A Review of Gary North's "What is Money?"

The inaugural installment of this collection of essays first appeared on LewRockwell.com on September 29, 2009 - fittingly, Ludwig von Mises' birthday. Dr. North is one of the foremost Austrian economists and economic historians working today, and has gained a wide following with his writing and lectures. These essays are virtually impossible to overrate; they clear up so much of what is misunderstood about money and banking.

Our civilization depends on sound money and honest banking. As North makes emphatically clear, we have neither.

A few excerpts should get my point across:

"The heart of the modern monetary system is fractional reserve banking. This system is based on fraud. At the very heart of the modern economy is fraud -- fraud on a gigantic scale. What is the nature of this fraud? Counterfeiting. Banks are government-licensed institutions that issue bogus IOUs. Because these IOUs function as money, they are counterfeit money. This is the heart, mind, and soul of all modern banking."

"Counterfeiting is universally condemned by civil governments. Wherever we go, a national civil government has passed a law imposing serious sanctions against anybody who would counterfeit the national monetary unit. Why do governments do this? Because they are all counterfeiters, and they deeply resent an invasion of their turf. Laws against counterfeiting in today's world are a form of gang warfare."

"To reform central banking is to perpetuate it. To perpetuate it is to accept the fundamental premise of modern economics: money is different. Money is not governed by the same laws of supply and demand that govern the rest of the economy. Money requires experts to administer it. Private contracts are not sufficient."

"Someday, perhaps, central banks will stop subsidizing their respective Treasury Departments. On that glorious day, governments will move rapidly toward bankruptcy, interest rates on government debt will rise, the markets will begin to crash, consumer prices will begin to fall, and the mother of all bank runs will begin. Get there early."

"The powers that be will cease to be powers if money dies. They have based their political control and their wealth on their control of digital money. This is the line to which the hook of state power is attached. To destroy the currency is to break this line. Better a new Great Depression than hyperinflation, if you are a central banker.

"If money dies, a lot more than money will die. This includes Bernanke's pension. He knows this."

I suppose one could be critical of the author for writing so informally about a subject that many would say cannot be translated into everyday language; that any attempt to translate it corrupts it and renders it misleading or just plain wrong.  But one of the hallmarks of Austrian School economics is the clarity of its expositors, a trait that seems to annoy the Keynesians who understand money only in the context of aggregates, equations, and central planning.  But if thought is to be a guide to individual action, then clarity of thought is indispensable, and North, in these essays, offers the reader a remarkable degree of lucidity.

There are other popular essays that delve into the nature of money.  Bastiat's What is Money? is instructive and entertaining, and Thomas Paine's attack on paper money lays bare what we've forgotten.

Having no real value in itself it depends for support upon accident, caprice, and party; and as it is the interest of some to depreciate and of others to raise its value, there is a continual invention going on that destroys the morals of the country.

Also highly recommended is Ron Paul's three-part lecture series, What is Money?

The sophisticated elites who run the monetary system proudly admit they don't know what money is, though they do concede that being unable to define money makes it difficult to manage. In a sense I can empathize with them.  Money - the commodity - was removed from the economy completely in 1971.  It is indeed hard to manage something that no longer exists, and if it did exist, would not require managing.  As Milton Friedman once wrote,

If a domestic money consists of a commodity, a pure gold standard or cowrie bead standard, the principles of monetary policy are very simple.  There aren't any.  The commodity money takes care of itself.  [p. 356]

North, borrowing from Mises, tells us what money is in six words, then proceeds to build on it.  Not very sophisticated, but infinitely usable.

Securing Property Rights in the Absence of a State

Many Rothbardians are vowing not to vote in this or any election since voting only supports the State.  But I wonder if they could be persuaded otherwise if they knew one of the ballot choices were to dissolve the governments and replace them with voluntary market institutions.  Of course, we don’t have that choice, and most people would either laugh or be scared to death if it were proposed.   But with sovereign nations riding the Keynesian sled into the Abyss, the dissolution might fall in our laps anyway.  Preposterous as it might sound, we might need to consider organizing society around something other than the coercive monopolies driving us to extinction.

Fortunately, we have both experience and theory to draw upon.  In this article I want to touch on two sources from each: The classic study by Terry L. Anderson and P. J. Hill, An American Experiment in Anarcho-Capitalism: The Not So Wild, Wild West and Robert P. Murphy’s Chaos Theory.

Thanks to Hollywood and popular literature, the American West [1830-1900] is often portrayed as violent and lawless.  As long as you had a fast gun and were willing to use it, you could get away with anything.  The reason: weak or nonexistent government.  In their literature search, though, Anderson and Hill found ample evidence to the contrary.  For example, W. Eugene Hollon, in his book Frontier Violence: Another Look found that “the Western frontier was a far more civilized, more peaceful, and safer place than American society is today [the early 1970s]."  Another researcher, Frank Prassel, writing in the mid-1930s, found that

if any conclusion can be drawn from recent crime statistics, it must be that this last frontier [the West] left no significant heritage of offenses against the person, relative to other sections of the country.

In the early West people protected their property and lives with private agencies.  Significantly, these agencies understood that violence was a costly method of resolving disputes and usually employed lower-cost methods of settlement such as arbitration and courts.  Nor was there a universal idea of justice common to these agencies.  People had different ideas of what rules they wished to live under and were willing to pay for.  Competition among the agencies provided a choice. 

Anderson and Hill looked at four institutions in the early West that approximated anarcho-capitalism (AnCap): land claims clubs, cattlemen’s associations, mining camps, and wagon trains.

Land Claims Clubs

Found throughout the Middle West, the land claims clubs or squatters’ associations showed how newly arriving pioneers joined together for common purposes without government assistance. 

Each claims association adopted its own constitution and by-laws, elected officers for the operation of the organization, established rules for adjudicating disputes, and established the procedure for the registration and protection of claims.

Though violence was an option to be used against those who didn’t follow the rules, at least one association used social ostracism to curtail or punish violators.  They formally resolved:

That we will not associate nor countenance those who do not respect the claims of settlers and further that we will neither neighbor with them . . . Trade barter deal with them in any way whatever.

