Razing the Servile State VII

The churches and other religious institutions pronounce on many matters of politics; but monetary phenomena, such as paper money, central banks, dollarization, currency boards, and so on, are hardly mentioned at all. ~ Jörge Guido Hülsmann, The Ethics of Money Production.

Some months ago, His Beatitude was on the Tonight Show (when Jay Leno was still there). During His glorious appearance he told us all that if college students would prefer jobs as engineers and physicians and such to jobs on Wall Street, then we would no longer have a boom-bust cycle. He did not explain how not having people working on Wall Street would do away with the boom-bust cycle. Neither did he explain how the boom-bust cycle is caused solely (apparently) by having people working on Wall Street (but not in the Eccles Building). Heck, like Mary Poppins, he never explains anything. And frankly, I don't think he has the slightest clue what cause the business cycle.

Presently, he wants to limit the size to which a financial institution can grow. The argument is that having institutions "too big to fail" is one of the contributors to the present economic malaise, the other one being the fact that there is anyone working on Wall Street in the first place. Key to this plan is placing limitations on the amount of risk such institutions can take on. We know that risk can make an economy grow. Apparently, it can also crash an economy. The key must be the amount of risk. But you would think that the growth of an economy would be some proportion to the amount of risk being taken. The larger the risk the greater the economic growth. Apparently, however, there is this point at which the risk is just too much and will bring the economy to its knees. (Now, if he thought for a moment how entrepreneurs determine risk, he'd be on his way to understanding something about the business cycle.) We have not been told how risk is divided into growth-causing and crash-causing. We've been told these practices led to the recession, but we've not had it explained how.

Why should he bother to do? The huddled masses, looking to him to supply all their needs by His riches in glory, don't need to know how Wall Street causes the boom-bust cycle. Neither do they need to know how having more people entering the engineering and medical professions does away with the cycle. They need only know two things: 1) Obama has said he will do away with the cycle; 2) He has said we must seek jobs in places other than Wall Street. What else do we need to know? Ostensibly, like him, less than nothing about economics.

Of course, giving us an explanation would mean including government's own role in the boom-bust cycle. And when you're wanting to persuade people that government can solve the boom-bust riddle, the last thing you want to do is acknowledge (if you even know) that the government has any role in the cycle, especially if that role is same whether the administration is Republican or Democrat, or Congress is controlled by Republicans or Democrats. In short, the proper explanation would have to include the Federal Reserve.

Now, why would His Beatitude not want to mention the Fed's role? Perhaps it is that the Fed, despite its role in the boom-bust cycle, still plays a useful role: it allows for government expansion without increases in taxes. Central banking in general, The Federal Reserve in particular, is the key to the size and scope of (un)federal power, the servile state. To understand this, is to understand so much of how our benevolent government reduces us to servility. To begin to understand this, however, we have to understand some basics of money and banking.

How money comes into existence

Money, despite the claims of what might be called the received view, is not a creation of government. It is created by private citizens negotiating among themselves what they desire as acceptable commodities of exchange. The life story of money always begin in barter, the direct exchange of one good or service for another. A farmer who grows potatoes trades a certain number of potatoes to the blacksmith for blacksmithing services, another number of potatoes to a farmer who grows grains, who in turn trades grain for whiskey from a distiller. This assumes, of course, that each one involved in the exchange has more of the good than he himself needs. Also, this will ultimately become inefficient when no one has anything to trade, or to trade for. This results in indirect exchange with some single commodity becoming the medium of this type of exchange. In prisons, the medium of exchange is the cigarette. (I don't know this from personal experience, of course; but I've heard.) Even inmates who do not smoke will accept cigarettes in exchange because there is always someone, at some point in the exchange process, who smokes and will be happy to have a cigarette. Moreover, those prisoners who smoke may be induced to reduce their smoking because to smoke means literally to burn money. Different cultures have had different media of exchange. Some cultures have used items such as bird feathers, beads, and even tea leaves as media of indirect exchange. For most, however, some precious metal such as silver or gold eventually becomes the medium of exchange. Mostly, this is because metals are, in comparison with most other commodities, relatively imperishable. Moreoever, men discovered that silver, by virtue of being more abundant than gold, was useful for small exchanges, whereas gold was useful for larger transactions.

