One of the most difficult points to get across, probably the single most difficult point in
all of monetary analysis and monetary economics, is that the banks create money fly out of
thin air.
Because everybody's been inured to thinking that the banks really simply borrow our money
and re-lend it, it's very difficult to make the mind shift and realize that the banks
are really engaging in a species, in a form of legalized counterfeiting, in other words
for creating new money out of thin air, without having to sell goods and services, because
usually on the market, the way to acquire money is to sell goods and services in exchange
for it, or else convince people, I was just going to say con people, convince people into
contributing money to your organization of some sort.
In other words, either donation or purchasing goods and services.
Also on the market, the only other way to get money is to dig it out of the ground,
or to dig the gold out of the ground, which is also a hassle.
Another way, of course, of getting income, acquiring money, is the governmental way of
stealing it.
Whereas this is taxation.
Well, of course, you won't get a chance to analyze taxation in depth in these lectures,
because it's not part of basic economics, basic economics really covering the market
and various forms of interferences in it, rather than complete aberrations like taxation.
Another way of acquiring money is to print it or create it out of thin air by some kind
of trusted digitization.
The major single lesson of the analysis of banking is this is what the banks do, this
is what the commercial banks do, this is what so-called, it's known euphemistically as fractional
reserve banking.
Certain coin collectors sell coins to people and keep them for their clients as a service
and then lend the money out or don't keep them or accept and don't have really the money
there, this is a form of fractional reserve banking, creating fictitious claims or another
way of putting it in the form of embezzlement, to use a harsher but I still think accurate
term.
Because it's really equivalent to the old movies of the 30s, the old movies of the 30s
we have a typical bank manager, and the bank manager is scorned with some of the funds,
but not to have scorned permanently, he has a great tip on a race, a sure bet on the sixth
aqueduct or whatever, he can take this money, even though it's not his money, he's going
to invest it in the tip, and it's a sure win, and then he'll be able to put the money back
and pocket the interest, the pocket of the gain, before the bank examiner comes.
And usually what happens is of course the bank examiner shows up unexpectedly early
of Money and Nice Court and goes to jail.
But the point is even if that doesn't happen, he's still a crook, it doesn't make any difference
whether he's caught.
Crookery is objective rather than whether, a function of whether he's caught or not.
In the case of the bank, if you have a very similar situation, the bank feels, usually
correctly of course, that they're able to issue one form or another uncovered bank notes
or uncovered bank deposits or, looking another way, fake warehouse receipts, to issue them
And because they know darn well, through experience on the market, through statistical experience
or whatever, that not everybody is going to call for, because people have crossed this
bank and they think their money is there, and so they're able to get away with it for
some time.
My contention, however, is that it's really a form of embezzlement, this issue of uncovered
bank notes.
Fake warehouse receipts, because usually if you have a warehouse receipt, there's supposed
to be something behind it.
If you have a certificate saying that we will redeem your 10,000 bushels of wheat at any
time you ask for it, there's supposed to be 10,000 bushels of wheat there.
There's a division of opinion within the sound money movement, let me put it that way, about
fractional reserve banking.
Some of us think that fractional reserve banking should be illegal as being fraudulent on the
same basis as any other sort of fraud or embezzlement.
Others believe that this is not fraud or embezzlement and it should not be illegal.
They should be able to do this until the actual bankruptcy appears.
In other words, the people claim their money and don't find it.
I'm in the pro-fraud camp. In other words, the camp that says that this is fraud should
be outlawed. Even if we assume this is legal, which of course it has been for many years,
several centuries, even if we assume that fractional reserve banking is legal, even
allowing this, there is on the market certain severe checks, certain severe limitations
on the degree to which the banks can expand money out of the thin air. We now examine
these limitations under a system of so-called free banking, free banking being defined technically
as a system where the banks are allowed to engage in fractional reserve banking, are allowed to create money out of thin air, but of course have to pay up,
people come and present the warehouse receipt, obviously that's the key, I mean nobody can deny it's an open contract promising the redeemment,
and free banking is a situation where the banks have to redeem their pledge to pay up when the bank deposit or the bank note is presented to them,
on the other hand, are allowed to engage in what I consider fraud, but other people consider not fraud.
In this situation, in the situation of free banking, we would have a very hard money situation.
We would not have too much bank credit expansion.
There are three kinds of checks in the free market on this kind of activity.
One check or one limitation on bank credit expansion in the free market is that the people
just don't use bank credit.
People don't trust the banks.
They think they're a bunch of crooks and they don't use it.
This is a very healthy situation.
In most so-called primitive countries, it still exists people don't use banks.
People worry about them.
They feel something crooked about the whole thing and they're absolutely right.
and so they don't use it, they don't accept bank credit.
If you don't accept bank credit, if you're a seller or a lender or something, you don't
accept bank credit or bank deposit, well, you don't accept the check, you tear it up
and throw it in the guy's face, then the bank can't expand credit because nobody will accept
it.
It's like me printing a hundred Rothbards and trying to buy something with it.
It would not get a good reception among the tradesmen of the neighborhood check.
As a matter of fact, people do not get paid in checks.
I mean, workers didn't get paid in checks until very recently, really until World War
II.
Before World War II, workers got paid in cash and paper money.
Treasury...
Most people didn't have bank accounts.
The whole idea of bank accounts is what people worry of, correctly so.
The whole idea of everybody having a checking account only comes in after World War II.
I think in Europe workers still get paid in cash, at least until very recently.
Banks only come in on a big scale fairly recently.
They start, of course, with merchants and with industrialists, etc.
The average person does not have a checking account until quite late.
Of course, the establishment of the monetary establishment, the government and its allies
and minions are trying to push the idea of banking all over them.
They push the cultural idea that it's so primitive in the end, or so, if anybody can distrust
the bank.
We used to see movies again in the 30s when the old geezer had his money under the floorboards
in the form of gold or cash, or something, and refused to use the bank, distrusted claims
Bankers of the banks are fraudulent. Everybody laughs at them. Only intellectual liberals and solid citizens of the town laugh at them. Of course, he was right, and metaphysically at least.
That's the sort of culture that gets spread around. It's silly not to put your money in a bank. Banks are really great. They're advanced. They're progressive. They're civilized.
And anybody who doesn't do that is really sort of the same status as a Kuwaiti nomad. Of course, they were really right, and we were wrong.
It's not like the Ethiopian natives and the Kuwaiti natives, not only don't they accept
bank credit, they don't accept paper money either, they don't accept even their own beloved
government's paper, they don't accept any of this stuff, they accept only gold and sometimes
silver.
As a result of which these countries cannot inflate, they can't have runaway inflation,
because nobody will accept the stuff that they're printing.
It's a beautiful and healthy situation, I commend the American citizenry.
Okay, so that's one check on the bank, but of course this check has faded out, it's faded
out under government cultural pressure, fading away of sound money ideas and money for the
public and so forth and so on.
As a matter of fact, even in the 1820s and 1830s, when money first got printed, paper
money first comes in a large scale.
In America, in those days they made paper money out of rags, it was very high quality
paper.
Now, of course, it's much cheaper paper.
At any rate, they made it out of rag paper, and the hard money people would write in the
newspapers, they'd say, don't accept ragged paper, it's filthy rag money, the only really
The second limitation, which is my particular favorite, sort of God's angry man, the wrath
of God type of thing, is the second choice, the second limitation.
Unfortunately, most people don't see it that way, and those of us who favor bank runs,
as they are called, considered hard-hearted monsters, I have a certain love for the bank
run.
The bank run is a situation where you have, the bank has cash or gold or whatever, let's
take cash out including gold and paper, let's say cash is a thousand dollars, demand deposits
or bank notes, five thousand dollars, IOUs, four thousand, this is known as fractional
reserve banking, fifty percent reserves, the reserve to meet the demand deposit, five thousand
dollars is outstanding out there in the field so to speak, it should be redeemed at any
Any time people want to redeem it, the bank has $1,000 in their till to pay off.
The other $4,000 is out there making profits for the bank out of the demand depositors'
money.
It was making profits out of other guys' money.
The bank run occurs when the clients of the bank, the people who have already accepted
the bank, are either accepting the bank's notes or demand deposits, lose confidence
in the bank.
For some reason feel the bank is really bankrupt.
So as I read more of my stuff, I think there was a law, and I can't swear to this, I think
I think there's a law on the books right now, a federal statute, that it's illegal to spread
false rumors about the monetary health of a bank.
It's illegal to spread false rumors about a bank being inherently bankrupt.
Now, nobody spreads rumors about General Motors being bankrupt, but obviously they're not
bankrupt.
For any other business in a bank, the asset column and liability column, every business
knows they have certain accounts payable.
In other words, certain liabilities are due, say here's a corporation, it has a million
dollars due in six months.
So they make darn sure that six months from now, they'll have a million dollars coming in, so they'll be able to pay it.
This is known as keeping the time structure of their assets proportionate to the time structure of their liabilities, even better.
In other words, if your liabilities are coming in to pay off something in a year, before a year is up, you try to get the money in.
So you try to keep your time structure, your assets.
All corporations do this, and all businesses do this. You've taught this in every management course.
Only with a commercial bank, not only don't they do it, but they can't do it because their liabilities are immediate.
Their time structure is right now and their assets, of course, can't be immediate.
They wouldn't be making any money on it.
They'd be a 100% reserve bank instead of a fractional reserve bank.
So, their assets are coming in, you know, six months, a year, two years, whatever it is,
and their demand, their liabilities are right now.
So, therefore, a bank is inherently bankrupt.
A bank run occurs when the people begin to realize, the clients begin to realize
that the bank is inherently bankrupt, they better get their money out fast,
because since the bank only has a thousand bucks,
five thousand bucks outstanding, you better be the first thousand to get it,
otherwise you're not going to get anything at all.
When this deep knowledge hits the consciousness of the public,
a bank run occurs, and it's a beautiful thing to watch.
It's just as triumphant.
One of the reasons why it's especially illegal
to force women about the inherent bankruptcies of a bank
is because I'm really in a state of illegality right now,
in the Bank of America, a free speech making this statement illegal.
If they took me to court and said it's illegal you're spreading false rumors about the bankruptcy
of the American banking system, I would say, no no, it's not false because they're inherently
bankrupt.
They would come out for their establishment of monetary theories claiming the bank is not
inherently bankrupt.
