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NOTE II. Money in a Free Society

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Chapter 2. Money in a Free Society

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1. The Value of Exchange

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How did money begin? Clearly, Robinson Crusoe had no need for money. He could not have eaten gold coins. Neither would Crusoe and Friday, perhaps exchanging fish for lumber, need to bother about money.

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Money. But when society expands beyond a few families, the stage is already set for the

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emergence of money. To explain the role of money we must go even further back and ask,

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why do men exchange at all? Exchange is the prime basis of our economic life. Without

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exchanges there would be no real economy and, practically, no society. Clearly, a voluntary

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The exchange occurs because both parties expect to benefit.

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An exchange is an agreement between A and B to transfer the goods or services of one

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man for the goods and services of the other.

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Obviously, both benefit because each values what he receives in exchange more than what

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he gives up.

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When Crusoe, say, exchanges some fish for lumber, he values the lumber he buys more

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than the fish he sells.

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How Friday, on the contrary, values the fish more than the lumber.

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From Aristotle to Marx, men have mistakenly believed that an exchange records some sort

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of equality of value, that if one barrel of fish is exchanged for ten logs, there is some

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sort of underlying equality between them.

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Actually, the exchange was made only because each party valued the two products in different

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order.

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Why should exchange be so universal among mankind? Fundamentally, because of the great

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variety in nature, the variety in man, and the diversity of location of natural resources.

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Every man has a different set of skills and aptitudes, and every plot of ground has its

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own unique features, its own distinctive resources. From this external natural fact of variety

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come exchanges. Wheat in Kansas for iron in Minnesota, one man's medical services for

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another's playing of the violin. Specialization permits each man to develop his best skill

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and allows each region to develop its own particular resources. If no one could exchange,

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if every man were forced to be completely self-sufficient, it is obvious that most of

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Two of us would starve to death, and the rest would barely remain alive.

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Exchange is the life blood, not only of our economy, but of civilization itself.

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2. Barter

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Yet direct exchange of useful goods and services would barely suffice to keep an economy going above the primitive level.

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Such direct exchange, or barter, is hardly better than pure self-sufficiency.

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Why is this?

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For one thing, it is clear that very little production could be carried on.

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If Jones hires some laborers to build a house, with what will he pay them?

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With parts of the house, or with building materials they could not use?

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The two basic problems are indivisibility and lack of coincidence of wants.

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Thus, if Smith has a plow, which he would like to exchange for several different things,

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say eggs, bread and a suit of clothes, how can he do so?

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How can he break up the plow and give part of it to a farmer and another part to a tailor?

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Even where the goods are divisible, it is generally impossible for two exchangers to find each

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other at the same time.

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If A has a supply of eggs for sale and B has a pair of shoes, how can they get together

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if A wants a suit?

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And think of the plight of an economics teacher who has to find an egg producer who wants

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to purchase a few economics lessons in return for his eggs.

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Clearly, any sort of civilized economy is impossible under direct exchange.

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3.

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Indirect Exchange

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What man discovered in the process of trial and error, the route that permits a greatly

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expanding economy, indirect exchange.

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Under indirect exchange, you sell your product not for a good which you need directly, but

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for another good which you then in turn sell for the good you want.

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At first glance, this seems like a clumsy and roundabout operation, but it is actually

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the marvelous instrument that permits civilization to develop.

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Consider the case of A, the farmer, who wants to buy the shoes made by B. Since B doesn't

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want his eggs, he finds what B does want, let's say, butter. A then exchanges his eggs

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for C's butter and sells the butter to B for shoes. He first buys the butter not because

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Because he wants it directly, but because it will permit him to get his shoes.

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Similarly, Smith, a plow owner, will sell his plow for one commodity which he can more

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readily divide and sell, say, butter, and will then exchange parts of the butter for

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eggs, bread, clothes, etc.

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In both cases, the superiority of butter, the reason there is extra demand for it beyond

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and Simple Consumption is its greater marketability.

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If one good is more marketable than another, if everyone is confident that it will be more

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readily sold, then it will come into greater demand because it will be used as a medium

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of exchange.

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It will be the medium through which one specialist can exchange his product for the goods of

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other specialists.

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Now just as in nature there is a great variety of skills and resources, so there is a variety

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in the marketability of goods.

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Some goods are more widely demanded than others, some are more divisible into smaller units

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without loss of value, some more durable over long periods of time, some more transportable

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over large distances.

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All of these advantages make for greater marketability.

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It is clear that in every society the most marketable goods will be gradually selected

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as the media for exchange.

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As they are more and more selected as media, the demand for them increases because of this

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use, and so they become even more marketable.

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The result is a reinforcing spiral.

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More marketability causes wider use as a medium, which causes more marketability, etc.

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Historically one or two commodities are used as general media in almost all exchanges,

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and these are called money.

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Historically many different goods have been used as media, tobacco in colonial Virginia,

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sugar in the West Indies, salt in Abyssinia, cattle in ancient Greece, nails in Scotland,

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Silver in Ancient Egypt and Grain, Beads, Tea, Cowrie Shells and Fish Hooks.

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Through the centuries two commodities, gold and silver, have emerged as money in the free

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competition of the market and have displaced the other commodities.

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Both are uniquely marketable, are in great demand as ornaments and excel in the other

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necessary qualities.

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In recent times, silver, being relatively more abundant than gold, has been found more

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useful for smaller exchanges.

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At any rate, the important thing is that whatever the reason, the free market has found gold

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and silver to be the mobility development of a medium of exchange on the free market

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is the only way money can become established.

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Money cannot originate in any other way, neither by everyone suddenly deciding to create money

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Money out of useless material, nor by government calling bits of paper money.

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For embedded in the demand for money is knowledge of the money prices of the immediate past.

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In contrast to directly used consumers' or producers' goods, money must have pre-existing

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prices on which to ground a demand.

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But the only way this can happen is by beginning with a useful commodity under barter, and

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and then adding demand for a medium for exchange to the previous demand for direct use, that

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is, for ornaments, in the case of gold.

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Thus, government is powerless to create money for the economy.

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It can only be developed by the processes of the free market.

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A most important truth about money now emerges from our discussion.

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Money is a commodity.

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Learning this simple lesson is one of the world's most important tasks.

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So often have people talked about money as something much more or less than this.

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Money is not an abstract unit of account, divorcible from a concrete good.

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It is not a useless token, only good for exchanging.

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It is not a claim on society.

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It is not a guarantee of a fixed price level.

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It is simply a commodity.

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It differs from other commodities in being demanded mainly as a medium of exchange.

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But aside from this, it is a commodity, and like all commodities, it has an existing stock,

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it faces demands by people to buy and hold it, etc.

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Like all commodities, its price, in terms of other goods, is determined by the interaction

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The emergence of money was a great boon to the human race.

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Without money, without a general medium of exchange, there could be no real specialization

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1, no advancement of the economy above a bare primitive level.

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With money, the problems of indivisibility and coincidence of wants that plagued the barter

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society all vanish.

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Now Jones can hire laborers and pay them in money.

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Smith can sell his plow in exchange for units of money.

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The money commodity is divisible into small units, and it is generally acceptable by all.

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So, all goods and services are sold for money, and then money is used to buy other goods

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and services that people desire.

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Because of money, an elaborate structure of production can be formed, with land, labor

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services and capital goods cooperating to advance production at each stage and receiving

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payment in money.

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The establishment of money conveys another great benefit.

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Because all exchanges are made in money, all the exchange ratios are expressed in money,

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and so people can now compare the market worth of each good to that of every other good.

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If a TV set exchanges for 3 ounces of gold and an automobile exchanges for 60 ounces

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of gold, then everyone can see that one automobile is worth 20 TV sets on the market.

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These exchange ratios are prices, and the money commodity serves as a common denominator

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for all prices.

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Only the establishment of money prices on the market allows the development of a civilized

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economy, for only they permit businessmen to calculate economically.

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Businessmen can now judge how well they are satisfying consumer demands by seeing how

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How the selling prices of their products compare with the prices they have to pay productive

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factors, their costs.

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Since all these prices are expressed in terms of money, the businessmen can determine whether

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they are making profits or losses.

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Such calculations guide businessmen, laborers and landowners in their search for monetary

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income on the market.

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Many such calculations can allocate resources to their most productive uses, to those uses

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that will most satisfy the demands of consumers.

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Many textbooks say that money has several functions, a medium of exchange, unit of account,

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or measure of values, a store of value, etc.

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But it should be clear that all of these functions are simply corollaries of the one great function,

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The Medium of Exchange

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Because gold is a general medium, it is most marketable.

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It can be stored to serve as a medium in the future as well as the present, and all prices

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are expressed in its terms.

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Money does not measure prices or values.

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It is the common denominator for their expression.

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In short, prices are expressed in money.

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They are not measured by it.

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As gold is a commodity medium for all exchanges, it can serve as a unit of account for present

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and expected future prices.

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It is important to realize that money cannot be an abstract unit of account or claim, except

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in so far as it serves as a medium of exchange.

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5.

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The Monetary Unit

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Now that we have seen how money emerged and what it does, we may ask, how is the money

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commodity used?

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Specifically, what is the stock or supply of money in society, and how is it exchanged?

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In the first place, most tanite is the distinctive unit of a tangible commodity, and so trading

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takes place in terms of units like tons, pounds, ounces, grains, grams, etc.

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Even those goods nominally exchanging in terms of volume, bale, bushel, etc., tacitly assume

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a standard weight per unit volume.

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Gold is no exception.

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Gold like other commodities will be traded in units of weight.

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One of the cardinal virtues of gold as money is its homogeneity.

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Unlike many other commodities, it has no differences in quality.

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An ounce of pure gold equals any other ounce of pure gold the world over.

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It is obvious that the size of the common unit chosen in trading makes no difference

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to the economist.

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One country on the metric system may prefer to figure in grams.

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England or America may prefer to reckon in grains or ounces.

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All units of weight are convertible into each other.

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One pound equals 16 ounces, one ounce equals 437.5 grains or 28.35 grams, etc.

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Assuming gold is chosen as the money, the size of the gold unit used in reckoning is

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immaterial to us.

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Jones may sell a coat for one gold ounce in America or for 28.35 grams in France.

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Both prices are identical.