Some claims associations were formed to oppose “speculators,” while others encouraged speculation, exemplifying how the clubs “developed rules consistent with the preferences, goals, and endowments of the participants.”

Cattlemen’s Associations and Mining Camps

Like the claims groups, cattlemen’s associations drew up formal rules governing their members, but their enforcement methods were often more violent.  As protection agencies, they hired gunfighters (stock detectives) to eliminate rustlers.  The mercenaries were not motivated by ethics, but by “the side which made them the first or best offer.”

Did the gunslingers ever form criminal associations of their own, selling protection and violating property rights as they wished?  There were a few loose associations of this kind, but they were “dealt with more quickly and more severely under private property protective associations than under government organization.”

The California gold rush of 1848 brought thousands of easterners west to seek their fortune, as did gold discoveries later in Colorado, Montana, and Idaho.  Many gold seekers organized before leaving home, and as with other private agencies the rules varied between organizations.  People had the choice of purchasing the set of rules they preferred.  Interestingly, many of the mining organizations prohibited lawyers from their districts and in one case specified no more than fifty nor less than twenty lashes for lawyers who were caught practicing law.

Anderson and Hill:

One early Californian writes, "We needed no law until the lawyers came," and another adds, "There were few crimes until the courts with their delays and technicalities took the place of miners' law.”

Miners courts provided a system of justice, and a judge and jury were selected from among the members.  Any law-abiding miner might serve as prosecutor or defender of the accused. 

In Colorado there is some evidence of competition among the courts for business, and hence, an added guarantee that justice prevailed.

Wagon Trains

Wagon trains rolling west in search of gold provide perhaps the best example of anarcho-capitalism in the American frontier.  Realizing they would be passing beyond the pale of the law, the pioneers “created their own law-making and law- enforcing machinery before they started.”  In many cases they created constitutions similar to the U.S. Constitution.  Once the travelers were beyond the jurisdiction of the federal government, they elected officers to enforce the rules laid out in the document. 

The constitutions also included eligibility for voting and decision rules for amendment, banishment of individuals from the group, and dissolution of the company. 

What made this arrangement work, according to the authors, was a profound respect for property rights.  Yet there was little mention of property rights in their constitutions.  The inviolability of property rights was so throughly ingrained that the pioneers rarely resorted to violence even when starvation was imminent.  Quoting John Phillip Reid from his study of the Overland Trail, the authors tell us:

While a few of those who were destitute may have employed tricks to obtain food, most begged, and those who were "too proud to beg" got along the best they could or employed someone to beg for them.

Certainly the transient nature of these rolling communities made them more adaptable to anarcho-capitalism.  The demand for “public goods” such as roads or schools never came up, for example, though they did have to protect themselves from Indian attacks without relying on the State.  For the most part, their arrangements worked.  People bought protection and justice, found competition among rules producers, and the result was an orderly society, unlike that generally associated with anarchy.

Murphy’s Case for Anarcho-Capitalism

In Chaos Theory, Robert P. Murphy sketches how market forces would operate to support the private production of justice and defense -- two areas that are traditionally conceded to be the sole province of the State.  Murphy contends that not only would the market be able to provide these services, but would do so much more efficiently and equitably than the system we have now.

Here, we’ll confine our discussion to a few key points he makes about the production of “justice” on the free market.

As with the western pioneers and the world today, no single set of laws or rules is needed to bind everyone.  People would enter into voluntary contracts that spell out the rules they agree to live by.   “All aspects of social intercourse would be ‘regulated’ by voluntary contracts.” 

Who makes the rules?  Private legal experts, who would draft laws under open competition with rivals.  The market deals with “justice” as it does with other services.  As Murphy notes,

“the market” is just shorthand for the totality of economic interactions of freely acting individuals. To allow the market to set legal rules really means that no one uses violence to impose his own vision on everyone else.

In an advanced AnCap society, insurance companies would play a major role.  People would buy policies, for example, to indemnify their victims if they were ever found guilty of a crime.  As they do now, insurance companies would employ experts to determine the risks of insuring a given individual.  If a person were considered too great a risk he might be turned down, and this would be information others would use in deciding if and how they wished to interact with him.

Critics say this might work for peaceful, rational people but what about incorrigible thieves and ax murderers?  How would market anarchy deal with them?

All Property is Privately Owned

Murphy reminds us that “wherever someone is standing in a purely libertarian society, he would be on somebody’s property.”  This allows for force to be used against criminals without violating their natural rights.  He cites the example of a person entering a movie theater, with an implicit contract such as the following:

If I am judged guilty of a crime by a reputable arbitration agency [perhaps listed in an Appendix], I release the theater owner from any liability should armed men come to remove me from his property.

In this way the use of force would have been authorized by the recipient himself beforehand.

But where do these armed men take the criminal?  On a free market, a high-security analog to jails would evolve.  These jails, though, would resemble hotels because they would be competing with each other for business, which in AnCap means both pleasing the criminal and guaranteeing his secure detention.  Unlike government prisons there would be no undue cruelty and virtually no chance of escape.  If a dangerous criminal escaped and killed again the insurance company would be held liable.  And a prisoner who didn’t like the way he was treated would have the option of switching to a different jail, as long as his insurance company was in agreement.

Would the Mafia Take Over?

People who support the State because they believe organized crime would take control of an AnCap society should consider that we’re already living  under the “most ‘organized’ criminal association in human history.”  Whatever crimes the Mafia has committed, they are nothing -- nothing -- compared to the wanton death and destruction states have perpetrated.   

We need to consider, too, that the mob gets its strength from the government, not the free market. 

All of the businesses traditionally associated with organized crime—gambling, prostitution, loan sharking, drug dealing—are prohibited or heavily regulated by the state. In market anarchy, true professionals would drive out such unscrupulous competitors.

Applying AnCap

Murphy discusses several applications of anarcho-capitalism in today’s world, one of which is medical licensing.  Almost everyone believes that without government regulation we would all be at the mercy of quacks.  “Ignorant consumers would go to whatever brain surgeon charged the lowest price, and would be butchered on the operating table.”  Therefore, we need the iron fist of government to restrict entry into the medical profession.