The judge will have to decide on the basis of high monetary theory, in which he's not
very well equipped.
So, the stacks are loaded against you. So, when the public finds out, the knowledge floods
into their consciousness, their brain at this damn bank in which they've invested their
life savings and bankrupt, then the run begins. Again, I go back to movies in the 1930s, classic
movies about bank runs, usually the Prussian, and suddenly rumors spread that the bank is
on sound, that they're losing money or whatever, they haven't got the money which people think
they've got, and then people start flooding into the bank, I don't want to get my money
They line up about five, six in the morning when the bank doors are open, they have lines
around the block, so each person goes up to the teller and demands his money.
The bank president or vice president is telling these people, these are false, wicked rumors
spread by communists and Bolsheviks, the bank is sound, don't worry about it, lying through
his teeth obviously, they have now seen through his prevarications and insisted on their money
and of course the bank folds very quickly, maybe in a couple of hours.
So many of the banks that have folded in this kind of situation, during the Great Depression
In 1929 to 1933, there were thousands of bank runs, the banks collapsing.
This, of course, is a beautiful check, a beautiful limitation, free market limitation on bank
credit expansion, because the banks know down deep in their heart that if the ratio gets
too low, people like myself will start spreading rumors and other people will start believing
it and start calling for their money and the whole issue of cards will collapse, because
it has to collapse.
Once people realize what's going on, it's got to collapse, because they ain't got no
money.
In American economic history, even among American economic historians, there's a great myth
of so-called wildcat banking.
We hear that before 1913 and before 1865, banking was free in the United States and
was wildcat.
It was a runaway inflation.
It was chaotic.
Total chaos prevailed.
Well, it's not quite true.
On the other hand, the offenders of wildcat banking claim it's really great because inflation
is important for economic development.
That's even less true.
Certainly, the reason why there were core wildcat banking is the Rothbard Bank had got
I've got no money at all, no cash. I issue $20,000 in Rothbard dollars. It says dollar,
redeemable in gold, you know, whatever, and here's the $20,000 bills and that sort of
stuff. I haven't got anything. I've got nothing. I've got peanuts. First of all, why will people
accept the money? Let's say they accept it. In the first place, I'm doing great as long
as they accept it. I'm spending the money, I'm lending it to my brother-in-law, whatever
it is, and everything is going great. The only problem is, what happens when people
The idea is to make your headquarters inaccessible.
If your headquarters or the bank offices are in New York City, Fifth Avenue or 42nd Street,
they'll find you very quickly and you'll go bankrupt fast before you can try to spend
this new money.
If, however, you're up in the wilds of what was then northern Michigan, Michigan was all
forest and jungle and all that in those days.
If you're up there in the wild with no roads getting up there, but only wildcats around
you and no people, then it takes months before the person can schlep his way to like your
bank headquarters and demand redemption.
That's why they were called wildcat banks.
These guys would sandwich themselves in the wolf in the woods and would take days of backpacking
to get there.
So that was unfortunate.
I think all these banks were fraudulent, but there was still a market check on them for
this reason.
First place, nobody really accepted.
If I established a Rothbard bank up in northern Michigan, the sophisticated people in New
in New York and Philadelphia, et cetera, wouldn't accept it.
They accepted a very huge discount.
In other words, one Rothbard dollar,
the Rothbard bank in Michigan would go for 10 cents in New York.
They would depreciate very rapidly,
and oil banks and all large merchants had weekly tables that would come out
listing the bank discount rate on the market.
The Rothbard bank would keep depreciating very rapidly
and finally go out of existence.
So there was a market check in that sense.
Secondly, they would circulate really at par right around northern Michigan,
The government steps in and says, you don't have to pay up.
This used to be called suspension of specie payments, which is a very highfalutin name
for allowing for a monstrous situation, allowing the bank not to pay up, but at the same time
the bank continues operations.
The bank is printing new money, the bank is being able to force their own debtors, the
guys who borrow money from the banks, they're still forced to pay money to the banks, but
the banks themselves are now exempt from any payment.
They're completely cut off from the legal contractual obligation of redeeming their
money.
Now, this situation has occurred in every depression in American history.
It started, well, the first banks on a massive scale really begin the War of 1812.
Before that, there were very few banks within the Mount of the Hill of Beans.
The War of 1812 was a very unpopular war that was fought essentially by the western states.
The New England states, which had most of the money, most of the capital, etc., were
against the war, so they couldn't borrow from the New England capitalists.
So the way the government financed the war effort was essentially by encouraging new
New banks are coming with no money, sort of like Rothbard banks, and they print a lot
of money and lend it to the government, buy government bonds, and the government would
take the money and spend it.
Now, unfortunately for the government, they had to spend it on manufactured products,
munitions, etc. in New England, because New England has the center of most of the manufacturing,
so the money found its way to the New England banks, who are non-exploitationary banks.
The New England banks then call upon the upstart Pennsylvania and Kentucky banks for redemption.
They didn't have the money, and then what was going to happen?
They were going to go bankrupt.
The Federal Government couldn't afford that because the whole war effort was being financed
by these guys.
On the Black Day of August 1814, the government issued a suspension of fee sheet payment as
a wartime emergency measure, allowed the banks to continue operation and new banks to come
in without paying anything.
They didn't have to pay a nickel.
This suspension of fee sheet payment continued long after the war was over.
The war was over in February 1815.
The suspension was allowed to continue until approximately March 1817, in other words, two
In the last two and a half years, we had a banking situation where not only were the banks committed to engaging fractional reserve and wildcat banking, they didn't have to pay up.
They could force their own debtors to pay up. They didn't have to pay a nickel.
It was an unbelievable situation.
There were then two schools of thought on how to solve this question.
The minority school of thought, headed by one of my own particular favorites, John Randolph of Roanoke, a marvelous old geezer,
And Daniel Webster, who at that time had to be pretty good on the question, kept changing his position in accordance with who bought him at the moment.
At any rate, he was, some good guy bought him at this point.
So Webster and Randolph gave great speeches in Congress saying, the only way to cure this is to force the banks to pay up.
If they don't pay up, they're bankrupt. That's all. Smash them.
And then you return it with sound specie currency.
But instead of that, the government took the easy way, and they set up a simple bank for the first time.
for the First Bank and the Second Bank of the United States, the Second Central Bank,
to pump more money to the system to allow the banks to return the specie payments, pay
them off, so to speak, and pump more money to the system so the banks can then use the
Central Bank notes as money.
And this could allow the inflation to not only continue, but they would even expand
after that and cause the first Great Depression in the United States, the Panic of 1819 as
a result.
So in every succeeding crisis, financial crisis, the government, state and federal governments
have allowed the banks to suspend species payments for the duration of the depression.
This happened in 1819, it happened in 1837, it happened in 1957, etc., etc., etc.
All the way down to 1933 when Franklin Roosevelt declared a bank holiday as soon as he came
in.
Now here we had a great opportunity.
Here was the last great opportunity we had in the United States to smash the fractional
reserve banking system.
It busted.
The whole system was collapsing.
The public had finally realized the banks were really bankrupt, so it runs on all the
banks.
All the banks were caving in.
At that point, all the banks could have been smashed. We could have gone immediately without any real hassle.
We could have gone right over to a pure gold standard system, 100% gold system, right then.
Instead of that, Franklin Roosevelt comes in and saves the banks by declaring a bank holiday.
In other words, allowing the banks to continue operation and to get money from their debtors,
and yet they themselves don't have to pay a nickel.
Hoover was going to do the same thing, so we can't blame it only on Roosevelt,
since Hoover and Roosevelt were ideological twins, feeding them and feeding leaves.
Mike Holliday saved them and then the thing that finally saved them permanently was one of the most monstrous acts of the new deal, which Milton Friedman is all in favor of.
The Federal Deposit Insurance Corporation system, coming in 1933, which now underwrites all the banks.
In other words, the FDIC guarantees that all demand are passed up to, I think, now $20,000.
So if a bank goes bankrupt, the FDIC will pay you off.
or even though the FDIC doesn't have the money, of the hundreds of billions of dollars in
deposits outstanding, the FDIC maybe has a couple of billion and even that's not in cash.
They don't have $605 billion, the FDIC has a couple of billions and that's mostly invested
in government bonds, but even though they don't have the money, the wisdom of the public
in a sense is correct.
In other words, the inherent folk wisdom of the public is correct in that they don't have
to have the money right now because the government, the Federal Reserve system can simply print
The FDIC has now wiped out the bank run check on the free market bank run limitation on
bank credit expansion.
The FDIC has managed to eliminate that, even though some widows and orphans and bank depositors
are salvaging the situation, this is at the core of wiping out, creating a system of potential
and the Runway Inflation for the whole country.
So now the government has managed to eliminate the runs on the banks because of the FDRC
and also the whole bank holiday or suspension of the species payment tradition.
Because you get to the point, you see the banks are about ready to collapse and the
government says we can't let the banks collapse.
There's too many depositors.
They're too important.
It's like the current tradition.
We can't allow any large corporation to collapse for similar reasons.
So when this tradition gets in, they have the end of the free enterprise system in the
The Bank Run tradition is out, which leaves us with only one free market check remaining
so far.
The final free market check, the first two free market checks, people not using the bank
credit at all.
The second check is runs on the banks, in other words, where the clients themselves
of the banks lose confidence.
The third free market check is non-clients redeeming, clawing upon the bank for redemption.
Here you have our hypothetical bank, Cash 1000, Manoposites 5000, IOU 4000, this is
the Bank of Brooklyn or whatever, Bank of Northern Michigan, whatever it is, let's say
the clients have perfect confidence in the bank, no problem about bank runs, the clients
believe in the bank heart and soul, but what's the problem here is there are other people
around who are not clients of this bank or clients of other banks, say this is the Bank
of Brooklyn, here's the Bank of Queens, well, some guy might take his $2000 of his demand
The bank deposits and write out a check for a car, pay it to somebody living in Queen's
who happens to be a client of the Bank of Queen's.
In that case, the Bank of Queen's will take this $2,000, call upon this bank here for
redemption.
You want the $2,000 in cash.
And they have got the $2,000.
They only have $1,000 and the bank goes bankrupt.