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All this might seem like laboring the obvious, except that a great deal of misery in the

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world would have been avoided if people had fully realized these things as abstract units

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for something or other, each cleaving uniquely to a certain country.

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Even when countries were on the gold standard, people thought in similar terms.

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American money was dollars, French was francs, German marks, etc.

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All these were admittedly tied to gold, but all were considered sovereign and independent,

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and hence it was easy for countries to go off the gold standard.

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Yet all of these names were simply names for units of weight of gold or silver.

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The British pound sterling originally signified a pound weight of silver.

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And what of the dollar?

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The dollar began as the generally applied name of an ounce weight of silver coined by

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by a Bohemian Count named Schlick in the 16th century.

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The Count of Schlick lived in Joachim's Valley or Joachimstal.

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The Count's coins earned a great reputation for their uniformity and fineness, and they

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were widely called Joachim's Taller's or, finally, Taller's.

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The name Dollar eventually emerged from Taller.

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In the free market, then, the various names that units may have are simply definitions

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of units of weight.

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When we were on the gold standard before 1933, people liked to say that the price of gold

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was fixed at $20 per ounce of gold.

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But this was a dangerously misleading way of looking at our money.

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Actually, the dollar was defined as the name for approximately one twentieth of an ounce

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of gold.

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It was therefore misleading to talk about exchange rates of one country's currency for another.

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The pound sterling did not really exchange for $5. Actually, the pound sterling exchanged

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for $4.87, but we are using $5 for greater convenience of calculation. The dollar was

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defined as 1 twentieth of a gold ounce, and the pound sterling was, at that time, defined

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as the name for one-fourth of a gold ounce, simply traded for five-twentieths of a gold

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ounce.

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Clearly, such exchanges and such a welter of names were confusing and misleading.

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How they arose is shown below in the chapter on government meddling with money.

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In a purely free market, gold would simply be exchanged directly as grams, grains or

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and such confusing names as dollars, francs, etc. would be superfluous.

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Therefore, in this section, we will treat money as exchanging directly in terms of ounces or grams.

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Clearly, the free market will choose as the common unit whatever size of the money commodity is most convenient.

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If platinum were the money, it would likely be traded in terms of fractions of an ounce.

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6. The Shape of Money

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If the size or the name of the money unit makes little economic difference, neither

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does the shape of the monetary metal. Since the commodity is the money, it follows that

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But the entire stock of the metal, so long as it is available to man, constitutes the

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world's stock of money.

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It makes no real difference what shape any of the metal is at any time.

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If iron is the money, then all the iron is money, whether it is in the form of bars,

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chunks, or embodied in specialized machinery.

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Iron hoes have been used extensively as money, both in Asia and Africa.

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Gold has been traded as money in the raw form of nuggets, as gold dust in sacks and even

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as jewelry.

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It should not be surprising that gold or other monies can be traded in many forms, since

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their important feature is their weight.

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It is true, however, that some shapes are often more convenient than others.

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In recent centuries, gold and silver have been broken down into coins for smaller day-to-day

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Transactions and into larger bars for bigger transactions.

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Other gold is transformed into jewelry and other ornaments.

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Now any kind of transformation from one shape to another costs time, effort and other resources.

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Doing this work will be a business like any other, and prices for this service will be

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set in the usual manner.

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Most people agree that it is legitimate for jewelers to make ornaments out of raw gold,

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But they often deny that the same applies to the manufacture of coins.

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Yet on the free market, coinage is essentially a business, like any other.

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Many people believed in the days of the gold standard that coins were somehow more really

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money than plain uncoined gold bullion, bars, ingots or any other shape.

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It is true that coins commanded a premium over bullion, but this was not caused by any

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7. Private Coinage

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The idea of private coinage seems so strange today that it is worth examining carefully.

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We are used to thinking of coinage as a necessity of sovereignty, yet after all we are not wedded

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to a royal prerogative, and it is the American concept that sovereignty rests not in government

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but in the people.

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How would private coinage work?

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In the same way we have said as any other business.

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Each minter would produce whatever size or shape of coin is most pleasing to his customers.

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The price would be set by the free competition of the market.

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The standard objection is that it would be too much trouble to weigh or assay bits of

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gold at every transaction.

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But what is there to prevent private minters from stamping the coin and guaranteeing its

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weight and fineness?

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Private minters can guarantee a coin at least as well as a government mint.

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Abraded bits of metal would not be accepted as coin.

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People would use the coins of those minters with the best reputation for good quality

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of product.

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We have seen that this is precisely how the dollar became prominent, as a competitive

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silver coin.

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Opponents of private coinage charge that fraud would run rampant, yet these same opponents

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would trust government to provide the coinage.

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But if government is to be trusted at all, then surely, with private coinage, government

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could at least be trusted to prevent or punish fraud.

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It is usually assumed that the prevention or punishment of fraud, theft or other crimes

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is the real justification for government.

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But if government cannot apprehend the criminal when private coinage is relied upon, what

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hope is there for a reliable coinage when the integrity of the private market place

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00:23:57.440 --> 00:24:03.160
operators is discarded in favor of a government monopoly of coinage?

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If government cannot be trusted to ferret out the occasional villain in the free market

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00:24:07.760 --> 00:24:13.380
in coin, why can government be trusted when it finds itself in a position of total control

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00:24:13.380 --> 00:24:19.780
over money, and may debase coin, counterfeit coin, or otherwise with full legal sanction

283
00:24:19.780 --> 00:24:23.680
perform as the sole villain in the marketplace?

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00:24:23.680 --> 00:24:29.240
It is surely folly to say that government must socialize all property in order to prevent

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00:24:29.240 --> 00:24:35.640
anyone from stealing property. Yet the reasoning behind abolition of private coinage is the same.

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00:24:36.920 --> 00:24:42.840
Moreover, all modern business is built on guarantees of standards. The drug store sells

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00:24:42.840 --> 00:24:48.840
an eight ounce bottle of medicine, the meat packer sells a pound of beef. The buyer expects these

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00:24:48.840 --> 00:24:54.840
guarantees to be accurate, and they are. And think of the thousands upon thousands of specialized

289
00:24:54.840 --> 00:25:01.160
have vital industrial products that must meet very narrow standards and specifications.

290
00:25:01.160 --> 00:25:08.200
The buyer of a half-inch bolt must get a half-inch bolt and not a mere three-eighths inch.

291
00:25:08.200 --> 00:25:10.720
Yet business has not broken down.

292
00:25:10.720 --> 00:25:15.900
Few people suggest that the government must nationalize the machine tool industry as part

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00:25:15.900 --> 00:25:19.700
of its job of defending standards against fraud.

294
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The modern market economy contains an infinite number of intricate exchanges, most depending

295
00:25:25.700 --> 00:25:29.460
on definite standards of quantity and quality.

296
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But fraud is at a minimum, and that minimum, at least in theory, may be prosecuted.

297
00:25:35.440 --> 00:25:38.660
So it would be if there were private coinage.

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00:25:38.660 --> 00:25:43.880
We can be sure that a midter's customers and his competitors would be keenly alert

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00:25:43.880 --> 00:25:50.120
to any possible fraud in the weight or fineness of his coins.

300
00:25:50.120 --> 00:25:54.320
Champions of the government's coinage monopoly have claimed that money is different from

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00:25:54.320 --> 00:26:00.480
all other commodities, because Gresham's law proves that bad money drives out good from

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00:26:00.480 --> 00:26:06.160
circulation. Hence the free market cannot be trusted to serve the public in supplying

303
00:26:06.160 --> 00:26:13.160
good money. But this formulation rests on a misinterpretation of Gresham's famous law.

304
00:26:13.160 --> 00:26:18.820
The law really says that money overvalued artificially by government will drive out

305
00:26:18.820 --> 00:26:23.080
of circulation artificially undervalued money.

306
00:26:23.080 --> 00:26:28.100
Suppose for example there are one ounce gold coins in circulation.

307
00:26:28.100 --> 00:26:34.360
After a few years of wear and tear let us say that some coins weigh only 0.9 ounces.

308
00:26:34.360 --> 00:26:40.200
Obviously on the free market the worn coins would circulate at only 90% of the value of

309
00:26:40.200 --> 00:26:47.240
of the full-bodied coins and the nominal face value of the former would have to be repudiated.

310
00:26:47.240 --> 00:26:52.320
To meet the problem of wear and tear, private coiners might either set a time limit on their

311
00:26:52.320 --> 00:26:59.280
stamped guarantees of weight or agree to re-coin anew either at the original or at the lower

312
00:26:59.280 --> 00:27:00.280
weight.

313
00:27:00.280 --> 00:27:05.320
We may note that in the free economy there will not be the compulsory standardization

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00:27:05.320 --> 00:27:11.160
One of the coins that prevails when government monopolies direct the coinage.

315
00:27:11.160 --> 00:27:16.200
If anything, it will be the bad coins that will be driven from the market.

316
00:27:16.200 --> 00:27:21.700
But suppose the government decrees that everyone must treat the worn coins as equal to new

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00:27:21.700 --> 00:27:26.940
fresh coins and must accept them equally in payment of debts.

318
00:27:26.940 --> 00:27:29.320
What has the government really done?

319
00:27:29.320 --> 00:27:35.200
It has imposed price control by coercion on the exchange rate between the two types of

320
00:27:35.200 --> 00:27:42.640
By insisting on the par ratio when the worn coins should exchange at 10% discount, it

321
00:27:42.640 --> 00:27:48.680
artificially overvalues the worn coins and undervalues new coins.

322
00:27:48.680 --> 00:27:55.360
Consequently, everyone will circulate the worn coins and hoard or export the new.

323
00:27:55.360 --> 00:28:01.040
Bad money drives out good money then, not on the free market, but as the direct result

324
00:28:01.040 --> 00:28:05.360
of Governmental Intervention in the Market.

325
00:28:05.360 --> 00:28:11.600
Despite never-ending harassment by governments, making conditions highly precarious, private

326
00:28:11.600 --> 00:28:14.960
coins have flourished many times in history.

327
00:28:14.960 --> 00:28:21.140
True to the virtual law that all innovations come from free individuals and not the state,

328
00:28:21.140 --> 00:28:25.640
the first coins were minted by private individuals and goldsmiths.