But this is pure fiction.  Since the demand for safe and effective medicine is universal, the market would respond accordingly with voluntary organizations that would allow only qualified doctors into their ranks.  Insurance companies, too, would only underwrite doctors who met their standards, since they would stand to lose millions in malpractice suits.

Regarding the ongoing controversy of gun control, Murphy sees legitimate points to both sides of the debate:

Certainly we cannot trust the government to protect us once it has disarmed us. But on the other hand, I feel a bit silly arguing that people should be able to stockpile atomic weapons in their basement.

How might AnCap resolve this?  Let’s say Joe Smith wants an insurance company to agree to pay $10 million to the estate of anyone Smith happens to kill.  “The company will be very interested to know whether Smith keeps sawed off shotguns—let alone atomic weapons—in his basement.”  In this way truly dangerous weapons would be restricted to those willing to pay the high premiums for owning them.

Though it’s hard to imagine any company willing to issue a policy to a holder of nuclear weapons, nevertheless, if someone wanted to, there would be no agency with the authority to prohibit owning them.  But without a policy, a person would be unable to guarantee his contracts with others and would find it virtually impossible to function in society.

Getting there from here

Establishing an AnCap society depends heavily on the history of the region.  North Korean market anarchists, for example, might have to use violence to curtail that brutal regime, while in the United States, “a gradual and orderly erosion of the State is a wonderful possibility.” 

The one thing all such revolutions would share is a commitment by the overwhelming majority to a total respect of property rights.

People already understand that rape and murder are crimes - even rapists and murderers.  The hard part is convincing people “that murder is wrong even when duly elected ‘representatives’ order it.”

We can build on intuitive notions of justice, just as newly arriving miners in California respected the claims of earlier settlers. 

To take a more modern example, even inner city toughs unthinkingly obey the “rules” in a pickup game of basketball, despite the lack of a referee.

As he explains in a footnote, the players in a pickup game still recognize the existence of a foul (and other rules), even if the offending player denies he committed one. 

Now, the market solution to such ambiguity and bias, for games deemed important enough to warrant the extra cost and hassle, is to appoint official referees to apply the “law” (which they too unthinkingly respect). Notice that at no point is a violent monopoly needed to achieve this orderly outcome. 

 Conclusion

Those who defend the State as necessary to protect  property rights should brush up on their history, from day one to the present.  As Murphy wraps up,

I ask that the reader resist the temptation to dismiss my ideas as “unworkable,” without first specifying in what sense the government legal system “works.”

George Ford Smith is the author of The Flight of the Barbarous Relic and two other books.  Robert P. Murphy is Libby Gadsen's scheduled guest for her radio show Gadsen Rising on Tuesday, October 16, 2012 from 4:30-6:00 P.M. ET.   His topic will be anarcho-capitalism.  Gadsen Rising is a www.FreedomizerRadio.com production.  Call 347-324-3704 to listen or participate.

Fiscal Cliffs and Monetary Mountains

On September 13, economist Frank Shostak had an article on Mises.org about the upcoming “fiscal cliff,” which he explains this way: 

The "fiscal cliff" refers to the impact of around $500 billion in expiring tax cuts and automatic government-spending reductions set for 2013 as a result of successive failures by Congress to agree on some orderly alternative method of reducing budget deficits.

The impact, according to the CBO, is that the federal deficit could fall by nearly half (43%), from $1.128 trillion in 2012 to $641 billion in 2013. 

How should we interpret this projection?  The IMF and CBO think it’s a looming disaster.  But the IMF and CBO are not staffed by Austrian economists.  Shostak:

Ultimately what matters for the economy is not the size of the budget deficit but the size of government outlays — the amount of resources that government diverts to its own activities. Note that, because the government is not a wealth-generating entity, the more it spends, the more resources it has to take from wealth generators. This means that the effective level of tax here is the size of the government and nothing else.

The projected decline in government spending for 2013 is $9 billion, which follows a projected decline of $40 billion for 2012.  You would think commentators would zero in on 2012’s decline rather than 2013, Shostak notes.

But wait - if it’s true government takes things out of the pot without putting anything in, why would so many people be afraid of a reduction in government outlays?  If the “pot” represents a snapshot of a society’s total wealth, with net revenue streams feeding it, wouldn’t it make sense to slap government’s hands for scooping up whatever it wants?  Yes, it would if the dominant economic theories were free market instead of Keynesianism.  In the Keynesian world, government doesn’t have to do anything useful to create jobs and prosperity, since, as Paul Krugman says, we’re in a liquidity trap.  By paying people to dig holes and fill them back up it puts real food on the table because those hole-workers will spend their money and induce farms and factories to grow more corn and produce more razor blades.  It’s not just the dirt diggers powering the recovery, either - it’s everyone they trade with, thanks to the Keynesian spending multiplier.  As economist George Reisman notes, “The multiplier and its benefits are allegedly restrained only by the disappearance of funds into the ‘leakage’ constituted by saving.”

Shostak then addresses the issue of expiring tax cuts - will we have less purchasing power in 2013?  You might think the answer is straight-forward: More for government means less for us.  But given the expected reduction in government outlays, Shostak argues, the tax increase will be “like a tight monetary policy.”

A tighter monetary stance in this respect should be seen as positive for wealth generators since it weakens various bubble activities that sprang up on the back of past loose monetary policies.

By this logic if you end up paying more in taxes next year you have reason to feel good, sort of.  You may not be able to save as much or go out to dinner as often, but on net you’re better off because the sub-group of market participants who qualify as wealth-generators will have a lighter economic burden because of the decline of certain bubble activities.

One supposes that if the tax increase were greater yet, more bubble activities would cease, and the result would be even more positive for wealth generators.  But if taxes continue to rise, at some point the monetary stance would become so tight it would strangle the process of wealth-generation.  The tax increase, therefore, is harmful to all economic actors, with the possible except of the government. 

Put another way: If the taxed individuals are wealth generators they will have less money with which to invest in capital goods.  Other things equal, they will produce less, not more.  Taxes may put the bubbles on the sidelines, but they also hurt the wealth generators.