So the final limitation, the most important limitation in practice was the fact that the
bank doesn't have unlimited number of clients.
as an international trade. International money, one country expands money too much, either
bank money or paper money. If England, say, expands money a lot, and France has not expanded
it, but money supply goes up in England, prices go up in England, money will then flow out
because the French prices are now cheaper than English prices, money will start flowing
from England to France. In other words, people will buy a lot more French goods and French
will buy a lot less English goods because of the high prices. Money will flow out from
of England and France, England will then have a so-called deficit in its balance of payments,
France will have a so-called surplus in its balance of payments, and this flow will continue
until the two prices are equalized, in other words, until English prices fall, French prices
go up until the two prices are equal, in other words, the two price levels of the purchasing
power of the gold ounce, let's say, in England and France are the same.
So in other words, the check in international trade on any one country's inflation, the
The big check is that gold will have to flow out of the banks to the other country, and
then the banks have to contract.
In other words, if you're building, you have a pyramid, the base of the pyramid is gold,
on top of that is, say, paper money of the treasury, on top of that is bank credit, or
bank deposits.
As you expand more, as banks expand more and more, or as the government expands more and
more, the top of the pyramid keeps going up, prices go up, and then the bottom of the pyramid
starts declining as gold flows out.
and so the ratio of unsoundness keeps increasing, in other words, 20% will go down to 10%, those demand deposits go up while cash reserves keep going down and the banks will finally have to stop this, otherwise they go bankrupt and they contract and then the whole thing is solved again.
Gold flowing out is the method by which the equilibration process in international trade takes place.
Eventually the deficits and balance of payments get cured, so to speak, and the price level is equalized.
Well, it's a similar situation here with one bank, you see, this is like a David Hume species
flow price mechanism within the country.
One bank expands and immediately starts losing, can't lose gold so much because it's supposed
to be on a paper currency, still lose paper, you're losing cash.
This bank will start losing cash because its clients will take this new money and spend
it on other clients of other banks, and if that happens, the other bank will fall upon
this bank for redemption, this bank goes bankrupt.
Consider, for example, a polar case here.
A polar case would be when every bank has only one client, in other words, extreme competition
among banks.
Everybody's got his own bank.
Of course, it's not very practical, but let's say it happens.
I'm a client of one bank, each of you a client of some other bank.
With each bank having only one client, no bank could really expand at all because as
soon as I spent any money at all, the other guy would immediately call upon my bank for
redemption.
This bank expands. It expands its credit. It's at $4,000. I take this $5,000 check.
As soon as I spend it, somebody will call upon my bank for redemption.
And that's true. There could be a cartel of banks. The banks will all get together and agree to accept each other's notes and not call upon each other.
That could happen, but it's a flimsy read for bank credit expansion to continue for any length of time.
So what about this check? Well, this check, this limitation, having a lot of non-clients.
Well, first place, this doesn't exist. Of course, we have only one bank.
We have only one bank in the whole country, or better still, one bank in the whole world.
Every bank, every local bank on the corner is a branch of the bank of the world, that's
that.
Then of course the bank can expand forever, I mean it can immediately multiply 5 to 1,
10 to 1, 20 to 1, as long as there are no bank runs, which we have ruled out, the bank
can just expand merrily forever because no other bank will call upon it for redemption,
it's just one monopoly bank.
So the more competition there is between banks, the better off we are in this situation.
There's more of a check, a bank credit expansion.
Knowing this, realizing this, the bankers themselves have gotten together, knowing also
the cartels in the free market don't work too well anyway, have gotten together and
put over upon us, just as big business put over upon us, government regulation, the guise
of being anti-monopolistic, but actually in order to impose monopoly and cartelization
in the Middle of the country.
So in the same way the banks got together and imposed upon us the great progressive
tradition or innovation of central banking, which has enabled us to arrive at a situation
where the central bank can eliminate any bank required upon each other for redemption by
getting every bank to expand together, uniformly and smoothly together.
Supplying reserves and supplying cash so that no bank will get into trouble and everybody
can sort of gently and smoothly tow and run away in flight.
Just as the regulatory commissions, the ICC and the antitrust laws and all that were put
in, in order to impose monopolization or cartelization under the guise of being anti-monopolistic,
a great con-job of being anti-monopolistic, to sell it to the public.
So in a similar way, several banks were sold to the public under the guise of restraining
bank inflation.
We need several banks, the story was, in order to restrict bank credit to keep these vicious
private greedy small banks from inflating the currency.
of Money.
Therefore, we need a wise governor out there, a central bank, to stop it.
So that was the way that central banking is sold to the public.
An actual fact was, the other way around, they put in central banking in order to permit
inflation.
You know what, even they call in their own private writings, elasticity of the money supply.
For the Federal Reserve system, for example, the money supply was not elastic enough.
Elastic is a fancy word meaning it wasn't inflated enough.
During the Depression, there was no way to stop pumping money in quickly.
The Federal Reserve Bank could do that. Central Bank started with the Bank of England, one of the great racquets of all time, the Bank of England, therefore became immediately hallowed in English tradition as almost equivalent of the queen and the flag.
The Bank of England started in the late 1690s, but we start pretty late in monetary history, when a Scottish crook named Wynion Patterson, a promoter with no money and that sort of stuff, comes to the king, the king's always in need of money, right?
People don't like to be taxed.
Those days, they had a lower boiling point on the tax question than we do now.
So the king was very wary about imposing taxes.
Here's a Scottish crook, William Paterson, comes to the king and he says,
Look, here's the way to do it.
Let me set up this bank, we'll call it Bank of England, make it a central bank.
I haven't got any money, but I'll print bank notes, Bank of England notes,
and you will accept it.
I will give it to the king in exchange for government bonds.
The king will write out, I'll use it.
See, then, King, you can take the money and spend it. You can spend it on missiles or whatever the 17th century equivalent was, palaces and stuff like that.
But King says it's a great idea. It's a great way to get money. As long as the public can accept, will be conned of accepting Bank of England notes, why not?
Make new steps forward.
Because it didn't look like paper money.
Because the banks sounded more respectable. Banks, after all, were around a lot earlier than paper money.
And this looks like a pretty respectable thing. It looks like a bank note and all that sort of stuff.
The public have been a newer to it.
The King gave the Bank of England all of his business.
He deposited all of his funds with the bank.
Let's say the Bank of England starts off with no money, which is not so far wrong.
The bank quote buys, unquote, government bonds.
The King issues a whole bunch of government bonds. No one can issue a bond.
It's Rothbard bonds.
The King issues government bonds. The bank quote buys it, unquote, let's say 10,000 pounds worth.
So now the Bank of England has £10,000 of government bonds and its assets, its laws,
a return for which the Bank of England graciously gives to the King $10,000 of new paper money printed by the Bank of England.
Now we have $10,000 and we have bank notes, which is an equivalent of demand deposits.
The King goes out and spends it. This is new money. I mean, the money created out of thin air again.
So let's assume that both the King and William Patterson start with no money at all.
The King gives Leon Paterson his bonds, Leon Paterson gives the Prince a new banknote, the
King goes out and spends it, and his inflation is inflationary, and the King uses the method
of taxation and so forth.
All the evils of inflation then follow.
The point I'm trying to make here is of course that the Central Bank, this has always been
what the Central Bank is doing, and this con job is still continuing.
As a matter of fact, you know, and one more thing the King did for the Bank of England,
The King gave to the Bank of England a monopoly of all banknotes within a certain area of
London, something like a 50-mile radius or something in London, which means that in the
real area where all the trade and finance goes on, only the Bank of England could print
banknotes.
This is the key to the Bank of England's power, except for banking control, because this method
for Lloyd's Bank, Barclay's Bank, or whatever other bank, to no longer issue banknotes near
London, they could, let's say, issue deposits.
In order that the customers want cash, they're not allowed to give them cash. They're not allowed to print banknotes.
They have to go to the Bank of England to get the banknotes.
And this gives the Bank of England its hole on the other banks. We'll see how that works in a minute.
So this starts a great central banking tradition.
One of the real tragedies is that during the 19th century when English classical liberalism was triumphant in England,
and laissez-faire was coming in, and even hard money theory was coming in,
They even record how it was pretty good on the money question.
Never really leveled the land, never really smashed the Bank of England, never really was,
didn't have the guts, it didn't have the, didn't want to break the tradition and all that.
Refused to really do what the Maoists call, carry the thing through to its completion,
refused to really smash the Bank of England, left it as a great symbol of national unity or whatever nonsense.
The point is they kept the Bank of England intact, which is of course disastrous.
The United States had our first, Alexander Hamilton, who this is of course extremely tangential.
Alexander Hamilton, I consider the Mephistophenean figure in American history, the evil genius
American history, put through the first bank in the United States, plus a lot of other
things, the tariff and paper money and god knows what else, public debt, federal taxes
and the whole business, and the Constitution itself as a matter of fact, the general welfare
clause and the whole business going on and on about Alexander Hamilton.
Anyway, first Bank of the United States comes in, that's the first central bank, but when
the Jeffersonians come in, after all the Jeffersonians were pledged to eliminate the Bank of the United
States and they did so.
It was eliminated in the Jefferson administration.
Then, however, we enter the War of 1812, which the Achilles heel in the Jeffersonian program
because as the Jeffersonians were marching on the road to liberty, they suddenly detour
on the war and of course all the Federalist stuff, all the status collective stuff comes
back in.
And part of the thing that comes back in is the second Bank of the United States takes
It takes, then, Andrew Jackson a huge amount of turmoil to get rid of it, and Jackson finally
does get rid of it as part of his program, by the way, to get rid of all his fractional
reserve banking.
Jackson, and particularly Jacksonian theoreticians, were brilliant monetary theorists who knew
exactly what the banks were about already, and they were out to smash them.
For one reason or another, they were largely a slavery question, and they didn't do it.
At any rate, the Second Central Bank Attempt, smashed by Jackson after a huge fight, then
During the Civil War, the Republicans used the Civil War as a method by which they put
in the Hamiltonian program, and part of that program was taxing the state banknotes out
of existence.
So what they essentially did was they put a prohibitory tax on all state banknotes.
In other words, all banknotes chartered by the states, which meant that only nationally
chartered banks could now issue paper money, which was a very small number of banks.
So that was the road to perdition, and then the Federal Reserve system was finally put
in from 1913.
Since the Federal Reserve System, we now are caught up with other countries, we now have
this beloved central banking system, which we were told by the entire establishment would
eliminate inflation, depression, stabilize the price level, etc.