329
00:28:25.640 --> 00:28:30.960
In fact, when the government first began to monopolize the coinage, the royal coins bore

330
00:28:30.960 --> 00:28:36.520
were the guarantees of private bankers, whom the public trusted far more, apparently, than

331
00:28:36.520 --> 00:28:42.200
they did the government. Privately minted gold coins circulated in California as late

332
00:28:42.200 --> 00:28:44.200
as 1848.

333
00:28:44.200 --> 00:28:49.520
8. The Proper Supply of Money

334
00:28:49.520 --> 00:28:56.200
Now we may ask, what is the supply of money in society, and how is that supply used? In

335
00:28:56.200 --> 00:29:01.800
In particular, we may raise the perennial question, how much money do we need?

336
00:29:01.800 --> 00:29:06.840
Must the money supply be regulated by some sort of criterion, or can it be left alone

337
00:29:06.840 --> 00:29:08.720
to the free market?

338
00:29:08.720 --> 00:29:15.880
First, the total stock or supply of money in society at any one time is the total weight

339
00:29:15.880 --> 00:29:18.940
of the existing money stuff.

340
00:29:18.940 --> 00:29:23.960
Let us assume for the time being that only one commodity is established on the free market

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00:29:23.960 --> 00:29:25.460
as money.

342
00:29:25.460 --> 00:29:31.140
Let us further assume that gold is that commodity, although we could have taken silver or even

343
00:29:31.140 --> 00:29:32.140
iron.

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00:29:32.140 --> 00:29:38.500
It is up to the market, and not to us, to decide the best commodity to use as money.

345
00:29:38.500 --> 00:29:45.640
Since money is gold, the total supply of money is the total weight of gold existing in society.

346
00:29:45.640 --> 00:29:51.060
The shape of gold does not matter, except if the cost of changing shapes in certain

347
00:29:51.060 --> 00:29:53.800
ways is greater than in others.

348
00:29:53.800 --> 00:29:58.120
For example, minting coins costing more than melting them.

349
00:29:58.120 --> 00:30:03.280
In that case, one of the shapes will be chosen by the market as the money of a count, and

350
00:30:03.280 --> 00:30:08.500
the other shapes will have a premium or discount in accordance with their relative costs on

351
00:30:08.500 --> 00:30:11.100
the market.

352
00:30:11.100 --> 00:30:17.580
Changes in the total gold stock will be governed by the same causes as changes in other goods.

353
00:30:17.580 --> 00:30:21.580
Increases will stem from greater production from mines.

354
00:30:21.580 --> 00:30:26.760
Changes from being used up in wear and tear in industry, etc.

355
00:30:26.760 --> 00:30:32.440
Because the market will choose a durable commodity as money, and because money is not used up

356
00:30:32.440 --> 00:30:38.120
at the rate of other commodities but is employed as a medium of exchange, the proportion of

357
00:30:38.120 --> 00:30:43.960
new annual production to its total stock will tend to be quite small.

358
00:30:43.960 --> 00:30:49.840
Changes in total gold stock, then, generally take place very slowly.

359
00:30:49.840 --> 00:30:52.760
What should the supply of money be?

360
00:30:52.760 --> 00:30:57.280
All sorts of criteria have been put forward, that money should move in accordance with

361
00:30:57.280 --> 00:31:03.080
population, with the volume of trade, with the amounts of goods produced, so as to keep

362
00:31:03.080 --> 00:31:06.240
the price level constant, etc.

363
00:31:06.240 --> 00:31:10.360
Few indeed have suggested leaving the decision to the market.

364
00:31:10.360 --> 00:31:16.320
But money differs from other commodities in one essential fact, and grasping this difference

365
00:31:16.320 --> 00:31:20.500
furnishes a key to understanding monetary matters.

366
00:31:20.500 --> 00:31:26.200
When the supply of any other good increases, this increase confers a social benefit.

367
00:31:26.200 --> 00:31:28.920
It is a matter for general rejoicing.

368
00:31:28.920 --> 00:31:33.140
More consumer goods mean a higher standard of living for the public.

369
00:31:33.140 --> 00:31:38.300
More capital goods mean sustained and increased living standards in the future.

370
00:31:38.300 --> 00:31:44.760
The discovery of new fertile land or natural resources also promises to add to living standards,

371
00:31:44.760 --> 00:31:46.800
present and future.

372
00:31:46.800 --> 00:31:48.500
But what about money?

373
00:31:48.500 --> 00:31:54.440
Does an addition to the money supply also benefit the public at large?

374
00:31:54.440 --> 00:31:57.840
Consumer goods are used up by consumers.

375
00:31:57.840 --> 00:32:04.000
Capital goods and natural resources are used up in the process of producing consumer goods.

376
00:32:04.000 --> 00:32:07.120
But money is not used up.

377
00:32:07.120 --> 00:32:13.180
Its function is to act as a medium of exchanges, to enable goods and services to travel more

378
00:32:13.180 --> 00:32:19.820
are expeditiously from one person to another. These exchanges are all made in terms of money

379
00:32:19.820 --> 00:32:26.300
prices. Thus, if a television set exchanges for three gold ounces, we say that the price

380
00:32:26.300 --> 00:32:32.500
of the television set is three ounces. At any one time, all goods in the economy will

381
00:32:32.500 --> 00:32:39.780
exchange at certain gold ratios, or prices. As we have said, money, or gold, is the common

382
00:32:39.780 --> 00:32:46.540
One denominator of all prices. But what of money itself? Does it have a price? Since

383
00:32:46.540 --> 00:32:52.940
a price is simply an exchange ratio, it clearly does. But in this case, the price of money

384
00:32:52.940 --> 00:32:59.620
is an array of the infinite number of exchange ratios for all the various goods on the market.

385
00:32:59.620 --> 00:33:06.620
Thus, suppose that a television set costs 3 gold ounces, an auto 60 ounces, a loaf of

386
00:33:06.620 --> 00:33:11.540
The price of bread one hundredth of an ounce, and an hour of Mr. Jones' legal services,

387
00:33:11.540 --> 00:33:13.060
one ounce.

388
00:33:13.060 --> 00:33:18.060
The price of money will then be an array of alternative exchanges.

389
00:33:18.060 --> 00:33:24.180
One ounce of gold will be worth either one-third of a television set, one-sixtieth of an auto,

390
00:33:24.180 --> 00:33:28.740
one hundred loaves of bread, or one hour of Jones' legal service.

391
00:33:28.740 --> 00:33:30.940
And so on down the line.

392
00:33:30.940 --> 00:33:35.780
The price of money, then, is the purchasing power of the monetary unit.

393
00:33:35.780 --> 00:33:42.220
in this case of the gold ounce. It tells what that ounce can purchase in exchange, just

394
00:33:42.220 --> 00:33:46.980
as the money price of a television set tells how much money a television set can bring

395
00:33:46.980 --> 00:33:53.500
in exchange. What determines the price of money? The same forces that determine all

396
00:33:53.500 --> 00:34:01.200
prices on the market, that venerable but eternally true law, supply and demand. We all know that

397
00:34:01.200 --> 00:34:05.480
And if the supply of eggs increases, the price will tend to fall.

398
00:34:05.480 --> 00:34:10.200
If the buyer's demand for eggs increases, the price will tend to rise.

399
00:34:10.200 --> 00:34:12.320
The same is true for money.

400
00:34:12.320 --> 00:34:16.560
An increase in the supply of money will tend to lower its price.

401
00:34:16.560 --> 00:34:20.160
An increase in the demand for money will raise it.

402
00:34:20.160 --> 00:34:23.400
But what is the demand for money?

403
00:34:23.400 --> 00:34:26.480
In the case of eggs, we know what demand means.

404
00:34:26.480 --> 00:34:31.640
Demand is the amount of money consumers are willing to spend on eggs, plus eggs retained

405
00:34:31.640 --> 00:34:34.000
and not sold by suppliers.

406
00:34:34.000 --> 00:34:39.760
Similarly, in the case of money, demand means the various goods offered in exchange for

407
00:34:39.760 --> 00:34:46.100
money, plus the money retained in cash and not spent over a certain time period.

408
00:34:46.100 --> 00:34:52.640
In both cases, supply may refer to the total stock of the good on the market.

409
00:34:52.640 --> 00:34:59.040
What happens then if the supply of gold increases, demand for money remaining the same?

410
00:34:59.040 --> 00:35:05.360
The price of money falls, that is, the purchasing power of the money unit will fall all along

411
00:35:05.360 --> 00:35:06.360
the line.

412
00:35:06.360 --> 00:35:11.880
An ounce of gold will now be worth less than one hundred loaves of bread, one third of

413
00:35:11.880 --> 00:35:14.480
a television set, etc.

414
00:35:14.480 --> 00:35:21.480
Conversely, if the supply of gold falls, the purchasing power of the gold ounce rises.

415
00:35:21.480 --> 00:35:25.440
What is the effect of a change in the money supply?

416
00:35:25.440 --> 00:35:30.160
Following the example of David Hume, one of the first economists, we may ask ourselves

417
00:35:30.160 --> 00:35:35.640
what would happen if, overnight, some good fairy slipped into pockets, purses and bank

418
00:35:35.640 --> 00:35:39.080
vaults and doubled our supply of money.

419
00:35:39.080 --> 00:35:43.360
In our example, she magically doubled our supply of gold.

420
00:35:43.360 --> 00:35:45.720
Would we be twice as rich?

421
00:35:45.720 --> 00:35:47.000
Obviously not.

422
00:35:47.000 --> 00:35:52.420
What makes us rich is an abundance of goods, and what limits that abundance is a scarcity

423
00:35:52.420 --> 00:35:57.300
of resources, namely land, labor, and capital.

424
00:35:57.300 --> 00:36:01.400
Multiplying coin will not whisk these resources into being.

425
00:36:01.400 --> 00:36:06.900
We may feel twice as rich for the moment, but clearly all we are doing is diluting the

426
00:36:06.900 --> 00:36:08.760
money supply.

427
00:36:08.760 --> 00:36:14.960
As the public rushes out to spend its newfound wealth, prices will very roughly double, or

428
00:36:14.960 --> 00:36:21.080
or at least rise until the demand is satisfied and money no longer bids against itself for

429
00:36:21.080 --> 00:36:22.680
the existing goods.

