Thursday, March 27, 2014

Is sound money an unsound idea?

Governments hate sound money.  Even worse, people hate sound money.  Governments hate it because it puts severe limits on what governments can do.  People hate it because it would mean taking responsibility for their own lives, relying on their resourcefulness instead of the government.  Sound money can’t be printed, and governments that can’t print can’t buy as many votes.  They tend to let the chips stay where they fall.

On a free market sound money is democracy in action. As Mises wrote, it is the most marketable commodity, as determined by market participants.  One of the reasons the market chose gold and silver as money was their limited supply, which is also the reason governments reject it.  People who allow their government to control the value of money, by controlling its supply, have surrendered their liberty.

I doubt that most people even know what sound money is.  Besides, they might retort, if there is such a thing as sound money, why is it so important?  Gold and silver are sound money?  We were plagued with Panics when gold was enthroned (forgetting that gold took the hit for fractional reserve banking).  And when recessions came, the economy languished because there was no printer of last resort to jump-start its productive engine (not admitting that printing created the problem in the first place).  The better people are proactive — they don’t like to sit and let matters take their course, as they did with 19th century crises.  Things are better today with a central bank ready to fend off catastrophe with liquidity injections.  Sometimes humongous injections.  Sound money is an unsound idea.  Gold is a barbarous relic, with the emphasis on barbarous.

Whether or not people accept sound money depends on whether or not they value liberty, defined here as “freedom from arbitrary or despotic control.”

When it all began

Archeological findings show us that people once lived much like wild animals, hunting and gathering their food.  When they discovered they could grow some of their food and domesticate certain plants and animals, they formed settlements.  Agriculture provided a surplus of food and allowed people to spend less time trying to feed themselves and more time working on other productive pursuits, thereby creating a diversification of labor.  With specialization came the opportunity to trade, beginning with barter and advancing to indirect exchange.  

All other discoveries that have raised our standard of living are contingent on the simple process of trading one good for another good that is highly liquid.  (Liquidity refers to a good’s marketability.)  With this eminently marketable good, it could be traded rather than consumed, and thus through successive trades individuals could acquire the goods they wanted that they couldn’t get through direct exchange.  Goods that became universally accepted in trade became known as money.  Only with the emergence of money could a division of labor develop to any great extent, enabling people to specialize in lines of production most suited to their skills, circumstances, or temperament.  Money made possible the advancement of civilization.

Looking back from our perch today we find something odd about this evolution from barter to money.  At no point was anyone able to exchange nothing for something — other than by cheating.  On the free market a person could not scoop up a handful of wet leaves, for example, call them federal reserve notes, and expect to trade them for a basket of eggs or admission to a stage play.  A trader had to bring something to market that people actually wanted, either consumption/capital goods or consumption goods that were also highly marketable.  People embraced the idea of money because it made them much wealthier: Unlike barter, they were no longer limited by a double coincidence of wants.  When gold and silver became universally adopted in the West, goods flowed across borders, hampered only by government policies.

Along with the development of civilization came its antithesis, the emergence of nation-states.  Warriors became rulers, imposing themselves on productive settlements.  Why work for a living when you can force others to work for you?  With the appropriate dressing, coercion could be made to seem like a pillar of civilization.  The world is a very dangerous place.  Farmers and cobblers need protection from invading warriors.  The ruling elite promises to provide that protection.  Their specialty is killing people.  Because that is their specialty they get to rule the farmers and cobblers.  They came to refer to themselves as civil government.

But there are problems.  Governments are supported by wealth extorted from the populace called taxes.  Taxation has always been unpopular.  When taxes get too high, the taxed try to evade them.  Sometimes they rebel.  Sometimes they are successful in their rebellion.  

Rulers don’t want a lot of trouble, so they began taxing indirectly, through the debasement of the coinage.  People saw that it was a cheat, but there was little they could do.  If they were caught hoarding less-debased coins, they often paid with their lives.

Eventually paper money began circulating as a more convenient substitute for vaulted coin money.  And almost immediately, bogus paper money circulated that passed for legitimate paper substitutes.  From the perspective of the issuers of paper money, this was truly a godsend.  Unlike adulterated coins, unbacked paper is identical in appearance to backed paper.  People could be easily duped.

The death of sound money

Through wars and financial crises, government was able to remove the backing from the paper altogether, leaving us with pure fiat currencies, inflatable at will — the will of the sovereign or its appointed central bank.  States crack down on any attempt to use something other than state legal tender.

In the West and especially in the United States we like to think of ourselves as mostly free, where the government serves the interests of the people somewhat.  We might expect a dictator to repress any attempt to use something other than the government’s money.  But what about democratic governments?   Did some economist discover a truth that happens to legitimize the activities of repressive governments?  Are we now subject to a scientific argument that says effectively that the more money we have the more prosperous we will be?  Is that why sound money is outlawed?

Close, but not quite.  No economist known by that title has stood for unlimited money creation, but almost all economists consider fiat money creation indispensable.  Hunter Lewis, in his How Much Money Does an Economy Need?, illustrates this point with a simple example taken from Milton Friedman:
Assume that the government decides to construct a road.  Rather than levy taxes to meet the expense, public officials simply start up the printing presses and run off some currency.  Everyone seems to benefit.  Workers get jobs.  The community gets a road.  No one had to pay for it.  It seems like “magic.” (pp. 31-32)
But magic of this sort is just sleight of hand.  It confuses money with wealth.  What really happens when money is printed and spent?  Someone is cheated.  History is replete with examples large and small, but one of the better known cases is the German hyperinflation of 1923, in which “millions of the hard-working, thrifty German people found that their life's savings would not buy a postage stamp.”  Lewis alludes to this problem with a simple illustration:
If you have four apples and a dollar, the dollar may help you price and trade the apples. But adding another dollar will not increase wealth; it will simply raise the price of the apples. To increase wealth, one must add an apple or some other commodity, product, or service.
It isn’t clear in this simple example what an additional dollar would do.  But in a real economy this is known as the Cantillon Effect, named for the 18th-century economist Richard Cantillon, who “posited that the original recipients of new money enjoy higher standards of living at the expense of later recipients.”  

This is not rocket science or even close to it.  But because the benefits of inflation are usually immediate, such as the new road and the jobs it creates, the downside is often overlooked — which in an extreme case is the collapse of the currency.

If we want to understand what government has done to our money,  there is no better place to start than by reading Murray Rothbard’s What Has Government Done to Our Money?  It is an intelligible read of only 100 pages.  The alternative to Rothbardian economics is to surrender control of money and banking to unelected experts who then must be trusted to keep the public's interest in mind as they manage the nation’s stock of money.  Experts not subject to the pressures of the market or the electorate, who are politically appointed, don’t work for the public.  It’s not the public who signs their paychecks.  

The flip side of a federal reserve note says In God We Trust.  The experts may or may not be trusting God, but the public is trusting the bureaucrats of the Federal Open Market Committee.  Under this committee’s guidance, the spread between the haves and have-nots has widened to the point where the poorest 23.3 million Americans earned 36% less than the richest 2,915 Americans in 2012. .

Sound money would reverse this trend.  Read Rothbard to find out how.

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