It’s hard to see how a tax is a net positive, at least for the taxpayer.

Here Comes Hyperinflation?

Another issue to surface this past week was inflation, the scary kind, as in destruction of the currency.  On September 12 Greg Hunter published an interview with Shadowstats founder John Williams, who predicted a dollar sell-off leading to digital wallpaper by 2014.  When Ben Bernanke announced a day later that the Fed would run the printing presses until the unemployment rate improved, it seemed like fulfillment of a prophecy. 

But will Bernanke print until the currency is no longer money?  Does that statement square with Williams’ acknowledgement that the Fed’s primary concern was “propping up the banks”?  How does turning the U.S. dollar into wallpaper help Citibank or Bank of America?  How does it help businesses produce, hire, and innovate when money becomes so plentiful it is more profitable to use as toilet paper?

More likely Bernanke will print and print, and print some more, then stop.  He will stop short of killing the dollar.  The bankers want to be able to buy things with their billions.  He will stop, and by then smart investors will be perched atop foreign currencies and precious metals as they watch the politicians flog the lifeless horse that was once our economy. 

Bernanke may be acting suicidal but I don’t believe he’s thinking that way.  He’s merely thinking like the Keynesian he is.  More spending is the great panacea.  People will not sit on cash if they think it’s getting worthless.

Paul Krugman says Bernanke is behaving in a manner consistent with his advice to “credibly promise to be irresponsible.”  By this he means Bernanke cannot get people spending unless they expect higher prices.  Monetary policy, therefore, should seek to instill this expectation.  Promising to print an additional $40 billion a month indefinitely might get them shopping in a panic.

But if they shop for precious metals, their strategy will have backfired.

Conclusion

Keynesians have been running things since the 1930s.  They are blind to oncoming train wrecks and spin their chronic failures with “too little, too late.”  The business cycle is a mystery they blame on the market rather than past interventions.  For them, the heart of the economy is a government-supported banking cartel that proudly distorts prices and a profligate Congress that blows the roof off its debt limits.  They are the enablers of a government that is growing more intrusive in every area of our lives.  Keynesians are bringing civilization to its knees, while being called on to save it.

I occasionally find it helpful to recall the words of my instructor, Dr. Robert P. Murphy, as he concluded a Mises Academy course on Keynes, Krugman, and the Crisis last year:

Ask yourself: What would the world look like if Keynesians were totally wrong?

It would look like it is today.

Still propagandized after all these years

I got a call from a young friend the other day complaining of writer’s block.  It wasn’t that he couldn’t think of anything to write, exactly; he couldn’t think of anything to satirize. 

“You’re crazy,” I said.  “What’s not to satirize?”

Brief silence.  “I can see you don’t know a thing about satire.“  He sighed.  “Satire requires an audience who would appreciate it.  Look, you don’t tell jokes to yourself, right?  You tell them to others.  If no one gets them, they’re not jokes.”

“Well--”

“They’re not jokes -- trust me.  Satire’s a little more complicated.  You want them to laugh, but when they’re done you want them to see what or who you’re picking on and agree with you.  You want them to take action.  If it’s political satire, you want them to overthrow the government.  Satire’s serious business.  You need to know what’s right, to laugh at what’s wrong.  But that’s the problem.  People don’t know.”

“Oh, yeah?  Tell that to the cast of Saturday Night Live.  Or Jon Stewart.  You’re burned out, man.  Let the field lie fallow.  You’ll get your touch back.”

“It’s not a case of lost touch.  Suppose you wanted to lampoon this stuff that passes for money, the fiat outpourings of the central banks.  Among the commentariat money is an issue, at least since the crisis of 2008.  At least on the internet.  But it’s not an issue with the middle class.  They still don’t get it.  They’ve been savaged by the bankers and politicians but they still don’t understand how it happens.  They have no freaking idea of what role gold has traditionally played in keeping these guys off their backs and out of their wallets.  They hear bright people say it’s barbarous, that to support it is like calling for the return of the biplane, and that serious discussion centers around whether Bernanke should impose another QE.   And if a few of them do get curious about gold as money, crowned experts like Bernanke slam the door in their faces.  He tells them that in the 1930s, the smart countries dumped gold before the others did.  Or that all those infamous panics of the 19th century were gold’s fault, that it forced bankers to redeem their notes for something of value.  So what if they issued more notes than they had gold on deposit?  That was acceptable practice and always has been.  If only people would simply believe that paper issued under a monopoly arrangement with the government was something valuable, everything would be fine.  The fact that we’ve had perpetual inflation and war since paper was crowned king is a fact lacking visibility.  To the general population.”

“No, you’ve lost your touch.  The material for a spoof of fiat money is there in abundance.”

“You could spoof it only for a select few.  The rest would be bored.  Okay, let’s try this: Suppose you wanted to satirize the War on Terror.  A ripe topic, right?”

“Over-ripe.”

“So what do you do?  You might say we’re winning the war and show the number of terrorists we have locked up in prison.  Yea for our side!  We’re number one!  But wait -- these guys don’t look like terrorists.  They’re not al-Zawahiri or al-Umari or al-Salada or something -- they’re al-Johnson or al-Jones or al-Richardson.”

“Great!”

“No, it isn’t.  No one on main street would laugh.  Half these prisoners are drug users.  They may not know it but they fund terrorism.  Their partners are the real ‘als’ planning the next attack.”

“Nooo!”

“That’s what people believe.  If you’re in jail, you’re a bad guy.  Bad guys support terrorists.  So you can’t satirize the War on Terror.”

“You just did!”

“Then why didn’t you laugh?”

“Your readers will, once you polish it.”

“They won’t.  My readers are the ‘als’ in prison.”

“Then dig deeper.  Hit the War on Drugs.”

“How?  By writing about soccer moms signing out kiddie aspirin at their local pharmacy, all the while chattering about their latest trip to the shore?”

“That’s a start.”

“Or a hospital scene depicting a shriveled old guy strapped to his mattress, his face a rictus of pain, while a canned video plays on his overhead TV detailing the evils of marijuana?”