430
00:36:22.680 --> 00:36:28.160
Thus we see that while an increase in the money supply, like an increase in the supply

431
00:36:28.160 --> 00:36:35.760
of any good, lowers its price, the change does not, unlike other goods, confer a social

432
00:36:35.760 --> 00:36:37.200
benefit.

433
00:36:37.200 --> 00:36:40.840
The public at large is not made richer.

434
00:36:40.840 --> 00:36:47.580
As new consumer or capital goods add to standards of living, new money only raises prices, that

435
00:36:47.580 --> 00:36:50.980
is, dilutes its own purchasing power.

436
00:36:50.980 --> 00:36:57.160
The reason for this puzzle is that money is only useful for its exchange value.

437
00:36:57.160 --> 00:37:02.780
Other goods have various real utilities, so that an increase in their supply satisfies

438
00:37:02.780 --> 00:37:05.260
more consumer wants.

439
00:37:05.260 --> 00:37:09.340
Money has utility only for prospective exchange.

440
00:37:09.340 --> 00:37:14.520
Its utility lies in its exchange value, or purchasing power.

441
00:37:14.520 --> 00:37:20.460
Our law, that an increase in money does not confer a social benefit, stems from its unique

442
00:37:20.460 --> 00:37:23.900
use as a medium of exchange.

443
00:37:23.900 --> 00:37:29.840
An increase in the money supply, then, only dilutes the effectiveness of each gold ounce.

444
00:37:29.840 --> 00:37:34.740
On the other hand, a fall in the supply of money raises the power of each gold ounce

445
00:37:34.740 --> 00:37:36.740
to do its work.

446
00:37:36.740 --> 00:37:42.940
We come to the startling truth that it doesn't matter what the supply of money is.

447
00:37:42.940 --> 00:37:46.620
Any supply will do as well as any other supply.

448
00:37:46.620 --> 00:37:51.940
The free market will simply adjust by changing the purchasing power or effectiveness of the

449
00:37:51.940 --> 00:37:53.420
gold unit.

450
00:37:53.420 --> 00:37:58.140
There is no need to tamper with the market in order to alter the money supply that it

451
00:37:58.140 --> 00:38:00.340
determines.

452
00:38:00.340 --> 00:38:05.500
At this point, the monetary planner might object, all right, granting that it is pointless

453
00:38:05.500 --> 00:38:10.560
As to increase the money supply, isn't gold mining a waste of resources?

454
00:38:10.560 --> 00:38:15.820
Shouldn't the government keep the money supply constant and prohibit new mining?

455
00:38:15.820 --> 00:38:20.540
This argument might be plausible to those who hold no principled objections to government

456
00:38:20.540 --> 00:38:25.120
meddling, though it would not convince the determined advocate of liberty.

457
00:38:25.120 --> 00:38:32.040
But the objection overlooks an important point, that gold is not only money but is also, inevitably,

458
00:38:32.040 --> 00:38:33.540
a commodity.

459
00:38:33.540 --> 00:38:39.340
An increased supply of gold may not confer any monetary benefit, but it does confer a

460
00:38:39.340 --> 00:38:41.700
non-monetary benefit.

461
00:38:41.700 --> 00:38:47.940
That is, it does increase the supply of gold used in consumption, ornaments, dental work

462
00:38:47.940 --> 00:38:52.420
and the like, and in production, industrial work.

463
00:38:52.420 --> 00:38:56.820
Gold mining, therefore, is not a social waste at all.

464
00:38:56.820 --> 00:39:01.940
We conclude, therefore, that determining the supply of money, like all other goods, is

465
00:39:01.940 --> 00:39:04.440
are best left to the free market.

466
00:39:04.440 --> 00:39:09.440
Aside from the general moral and economic advantages of freedom over coercion,

467
00:39:09.440 --> 00:39:12.940
no dictated quantity of money will do the work better,

468
00:39:12.940 --> 00:39:17.940
and the free market will set the production of gold in accordance with its relative ability

469
00:39:17.940 --> 00:39:23.940
to satisfy the needs of consumers as compared with all other productive goods.

470
00:39:23.940 --> 00:39:29.440
Gold mining is, of course, no more profitable than any other business.

471
00:39:29.440 --> 00:39:35.440
In the long run, its rate of return will be equal to the net rate of return in any other industry.

472
00:39:37.440 --> 00:39:40.440
9. The Problem of Hoarding

473
00:39:41.440 --> 00:39:45.440
The critic of monetary freedom is not so easily silenced, however.

474
00:39:45.440 --> 00:39:49.440
There is in particular the ancient bugbear of hoarding.

475
00:39:49.440 --> 00:39:56.440
The image is conjured up of the selfish old miser who, perhaps irrationally, perhaps from evil motives,

476
00:39:56.440 --> 00:40:15.360
In the first place, what has simply happened is an increased demand for money on the part

477
00:40:15.360 --> 00:40:16.940
of the miser.

478
00:40:16.940 --> 00:40:23.360
As a result, prices of goods fall, and the purchasing power of the gold ounce rises.

479
00:40:23.360 --> 00:40:28.720
There has been no loss to society, which simply carries on with a lower active supply of more

480
00:40:28.720 --> 00:40:31.520
powerful gold ounces.

481
00:40:31.520 --> 00:40:36.660
Even in the worst possible view of the matter, then, nothing has gone wrong, and monetary

482
00:40:36.660 --> 00:40:39.720
freedom creates no difficulties.

483
00:40:39.720 --> 00:40:44.940
But there is more to the problem than that, for it is by no means irrational for people

484
00:40:44.940 --> 00:40:50.160
to desire more or less money in their cash balances.

485
00:40:50.160 --> 00:40:53.840
Let us at this point study cash balances further.

486
00:40:53.840 --> 00:40:57.400
Why do people keep any cash balances at all?

487
00:40:57.400 --> 00:41:01.920
Suppose that all of us were able to foretell the future with absolute certainty.

488
00:41:01.920 --> 00:41:06.400
In that case, no one would have to keep cash balances on hand.

489
00:41:06.400 --> 00:41:10.780
Everyone would know exactly how much he will spend and how much income he will receive

490
00:41:10.780 --> 00:41:12.720
at all future dates.

491
00:41:12.720 --> 00:41:17.920
He need not keep any money at hand, but will lend out his gold so as to receive his payments

492
00:41:17.920 --> 00:41:22.560
and the needed amounts on the very days he makes his expenditures.

493
00:41:22.560 --> 00:41:27.560
But of course, we necessarily live in a world of uncertainty.

494
00:41:27.560 --> 00:41:32.960
People do not precisely know what will happen to them or what their future incomes or costs

495
00:41:32.960 --> 00:41:34.400
will be.

496
00:41:34.400 --> 00:41:39.800
The more uncertain and fearful they are, the more cash balances they will want to hold.

497
00:41:39.800 --> 00:41:44.400
The more secure, the less cash they will wish to keep on hand.

498
00:41:44.400 --> 00:41:50.040
Another reason for keeping cash is also a function of the real world of uncertainty.

499
00:41:50.040 --> 00:41:54.560
If people expect the price of money to fall in the near future, they will spend their

500
00:41:54.560 --> 00:42:01.760
money now while money is more valuable, thus dishorting and reducing their demand for money.

501
00:42:01.760 --> 00:42:07.480
Conversely, if they expect the price of money to rise, they will wait to spend money later

502
00:42:07.480 --> 00:42:12.560
when it is more valuable, and their demand for cash will increase.

503
00:42:12.560 --> 00:42:20.040
People's demands for cash balances, then, rise and fall for good and sound reasons.

504
00:42:20.040 --> 00:42:25.160
Economists err if they believe something is wrong when money is not in constant, active

505
00:42:25.160 --> 00:42:32.480
circulation. Money is only useful for exchange value, true. But it is not. This truth has

506
00:42:32.480 --> 00:42:39.280
been often overlooked. Money is just as useful when lying idle in somebody's cash balance,

507
00:42:39.280 --> 00:42:46.400
in a Miser's Horde. At what point does a man's cash balance become a faintly disreputable

508
00:42:46.400 --> 00:42:54.080
horde or the prudent man a miser? It is impossible to fix any definite criterion. Generally the

509
00:42:54.080 --> 00:42:59.840
charge of hoarding means that A is keeping more cash than B thinks is appropriate for

510
00:42:59.840 --> 00:43:07.680
A. For that money is being held now in weight for possible future exchange. It supplies

511
00:43:07.680 --> 00:43:13.600
is to its owner, right now, the usefulness of permitting exchanges at any time, present

512
00:43:13.600 --> 00:43:17.080
or future, the owner might desire.

513
00:43:17.080 --> 00:43:22.160
It should be remembered that all gold must be owned by someone, and therefore that all

514
00:43:22.160 --> 00:43:25.900
gold must be held in people's cash balances.

515
00:43:25.900 --> 00:43:32.760
If there are 3,000 tons of gold in society, all 3,000 tons must be owned and held at any

516
00:43:32.760 --> 00:43:37.080
one time in the cash balances of individual people.

517
00:43:37.080 --> 00:43:43.480
The total sum of cash balances is always identical with the total supply of money in the society.

518
00:43:43.480 --> 00:43:49.560
Thus, ironically, if it were not for the uncertainty of the real world, there could be no monetary

519
00:43:49.560 --> 00:43:51.420
system at all.

520
00:43:51.420 --> 00:43:56.920
In a certain world, no one would be willing to hold cash, so the demand for money in society

521
00:43:56.920 --> 00:44:03.120
would fall infinitely, prices would skyrocket without end, and any monetary system would

522
00:44:03.120 --> 00:44:05.040
break down.

523
00:44:05.040 --> 00:44:10.560
Instead of the existence of cash balances being an annoying and troublesome factor, interfering

524
00:44:10.560 --> 00:44:17.240
with monetary exchange, it is absolutely necessary to any monetary economy.

525
00:44:17.240 --> 00:44:21.640
It is misleading, furthermore, to say that money circulates.

526
00:44:21.640 --> 00:44:26.640
Like all metaphors taken from the physical sciences, it connotes some sort of mechanical

527
00:44:26.640 --> 00:44:33.040
process, independent of human will, which moves at a certain speed of flow or velocity.