Of course, as Friedman has pointed out in his historical book, the fluctuations, the
inflations of depression have been much worse since the Federal Reserve System came in than
they were before.
There's no question about that.
During the 1920s, it was supposed to be the new era, where no more depression, there weren't
going to be any more depressions anymore, they all said in the 1920s, because the Federal
The Federal Reserve banks are out there stabilizing everything and wisely planning a system and
of course comes a big collapse and you don't hear any more of those people for quite a
while.
So we now have the federal bank working and manipulating so as to eliminate these individual
checks from one bank to another and that means that the only check left are no more free
market checks or free market limitations on bank credit expansion.
The only limitation now is the Federal Reserve system itself and it's wisdom, in other words
and Legal or Administrative Regulations, which means we have to put all of our trust in the
government itself, which is, of course, something which I'm never eager to do.
Well, here's the mechanism I wish the control comes about currently, since the Federal Reserve
system.
Cash is now, or reserves are now only, of course, paper, since the gold standard has
been abolished in 1933.
We now have two sets of banks, basically.
The Federal Reserve Bank is a commercial bank with its assets and liabilities column and
then underneath it we should have the Federal Reserve Bank with their assets and liabilities
column.
The Federal Reserve Banks are bankers' banks, so the Federal Reserve Banks are compulsory
banks without commercial banks.
Every commercial bank, first of all every nationally chartered commercial bank, every
state bank over a certain amount has to be a member of the Federal Reserve System.
They don't mind that.
I mean the banks love the Federal Reserve System, the sweet compulsion so to speak.
As a matter of fact, the banks put in the Federal Reserve System, it was a large bank.
And then the other key thing is the Federal Reserve System, the Federal Reserve Banks
now have a monopoly on old paper money, in other words, whereas before 1913 Chase National
Bank and National City Bank issued their own bank notes, if you wanted cash, if you had
a checking account in Chase Bank then, you wanted cash for some reason, you know, you
want to pay people in cash, you could go to the Chase Bank and get the Chase Bank bank
bank notes, dollar bills with a Chase bank stamp on it, Chase bank insignia, etc.
And most people didn't care whether they had Chase bank notes or federal paper.
In 1913, this was made illegal.
The only institution that could supply paper and money to anybody is the Federal Reserve
Bank itself.
So that means when somebody wants to cash in their bank notes, the man deposits, the
checking account is the only liability left since bank notes have been prohibited.
The bank has to go to the Federal Reserve Bank to buy banknotes, basically.
This becomes the key to Federal Reserve control.
One of the banks has to join up, of course, with the Federal Reserve system, but two even
more so, that since they can't issue banknotes on their own hook, they have to go to the
Federal Reserve Bank to get banknotes, to buy banknotes by going down their own deposits.
So what we have is we have people, individual people in the public, with demand deposits,
checking accounts for the bank.
and so on.
Leave aside savings accounts as being a complication, we can't go into it here.
Well, then there's IOUs and then there's cash, which now is not so much paper money,
but demand deposits by the bank at the Federal Reserve Bank.
Think of the Federal Reserve Bank as a banker's bank, as a bank which only commercial banks
can have accounts in.
So we have reserves which are demand deposits at the Federal Reserve Bank.
The bank itself, I mean, commercial bank, Chase Bank and Hand Bank has very little cash
on hand, just enough to pay out, you know, hour-to-hour stuff.
Their deposits at the Federal Reserve Bank, their claims aren't cash.
If they have, in other words, let's say the bank has a million dollars reserves of the
Federal Reserve Bank, this means that the bank, if they wanted to, the Chase Bank, they
could go to the Federal Reserve Bank and get a million dollars' worth of cash and paper
money if they wanted to.
Basically, the money is in the reserve account, and then there's IOUs and demand deposits.
The Chase Bank has reserves of $1 million, demand deposits of $5 million, and IOUs of
$4 million.
So we have the Chase Bank multiply the money supplied by fivefold.
Cash or demand on cash is $1 million, issues $4 million worth of IOUs, runs out $4 million,
has $5 million and outstanding, which means it is a pyramid of money supplied by 5.1 on
its own hook.
I'm trying to look at a balance sheet of the bank on a paper because they have to have
quarterly or something balance sheets.
See what the reserves are of a cash or reserves in relation to the man deposit and also the
prime deposit and you see the story.
Fractional reserve banking has worked.
So essentially the commercial bank has three major items in its balance sheet, IOUs, reserves
and demand deposits and liabilities.
The Federal Reserve Bank has demand deposits owed to the bank.
Bank, in this case it will be the same one million, in other words, let's say they have
the Chase account, these two will be equal, whereas the reserve account of the commercial
bank will be exactly equal to the demand deposit liability account of the Federal Reserve Bank,
the same thing.
It's the checking account which the banks have of the Federal Reserve Bank.
The other big Federal Reserve Bank liability is Federal Reserve notes, in other words paper
money.
Almost every dollar of paper money is now Federal Reserve notes, virtually 100 percent.
The Federal Reserve notes are legal tender.
We have to accept them by law for payment of debts and dollars.
They have a name, dollar, so to speak.
The Federal Reserve bank is the only institution in the country which every time it creates
a new liability, a new debt, so to speak, it prints new money.
In other words, it adds its own money supply at the same time it creates debt.
We can't do that of course.
When we issue a debt notice, we issue an IOU, we borrow money or something, we don't print
new money at the same time along with it, but the Federal Reserve does.
So these are the two basic liabilities.
The man deposits to the banks, in other words bank reserves and Federal Reserve notes.
The asset side, Federal Reserve banks have gold, virtually all the gold in the country,
a rather gold certificate for the treasury owning the gold, that's really formality.
And the rest of it is IOUs, and these are the two basic assets side.
In this situation, supposing $800,000, supposing Christmas time comes and every year at Christmas
people want more cash, they draw down their demand deposit, get more cash, give tips and
presents and all that kind of stuff.
Well in that situation, here if people want $800,000 worth of cash from a chase bank at
this point, the reserves are drawn down at $200,000 and the demand deposit will be down
The Federal Reserve now steps in with its own governmental check, namely the so-called
The minimum reserve ratio, in other words, the Congress fixes a certain range of reserve
rate, minimum reserve requirement by every bank, and the Federal Reserve can change it
at will within that range.
In other words, this is the same thing as the maximum ratio of deposits to reserves.
Minimum ratio of reserves to deposits, maximum ratio of deposits to reserves.
This situation here, if the Chase Bank has reserves of $1 million, and if say the maximum
The minimum deposit ratio is 5 to 1, the minimum reserve ratio is 20%, and therefore the maximum
deposit ratio is 5 to 1, and it cannot have more than $5 million on a $1 million base.
It's prevented by law and by administrative requirement from expanding the money supply
beyond that amount, beyond this 5 to 1.
See, now it's troubled because it's even deeper if we look at it.
People demand cash, if reserves go down to $200 million, it still has, however, demand
The Federal Reserve has a deposit of 4.2 million, which is 20 to 1, but if the reserve ratio
remains at 5 to 1, this bank is bankrupt, this bank has had it.
We have the Federal Reserve controlling banking system by minimum reserve ratio or maximum
deposit ratio.
During the Great Depression, the phenomenon of excess reserves came up, which meant the
banks were so afraid, because the industries were going bankrupt all over the place, firms
were going bankrupt, banks were so afraid to expand, they didn't even expand whatever,
They didn't perform the legalized counterfeiting that they could perform, and they allowed
the reserves to pile up, because they were scared, I mean, they were afraid if they lend
the money out, the firm would go bankrupt, they bought bonds, the bonds would become
worthless, so then they really go bankrupt, so the reserves pile up, of course the Hoover
administration, Roosevelt administration, bitterly attack the banks for somehow selling
out, for treason, for not lending out money, banks love to lend out money, the point was
that they were, there was a bad depression situation, it was obvious they were, in this
," and this is probably a unique situation. They didn't... they piled up excess reserves. They were literally attacked for it.
But barring that, this happens very rarely, most banks are quote, fully loaned up unquote.
In other words, they will create new money up to the limit that they're legally allowed to.
This is generally the situation, aside from deep depression.
One method of control, if the Federal Reserve System wants to say, put more money in the system,
they want to create more inflation, which they almost always do, one way they could do it,
The Federal Reserve, fiat money, fractional reserve banking, Human Action, Man Economy
In fact, we had during the 30s, something which has not been recognized really, the phenomenon
of inflationary recession.
We had a recession, deep depression, lots of unemployment, yet we had an inflationary
boom going on from 1933 to 1937.
It was a weird situation, the first time officially it had happened.
As a result of that, the Federal Reserve system got scared and suddenly double reserve requirements.
They nowadays would be unheard of.
It's like the Bazaar or the Supreme Market and Post Office, things like that.
Unheard of situation.
They just doubled, I think, from 10% to 20%, just like that, and of course the banks went
mad and they had to contract their loans very, very fast, because most banks were fairly
well fully loaned up, not completely, but in a bad state of shortage of reserves, which
meant they had to contract very quickly, sell their bonds, call in their loans, etc., etc.,
and this precipitated a big depression of 38.
After that, the Federal Reserve has been too scared to use this instrument by any kind
of enthusiast.
Nowadays, they change the minimum reserve requirements in very, very teeny steps, almost
ludicrous degrees, like one quarter of one percent.
It's sort of like a psychological thing more than anything else, the Federal Reserve wants
to announce to the world they really want to check inflation, they raise the reserve
requirement by a quarter of one percent, it's really, boy, it's really terrific.
I'd much rather see them double the reserve requirement, then I figure they're serious.
So really, this instrument has fallen into disuse.
It's sort of like, I suppose they consider it overkill, you know, it's like atom bombing
Bank of the United States, the Bank of the United States, the Bank of the United States,
The Federal Reserve Bank imposes a 20% reserve requirement on it, while supposing its reserves
are $1 billion, the man deposits $5 billion, the man deposits outstanding reserve bank would
be $1 billion, and its IOUs would be $4 billion.
Total money supply is $5 billion in the whole country.
Let's say the Federal Reserve wants to expand, wants to inflate, as they almost always do.
Let's say that by some means they increase, and I'm going into that a little later, how
they can control total reserves.
By some means they increase total reserves.
They get more reserves into the hands of the commercial bank.
I don't know if that goes up to two billion.
That would make it really rugged.