“That’s good.  Dark, but good.”

“Of course there’s the old standby, cops armed with controlled substances to plant on troublemakers they want to send up.”

“That’s satire?”

“It might be if a cop’s kid gets hold of the stuff and is collared by some dick in another city.”

“You’re on a roll, man.  You need to hang up and get this stuff down.”

“You still don’t understand.  You know that puzzle about a tree falling in a forest with no one there -- would it make a sound?  I would be like that tree.  It’s not that there’s no one around.  They’re here but they’re lobotomized.  Regular people no longer think critically about the government.  Today’s normal is yesterday’s outrage, with the outrage removed.  Satire would play on that outrage, but it’s not there.  They’ve made peace with it in a psychotic sort of way.  They live in Huxley’s world without knowing it.  They love their servitude and call it freedom.  They still have their ball games and fishing trips, their malls and sitcoms.  Water still runs downhill, the sun rises and sets.  They can even speak freely, because their words are powerless.  In this blissful metamorphosis Julian Assange is the problem, not the corrupt governments.  You satirize that, they won’t laugh.  Satire’s not just humor, it’s an instrument of change.  Its fuel is outrage.”

“You’ve overlooked the elephant in the living room, my friend.  People have been screaming about the banks and Wall Street for at least four years.  They may not understand gold, but anti-Fed sentiment is all over the place!”

“Someone’s already tested the water on your elephant, buddy.  In this case a Brazilian elephant.  You say such animals don’t exist?  I say they’re invisible -- to the middle class.  They’re invisible to the middle class because they believe in the rightness of central banking.  Which, as I said earlier, is why they’re going broke.

“No satire I could ever write could top this.  It seems the staff of Brazil’s central bank is on strike.  They’re demanding a 23 percent pay increase.  Why?  Because of inflation.  They want the pay increase to cover the inflation they’ve created since 2008.”

“You’re making that up.”

“The Brazilian bank violated the first law of institutional counterfeiting: It didn’t take care of its own.  But who noticed?  No one.  Who cares?  No one.  Stand at the entrance to your local grocery store on a Saturday morning and ask the SUVs and mini-vans coming in if they’ve even heard of the strike . . or the central bank . . . or if they know what a central bank is.  Or if they have heard of a central bank, ask them if they think it’s an inflation fighter.  They’ll probably say yes.  ‘Thank God we have a central bank in the U.S., keeping a lid on inflation.  Unlike those boobs in Brazil.’  And if you stand there too long the store manager will order you off the premises, because he noticed you’re not selling girl scout cookies.”

“Look, you can’t expect political satire to ignite a revolution among everyday grocery shoppers.  If you were to conduct a survey you’d scare half of them and leave the rest thinking you’re a kook.  There’s an audience for your satire.  Not everyone’s been cleansed of outrage.  You need to find those people.”

“Yeah.  I believe they’re called ‘the choir.’  By definition you can’t change them.”

“That’s right -- and for the rest you need to be a teacher.  Satire isn’t a good teaching tool.  You build outrage with sound arguments.  Satire coaxes that outrage to the surface in the form of humor.  But you have to build it first.”

“But they’re lobotomized.”

“A better word would be ‘propagandized.’  It’s treatable.”

Then quietly, “Yeah,” followed by another silence so long I started to wonder if the connection broke.  Finally, to my surprise: “Yeah.  Yeah, that might work.  Talk to you later.”

Does the Fed really monetize government debt?

If monetizing debt is understood to mean printing money to pay for government deficits, then the Fed is guilty.

The basics are quite simple.  The federal government issues and the Fed buys interest-bearing debt certificates.  The Fed pays for these securities by creating digits on a computer that represent dollars.  In this Age of Ron Paul, more people are learning that the digits do not represent savings borrowed from the public.  The Fed is not a financial intermediary; it is a money factory.  And while factories under capitalism produce for the benefit of the masses, this factory cranks out dollars for the politically-favored, to the detriment of the masses.   The Fed is thus an anti-capitalist, anti-free market institution.  The 12 members of the FOMC decide how much money they need and create the digits on-the-fly, from nothing.  The idea of Bernanke or other Fed chairmen printing money is a metaphor, but an accurate one.  It’s simply more convenient for the Fed to create digits than to print money. 

It might be objected that this is not the equivalent of printing money because fiat money is not an interest-bearing asset.  By purchasing government bonds, the argument runs, the Fed collects interest from the Treasury, thus providing an additional windfall for the central bank, which also collects the principal.  The government would’ve been better off issuing a service order to its “money factory” and having it print the amount demanded and avoid the interest payments.  In other words, instead of Bernanke creating digits, have Geithner create them.

Simply printing money to pay one’s debts, though, even when done by a legitimate government, runs the risk of being seen as such.  Even eight-year-olds know a counterfeiter is a crook who prints money then spends it.  It’s always possible kids today would survive government schools to adulthood, still believing the emperor is stark naked, and that could lead to revolution.  Most adults, of course, have little interest in where money comes from as long as it buys things at the mall, and most economists have a habit of not biting the hand that feeds them, and thus lend support for an “independent” Fed.

If cheating is the goal, what’s needed is a circuitous means of printing money to keep the public befuddled and indifferent, and this is the reason for having a central bank.  It’s true, the Fed collects interest on the government securities it holds, but it gives most of it back to the Treasury.  After deducting for operating and other expenses, it pays member banks a 6% dividend on the stock they hold in their reserve banks, which in 2010 amounted to $1.5 billion.  (By law, member banks must subscribe to stock in the Federal reserve bank of their district equal to 3% of their capital, at a fixed rate of $100 per share, with another 3% subject to call of the Board of Governors.  See here.)  The remaining balance of the Fed’s interest receipts, including interest from assets other than U.S. bonds, is remitted to the Treasury at the end of each fiscal year.  In 2010, this amounted to $79.3 billion.  (See the 2010 annual report, pg. 130, Table 4 for details.)  Thus by giving the Treasury all the revenue it receives after deducting for expenses and dividends, the Fed in effect is granting the government loans at nearly zero interest.  As for the principal, the Fed simply keeps it on their books.  It could demand payment from the government, but so far it hasn’t.  If the Fed ever decides to defend the value of the dollar, unrestrained government as we've known it is doomed.