Money is a social institution, not a state institution. Perhaps one of the most famous of coined money is the dollar. And it was coined by a private citizen, not a government bureaucrat, named Hieronymus Schlick. What we now call the dollar was called Joachimstaler, from Joachimstal, the valley where the silver for these coins was mined. Joachimstaler was shortened to "taler", becoming "daler" in Danish, Swedish and Norwegian. In English it became "dollar". As a "dollar" it was a unit of weight, a "dollar" being equal to .05 of an ounce. Twenty dollars equaled one ounce. To pay a certain number of "dollars" for something was to pay a certain weight in silver for it. One of the reasons the "dollar" came to be so widely used was Schilck's reputation for a coin reliable for its weight and fineness. In fact, as a private citizen, he had to guarantee these things, unlike governments, which simply command that their debased coins and worthless paper be accepted at face value.

How governments insert themselves into the process

Of course, there's no good thing that a government can't screw up. Money is no exception. Government intrusion begins with the power to tax. This is bad enough. Eventually, however, governments want to do more than tax revenues will pay for. The power to tax is also the power to inspire revolution, as people grow weary of watching their money disappear from their hands. And when it does not inspire revolution it kills economies, because people tend to hide their gold and silver as a means of protecting it from government seizures. Any tax is a tax on economic activity. If you don't want to be taxed, simply engage in no such activity, or as little as possible. Above all, put no money at risk; make no investments.

There is a way of getting money from the people without their realizing it -- until it's too late anyway. When gold and silver are collected as taxes, the government can shave, or clip, pieces from the the coins. The shavings or clippings can be melted down and fashioned into new coins, coins which, not being debased, do have their face value, and with which the government can pay its debts, those things governments enjoy to do -- for their pals -- for which there is not enough in tax revenues. Those shaved or clipped coins, however, have been devalued by virtue of not weighing what they say they weigh. The coin may say $1 on it, but recall that a dollar is a unit of weight, being equal to .05 of an ounce. Once some bit of it has been shaved or clipped off, it no longer weighs .05 of an ounce. A merchant who sells an item for $1 expects to receive .05 of an ounce. Noting that the coin has been shaved, perhaps several times, he may weigh it and find that it weighs .0475 of an ounce, or 95 cents, despite the fact that it says "One Dollar" right there on the coin. Needing to pay his own debts, he will raise his price by 5 cents (or .0025 of an ounce), because $1.05 in "new" (i.e., debased) dollars is the equivalent of $1.00 in old, undefiled dollars. You see what has happened here? Government has robbed the people, not by taxing them, but by debasing their money. For each "dollar" they possess, they have lost a nickle. Government has also generated price increases as its subjects try to make up the loss of a nickle on each dollar they possess.

It's worse with paper money. At least with coin you can see the debasement. You can weigh the coin to see if it is what it claims to be: a "dollar" weighs a dollar, .05 of an ounce. When it debases coin, the government is still dealing with a relatively fixed number of coins. There is some limitation to the amount of debasement a government can get away with. In order for the government to mint truly new coin, it must employ newly mined precious metals. This is not the case with paper money. Printing new paper money requires only newly produced paper and ink, and a press. That is the point of paper money. The government no longer needs to clip or shave coins. It claims the right to control the currency, including the amount of currency to be in the market, declares pieces of paper to be the only acceptable legal tender, and then simply prints up more paper as it requires. And if you don't know how much paper is circulating today, compared with tomorrow, then you have no idea what is the value of the paper in your pocket. With coin, you can see the debasement, but not with paper. Paper hides it until it is too late. But I'm getting ahead of myself.