We'll see what happens.
Take the unusual hypothesis that the Federal Reserve prints more money out, prints cash,
and gives it to the bank of the United States.
One billion dollars more.
Unmarked Bills by Herbert Kumbach or somebody. Dead of Night. They get a billion dollars. What are they going to do with it?
Boy, oh boy, the financial reserve requirements are only 20 percent. They now have 40 percent. What they do is they simply go out and they create more demand deposits.
They go out and they say, hey, they go to General Motors, they go to John Blow. They say, I'd like some more loans to give you a really cheap credit because now they can create more money again.
They no longer fully loaned up. And they say, hey, that's terrific. Only 4 percent instead of 8 percent. Great. And whatever.
They now shovel out increased demand deposits of $10 billion out of thin air, create new
money out of thin air, new fraudulent demand deposits, warehouses, and now have $8 billion
in IOUs.
And everything is hunky-dory.
They're now fully loaned up.
This is an immediate situation.
Actually, this would be, the status would be a healthier situation than there is now,
but it's easy to understand.
Even the bankers themselves couldn't calm themselves into believing they weren't really
creating new money.
It's pretty obvious what they were doing.
The current situation, however, when you have competing banks, more cloudy, more complicated,
and every banker can caught himself into thinking he's not really extending money to buy, he's
really only borrowing money from one set of people and lending it out to another set.
It works something like this, we have a bunch of banks, A, B, C, D, they're all fully loaned
The Federal Reserve goes into debt at night, gives a new billion dollar bag to Bank A and
they have a billion dollars more in reserves.
It's now up to two billion.
They now have two billion dollars, let's say, plus a billion, one billion dollar more in
reserves.
Say, they give us a band deposit, they give Combox, or whatever, a billion dollars on
Bank A can't do that exactly all at once.
They can't just create a $4 billion new or more demand deposit and lend it out to General
Motors or John Blow.
If they do that, Bank B or Bank C, etc., I mean General Motors or John Blow will buy
equipment or pay workers or something, they'll be clients of different banks and they'll
call upon Bank A for redemption, they'd be going bankrupt because if they print $4 billion
more, quote, and they now have five billion dollars of more demand deposits.
What happens if the banks, VC&D, call upon them for the four billion, they only have one
billion.
They will go bankrupt.
So they can't do that.
They can't expand, in other words, by the full four billion right away, or by the full
five billion demand deposits.
What they can do, and let's assume it's a 20 percent reserve requirement, instead of
expanding by five to one right away, they expand by 80 percent, instead of creating
Bank B, they call upon Bank A for redeeming the 800 million, they have the 800 million,
they have enough, because they have two reserves of a billion, they can pay out the billion,
they now have, the reserves are now increased by only 200 million, and they're now all set,
they have demand deposits, this goes down also by 800 million, because that's the Joe
Blow's or whatever, you know, supplier's bank, and now the demand deposits are again
up by a billion, and the reserves are up by 200 million, they're all set, they've expanded
Bank A is out of the picture, however, what it has done is it has contributed $800 million
in more reserves which will now go into Bank B's pocket.
Bank B now has cash of $800 million, has reserves of the Federal Reserve of $800 million.
So, its reserves are now going up by $800 million, and if the man deposits the supplier
of General Motors has a man-aposite checking account, 800 million.
So, it's plus 800 million now, and plus 800 million demand-aposites.
What we have here, notice what's happened.
Bank A started with plus a billion reserves, plus a billion demand-aposites, it winds up,
it's plus a billion demand-aposites, plus 200 million reserves, and the other 800 million
reserves have been spread out, spread the reserves, it's shifted the reserves to another
bank.
Okay, the same thing happens to the other bank, except with 80% of the previous one,
20% less now.
It lends out $640 million, in other words, it can create, not five times as much money,
but 80% more money than it has.
Yet, it caused itself in the thinking it's only lending at 80% of the money it took in,
except the point is the money it took in is permitting on top of the other money.
It's really increasing its money by 80%.
It's in a situation now of 100% reserve banking, at least for the new money, and now it lends
out $640 to John Smith, grocer, and now has an IOU of $640.
This increases the man deposits from 800 to 1,440, 1,440 million, 600 million, 640 million
has been created out of thin air, and now has an IOU of 640, which charges interest.
640, however, as soon as it gets shifted around to somebody else, let's say the guy who produces
the counters, cash registers, say, from Joe Smith's grocery store, he's, let's say, a
client of Bank C. Of course, it could be a client of Bank A, that'd be better for the
bank.
Bank C calls upon Bank B for the $640 million.
Bank B pays up and has the money because it's only expanded by 80%, so he's been prudent
enough to expand the money to probably by only 80%.
Reserves are now going up by $160, demand deposits are going up by $800, and Bank B
is out of the picture with, and now Bank C again has $640 new reserves, and it increases
some more by 80% of that, which is something like $512 or something, et cetera, et cetera.
The result of this whole process is $1 billion more in demand of property of the bank A,
$800 million more in bank B, $640 million in bank C, etc., etc., continue to wind up
with $5 billion altogether in new money.
It takes longer, but the final effect is the same, because due to the reserve system, the
fact that all these banks, members of the Federal Reserve system are all regulated by
it, we have a system whereby competing banks don't really mean anything anymore, because
this is all going to be one bank, and even better, because then we can see clearly that
the bank is expanding the money to find out it's in there.
This process is so arcane and so confusing that even the bankers themselves often don't
know what they're doing.
And when I first studied economics, my first class in economics in college, a professor
said that bankers know less about money than anybody else in the system, in economy.
I thought he was crazy at the time, and I now see that he is really right.
Either that, of course, or they're totally evil.
This arcane process, you work it out yourself as a diagram, how this thing works, the final
result of this five-for-one.
Total demand of process is going up by five billion, reserves are going up by one billion.
So therefore the key, since the reserve requirement thing isn't changing anymore, the key to
Federal Reserve control of the banks is controlling total reserves, this item here, total reserves
in the bank.
The Federal Reserve can manipulate total reserves.
If total reserves go up by one billion, demand deposits, checking account goes up by five
billion.
The ratio right now ranges from fourteen or something to seventeen percent for different
classes of banks, something like six to one, but the principle is the same.
So therefore, the key instrument by which the Federal Reserve system manipulates the
money supply, usually of course increasing it, is by increasing total bank reserves.
How about the Federal Reserve reserves?
Is there any limitation on the Federal Reserve system, increasing total reserve?
Not anymore.
It used to be.
If we go back again to these two diagrams of the commercial banks, the top assets and
liabilities, and the Federal Reserve bank, the bottom assets and liabilities, supposedly
We have our billion and five billion to use as a useful amount.
Those consumer commercial banks have reserves of one billion, that's their demand deposits
of the Federal Reserve Bank.
Demand deposits of five billion and IOUs of four billion, they're in great shape, they've
inflated by five times their amount, but they're in great shape financially because they're
within the 20% ratio, legal ratio.
Meantime, the Federal Reserve System now has demand deposits owed to Federal Reserve Banks
1 billion, 1.8 billion
and commercial banking on top of that, each one is related to the other.
It seems to be a fairly severe three to one, two and a half to one requirement on the Federal
Reserve System.
It was progressively weakened over the years by Congress, and now there's no requirements
whatsoever.
It's zilch.
The Federal Reserve can inflate 200 million times on top of the gold supply, there's nothing
to stop it.
So we're now totally in the hands of the Federal Reserve Governors, the wisdom and brilliance
of the Federal Reserve System now running us all.
So what does the Federal Reserve, what instruments does the Federal Reserve have to manipulate
total reserve?
First place, there are other influences on total reserve, one of them I mentioned already,
people who are demanding cash, this can embarrass total reserve, it can decrease it.
The Federal Reserve, however, has the instrument to offset that and also add more on top of
it.
What are these instruments?
Well, two basic ones I've been talking about in the past.
One is lending money, you know, lending reserves for the banks, very simple, something like
the giving the money in a paperback, but we lend them the money in a paperback, lend them
The Federal Reserve is in trouble here. It needs $200 million reserves fast. People are
calling upon the banks for redemption. People can still call upon the banks for redemption
now. So they can do that. It embarrasses the banks. They need $200 million more, and the
Federal Reserve simply lends them. The reserves are now up to $1.2 billion. They can expand
another billion on top of that in a great shape. Then, of course, they have to pay back
the Federal Reserve when their profile is over, but that can work that out. That's simply
In the 19th century, banks were collapsing a lot, and it was a real pleasure.
Walter Badgett, probably one of the most overrated political theorists and economists in the history
of the world, was beloved by almost every historian.
The Central Bank is morally obligated to bail out old banks and turn them into public, a
very convenient pronunciamento, and the banks, of course, took to it like a duck took to water,
and it's been established in monetary theory ever since, that the banks are somehow a God-given
The Federal Reserve Bank must bail out the banks.
This is called the theory of the bank as a lender of last resort.
In other words, when the banks are really in trouble, there's always the Godfather
over there.
The Federal Reserve Bank would come in and bail the banks out.
Okay, so that was established.
It was established then, the Federal Reserve had to always bail out the banks.
They always had to stand ready to lend money to any bank, regardless of what bad shape
and how crooked or whatever the bank was.
But however the Federal Reserve Bank could charge interest, they could change the interest
rate.
They can stand ready to lend because lending is a punitively high interest rate.
So, a lot of publicity has been focused on the financial pages on the, on the re-discount
rate as it's called.
In other words, the rates that the Federal Reserve banks charge the commercial banks
for lending them reserve interest rates.
It's called the re-discount rate.
Every once in a while when the Federal Reserve wants to announce that it's really against
inflation, it raises the re-discount rate by a quarter of one percent, a big deal.
It wants to inflate it, lowers it, but really this is, again, this is really baloney.
It's really a psychological value rather than anything important.
First place, the banks aren't that much in debt to the Federal Reserve Bank.
That's not really a very important mechanism anymore.
Also, the banks have created a very typical sort of way the market pops up in different
areas.
The banks have created by themselves a market in bank reserves.
If one bank is out of line, it's below 20%, let's say, and another bank is a little bit
above 20%, the below bank borrows reserves for a couple of months from the third-plus
bank.
It's called the Federal Funds Market, and they borrow at a certain interest rate.
This is almost wiped out, Federal Reserve loans to the banks, so that instrument is
really out.