As we can see the government, in issuing bonds, is getting money for virtually nothing, then spending it.  As kings of old did when they literally ran the printing presses to pay for expenses beyond what they collected in taxes, today’s government does the same but through the esoteric world of central banking.

Why would bankers agree to such an unprofitable arrangement?

The commercial banks make their profits through the protection afforded by the government cartel of central banking.  Fractional-reserve banking has been the norm in banking for thousands of years, but while it can be very profitable it is also subject to instant disaster when banks over-inflate.  Under central banking in a fiat paper money regime, member banks inflate at a uniform rate and thus avoid currency drains from other banks and runs from the public.  And since money is paper or digits representing paper, the central bank, with its monopoly of the note issue and commodity money outlawed, can generate as much money as needed should problems arise.

As cozy as this arrangement is, most bankers don’t seem to recognize that central bank inflationary policies (“easing” or “accommodative”) will eventually bring an end to their scheme.  The money will become so worthless people stop using it.

The solution is to separate money and banking from the government, completely and permanently.

Honest money in dishonest hands

People are always looking for better ways of doing things, and this includes a better way of imparting a message to a misinformed American public.  In particular, if a layman wanted to learn about the nature of our money and banking system I would direct them to Murray Rothbard’s What Has Government Done to Our Money?  In my view Rothbard’s classic has always been the best introduction to the topic.  But Gary North has written an elementary work called Honest Money that held my interest not merely for its economic reasoning, but for the many original touches I found throughout.  Would North’s book reach more people than Rothbard’s?

I must point out that Honest Money is subtitled, “The Biblical Blueprint for Money and Banking,” and each chapter begins with references to the Bible and Christian ethics.  In the introduction he says his book asks a question:

What violations of the principles of the Bible did the West commit that led us into this mess [referring to the crisis of 2008 and its aftermath]? It also asks this question: What should we build on the ruins of the present system after the collapse?

For those who would find relief knowing the Bible sanctions honest money, North’s work will come as a godsend (no pun intended).  Even for those reprobates who forswear a religious worldview, his book will provide a solid grounding in monetary theory and history.  North’s vast understanding of money and banking coupled with his lean, no-jargon writing style takes the labor out of reading.  His narrative carries us on a journey from the development of money in its innocent youth, where it was used solely as a means of facilitating trade, to money in its corrupt maturity, where today it also serves to facilitate power and profit for a ruling elite. 

Very importantly Honest Money also includes numerous bullet points at the end of each chapter covering the main ideas.  I found these bullets indispensable.  More good news: The book can be read comfortably in one evening.

Crusoe’s Choices

North begins with the familiar star of economic analysis, Robinson Crusoe.  But rather than the usual pedestrian account of how Crusoe will budget his time, North dramatizes the situation somewhat, as would be appropriate for someone recently shipwrecked on an unknown island.  He writes:

Say that [Crusoe] has a pile of goods to take from the ship. He has put together a crude and insecure raft that he can use to float some goods back to shore. The ship is slowly sinking, so he has limited time. A storm is coming up over the horizon. He can’t grab everything. What does he take? What is most valuable to him? Obviously, he makes his decision in terms of what he thinks he will need on the island. . . .

The value of a tool as far as he is concerned has nothing to do with the money it cost originally. He might be able to pick up a sophisticated clock, or an expensive musical instrument, but he probably won’t. He would probably select some inexpensive knives, a mirror (for signaling a passing ship), a barrel (for collecting rain water), and a dozen other simple tools that could mean the difference between life and death.

In short, value is subjective. . .  the value of the [tools he selects] is completely dependent on the value of [their] expected future output. . .  Then he calculates how much time he has until the ship sinks, how much weight each tool contributes, how large his raft is, and how choppy the water is. He selects his pile of tools and other goods accordingly.

There are objective conditions on the island, and the various tools are also objective, but everything is evaluated subjectively by Crusoe. He asks the question, “What value is this item to me?” His assessment is the sole determining factor of what each item is worth.

North then wonders: What if Crusoe knew the captain had a chest full of gold coins?  Would he go back to the captain’s quarters and drag the chest to the edge of the ship and attempt to lower it onto his raft?  Unless he expected to be rescued soon, he would not.  Gold coins would be of no help to a man marooned indefinitely on a desert island.  In Crusoe’s case,

Gold isn’t wealth. It’s heavy. It displaces tools. It sinks rafts. It’s not only useless; it’s a liability.

This is how North introduces the reader to the distinctions between objective reality and subjective preferences, and to the fact that money arises only in a social context.  With no one to trade with, poor Crusoe had no need of it.

What is money and where did it come from?

In subsequent chapters he builds on these ideas.  Money is a universally-accepted medium of exchange.  Originally, it was not imposed from above but evolved from competition with all other goods on the market, as the good most acceptable in trade.  Over the centuries, gold and silver became the most commonly used monies.

We know what money is worth right now because we observed what it could buy yesterday, and for this reason we expect it to have purchasing power tomorrow.  If we march back in time, (following Mises’ argument, as articulated by Robert P. Murphy) we can use the previously observed purchasing power component of this commodity we call money to explain the derived expectations of it.  If we continue going back, day after day, we reach the point at which this commodity was just a widely accepted medium of exchange (not yet money).  Going back further still, we reach the point where the first person accepted it as a medium of exchange.  From there, it became more acceptable because someone had previously accepted it not for consumption but to trade away for something else.  Prior to that, this commodity that is now money was valued strictly for its use in direct exchange.

Thus, money evolves from a commodity used in direct exchange, to a good used in indirect exchange, to a widely used medium of exchange, to a universally accepted medium of exchange.   

What about the supply of money?  Who determines that?

If we have honest money, the market controls its supply.  In today’s world it’s a committee.  Just as we wouldn’t want a committee to set prices for us, North says, “why should it be allowed to control the supply of money in which all prices are quoted?”