528
00:44:33.040 --> 00:44:43.040
Actually, money does not circulate. It is, from time to time, transferred from one person's cash balance to another's.

529
00:44:43.040 --> 00:44:50.040
The existence of money, once again, depends upon people's willingness to hold cash balances.

530
00:44:50.040 --> 00:44:56.040
At the beginning of this section, we saw that hoarding never brings any loss to society.

531
00:44:56.040 --> 00:45:10.040
Now we will see that movement in the price of money caused by changes in the demand for money yields a positive social benefit, as positive as any conferred by increased supplies of goods and services.

532
00:45:10.040 --> 00:45:18.040
We have seen that the total sum of cash balances in society is equal and identical with the total supply of money.

533
00:45:18.040 --> 00:45:23.040
Let us assume the supply remains constant, say at 3,000 tons.

534
00:45:23.040 --> 00:45:30.640
Now suppose, for whatever reason, perhaps growing apprehension, people's demand for cash balances increases.

535
00:45:30.640 --> 00:45:35.640
Surely it is a positive social benefit to satisfy this demand.

536
00:45:35.640 --> 00:45:41.140
But how can it be satisfied when the total sum of cash must remain the same?

537
00:45:41.140 --> 00:45:43.140
Simply as follows.

538
00:45:43.140 --> 00:45:50.140
With people valuing cash balances more highly, the demand for money increases, and prices fall.

539
00:45:50.140 --> 00:46:03.140
As a result, the same total sum of cash balances now confers a higher real balance, that is, it is higher in proportion to the prices of goods, to the work that money has to perform.

540
00:46:03.140 --> 00:46:08.140
In short, the effective cash balances of the public have increased.

541
00:46:08.140 --> 00:46:15.140
Conversely, a fall in the demand for cash will cause increased spending at higher prices.

542
00:46:15.140 --> 00:46:25.140
The public's desire for lower effective cash balances will be satisfied by the necessity for given total cash to perform more work.

543
00:46:25.140 --> 00:46:35.140
Therefore, while a change in the price of money stemming from changes in supply merely alters the effectiveness of the money unit and confers no social benefit,

544
00:46:35.140 --> 00:46:36.140
benefit.

545
00:46:36.140 --> 00:46:43.780
A fall or rise caused by a change in the demand for cash balances does yield a social benefit,

546
00:46:43.780 --> 00:46:49.660
for it satisfies a public desire for either a higher or lower proportion of cash balances

547
00:46:49.660 --> 00:46:52.420
to the work done by cash.

548
00:46:52.420 --> 00:46:58.000
On the other hand, an increased supply of money will frustrate public demand for a more

549
00:46:58.000 --> 00:47:04.340
effective sum total of cash, more effective in terms of purchasing power.

550
00:47:04.340 --> 00:47:10.180
People will almost always say, if asked, that they want as much money as they can get.

551
00:47:10.180 --> 00:47:16.060
But what they really want is not more units of money, more gold ounces or dollars, but

552
00:47:16.060 --> 00:47:23.040
more effective units, that is, greater command of goods and services bought by money.

553
00:47:23.040 --> 00:47:29.740
We have seen that society cannot satisfy its demand for more money by increasing its supply,

554
00:47:29.740 --> 00:47:34.860
For an increased supply will simply dilute the effectiveness of each ounce, and the money

555
00:47:34.860 --> 00:47:38.940
will be no more really plentiful than before.

556
00:47:38.940 --> 00:47:44.400
People's standard of living, except in the non-monetary uses of gold, cannot increase

557
00:47:44.400 --> 00:47:46.620
by mining more gold.

558
00:47:46.620 --> 00:47:51.660
If people want more effective gold ounces in their cash balances, they can get them

559
00:47:51.660 --> 00:47:56.660
Only Through a Fall in Prices and a Rise in the Effectiveness of Each Ounce

560
00:47:56.660 --> 00:48:01.260
10.

561
00:48:01.260 --> 00:48:03.900
Stabilize the Price Level?

562
00:48:03.900 --> 00:48:08.780
Some theorists charge that a free monetary system would be unwise because it would not

563
00:48:08.780 --> 00:48:13.380
stabilize the price level, that is, the price of the money unit.

564
00:48:13.380 --> 00:48:18.580
Money, they say, is supposed to be a fixed yardstick that never changes.

565
00:48:18.580 --> 00:48:22.580
Therefore its value or purchasing power should be stabilized.

566
00:48:22.580 --> 00:48:26.580
Since the price of money would admittedly fluctuate on the free market,

567
00:48:26.580 --> 00:48:32.580
freedom must be overruled by government management to ensure stability.

568
00:48:32.580 --> 00:48:36.580
How the government would go about this is unimportant at this point.

569
00:48:36.580 --> 00:48:41.580
Basically it would involve governmentally managed changes in the money supply.

570
00:48:41.580 --> 00:48:46.580
Stability would provide justice, for example, to debtors and creditors

571
00:48:46.580 --> 00:48:51.560
who will be sure of paying back dollars or gold ounces of the same purchasing power as

572
00:48:51.560 --> 00:48:53.820
they lent out.

573
00:48:53.820 --> 00:48:58.860
Yet if creditors and debtors want to hedge against future changes in purchasing power,

574
00:48:58.860 --> 00:49:01.800
they can do so easily on the free market.

575
00:49:01.800 --> 00:49:06.580
When they make their contracts, they can agree that repayment will be made in a sum of money

576
00:49:06.580 --> 00:49:12.840
adjusted by some agreed-upon index number of changes in the value of money.

577
00:49:12.840 --> 00:49:18.300
The stabilizers have long advocated such measures, but strangely enough, the very lenders and

578
00:49:18.300 --> 00:49:23.540
borrowers who are supposed to benefit most from stability have rarely availed themselves

579
00:49:23.540 --> 00:49:25.680
of the opportunity.

580
00:49:25.680 --> 00:49:31.120
Must the government then force certain benefits on people who have already freely rejected

581
00:49:31.120 --> 00:49:32.120
them?

582
00:49:32.120 --> 00:49:36.780
Apparently, businessmen would rather take their chances in this world of irremediable

583
00:49:36.780 --> 00:49:42.080
uncertainty on their ability to anticipate the conditions of the market.

584
00:49:42.080 --> 00:49:46.960
After all, the price of money is no different from any other free price on the market.

585
00:49:46.960 --> 00:49:50.900
They can change in response to changes in demand of individuals.

586
00:49:50.900 --> 00:49:54.180
Why not the monetary price?

587
00:49:54.180 --> 00:50:00.120
Artificial stabilization would in fact seriously distort and hamper the workings of the market.

588
00:50:00.120 --> 00:50:05.180
As we have indicated, people would be unavoidably frustrated in their desires to alter their

589
00:50:05.180 --> 00:50:08.240
real proportion of cash balances.

590
00:50:08.240 --> 00:50:14.800
There would be no opportunity to change cash balances in proportion to prices. Furthermore,

591
00:50:14.800 --> 00:50:19.960
improved standards of living come to the public from the fruits of capital investment. Increased

592
00:50:19.960 --> 00:50:25.480
productivity tends to lower prices and costs, and thereby distribute the fruits of free

593
00:50:25.480 --> 00:50:31.700
enterprise to all the public, raising the standard of living of all consumers. Forcible

594
00:50:31.700 --> 00:50:37.740
propping up of the price level prevents this spread of higher living standards.

595
00:50:37.740 --> 00:50:45.180
Money in short is not a fixed yardstick, it is a commodity serving as a medium for exchanges.

596
00:50:45.180 --> 00:50:51.740
Flexibility in its value in response to consumer demands is just as important and just as beneficial

597
00:50:51.740 --> 00:50:55.980
as any other free pricing on the market.

598
00:50:55.980 --> 00:51:01.220
11. Coexisting Monies

599
00:51:01.220 --> 00:51:07.120
So far we have obtained the following picture of money in a purely free economy. Gold or

600
00:51:07.120 --> 00:51:12.840
for Silver coming to be used as a medium of exchange, gold minted by competitive private

601
00:51:12.840 --> 00:51:19.360
firms circulating by weight, prices fluctuating freely on the market in response to consumer

602
00:51:19.360 --> 00:51:26.280
demands and supplies of productive resources. Freedom of prices necessarily implies freedom

603
00:51:26.280 --> 00:51:31.560
of movement for the purchasing power of the money unit. It would be impossible to use

604
00:51:31.560 --> 00:51:36.960
force and interfere with movements in the value of money without simultaneously crippling

605
00:51:36.960 --> 00:52:01.400
Thus far we have simplified the problem by assuming only one monetary metal, say gold.

606
00:52:01.400 --> 00:52:06.880
Suppose that two or more monies continue to circulate on the world market, say gold and

607
00:52:06.880 --> 00:52:13.120
silver. Possibly gold will be the money in one area and silver in another, or else they

608
00:52:13.120 --> 00:52:19.380
both may circulate side by side. Gold, for example, being ounce for ounce more valuable

609
00:52:19.380 --> 00:52:25.780
on the market than silver, may be used for larger transactions and silver for smaller.

610
00:52:25.780 --> 00:52:31.040
Would not two monies be impossibly chaotic? Wouldn't the government have to step in and

611
00:52:31.040 --> 00:52:37.720
and impose a fixed ration between the two, bimetallism, or in some way demonetize one

612
00:52:37.720 --> 00:52:41.920
or the other metal, impose a single standard?

613
00:52:41.920 --> 00:52:46.940
It is very possible that the market, given free rein, might eventually establish one

614
00:52:46.940 --> 00:52:49.340
single metal as money.

615
00:52:49.340 --> 00:52:54.320
But in recent centuries silver stubbornly remained to challenge gold.

616
00:52:54.320 --> 00:52:59.040
It is not necessary, however, for the government to step in and save the market from its own

617
00:52:59.040 --> 00:53:05.160
and Folly in Maintaining Two Monies. Silver remained in circulation precisely because

618
00:53:05.160 --> 00:53:11.640
it was convenient, for small change, for example. Silver and gold could easily circulate side

619
00:53:11.640 --> 00:53:17.900
by side, and have done so in the past. The relative supplies of and demands for the two

620
00:53:17.900 --> 00:53:24.640
metals will determine the exchange rate between the two, and this rate, like any other price,

621
00:53:24.640 --> 00:53:29.320
will continually fluctuate in response to these changing forces.