It gets a lot of publicity, but it's really not worth anything.
The real mechanism by which the Federal Reserve banks manipulate total reserves and thereby
manipulate money supply is as follows.
Here's the Federal Reserve Bank, here we have the 1.4, you know, 1.2, 1.4, 5, 7, and here
we have the Federal Reserve Bank.
Federal Reserve Bank, let's say, wants to inflate, wants badly to inflate, wants to
And they can buy old houses, they can buy paper clips for a billion dollars, they can
buy old dirt, it doesn't really make a difference, all they have to do is go out and buy something
and pay a check on it, that's all that's necessary.
Say if I buy my old portfolio for a billion dollars, let's take a really bizarre example
like that.
In that situation, they buy me out, sell out the portfolio for a billion dollars, sell
my portfolio for about a quarter, a billion dollars.
The Federal Reserve Asset Column, Portfolio, $1 billion, they valued it a billion, I mean
they bought it at a billion, who was anybody to say the name, alright, I'm not challenging
them, it could really be a billion dollars worth of money, and they pay for that by writing
out a check of a billion dollars, no I can't do anything with a check, a check says pay
to the order of Murray and Rothbard, $1 billion for my Federal Reserve Bank in New York, what
can I do with it, I ain't got an account of Federal Reserve Bank in New York, I go to
From my bank, my commercial bank, let's say Chase Manhattan, I deposit it with great glee
at Chase Manhattan.
My bank account goes up, in other words, demand deposits by Chase Manhattan go up from five
billion to six billion.
The demand deposits of the banking system go up from five to six.
But Chase Manhattan is even more gleeful about it than I am.
I'm only getting a billion dollars.
Chase is getting a billion dollars worth of reserves on which the banking system can pyramid
five to one.
Five billion, never mind the one billion.
So, Chase Manhattan runs as fast as their little ladies can carry them to the Federal
Reserve Bank in New York.
The Federal Reserve Bank posits a check on the Federal Reserve Bank of New York, gets
an increase in its reserves, because that's what the Federal Reserve Bank is, the bankers
bank, they have now 2 billion dollars of reserves, the man that posits outstanding of the Federal
Reserve Bank is now 2 billion.
Notice that it all balances, we now have the first set of balance here, we have a commercial
bank, IOUs 4 billion, reserves 2 billion, the man that posits 6 billion, and that balances,
In the Federal Reserve account, we have portfolio now, we've added portfolio of $1 billion to
the assets, and portfolio means not that bonds, it means my portfolio of $1 billion, so we've
added another billion dollars to demand deposits over the commercial banks.
It's not the end of it of course, what happens now is the banks go into a complete cap fit
here of joy, and they expand by five to one, either if Chase is a monopoly they expand
right away, if the competing bank as it is now takes a little bit more time, but we wind
And we wind up then, $2 billion of reserves, we wind up with demand deposits not of $6 billion, but of $10 billion,
and IOUs of $8 billion, and we now have expanded the money to be double the money supply from $5 to $10 billion.
Just by the Federal Reserve Bank buying my old portfolio for $1 billion.
I say, it doesn't matter what they buy. What they buy is unimportant. The important thing is what they pay out.
They pay out a check. As soon as they pay out a check, this mechanism goes into effect of quintupling the money supply.
In practice, of course, they don't buy my old gold, yeah, too blatant, too blatant, and they don't buy old houses and all that, what they buy is government bonds, U.S. government bonds, they buy old government bonds, every now and then there's a drive on to allow them to buy new ones, they buy old government bonds, it's not important that they buy old government bonds, it's important for the bond market, but it's not that crucial, the crucial thing here is, they buy a billion dollars worth of government bonds, the bond dealers rush out, take the check,
The Federal Reserve Bank deposits them in their commercial bank, Chase Bank, let's say.
They get an increase in their demand of deposits, Chase gets an increase in reserves, and they
can now quintuple their money supply.
That's the process by which we have it.
Process is called open market operations by Federal Reserve Banks, or open market purchases.
Usually the sales are very few and far between.
Sales is when the Federal Reserve sells bonds, then of course you have the reverse situation.
When the Federal Reserve Bank disgorges some of these bonds, then people buy it.
I ran out of check.
Let's say I buy a government bond of a billion dollars.
I ran out of check on my bank.
My bank loses reserves, and the banking system has to contract.
That's the other side of the coin.
It's called the market fails.
So, in other words, in practice, instead of this portfolio thing, the IOUs here, the 1.8
billion, are U.S. government securities.
Over the years, of course, the Federal Reserve, which started with zero government securities,
now has billions and billions of them.
I don't know what the figures are, but they're enormous, because every year they're piling
on more.
In other words, the way in which the federal government increases money supply year after
year by approximately 10%, give or take a bit, is by the Federal Reserve banks going
out on the open market and buying government bonds, seemingly harmless operations, done
continually with almost no publicity, financial pages are not, you know, publicized every
time the Federal Reserve buys bonds, it's like a normal thing every day, and as a federal
open market committee, which meets, I think, once a week and decides how much to buy, all
The point is that the upshot of all these things is this is the way in which money supplies
regulate it and inflate it.
The Federal Reserve feels that New York is inflating too much beyond Boston.
There might be some harmless Boston banks calling upon New York banks for redemption.
They just shovel all bond buying at the Boston market and equalizing the situation.
So the whole economy, all the banks can inflate beautifully together, but not too much calling
upon redemption of one bank upon another bank, because if everybody's inflating together,
The amount that Chase calls upon National City for redemption will be more or less offset
by the amount that National City holds on Chase for redemption.
They can clear it and nothing happens.
The one check here, the one limitation on the Federal Reserve in this balance sheet,
the Federal Reserve expansion, of course, gold, the fact that the Federal Reserve used
to have to pay their liabilities in gold on the gold standard.
Well, that of course was eliminated, first it was eliminated very gradually by the government
by establishment, by spreading the cultural value around it, really like the old geezer
who didn't want to have his money in the bank, because the other old geezer, or the same
old geezer, doesn't want to have his money in gold, you know, carry gold around.
This is considered neanderthal, it's considered ridiculous, it's considered lots of stories
about crazy old geezer who wants to have his money in gold, why doesn't he have his money
in paper or bank credits, it's more comfortable, it's lighter in weight and all that sort of
stuff.
And so, the idea of people actually using gold coins in day-to-day transactions gradually
The Depression was over several years thereafter, and of course the gold has not yet been siphoned
back on public coffers.
Here we are 35 years approximately since the Depression, there ain't no gold anymore,
and the gold has not been paid back to us by our government.
In other words, government confiscated the gold.
Incidentally, just as sort of a pecan note here, favorite character of American history
is Samuel Chase, who was the secretary, was a Jacksonian hard money man, was the secretary
Treasury during the Civil War, the Union side, Prince of the Greenbacks, which later deflated,
and then several years after the Civil War, the case comes before the Supreme Court, were
these Greenbacks constitutional?
Was it legal for the Federal Government to issue paper money at all?
Not even talking about irredeemable paper after them, talking about just paper money
irredeemable at the time, even, Greenback, was it legal?
And the Supreme Court decided four to three, I believe, there were two vacancies on the
court, four to three, it was unconstitutional, so for a few glorious years, paper money,
and the Third Evil Paper Money was unconstitutional.
Chief Justice Chase wrote the decision, which made his own actions as Secretary of the Treasury
illegal and unconstitutional.
It's a beautiful, probably unique act on the history of the world, denouncing himself for
evil paper money, inflationary paper money.
Okay, what happened was, and I think Pecan's interesting note, is that the President Grant
who was in the pay of the Watergate types at the time, the inflationary government subsidized
types.
Then I pointed to the two vagacies of the Supreme Court, two gentlemen, I think Bradley
and somebody else, both of whom turned out to be lawyers for the big railroads, and both
of whom then, when the decision was re-argued a couple of years later, argued on the pro-paper
money side and the decision was reversed by five to four.
The reason why the railroad lawyer thing becomes important is because the railroads are heavily
in debt.
Railroads were great bond issuers at the time, and of course bondholders, debtors, the bond
issuers, rather, like to have inflation because this wipes out the purchasing power of the
The way by which this legalized money counterfeiting takes place now is through this Federal Reserve
purchase of the bond.
Another pecan touch, remember I talked about the Bank of England and William Patterson,
they have a similar thing with government deficits.
The Government has a deficit of $10 billion.
How does it finance it?
Well, there are three ways it can finance it, or any combination of these three ways.
One way is to just print the $10 billion, the old-fashioned method, printing the paper money and spending it.
Now, this would mean we have a $10 billion deficit.
If it simply finances the deficit, let's say its revenue is $30 billion and its expenditures are $40 billion, whatever, however it gets to the $10 billion.
Method number one of financing the deficit is by printing the money.
Print the old greenbacks, the Continentals, and you print the 10 billion, spend it.
Now of course this is inflationary, we can say there's a 10 billion dollars worth of
inflation has been injected into the system, prices will go up accordingly.
The other hand, there's something sort of lovable about this method because it's clear
and honest.
I mean, in the sense that there it is, everybody knows, you printed the 10 billion, everybody
knows that's inflationary, and that's it.
Ok, that's one method. The second method, financing the deficit, is borrowing money
from the public. So the government issues bonds and sells it to you and I and Nelson Rockefeller
or whoever else buys them. So, borrowing from the public. Now this method of selling ten
billion dollars worth of bonds to the public is not inflationary at all, because it doesn't
increase the money supply at all. The first method increased the money supply by ten billion
dollars, so that's inflationary, that's bad. The second method is not inflationary, because
We reduce our bank deposits, UI and us in Rockefeller reduce our bank deposits by ten
billion and the bank deposits get turned over to the Treasury Department and the Treasury
takes the money and spends it on missiles, paper clips and other productive things.
And that's it.
The money circulates and the resources get shifted from high prices of paper clips and
missiles but it's not inflationary.
There's other bad things wrong with it.
It shifts money from private hands to public hands but at least it's not inflationary.
The bad thing here, aside from this shift of resources, is that then, the government
has to pay back the 10 billion to bondholders, plus interest, depending on what the interest
is, we now have a lot more.
In other words, over the years, the government, let's say, has to pay back 20 billion, so
we have taxes go up by 20 billion, so the second method of borrowing from the public
is lovably non-inflationary.