The Private Origins of Paper Money

But even paper money doesn't begin its life as a production of government. Paper money begins its life as a bank note, a private bank note. Banks issued these notes on the basis of the real money (i.e., gold and, or, silver) which they had on hand, in reserve. These bank notes, because they represented and were backed by real money, were treated as real money. Note, they were only treated as real money. It is important to bear in mind that the issuance of bank notes always assumes that each and every such note can and will be redeemed in specie; that is, each bank note, when presented to the issuing bank will get the bearer of such note the face value of the note in gold or silver. Present the bank with a one-dollar bank note; get .05 of an ounce of gold coin in return. On one hand this doesn't sound very reliable. You mean, one is supposed simply to trust a bank to keep its word? However personally ethical a banker may be, or may not be, the thing that will keep him honest is the need to keep his customers happy. The other thing that will keep him honest is suffering the consequences for malfeasance in issuing bank notes. Let's say a banker gets into his head to issue more notes than he has gold or silver in reserve. It's a risky venture. He has to have some reason for believing that at no time will all his note-holders come wanting to redeem their notes for specie. If the notes are issued as loans, then he hopes to make back more in interest than will be withdrawn in specie, just to keep explanations simple. Of course, if his customers (or the wrong customers) learn of this practice they will cease to do business with him, withdrawing their specie deposits. Here he must suffer the consequences as each gold or silver depositor removes his gold or silver out of the vaults of such an unscrupulous man. This is a real bank run, real because the object is real money, not paper.

But even if no one finds out that the banker is loaning more in paper than he has in specie deposits, the paper is still floating about the economy. As the amount of paper increases (inflation) so will prices, because price is always a proportion of the total money supply (or, the assumed money supply).

Government-dictated legal tender, fiat money

Inevitably, it seems, people come to accept the notion of the necessity of government control and guarantee of the currency. Perhaps the best argument in favor is precisely the inflationary practice I outlined above. Another practice, to round out the picture, is fractional-reserve banking. Of the total deposits, a banker keeps only a fraction in his vault, lending out the rest, as high as 90%, keeping only 10% on hand (reserve) to redeem his depositors' claims. (A bank run occurs when a significant number of his depositors come to claim their deposits and close their accounts. A critical number of bank runs can cause a panic. Banks practicing fractional reserve banking are all just one run away from failure.)

Thanks to the paper inflating and credit expanding behavior of banks (i.e., private, but not market-driven control of the money supply), government control of the money supply just seems a necessity. It isn't, but it seems that way. It isn't necessary because a simple government fix is for government to out-law fractional reserve banking, and other inflationary practices, such as credit expansion. A better, private fix, is for consumers not to do business with banks which practice fractional reserve banking and credit expansion, in favor of those who practice full-reserve banking and engage in no credit expanding practices whatsoever.

However, after a few bank runs and panics, the word "private" is frightening. After all, to be fair, the banks which caused the difficulties were controlling the money supply privately. So, government control it is. But governments, as I said above, usually want to do things for which sufficient funds cannot be raised via taxes. So, even if government control of the money supply is initially responsible, backing the paper totally with redeemable specie, it eventually departs from this sound practice, especially during times of war. The colonies did it during the Revolution, issuing unbacked "Continentals". The Union and the Confederacy both did it during the War for Southern Independence. Some sort of crisis, real, imagined, or fabricated, is usually used as grounds for departure from gold or silver standards. And when these departures are made, these worthless, unbacked pieces of paper are declared "legal tender" and become fiat money; the public are informed that they shall not be permitted to redeem these pieces of paper for specie. Thus, and here is where the servility comes in, the people, who freely created money in the first place, first in direct exchange and subsequently in indirect exchange, using real commodities in both cases, are now commanded what commodities (i.e. paper and ink) to value and by how much. (This measure is needed in order to save the "free" market.) Where they were formerly free to value and exchange whatsoever commodities their respective, and free, markets would accept, they are now commanded by their governments to treat pieces of paper as if they had the same value as silver or gold.

We may stipulate a role for government, but the power to command people what to value in exchange is a power (one of many) we should question.