622
00:53:29.320 --> 00:53:35.120
At one time, for example, silver and gold ounces might exchange at 16 to 1, another

623
00:53:35.120 --> 00:53:38.480
time at 15 to 1, etc.

624
00:53:38.480 --> 00:53:43.400
Which metal will serve as a unit of account depends on the concrete circumstances of the

625
00:53:43.400 --> 00:53:44.740
market.

626
00:53:44.740 --> 00:53:50.240
If gold is the money of account, then most transactions will be reckoned in gold ounces,

627
00:53:50.240 --> 00:53:56.480
And silver ounces will exchange at a freely fluctuating price in terms of the gold.

628
00:53:56.480 --> 00:54:00.480
It should be clear that the exchange rate and the purchasing powers of the units of

629
00:54:00.480 --> 00:54:04.640
the two metals will always tend to be proportional.

630
00:54:04.640 --> 00:54:10.340
If prices of goods are fifteen times as much in silver as they are in gold, then the exchange

631
00:54:10.340 --> 00:54:14.160
rate will tend to be set at fifteen to one.

632
00:54:14.160 --> 00:54:20.080
If not, it will pay to exchange from one to the other until parity is reached.

633
00:54:20.080 --> 00:54:26.200
Suppose if prices are 15 times as much in terms of silver as gold, while silver to gold

634
00:54:26.200 --> 00:54:32.600
is 20 to 1, people will rush to sell their goods for gold, buy silver and then re-buy

635
00:54:32.600 --> 00:54:37.340
the goods with silver, reaping a handsome gain in the process.

636
00:54:37.340 --> 00:54:42.120
This will quickly restore the purchasing power parity of the exchange rate.

637
00:54:42.120 --> 00:54:48.440
As gold gets cheaper in terms of silver, silver prices of goods go up and gold prices of goods

638
00:54:48.440 --> 00:54:50.340
go down.

639
00:54:50.340 --> 00:54:56.200
The free market, in short, is eminently orderly, not only when money is free, but even when

640
00:54:56.200 --> 00:54:59.480
there is more than one money circulating.

641
00:54:59.480 --> 00:55:02.660
What kind of standard will a free money provide?

642
00:55:02.660 --> 00:55:07.920
The important thing is that the standard not be imposed by government decree.

643
00:55:07.920 --> 00:55:14.020
If left to itself, the market may establish gold as a single money, gold standard, silver

644
00:55:14.020 --> 00:55:20.860
as a Single Money, Silver Standard, or, perhaps most likely, both as monies, with freely fluctuating

645
00:55:20.860 --> 00:55:25.140
exchange rates, parallel standards.

646
00:55:25.140 --> 00:55:27.580
12.

647
00:55:27.580 --> 00:55:30.460
Money Warehouses

648
00:55:30.460 --> 00:55:35.420
Suppose then that the free market has established gold as money, forgetting again about silver

649
00:55:35.420 --> 00:55:37.900
for the sake of simplicity.

650
00:55:37.900 --> 00:55:42.580
Even in the convenient shape of coins, gold is often cumbersome and awkward to carry and

651
00:55:42.580 --> 00:55:49.420
used directly in exchange. For larger transactions, it is awkward and expensive to transport several

652
00:55:49.420 --> 00:55:55.460
hundred pounds of gold. But the free market, ever ready to satisfy social needs, comes

653
00:55:55.460 --> 00:56:01.660
to the rescue. Gold, in the first place, must be stored somewhere. And just as specialization

654
00:56:01.660 --> 00:56:06.540
is most efficient in other lines of business, so it will be most efficient in the warehousing

655
00:56:06.540 --> 00:56:12.540
business. Certain firms, then, will be successful on the market in providing warehousing services.

656
00:56:12.540 --> 00:56:17.540
Some will be gold warehouses and will store gold for its myriad owners.

657
00:56:17.540 --> 00:56:27.540
As in the case of all warehouses, the owner's right to the stored goods is established by a warehouse receipt which he receives in exchange for storing the goods.

658
00:56:27.540 --> 00:56:32.540
The receipt entitles the owner to claim his goods at any time he desires.

659
00:56:32.540 --> 00:56:40.540
This warehouse will earn profit no differently from any other, that is, by charging a price for its storage services.

660
00:56:40.540 --> 00:56:50.540
There is every reason to believe that gold warehouses or money warehouses will flourish on the free market in the same way that other warehouses will prosper.

661
00:56:50.540 --> 00:57:04.540
In fact, warehousing plays an even more important role in the case of money, for all other goods pass into consumption and so must leave the warehouse after a while to be used up in production or consumption.

662
00:57:04.540 --> 00:57:16.540
But money, as we have seen, is mainly not used in the physical sense, instead it is used to exchange for other goods, and to lie and wait for such exchanges in the future.

663
00:57:16.540 --> 00:57:23.540
In short, money is not so much used up as simply transferred from one person to another.

664
00:57:23.540 --> 00:57:33.540
In such a situation, convenience inevitably leads to transfer of the warehouse receipt, instead of the physical gold itself.

665
00:57:33.540 --> 00:57:39.900
Suppose, for example, that Smith and Jones both store their gold in the same warehouse.

666
00:57:39.900 --> 00:57:44.060
Jones sells Smith an automobile for 100 gold ounces.

667
00:57:44.060 --> 00:57:49.060
They could go through the expensive process of Smith's redeeming his receipt and moving

668
00:57:49.060 --> 00:57:55.180
their gold to Jones' office, with Jones turning right around and redepositing the gold again,

669
00:57:55.180 --> 00:57:59.300
but they will undoubtedly choose a far more convenient course.

670
00:57:59.300 --> 00:58:05.260
Roth simply gives Jones a warehouse receipt for 100 ounces of gold.

671
00:58:05.260 --> 00:58:12.980
In this way, warehouse receipts for money come more and more to function as money substitutes.

672
00:58:12.980 --> 00:58:16.860
Fewer and fewer transactions move the actual gold.

673
00:58:16.860 --> 00:58:22.260
In more and more cases, paper titles to the gold are used instead.

674
00:58:22.260 --> 00:58:26.540
As the market develops, there will be three limits on the advance of this substitution

675
00:58:26.540 --> 00:58:28.300
process.

676
00:58:28.300 --> 00:58:34.740
One is the extent that people use these money warehouses, called banks, instead of cash.

677
00:58:34.740 --> 00:58:40.580
Clearly, if Jones, for some reason, didn't like to use a bank, Smith would have to transport

678
00:58:40.580 --> 00:58:42.920
the actual gold.

679
00:58:42.920 --> 00:58:47.420
The second limit is the extent of the clientele of each bank.

680
00:58:47.420 --> 00:58:52.680
In other words, the more transactions taking place between clients of different banks,

681
00:58:52.680 --> 00:58:55.840
the more gold will have to be transported.

682
00:58:55.840 --> 00:59:00.560
The more exchanges are made by clients of the same bank, the less need to transport

683
00:59:00.560 --> 00:59:02.320
the gold.

684
00:59:02.320 --> 00:59:08.160
If Jones and Smith were clients of different warehouses, Smith's Bank, or Smith himself,

685
00:59:08.160 --> 00:59:11.760
would have to transport the gold to Jones' Bank.

686
00:59:11.760 --> 00:59:17.420
Third, the clientele must have confidence in the trustworthiness of their banks.

687
00:59:17.420 --> 00:59:22.160
If they suddenly find out, for example, that the bank officials have had criminal records,

688
00:59:22.160 --> 00:59:27.880
The bank will likely lose its business in short order. In this respect, all warehouses

689
00:59:27.880 --> 00:59:32.740
and all businesses resting on good will are alike.

690
00:59:32.740 --> 00:59:37.700
As banks grow and confidence in them develops, their clients may find it more convenient

691
00:59:37.700 --> 00:59:43.980
in many cases to waive their right to paper receipts, called bank notes, and instead to

692
00:59:43.980 --> 00:59:50.260
keep their titles as open book accounts. In the monetary realm, these have been called

693
00:59:50.260 --> 00:59:52.140
Bank Deposits

694
00:59:52.140 --> 00:59:58.040
Instead of transferring paper receipts, the client has a book claim at the bank. He makes

695
00:59:58.040 --> 01:00:03.780
exchanges by writing an order to his warehouse to transfer a portion of this account to someone

696
01:00:03.780 --> 01:00:10.120
else. Thus, in our example, Smith will order the bank to transfer book title to his one

697
01:00:10.120 --> 01:00:16.960
hundred gold ounces to Jones. This written order is called a check.

698
01:00:16.960 --> 01:00:22.000
It should be clear that economically there is no difference whatever between a bank note

699
01:00:22.000 --> 01:00:24.080
and a bank deposit.

700
01:00:24.080 --> 01:00:27.520
Both are claims to ownership of stored gold.

701
01:00:27.520 --> 01:00:33.080
Both are transferred similarly as money substitutes, and both have the identical three limits on

702
01:00:33.080 --> 01:00:34.940
their extent of use.

703
01:00:34.940 --> 01:00:40.440
The client can choose, according to his convenience, whether he wishes to keep his title in note

704
01:00:40.440 --> 01:00:42.760
or deposit form.

705
01:00:42.760 --> 01:00:48.720
A third form of money substitute will be token coins for very small change.

706
01:00:48.720 --> 01:00:55.880
These are, in effect, equivalent to banknotes, but printed on base metal rather than on paper.

707
01:00:55.880 --> 01:01:00.760
Now what has happened to their money supply as a result of all these operations?

708
01:01:00.760 --> 01:01:05.840
If paper notes or bank deposits are used as money substitutes, does this mean that the

709
01:01:05.840 --> 01:01:10.720
effective money supply in the economy has increased even though the stock of gold has

710
01:01:10.720 --> 01:01:12.680
remained the same?

711
01:01:12.680 --> 01:01:18.680
For the money substitutes are simply warehouse receipts for actually deposited gold.

712
01:01:18.680 --> 01:01:24.680
If Jones deposits 100 ounces of gold in his warehouse and gets a receipt for it,

713
01:01:24.680 --> 01:01:32.680
the receipt can be used on the market as money but only as a convenient stand-in for the gold, not as an increment.