On the other hand, it's not so lovable that taxes go up by approximately twice the amount
of the previous inflation.
And the fact is that the taxpayers have to pay now and in the future, on and on, for
the next 20 years or so for this debt.
Now we have a third method, which is a method generally used, and a method most sophisticated,
most beloved by sophisticated establishment economics, that is, you finance the deficit
by borrowing money from the banking system.
Now this is the equivalent of the king financing his deficit, his personal deficit, by borrowing
money from William Paterson, borrowing money from the banking system.
When you do that, you increase the money supply by $10 billion the same way because what happens
is we now have, we look at the banks, commercial banks, assets and liabilities, you now have
demand deposits go up by $10 billion, in other words the banks create $10 billion of new
money, new demand deposit.
They hand over to the government, treasury, department, and it spends the money on paper
In return for that, the banks get, the IOUs now, government bonds in short, $10 billion.
So, in other words, the money supply is going up by $10 billion through the issuers of more
bank money.
So, we have inflation, $10 billion worth of inflation on method three.
However, in addition to the $10 billion worth of inflation which we suffer from printing
press, the old-fashioned printing press method, we now have to pay the banks back, in quotes,
to the tune of $20 billion.
In other words, taxes go up by 20 billion in order to pay off the principal and the
interest of government bonds in the next 20 years.
Method 3, which is the dominant method, of course, is a method which we suffer the worst
of both worlds.
We both have inflation and increased taxes, so taxes go up, taxes increase by 20 billion.
I know this is sort of a moral situation here, or the moral dimension of this system.
We the taxpayer, we the American taxpayer, are paying the banks both the principal and
and the Hefty Interest Rate, for the dubious service of inflating the money supply which
they themselves benefit from, to look at from any ethical system, or ethical principles is
kind of a bizarre system.
It's bad enough to have the banks inflating, it's even worth to have the taxpayer gratefully
paying them back, in quotes.
People comfortable with paying them back assume that they save their own money up, or they
borrow money from other people and have these, the money, the capital saved up by the small
savers over the country, this is invested in government bonds and the commitment to pay
them back.
The banks, remember, created new money and then bought the bonds with the newly created
checkbook money.
All right, we're borrowing from the banking system.
We're combining the worst of both methods and I say this is the dominant, this is the
modern sophisticated equivalent of the, of the king borrowing from William Patterson
and both are making this deal and William Patterson hasn't got any money, King hasn't
got any money, they both wind up with lots of money.
It's the same way here with the government and the banks.
You might ask the question, how, how did the banks get the 10 billion to buy the government
The Federal Reserve banks help out by pumping $1 billion worth of reserves and thereby giving
the banks the $10 billion to spend, enabling them to increase by $8 billion more.
So, we have reserves going up by $2 billion, this is done by the Federal Reserve banks
buying $2 billion worth of old bonds in the open market, this completes this complicated
chain.
The Treasury wants to borrow $10 billion on inflate, to finance the deficit.
The Federal Reserve banks go into the open market, buy $2 billion worth of old government
bonds, old existing government bonds, thereby increasingly paying out checks, $2 billion
worth of checks, which old bond dealers get, and the old bond dealers take this money and
they profit in their banks, their banks get $2 billion worth of more reserves, banks inflate
$10 billion on top of that, and they inflate by buying $10 billion worth of new bonds issued
by the Government of the Treasury to Finance their Deficit.
In this complicated process, we wind up with $10 billion worth of inflation and something
like $20 billion worth of new taxes over the years.
Okay, so this more or less is the monetary inflationary mechanism going on.
Now the question is, the final point of the course is to talk about one of the effects
of this inflationary process, which we don't think much about, in addition to the increase
In addition to the possible and probable runaway inflation eventually, there's another effect
of increase in bank credit, which is to generate the dread and famous business cycle.
It brings us to our final topic, the business cycle.
And obviously, it's sort of ludicrous to go through the entire business cycle process
in about a half hour, but I'll try to do my best.
In the old days, in other words, in the day before approximately 1750, unless I mean right
is pretty obvious, or a specific event or a war would take place, and credit would get
shut off.
One of the last famous cases of this was during the Civil War, American Civil War, Britain's
major industry was cotton textiles, and they were dependent, and their major supplier of
cotton was the American South, and comes the Civil War, and the cotton supply was cut off,
so the British cotton industry goes into depression, Britain goes into depression.
It's obvious why.
I don't mean any sophisticated business cycle theory to figure it out.
This is the sort of depressionism that takes place before approximately 1750, where you
can easily pinpoint the cause.
Anybody who has any sense and knows the scene, knows what the score was, and usually it's
the government.
All right.
Then what happens is that approximately 1750, there occurs a phenomenon in the Western world
and any sort of developed market economy, a dread phenomenon whereby you have a seemingly
and the regular alternation of booms and busts, the so-called business cycle or trade cycle,
where business will sort of go up and then collapse suddenly and go up again and so forth
and so on.
You have some kind of a cycle, a phenomenon.
So as this became evident, an economist began to force himself to explore it as economists
as a profession of economics comes up, or as people think about economic problems, to
try to figure out what the cause of this whole thing was, because it's certainly not obvious.
It shouldn't happen. If you look at it from the point of view of micro-theory, everything
should be sort of hunky-dory. The market's always clear, there's always full employment,
all the tendency toward it. So what's the matter? What's this boom and bust business?
As a matter of fact, Ford Keynes in probably the worst chapter of that book, General Theory,
wrote a historical chapter of about five pages or something. He said that for him, nobody
ever thought about business cycles. The people he called the classical economists didn't
The Theory of Money and Credit
Bank Collapses and Banks Collapse, the so-called panic or so-called crisis is the most ever
dramatic and disturbing event and for a while there it so happened about every ten years
there was a big crisis so there was a theory of periodicity where the idea was it was some
kind of periodic cycle every 9.8 years and some economists attributed a sunspot and the
whole thing on that.
This has fortunately been forgotten.
So anyway and it turned out it wasn't periodic, it wasn't 9.8 years and that's what's going
down in the drain.
and what you have is a series of booms and busts which are not periodic but keep going
anyway before they're mating.
Now there have been two kinds of explanations of the cause of this business cycle.
One is the dominant explanation now for many years is the idea that, well, a dominant type
of explanation is that the cause is somehow deep within the Industrial Revolution.
All comes about because of the Industrial Revolution and the market economy.
There's something within the processes of the industrial system that bring about a boom-and-buff
cycle.
Most people don't like a boom-and-buff cycle and consider it evil, therefore there's something
evil about the market or something evil about the industrial system.
In one way or the other, the Keynesian system, the Marxian system, etc., etc., all come under
this rubric of blaming the industrial revolution or blaming the market, even if they don't
have any specific causal explanation.
It's like, well, it's something within the market or something in the industrial revolution.
And therefore, usually it includes the government has to step in and do something about it.
Either abolish the market or regulate it or whatever.
Another system, another group of theories of explaining the business cycle, which has
been almost forgotten until fairly recently, which used to be dominant in the 19th century,
which essentially says, no, it's not the free market, it's not the Industrial Revolution,
which comes about around the mid-18th century.
Something else which came about in the mid-18th century, which is the real cause, comes about
In other words, at the same time, approximately the Industrial Revolution, that's the rise
of commercial banking, the rise, in other words, of fractional reserve banking.
This process, which is obviously not a market process, which intervenes in the market, either
by the banks themselves or by the government or a combination, that this is the worm and
the apple.
Without the monetary intervention in the market, without the fractional reserve banking, we
wouldn't have the movement bus cycle.
Basically, as Ludwig von Mises, I think, was the first one to really point out, the Xavier
and Human Species Flow Price Mechanism is really the first primitive business cycle
model.
In other words, if you look at it, remember I talked about England and France and England
inflates and so forth and England and the English banks, with the behest of the English
government inflate, English prices go up and then what happens is that gold flows out from
France to England as a deficit in the English balance of payments and a surplus in the French
balance of payments and then finally the the pyramiding effect of the bank notes or bank
Deposit on top of gold becomes so top-heavy and the banks are obviously in such a bad shape,
they have to contract and as they contract, there's a recession, prices fall and bankruptcies
and gold starts falling out and starts falling back again.
This is a one-shot model of the business cycle, in other words, there's an inflation brought
about by the bank, bank credit expansion, prices go up, there's a feeling of prosperity
and exhilaration and such and such, and finally there's a contraction because gold has been
falling out and then the banks collapse and such and such.
and the Boehm-Bawerk cycle.
The next question is, of course, why does the Boehm start up again?
Why isn't it just a one shot thing?
And the reason, of course, that Mises pointed out,
is because the banks are inherently inflationary,
inherently want to create money, and the government joins them.
As soon as they get the chance, they start inflating again.
As soon as the banks have re-established their credibility, as we now say,
and they're off again on the other cycle, and the Boehm-Bawerk cycle continues on.
Now, that, I think, is a pretty good explanation.
It's not sufficient.
It became known as the purely monetary theory of the business cycle, which the Friedmanites
have essentially brought back in a kind of weird kind of way.
Weird in the sense that the Ricardians, Ricardo and his school have the initial theory of
the monetary theory of the business cycle.
Their view was therefore you shouldn't inflate, therefore you should have hard money, a pure
gold standard, whatever, and don't inflate, because what they want to do is not to have
the boom-bust cycle.
On the other hand, Friedman and I are interested largely in stabilizing the price level and
realizing that prices will tend to fall as the supply of business services increases
with productivity.
Therefore, we want to pump in more money in order to offset the general tendency toward
a falling price level.
It's a very different kind of situation.
But the emphasis on a purely monetary explanation of the business cycle is still there.
When Mises contributed, Mises and Hayek, following him, contributed to the theory of business
The Austrian business cycle is joining with this another strand of this monetary explanation.
Namely, when the banks expand credit and expand the money supply, they're also doing something
else in addition to being inflationary.
They're also lowering the interest rate below the free market level and pouring that new
money into basically the new business loans.
In other words, they're mostly lending money not to the consumers but the businessmen to
invest more.
And in doing that, they're causing over-investment in the so-called higher orders of production
and so-called, in the remote orders of capital goods.
And they're causing, in other words, an over-investment in capital goods, an under-investment in consumer
goods.
They're causing too much resources to be invested in, say, nails and cement and construction.
They're too little in clothing and hi-fi sets and whatever.
