuals take out loans in order to buy houses for example. Hence, they become more dependent on and connected to financial institutions. If people save at all, inflation forces them to become acquainted with modern financial products in order to protect their savings from depreciation. Traditional ways of saving are no longer sensible. People tend to become more materialistic and less future oriented. The growing welfare state that can only be financed through fiat money expansion not only destroys the willingness to contribute to voluntary charity, it also leads to the disruption of traditional social institutions like the family. The authors summarize:

Bad money makes people increasingly dependent, adolescent, socially isolated, torn from their roots, careless, unscrupulous, egotistical, materialistic, superficial, stressed, and depressed. (p. 124)

Most readers of the book will recognize elements of their own lives. The real tragedy of all the monetary interventions that took place over the past generations is that they lead to all sorts of unintended consequences — economic, social and moral. It has fostered the growth of government and caused problems that the government itself attempts to solve by further interventions. The idea of interventionist spirals that was also developed by Mises and Hayek is the subject of chapter seven.

Interventionism has put Western societies on an unsustainable path. There are a number of conceivable ways out presented in chapter eight, none of which is free of pain in the short run. Yet, the single most important thing that we can do in order to prevent the ongoing march on the road to serfdom is to educate and inform ourselves, friends and family. Raising awareness about the functioning of the modern financial system and the numerous detrimental consequences of excessive monetary expansion are the first step in the right direction. In their concluding chapter, the authors give Ludwig von Mises the last word:

The aim of the popularization of economic studies is not to make every man an economist. The idea is to equip the citizen for his civic functions in community life. The conflict between capitalism and totalitarianism, on the outcome of which the fate of civilization depends, will not be decided by civil wars and revolutions. It is a war of ideas. Public opinion will determine victory and defeat.

Philipp Bagus and Andreas Marquart have contributed to this quest — the battle against bad ideas. They have put the better ideas into a form that is accessible to the interested layman. The reader of Blind Robbery! will not become an economist over-night but will understand some of the fundamental problems of our times.

Karl-Friedrich Israel holds a PhD in Economics from the University of Angers, France, and is currently working as a Senior Researcher at Leipzig University, Germany

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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