714
01:01:32.680 --> 01:01:37.680
The gold in the vault is then no longer a part of the effective money supply

715
01:01:37.680 --> 01:01:45.080
Supply, but is held as a reserve for its receipt to be claimed whenever desired by its owner.

716
01:01:45.080 --> 01:01:51.660
An increase or decrease in the use of substitutes, then, exerts no change on the money supply.

717
01:01:51.660 --> 01:01:56.160
Only the form of the supply is changed, not the total.

718
01:01:56.160 --> 01:02:01.360
Thus the money supply of a community may begin as ten million gold ounces.

719
01:02:01.360 --> 01:02:07.320
Then six million may be deposited in banks in return for gold notes, whereupon the effective

720
01:02:07.320 --> 01:02:13.240
Reserve supply will now be 4 million ounces of gold, 6 million ounces of gold claims in

721
01:02:13.240 --> 01:02:14.960
paper notes.

722
01:02:14.960 --> 01:02:18.560
The total money supply has remained the same.

723
01:02:18.560 --> 01:02:23.880
Curiously, many people have argued that it would be impossible for banks to make money

724
01:02:23.880 --> 01:02:31.760
if they were to operate on this 100% reserve basis, gold always represented by its receipt.

725
01:02:31.760 --> 01:02:35.740
Yet there is no real problem, any more than for any warehouse.

726
01:02:35.740 --> 01:02:42.400
Almost all warehouses keep all the goods for their owners 100% reserve as a matter of course.

727
01:02:42.400 --> 01:02:46.700
In fact, it would be considered fraud or theft to do otherwise.

728
01:02:46.700 --> 01:02:50.680
Their profits are earned from service charges to their customers.

729
01:02:50.680 --> 01:02:54.460
The banks can charge for their services in the same way.

730
01:02:54.460 --> 01:02:58.860
If it is objected that customers will not pay the high service charges, this means that

731
01:02:58.860 --> 01:03:02.920
the bank's services are not in very great demand, and the use of their services will

732
01:03:02.920 --> 01:03:07.460
will fall to the levels that consumers find worthwhile.

733
01:03:07.460 --> 01:03:13.280
We come now to perhaps the thorniest problem facing the monetary economist, an evaluation

734
01:03:13.280 --> 01:03:16.440
of fractional reserve banking.

735
01:03:16.440 --> 01:03:21.880
We must ask the question, would fractional reserve banking be permitted in a free market,

736
01:03:21.880 --> 01:03:24.720
or would it be proscribed as fraud?

737
01:03:24.720 --> 01:03:31.100
It is well known that banks have rarely stayed on a 100% basis very long, since money can

738
01:03:31.100 --> 01:03:48.100
If the bank can remain in the warehouse for a long period of time, the bank is tempted to use some of the money for its own account, tempted also because people do not ordinarily care whether the gold coins they receive back from the warehouse are the identical gold coins they deposited.

739
01:03:48.100 --> 01:03:54.100
The bank is tempted then to use other people's money to earn a profit for itself.

740
01:03:54.100 --> 01:04:00.820
If the banks lend out the gold directly, the receipts, of course, are now partially invalidated.

741
01:04:00.820 --> 01:04:03.860
There are now some receipts with no gold behind them.

742
01:04:03.860 --> 01:04:10.120
In short, the bank is effectively insolvent, since it cannot possibly meet its own obligations

743
01:04:10.120 --> 01:04:12.300
if called upon to do so.

744
01:04:12.300 --> 01:04:17.580
It cannot possibly hand over its customers' property should they also desire.

745
01:04:17.580 --> 01:04:29.580
Generally, banks, instead of taking the gold directly, print uncovered or pseudo warehouse receipts, that is, warehouse receipts for gold that is not and cannot be there.

746
01:04:29.580 --> 01:04:32.580
These are then loaned at a profit.

747
01:04:32.580 --> 01:04:40.580
Clearly, the economic effect is the same. More warehouse receipts are printed than gold exists in the vaults.

748
01:04:40.580 --> 01:04:51.080
What the bank has done is to issue gold warehouse receipts which represent nothing, but are supposed to represent 100% of their face value in gold.

749
01:04:51.080 --> 01:05:00.580
The pseudo-receipts pour forth on the trusting market in the same way as the true receipts, and thus add to the effective money supply of the country.

750
01:05:00.580 --> 01:05:17.580
In the above example, if the banks now issue 2 million ounces of false receipts with no gold behind them, the money supply of the country will rise from 10 to 12 million gold ounces, at least until the hocus-pocus has been discovered and corrected.

751
01:05:17.580 --> 01:05:28.580
There are now, in addition to 4 million ounces of gold held by the public, 8 million ounces of money substitutes, only 6 million of which are covered by gold.

752
01:05:28.580 --> 01:05:36.580
Issue of pseudo receipts, like counterfeiting of coin, is an example of inflation, which will be studied further below.

753
01:05:36.580 --> 01:05:46.580
Inflation may be defined as any increase in the economy's supply of money, not consisting of an increase in the stock of the money metal.

754
01:05:46.580 --> 01:05:52.580
Fractional reserve banks, therefore, are inherently inflationary institutions.

755
01:05:52.580 --> 01:06:09.580
Defenders of banks reply as follows. The banks are simply functioning like other businesses. They take risks. Admittedly, if all the depositors presented their claims, the banks would be bankrupt, since outstanding receipts exceed gold in their vaults.

756
01:06:09.580 --> 01:06:16.580
But banks simply take the chance, usually justified, that not everyone will ask for his gold.

757
01:06:16.580 --> 01:06:21.700
The great difference, however, between the fractional reserve bank and all other businesses

758
01:06:21.700 --> 01:06:28.180
is this. Other businessmen use their own or borrowed capital in ventures, and if they borrow

759
01:06:28.180 --> 01:06:33.940
credit, they promise to pay at a future date, taking care to have enough money at hand on that

760
01:06:33.940 --> 01:06:41.060
date to meet their obligation. If Smith borrows 100 gold ounces for a year, he will arrange to

761
01:06:41.060 --> 01:06:45.580
to have 100 gold ounces available on that future date.

762
01:06:45.580 --> 01:06:48.580
But the bank isn't borrowing from its depositors.

763
01:06:48.580 --> 01:06:52.660
It doesn't pledge to pay back gold at a certain date in the future.

764
01:06:52.660 --> 01:06:58.660
Instead, it pledges to pay the receipt in gold at any time on demand.

765
01:06:58.660 --> 01:07:03.460
In short, the banknote or deposit is not an IOU or debt.

766
01:07:03.460 --> 01:07:07.060
It is a warehouse receipt for other people's property.

767
01:07:07.060 --> 01:07:13.100
Further, when a businessman borrows or lends money, he does not add to the money supply.

768
01:07:13.100 --> 01:07:18.700
The loaned funds are saved funds, part of the existing money supply being transferred

769
01:07:18.700 --> 01:07:21.340
from saver to borrower.

770
01:07:21.340 --> 01:07:27.040
Bank issues, on the other hand, artificially increase the money supply, since pseudo-receipts

771
01:07:27.040 --> 01:07:29.780
are injected into the market.

772
01:07:29.780 --> 01:07:33.980
A bank, then, is not taking the usual business risk.

773
01:07:33.980 --> 01:07:39.260
It does not, like all businessmen, arrange the time pattern of its assets proportionately

774
01:07:39.260 --> 01:07:41.900
to the time pattern of liabilities.

775
01:07:41.900 --> 01:07:47.500
That is, see to it that it will have enough money on due dates to pay its bills.

776
01:07:47.500 --> 01:07:53.860
Instead, most of its liabilities are instantaneous, but its assets are not.

777
01:07:53.860 --> 01:07:59.320
The bank creates new money out of thin air, and does not, like everyone else, have to

778
01:07:59.320 --> 01:08:03.180
acquire money by producing and selling its services.

779
01:08:03.180 --> 01:08:07.940
In short, the bank is already, and at all times, bankrupt.

780
01:08:07.940 --> 01:08:14.680
But its bankruptcy is only revealed when customers get suspicious and precipitate bank runs.

781
01:08:14.680 --> 01:08:18.640
No other business experiences a phenomenon like a run.

782
01:08:18.640 --> 01:08:24.060
No other business can be plunged into bankruptcy overnight simply because its customers decide

783
01:08:24.060 --> 01:08:26.780
to repossess their own property.

784
01:08:26.780 --> 01:08:33.260
No other business creates fictitious new money which will evaporate when truly gauged.

785
01:08:33.260 --> 01:08:38.620
The dire economic effects of fractional bank money will be explored in the next chapter.

786
01:08:38.620 --> 01:08:43.440
Here we conclude that morally such banking would have no more right to exist in a truly

787
01:08:43.440 --> 01:08:47.700
free market than any other form of implicit theft.

788
01:08:47.700 --> 01:08:52.700
It is true that the note or deposit does not actually say on its face that the warehouse

789
01:08:52.700 --> 01:09:12.700
The US guarantees to keep a full backing of gold on hand at all times, but the bank does promise to redeem on demand, and so when it issues any fake receipts, it is already committing fraud, since it immediately becomes impossible for the bank to keep its pledge and redeem all of its notes and deposits.

790
01:09:13.700 --> 01:09:19.700
Fraud, therefore, is immediately being committed when the act of issuing pseudo receipts takes place.

791
01:09:19.700 --> 01:09:31.700
Which particular receipts are fraudulent can only be discovered after a run on the bank has occurred, since all the receipts look alike, and the late-coming claimants are left high and dry.

792
01:09:31.700 --> 01:09:43.700
Perhaps a libertarian system would consider general warrant deposits, which allow the warehouse to return any homogeneous good to the depositor, as specific warrant deposits,

793
01:09:43.700 --> 01:09:49.100
which, like bills of lading, pawn tickets, dock warrants, etc., establish ownership to

794
01:09:49.100 --> 01:09:52.240
certain specific earmarked objects.

795
01:09:52.240 --> 01:09:56.700
For in the case of a general deposit warrant, the warehouse is tempted to treat the goods

796
01:09:56.700 --> 01:10:01.740
as its own property, instead of being the property of its customers.