There’s another question. How do we know that the committee will act only in behalf of us citizens? How can we be sure that the committee won’t start fooling around with the money supply in order to feather its own economic nest?

Fooling around with the money supply was more difficult when money was a precious metal.  Yet, fraudsters found ways to cheat.  Normally, the weight of the money would be far lower than the weight of the item being purchased, and the seller could adjust the scales to make the money even lighter and the product heavier.  Interestingly, North tells us that God delivered men from bondage and has the power to enslave them again if they cheat in money matters.  For Christians, is central banking an expression of God’s wrath?  Whether it is or not, our arrangement with the Fed is a form of enslavement.

Fraudulently adjusting the scales is an attempt to get something for nothing.  Coin clipping and coin debasement are likewise early entries in the cheaters‘ bible.  Paper money issued as pseudo-receipts for commodity money inaugurated a new era of theft: “A counterfeit coin . . . can be weighed.  A piece of paper looks just like other pieces of paper.” And the biggest cheat of all are the government-issued fiat paper currencies that have proliferated the world since August 15, 1971. 

A complacent public

But what about the hapless public through all this?  Will they ever revolt?

Not very often. The public decides that paper money is money, not pieces of shiny metal. If paper is acceptable by the store down the street, then who cares? Who cares if prices go up, year after year? What’s “a little” price inflation? We’re all doing better, aren’t we? . . . .

“Inflation can’t hurt anyone too badly” is a delusion of fully employed younger workers. It can hurt everyone who isn’t staying ahead of it with pay increases, and I mean after-tax pay increases.

Inflation acts as a turbocharger for the progressive income tax.  The latter was passed in 1913 with rates so low and applied to incomes so high that almost no one worried, just as no one worries about a little inflation.  The average family made $1,000 a year, but the tax didn’t kick in until the $20,000 level, and even there it was only 1%.  Those few who made $500,000 or more were “soaked” at only 7%.

But once the law was in place the politicians changed the rules.  Imagine that.  In 1916, while Woodrow Wilson was bragging to voters about keeping us out of war, the top rate was bumped to 15%.  The following year, while Wilson was shipping American men “over there,” the bottom bracket plunged from $20,000 to $2,000 while the top rate reached 67%, then 77% a year later. 

Here was their plan: lower the level of taxable income, and increase the rate of taxation in every bracket. Next, inflate the money supply, so that everyone is pushed into higher and higher taxable brackets. The higher your money income, the larger the percentage of your income gets collected by the State.

And as Rothbard has noted,

As luck would have it, the new Federal Reserve System coincided with the outbreak of World War I in Europe, and it is generally agreed that it was only the new system that permitted the U.S. to enter the war and to finance both its own war effort, and massive loans to the allies; roughly, the Fed doubled the money supply of the U.S. during the war and prices doubled in consequence. [p. 120]

Inflation is another name for counterfeiting.  Counterfeiters create money from nothing then spend it.  The private counterfeiter and the government counterfeiter have the same goal: to get something for nothing.

The public doesn’t trust private counterfeit money. The public does trust government counterfeit money, at least for a long time, until people’s trust is totally betrayed (mass inflation).

What is the difference in principle between private counterfeiting and government counterfeiting? None.

A Tale of Three Counterfeiters

One of the most memorable parts of Honest Money is North’s tale of the counterfeiters.  Counterfeiting is evil, right?  It’s an act of swindling others.  But it acquires a high moral luster if it’s practiced in plain sight by the right people.

In North’s tale three men counterfeit and are discovered.

The first one is a businessman with an offset printing press who prints 500 $20 bills and spends them into circulation. 

The second man is an employee of the Bureau of Engraving and Printing who prints a million $20 bills, and the government spends them into circulation.

The third is the chairman of a major New York bank that has loaned a billion dollars of fractional-reserve money to Pemex, the oil company owned by the Mexican government.  Pemex cannot meet interest payments on the loan because the price of oil has collapsed.

What happens to these three men?

The businessman is convicted of counterfeiting and sent to prison.

The government employee continues to print money until he reaches age 65, when he retires and collects a pension.

The bank chairman calls the Fed, who in turn calls the Mexican government to get them to issue a bond for $25 million.  The Fed subsequently creates $25 million to buy the bond.  The Mexican government sends the money to Pemex, which then sends it to the New York bank to meet its quarterly interest payment.  “The chairman of the New York bank gets a round of applause from the bank’s board of directors, and perhaps even a $100,000 bonus for his brilliant delaying of the bank’s crisis for another three months.”

The $25 million then multiplies through the U.S. fractional reserve banking system, creating millions of new commercial dollars in a mini-wave of inflation.

The World’s Most Powerful Insurance Company

Counterfeiters need protection if they are to succeed.  The biggest counterfeiters, the major banks, sought and established the protection they wanted in 1913, with the Federal Reserve System.  The details of the Fed were developed in a highly secret meeting of banking elites and a U.S. senator held at Jekyll Island, Georgia in 1910.  For years, the Fed’s defenders not only denied the meeting took place, but regarded any suggestion that it did as laughable.  In 2010, the denials were long forgotten when Fed officials met at Jekyll to celebrate its founding. 

The Fed’s public purpose was to prevent banking panics, as recessions were once called.  It was to create an elastic currency to meet the needs of business, through dispassionate and skillful management of the money supply.

The elasticity has stretched mostly in one direction - expansion - as the bank has created many hundreds of billions of dollars out of nothing since it began operations in 1914.  Under its watch, the economy has experienced at least 11 recessions over the last century, including the longest one on record, 1929-1945.

From 1930-1933 6,000 banks failed, only one of which was considered a major bank, The Bank of the United States.  Unlike the other big banks, it was not an “insider’s” bank, but was financed mostly by small merchants, especially Jewish merchants.  The state of New York shut it down in 1930, North tells us.

One of the greatest services the Fed does for government is monetize its debt.  When the federal government can’t raise taxes without facing a tax revolt and borrowing from private sources would entail high interest rates, it calls on the Fed to buy its debt on the cheap. 

The Treasury creates the debt certificates (usually on a computer entry: liability). The central bank buys them by creating another entry: money. The computer blips are swapped. . . .