And the result just distorts the production structure.
As the inflationary process continues, as the credit expansion continues, the distortion
piles up more and more, necessitating a final reshift, a shifting back of resources, and
this shifting back is essentially the impression of the recession.
For example, it's going to be very rough if I explain in a few minutes, this is the
magnificent Austrian theory of the structure of production, essentially I guess, in this
hinted at by Carl Menger, the founder of the Austrian School, developed in great detail by Boehm-Bawerk, the great leader of the Austrian School, and finally by Hayek, applied to the business cycles by Hayek, the students of Ludwig von Mises.
Essentially what you have, consider the consumers are spending a certain amount of money, a bar, the length of the bar being the amount they spend. I'd say the consumers spend $200 billion a year on retail products.
So, this is consumption. So, money is going from consumers to retail sellers, retailers.
So, here's two billion, two hundred billion going from the consumers to the retailer.
Let's take a hundred billion and make it simpler.
A hundred billion dollars is going from consumers to retailers over, let's say, over a year or a month.
It doesn't really matter with time period.
And goods and services are going from the retailer to the people, consumers.
Okay, retailers take a certain amount of that. They take a certain amount of that hundred billion
and spend it on our own payment of wages to people working in the retail industry, rents
to landlords in the retail industry and profits, an interest rate.
So there's a certain amount of payments to factors of production in that industry, let's
say 10 billion worth.
So 10 billion goes up the ceiling here where there's factor payments.
90 billion, let's say, goes to the wholesalers, and 10 billion goes up to the factors of production
in that industry.
Another 80 billion goes to the wholesalers, and the same thing happens to the wholesalers.
10 billion, let's say, gets paid out to the land, labor, and capital, and entrepreneurs
in the wholesale industry.
Another 80 billion goes to the jobbers, another 10 billion up here, and 80 billion goes to
the jobbers, and 70 billion to the manufacturers, etc., etc.
So what you have in other words is the structure of production.
At each stage of production, every time the money is turned over, every time you're going
up the stage of production, more money gets hived off, you wind up with something like
When the number of stages of production increases, so you have what Hayek calls a lengthening
of the structure of production, as saving and investment increase, when I say the number
of stages of the structure of production lengthens, and without going into the whole analysis
of all the triangles, under credit expansion, too much gets invested in the higher orders
of production.
There's too much stuff for construction, these are called the higher orders, these are consumer
goods of lower orders.
Too much gets invested up here, not enough down here.
And then, what happens is, let's say people build new dams and new construction projects,
and the businessmen get the money for construction projects, pay them out to the workers, these
workers take the money and they spend it on consumer goods.
They haven't increased their savings at all.
Their savings is still, let's say, the old proportion, the old 10% of their income.
If not 20% as it would have to be to validate the new investments, they reestablish their
oil consumption proportions and as they do that, these industries out here collapse.
These industries in the higher orders of production collapse.
The structure of production shortens again in order to satisfy the consumers in the best
possible way.
In other words, in order to satisfy the time preference of consumers.
So what the credit expansion does, it violates the time preference of consumers.
In other words, consumers have a certain time preference structure.
They assume a certain amount of current goods.
They save and invest a certain amount for future goods.
Credit expansion, bank credit expansion, inflationary money supply into the business loan makes
it appear as if there's a lot more savings available for future investment, I mean, there
really isn't.
Makes it appear that time preference is a lot lower than it really is, and too much
is invested in these remote orders of production.
So then the question is, okay, if consumers then reestablish the role proportion, why
doesn't the business cycle come to an end in a couple of months?
You know, as soon as the producers, the businessmen pay out the money and the workers start spending
it, the whole thing should be over in a couple of months.
Why does the business cycle last about several years, four, five, six, seven, eight years?
Well, the reason is, the reason why the boom continues is precisely because more bank credit
is being poured in.
In other words, the bank credit expansion is not a one-shot thing, it's a continuous
thing.
And it's a process by which the business system is allowed to remain one step ahead
of retribution.
In other words, the overinvestment, the calling to account, the calling to judgment of overinvestment
is constantly being postponed by the fact that new bank credit has been poured in, and so this thing is one step ahead of the workers' reestablishment of their own proportions.
This is now often called a liquidity crisis, a liquidity crunch, which turns out businessmen don't have enough money anymore.
And this simply means that bank credit isn't expanding fast enough in these situations to validate this over-investment.
When bank credit expansion stops, then this whole process goes into effect, the shortening process,
and workers get unemployed in these areas or the poor on prices in the capitalist industry
as a re-establishment of the old orders of production.
So according to the Austrian theory of business cycle, recession is not simply a result of
contraction of the money supply.
Recession becomes inevitable and healthy once there's a boom.
In other words, the boom is a bad thing.
The boom distorts production process in ways different from what the consumers want and
the recession is the process by which, the painful but necessary process by which the
and the theme market restores the proper production structure in relation to the time preference of consumers.
Session then becomes inevitable and a good thing, in quotes, in relation to the boom.
Therefore, the policy conclusion, of course, is the exact opposite of the current Keynesian and post-Keynesian policy conclusion.
Keynesian policy conclusion is, for various reasons, if you haven't got a chance to know more about the Keynesian theory,
for various reasons it is, if there's a recession, pump more money in, put more spending in, inflate, secure it.
The Austrian theory, first of all if there's an inflation, stop inflating, stop increasing
money supply, stop pouring more bank credit in, and then if there's a recession, don't
do anything about it, keep the government's hands off, thus allowing the adjustment process
to proceed as fast as possible and wipe this whole thing out, because the government interferes
in their adjustment process by pumping up wage rates or pumping up, lending money to
unsound businesses, etc.
All it does is it postpones the business cycle, lengthens the depression, postpones the adjustment
Process and keeps the economy, the state of sort of chronic depression as it did in the 1930s.
The thing that it was to leave the process alone and not let it adjust as fast as possible.
Usually these recessions are very fast, even if they're very deep.
For example, in 1921, there was a recession in response to the big post-war boom, 1914,
and it was a very sharp recession.
Prices fell about a third or 40% or something like that.
But the recession, the whole recession was over in about nine months.
When the government leaves them alone, there's a free market attitude toward recessions, in other words.
They're over very, very quickly. You can hardly know that they're there.
It's only when the government steps in to, quote, cure them, unquote, that they're promoted and almost rendered permanent.
And the only other thing that culture can do, so to speak, to speed up the adjustment process and alleviate the depression,
is in contrast to the Keynesian system of trying to get people to spend more, you know, spend more and thereby pump the, find the pump.
The culture should be doing it to alleviate the pressures and encourage people to save more.
The more they save and the less they consume during recessions, the faster the recession will be cured,
because the more these investments will no longer be excessive and will now be validated by genuine shifts in time preference.
If these are genuine shifts, of course.
The more you get people to save and invest, the more thrifty you get them to be, the less painful the recession will be.
And, of course, the more capitalized the structure will be.
Just the exact reverse of the Keynesian prescription.
This explanation, by the way, accounts for every boom-bust cycle
since 1750 and even before that and localized cases.
The 1929 Depression is a beautiful example of Austrian theory at work,
Austrian analysis of the situation at work.
Most people think of the 1920s as a great era of laissez-faire in the United States.
It was not an era of laissez-faire, especially in the area of money and banking
where the Federal Reserve System had been established.
The Federal Reserve System is deliberately inflating the money supply and expanding bank credit for various reasons in order to help Britain with the usual argument.
Because Britain wasn't fighting rapidly in those days as usual.
We had to fight in order not to allow Britain, not put the pressure on Britain on losing a lot of gold to us.
Because if we were to fight about the same proportions Britain did, they wouldn't lose much gold to us.
Actually the situation is even more sinister than that.
Since both the Federal Reserve System in the 20s and the Bank of England was essentially run by the Morgan interests, but that's really another story.
And then we have the phenomenon of inflationary recession, as explained by the Western theory, because during the Depression period, what happens is that prices of capital goods, prices of construction goods, wage rates in these industries are supposed to fall,
and prices of consumer goods industry is supposed to rise,
thereby inducing resources to shift back from the construction of capital goods to consumer goods.
So there always is a rise in consumer goods industry during depression.
In other words, say during the 1929 Depression, all prices fell,
but the prices of capital goods, the prices of construction of machine tools,
fell much faster than the prices of consumer goods, much more rather.
They would fall, let's say, by 50% in the construction industry and by 20% in the retail industry.
What happened in old depressions, classic depressions was, old prices would fall, and
then capital goods would fall a lot more than consumer goods, so this meant that consumer
goods really went up relative in price relative to other products, but nobody cared about
that because the consumers, because the one good thing about an old-fashioned depression
is one good thing, one good thing alone, and that is you can enjoy a nice fall in your
consumer prices.
My parents were best off their whole lives in the Great Depression, because since they
They were employed, and most people I've heard were employed, everything was a great bargain.
Furniture was very cheap, houses were cheap, everything was terrific.
So that was the one good thing about an impression.
Now they've taken that away from us because they've, instead of allowing a deflation of
bank credit, because in every classic depression banks have to contract their credit and all
prices would fall as a result.
Now of course they don't allow any bank credit contraction ever so prices are never allowed
to fall again and therefore this healthy deflation is eliminated and we now have all we have
We have a rise in consumer goods prices relative to other prices, which means that the prices
are going up, money supply is inflating, a lot of deflating.
We now suffer, during a recession, from a rise in consumer goods prices.
In other words, we now have the worst of both worlds.
We have the bankruptcy, unemployment, and all the rest of it is associated with recession.
We also have what's classically associated with an inflation, which is a rise in prices.
Now, the Keynesians can't meet this thing, because the Keynesians' whole theory rests
on the dichotomy.
And once you have two abysses, it's a function of the government to steer the car, so to speak, across this tightrope of an abyss on either side.
One of the abyss of inflation, the other is the abyss of unemployment.
And since we're having both, and what do you do?
Of course, the Keynesians have no answer whatsoever for this.
The feminists don't have any answer either.
And so we wind up with none of the establishment economists knowing what to do about the current situation
when there's this whole series of inflationary recessions punctuated by runaway inflation in between,
or increasingly runaway inflation in between.
in between. Only the Austrian theory really can explain the solution and explain the situation
and also come up with a solution. Solution essentially being get the government out of
the whole business, which is really I guess the lesson in the middle of the whole course.