797
01:10:01.740 --> 01:10:06.420
This is precisely what the banks have been doing.

798
01:10:06.420 --> 01:10:11.720
If fraud is to be proscribed in a free society, then fractional reserve banking would have

799
01:10:11.720 --> 01:10:14.420
have to meet the same fate.

800
01:10:14.420 --> 01:10:19.400
Fraud is implicit theft, since it means that a contract has not been completed after the

801
01:10:19.400 --> 01:10:21.600
value has been received.

802
01:10:21.600 --> 01:10:28.080
In short, if A sells B a box labeled cornflakes and it turns out to be straw upon opening,

803
01:10:28.080 --> 01:10:31.720
A's fraud is really theft of B's property.

804
01:10:31.720 --> 01:10:37.040
Similarly, the issue of warehouse receipts for non-existent goods, identical with genuine

805
01:10:37.040 --> 01:10:44.760
Receipts is fraud upon those who possess claims to non-existent property.

806
01:10:44.760 --> 01:10:49.560
Suppose however that fraud and fractional reserve banking are permitted, with the banks

807
01:10:49.560 --> 01:10:55.440
only required to fulfill their obligations to redeem in gold on demand.

808
01:10:55.440 --> 01:10:59.280
Any failure to do so would mean instant bankruptcy.

809
01:10:59.280 --> 01:11:02.980
Such a system has come to be known as free banking.

810
01:11:02.980 --> 01:11:07.820
Would there then be a heavy fraudulent issue of money substitutes with resulting artificial

811
01:11:07.820 --> 01:11:10.160
creation of new money?

812
01:11:10.160 --> 01:11:15.500
Many people have assumed so, and believed that wild-cat banking would then simply inflate

813
01:11:15.500 --> 01:11:21.060
the money supply astronomically, but on the contrary, free banking would lead to a far

814
01:11:21.060 --> 01:11:24.940
harder monetary system than we have today.

815
01:11:24.940 --> 01:11:29.620
The banks would be checked by the same three limits that we noted above, and checked rather

816
01:11:29.620 --> 01:11:30.820
rigorously.

817
01:11:30.820 --> 01:11:35.780
In the first place, each bank's expansion will be limited by a loss of gold to another

818
01:11:35.780 --> 01:11:36.780
bank.

819
01:11:36.780 --> 01:11:42.180
For a bank can only expand money within the limits of its own clientele.

820
01:11:42.180 --> 01:11:48.300
Suppose for example that Bank A, with 10,000 ounces of gold deposited, now issues 2,000

821
01:11:48.300 --> 01:11:53.620
ounces of false warehouse receipts to gold and lends them to various enterprises, or

822
01:11:53.620 --> 01:11:56.020
invests them in securities.

823
01:11:56.020 --> 01:12:00.820
The borrower or former holder of securities will spend the new money on various goods

824
01:12:00.820 --> 01:12:02.100
and services.

825
01:12:02.100 --> 01:12:06.660
Eventually, the money going the rounds will reach an owner who is a client of another

826
01:12:06.660 --> 01:12:08.900
bank, B.

827
01:12:08.900 --> 01:12:14.020
At that point, Bank B will call upon Bank A to redeem its receipt in gold, so that the

828
01:12:14.020 --> 01:12:17.220
gold can be transferred to Bank B's vaults.

829
01:12:17.220 --> 01:12:22.360
Clearly, the wider the extent of each bank's clientele and the more the clients trade with

830
01:12:22.360 --> 01:12:27.240
with one another, the more scope there is for each bank to expand its credit and money

831
01:12:27.240 --> 01:12:28.520
supply.

832
01:12:28.520 --> 01:12:33.680
For if the bank's clientele is narrow, then soon after its issue of created money it will

833
01:12:33.680 --> 01:12:38.880
be called upon to redeem, and, as we have seen, it doesn't have the wherewithal to redeem

834
01:12:38.880 --> 01:12:41.880
more than a fraction of its obligations.

835
01:12:41.880 --> 01:12:46.560
To avoid the threat of bankruptcy from this quarter, then, the narrower the scope of a

836
01:12:46.560 --> 01:12:51.880
bank's clientele, the greater the fraction of gold it must keep in reserve, and the less

837
01:12:51.880 --> 01:12:57.320
it can expand. If there is one bank in each country, there will be far more scope for

838
01:12:57.320 --> 01:13:02.620
expansion than if there is one bank for every two persons in the community. Other things

839
01:13:02.620 --> 01:13:08.240
being equal then, the more banks there are and the tinier their size, the harder and

840
01:13:08.240 --> 01:13:14.600
better the monetary supply will be. Similarly, a bank's clientele will also be limited by

841
01:13:14.600 --> 01:13:20.920
those who don't use a bank at all. The more people use actual gold instead of bank money,

842
01:13:20.920 --> 01:13:24.920
and the less room there is for bank inflation.

843
01:13:24.920 --> 01:13:29.880
Suppose, however, that the banks form a cartel and agree to pay out each other's receipts

844
01:13:29.880 --> 01:13:35.920
and not call for redemption, and suppose further that bank money is in universal use.

845
01:13:35.920 --> 01:13:39.000
Are there any limits left on bank expansion?

846
01:13:39.000 --> 01:13:44.240
Yes, there remains the check of client confidence in the banks.

847
01:13:44.240 --> 01:13:49.340
As bank credit and the money supply expand further and further, more and more clients

848
01:13:49.340 --> 01:13:54.740
will get worried over the lowering of the reserve fraction, and in a truly free society

849
01:13:54.740 --> 01:13:59.980
those who know the truth about the real insolvency of the banking system will be able to form

850
01:13:59.980 --> 01:14:06.000
anti-bank leagues to urge clients to get their money out before it is too late.

851
01:14:06.000 --> 01:14:11.060
In short, leagues to urge bank runs or the threat of their formation will be able to

852
01:14:11.060 --> 01:14:15.380
stop and reverse the monetary expansion.

853
01:14:15.380 --> 01:14:20.220
None of this discussion is meant to impugn the general practice of credit, which has

854
01:14:20.220 --> 01:14:23.780
an important and vital function on the free market.

855
01:14:23.780 --> 01:14:29.100
In a credit transaction, the possessor of money, a good useful in the present, exchanges

856
01:14:29.100 --> 01:14:36.220
it for an IOU payable at some future date, the IOU being a future good, and the interest

857
01:14:36.220 --> 01:14:42.300
charge reflects the higher valuation of present goods over future goods on the market.

858
01:14:42.300 --> 01:14:48.940
Banknotes or deposits are not credit. They are warehouse receipts, instantaneous claims

859
01:14:48.940 --> 01:14:55.700
to cash, that is, gold, in the bank vaults. The debtor makes sure that he pays his debt

860
01:14:55.700 --> 01:15:02.080
when payment becomes due. The fractional reserve banker can never pay more than a small fraction

861
01:15:02.080 --> 01:15:05.580
of his outstanding liabilities.

862
01:15:05.580 --> 01:15:09.980
We turn in the next chapter to a study of the various forms of governmental interference

863
01:15:09.980 --> 01:15:26.060
13. Summary.

864
01:15:26.060 --> 01:15:31.020
What have we learned about money in a free society? We have learned that all money has

865
01:15:31.020 --> 01:15:36.780
originated and must originate in a useful commodity chosen by the free market as a medium

866
01:15:36.780 --> 01:15:38.580
System of Exchange.

867
01:15:38.580 --> 01:15:44.300
The unit of money is simply a unit of weight of the monetary commodity, usually a metal

868
01:15:44.300 --> 01:15:46.660
such as gold or silver.

869
01:15:46.660 --> 01:15:51.920
Under freedom, the commodities chosen as money, their shape and form, are left to the voluntary

870
01:15:51.920 --> 01:15:54.900
decisions of free individuals.

871
01:15:54.900 --> 01:16:00.900
Private coinage, therefore, is just as legitimate and worthwhile as any business activity.

872
01:16:00.900 --> 01:16:06.140
The price of money is its purchasing power in terms of all goods in the economy, and

873
01:16:06.140 --> 01:16:12.140
This is determined by its supply and by every individual's demand for money.

874
01:16:12.140 --> 01:16:16.940
Any attempt by government to fix the price will interfere with the satisfaction of people's

875
01:16:16.940 --> 01:16:18.940
demands for money.

876
01:16:18.940 --> 01:16:23.740
If people find it more convenient to use more than one metal as money, the exchange rate

877
01:16:23.740 --> 01:16:28.820
between them on the market will be determined by the relative demands and supplies and will

878
01:16:28.820 --> 01:16:33.540
tend to equal the ratios of their respective purchasing power.

879
01:16:33.540 --> 01:16:38.300
Since there is enough supply of a metal to permit the market to choose it as money, no

880
01:16:38.300 --> 01:16:44.340
increase in supply can improve its monetary function. An increase in money supply will

881
01:16:44.340 --> 01:16:50.800
then merely dilute the effectiveness of each ounce of money without helping the economy.

882
01:16:50.800 --> 01:16:57.460
An increased stock of gold or silver, however, fulfills more non-monetary wants—ornament,

883
01:16:57.460 --> 01:17:02.980
industrial purposes, etc. served by the metal, and is therefore socially useful.

884
01:17:02.980 --> 01:17:09.060
Inflation, an increase in money substitutes not covered by an increase in the metal stock,

885
01:17:09.060 --> 01:17:15.180
is never socially useful, but merely benefits one set of people at the expense of another.

886
01:17:15.180 --> 01:17:20.380
Inflation, being a fraudulent invasion of property, could not take place on the free

887
01:17:20.380 --> 01:17:22.300
market.

888
01:17:22.300 --> 01:17:28.660
In sum, freedom can run a monetary system as superbly as it runs the rest of the economy.

889
01:17:28.660 --> 01:17:33.100
Contrary to many writers, there is nothing special about money that requires extensive

890
01:17:33.100 --> 01:17:35.380
governmental dictation.

891
01:17:35.380 --> 01:17:41.900
Here too, free men will best and most smoothly supply all their economic wants.

892
01:17:41.900 --> 01:17:47.660
For money, as for all other activities of man, liberty is the mother, not the daughter,

893
01:17:47.660 --> 01:17:48.220
of order.