The money is then used by the government to buy whatever it wants (mainly votes). This new money goes through the economy. If the banking system is a fractional reserve system, the money multiplies many times over. This is the process of legalized counterfeiting we call inflation.

The Fed doesn’t buy the government securities directly.  It buys them from a select group of about 20 banks and securities trading firms in New York City, who collect commissions from the trades. 

Question: Why doesn’t the Fed buy these bonds directly? Answer: because it couldn’t generate commissions for the favored 20 banks.

Conclusion

Honest money is not necessarily a gold - silver standard, North says.  “The only standard that matters is the no fractional reserves standard, coupled with the no false balances standard.”

Honest money is the product of honest people.  “[It] requires honest law and people who are self-disciplined. Let the people have what they want, just so long as it is morally valid, non-fraudulent, and non-coercive.”

As long as the Fed is around, we will never have honest money.  The purpose of the Fed is to inflate for the benefit of its friends: the big banks and government.  Honest money is a rare commodity and as such is an inflationist’s nightmare.  In light of this situation we should never question the success of government schooling.  Even today, there is widespread belief that the Fed is the nation’s number one inflation fighter, and few people would know how to disagree, including trained economists.

My recommendation: Give John Q copies of Rothbard and North.   Like me, he just might get hooked.

Very bad exchanges

An election in today’s welfare-fiat world is somewhat like gangs of people pushing on a big sow in different directions, trying to get it to move their way.  So who won the pushing contest Sunday in Greece?  The media tells us it’s the conservatives, who will stay the course and keep the sow on an austerity diet once they form a new government.  But the losers are not without influence, and they don’t like this frugality business, so maybe the new government will only mostly stay the course.  They will negotiate with creditors.  They will attempt to exchange their present deal for something more pleasing to the also-rans.

In the perpetual crisis of modern banking and sovereign states it may seem that economics is an arcane art beyond man’s comprehension.  Yet, its mystery is purely man-made.

In its broadest sense, economics can be thought of as the study of exchanges.  This is how it is defined by Robert Murphy, author of an unusual textbook called Lessons for the Young Economist.  It’s unusual in that it’s methodical without being tedious.  In fact, it’s downright fascinating.

The economists who were blindsided by the 2008 crisis were neck-deep in charts, aggregates, and bad theory they believe in to this day.  They tell us no one saw the train coming, so if everyone was blind, no one was blind.  The train wreck was just an unfortunate reminder that economics is hard stuff.  Better to leave it to the experts at the Fed and other places where high IQs run rampant.   

Problem is, economists of the Austrian school, such as Murphy, saw the train coming as soon as it left the station.  Every train that leaves the interventionist station has its fate written in economic law, as expounded in the works of Mises, Hayek, Rothbard, and others, including Ron Paul.  Everything that has happened in the past decade, and longer, has had all the suspense of a bad novel - for Austrians.

Did the Fed inflate pre-crisis?  Like mad.  Perhaps at Paul Krugman’s suggestion, Alan Greenspan created a monster housing bubble to replace the dot-com bubble.  Did it inflate in response to the bust?  Bernanke spiked the monetary base.  Are investors calling for even more monetary pumping?  The ones calling for QE3 are.  And there are countless nervous others hovering around the panic button ready to join them.  Will this pattern ever end?  Yes - and there’s an unspoken terror behind that thought. 

Murphy’s book, though geared to bright middle schoolers, provides the tools for understanding what the interventionist crowd seems unable to grasp, which is this: Unhampered markets have built-in regulatory mechanisms that keep the train on the tracks.  And the issue at stake could not be more critical.   As we read on page 9:

Unlike other scientific disciplines, the basic truths of economics must be taught to enough people in order to preserve society itself. It really doesn’t matter if the man on the street thinks quantum mechanics is a hoax; the physicists can go on with their research without the approval of the average Joe. But if most people believe that minimum wage laws help the poor, or that low interest rates cure a recession, then the trained economists are helpless to avert the damage that these policies will inflict on society.

The world’s policymakers as well as the people who suffer under them could benefit enormously from committing that passage to memory.  We have, in essence, exchanged sound economic principles for very bad ones - ancient fallacies framed in modern jargon - and are now wondering why the economic outlook is so threatening.

The idea of “exchange,” though, is not limited to the trading activities of individuals in which goods and services are traded for money or for other goods and services.  In every aspect of our lives we’re confronted with the possibility of exchanging the status quo for something else.  The exchange can be performed by an individual in isolation, such as the shipwrecked fictional character Robinson Crusoe who must build a one-man economy, or the change can be brought about by people acting together . . . as Greek voters did recently. 

Exchanging education for state indoctrination

In the early 19th century educational reformers began “exchanging” the Jeffersonian system of voluntary parental education for a more collectivist approach inspired by the despotic Prussian system.  Jefferson was a strong advocate of public schools for the poor, but an equally staunch opponent of compulsion in education.  Yet, by the end of the 19th century almost every state had compulsory public schools in which the “virtues” of obedience, equality, and uniformity were inculcated, sometimes violently, while independent thinking was discouraged or punished.

Given the educational system, should we be surprised that government inroads into the economy and our private lives take place without much resistance?

In 1913, we exchanged a high tariff for the income tax.  Then got the high tariff again later.

In 1917, we exchanged peace for war.  Then peace for war again a generation later.  And finally peace for perpetual war.

In 1933, we exchanged economic liberty for economic fascism.  It still bears the name of “free market capitalism,” though, which is useful for confusing people when the fascists in power screw things up.

After 2001, we exchanged freedom for security and are getting less of both.

But the biggest disaster has been the exchange of market money for political money, initiated in 1933 and completed in 1971.  Every American and dollar holder is now at the mercy of bureaucrats instead of Mother Nature.

In economics, all voluntary exchanges are win-win agreements at the time of the transaction.  Both sides to the trade believe they’re improving their lot, otherwise they wouldn’t agree to make it.  When politicians take to making exchanges for our benefit, however, we’re almost always on the losing side.  Someone must be winning, but in the end it’s not clear who.