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NOTE III. Government Meddling With Money

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Chapter 3. Government Meddling with Money

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1. The Revenue of Government

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Governments, in contrast to all other organizations, do not obtain their revenue as payment for their services.

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Consequently, governments face an economic problem different from that of everyone else.

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Government private individuals who want to acquire more goods and services from others

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must produce and sell more of what others want. Governments need only find some method

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of expropriating more goods without the owner's consent. In a barter economy, government officials

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can only expropriate resources in one way, by seizing goods in kind. In a monetary economy,

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They will find it easier to seize monetary assets, and then use the money to acquire

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goods and services for government, or else pay the money as subsidies to favored groups.

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Such seizure is called taxation.

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Direct seizure of goods is therefore not now as extensive as monetary expropriation.

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Instances of the former still occurring are due process seizure of land under eminent

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Domain, quartering of troops in an occupied country, and especially compulsory confiscation

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of labor service, for example, military conscription, compulsory jury duty, and forcing business

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to keep tax records and collect withholding taxes.

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Taxation, however, is often unpopular, and in less temperate days, frequently precipitated

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revolutions.

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The emergence of money, while a boon to the human race, also opened a more subtle route

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for governmental expropriation of resources.

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On the free market, money can be acquired by producing and selling goods and services

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that people want, or by mining, a business no more profitable in the long run than any

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other.

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But if government can find ways to engage in counterfeiting, the creation of new money

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out of thin air, it can quickly produce its own money without taking the trouble to sell

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services or mine gold.

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It can then appropriate resources slyly and almost unnoticed without rousing the hostility

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touched off by taxation.

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In fact, counterfeiting can create in its very victims the blissful illusion of unparalleled

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prosperity.

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Banking is evidently but another name for inflation, both creating new money that is

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not standard gold or silver and both functioning similarly.

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And now we see why governments are inherently inflationary, because inflation is a powerful

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and subtle means for government acquisition of the public's resources, a painless and

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all the more dangerous form of taxation.

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2. The Economic Effects of Inflation

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To gauge the economic effects of inflation, let us see what happens when a group of counterfeiters

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set about their work. Suppose the economy has a supply of 10,000 gold ounces, and counterfeiters,

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so cunning that they cannot be detected, pump in 2,000 ounces more. What will be the consequences?

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First there will be a clear gain to the counterfeiters.

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They take the newly created money and use it to buy goods and services.

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In the words of the famous New Yorker cartoon, showing a group of counterfeiters in sober

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contemplation of their handiwork, retail spending is about to get a needed shot in the arm.

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Precisely.

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Local spending indeed does get a shot in the arm.

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The new money works its way step by step throughout the economic system.

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As the new money spreads, it bids prices up.

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As we have seen, new money can only dilute the effectiveness of each dollar.

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But this dilution takes time and is therefore uneven.

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In the meantime, some people gain and other people lose.

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In short, the counterfeiters and their local retailers have found their incomes increased

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before any rise in the prices of the things they buy, but on the other hand, people in

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remote areas of the economy who have not yet received the new money find their buying prices

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rising before their incomes. Retailers at the other end of the country, for example,

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will suffer losses. The first receivers of the new money gain most, and at the expense

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of the Latest Receivers.

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Inflation then confers no general social benefit.

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Instead, it redistributes the wealth in favor of the first-comers and at the expense of

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the laggards in the race.

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And inflation is, in effect, a race, to see who can get the new money earliest.

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The late-comers, the ones stuck with the loss, are often called the fixed-income groups.

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Ministers, teachers, people on salaries lag notoriously behind other groups in acquiring the new money.

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Particular sufferers will be those depending on fixed money contracts, contracts made in the days before the inflationary rise in prices.

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Life insurance beneficiaries and annuitants, retired persons living off pensions, landlords with long-term leases,

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It has become fashionable to scoff at the concern displayed by conservatives for the

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widows and orphans hurt by inflation, and yet this is precisely one of the chief problems

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that must be faced.

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Is it really progressive to rob widows and orphans and to use the proceeds to subsidize

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farmers and armament workers?

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Inflation has other disastrous effects.

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It distorts that keystone of our economy, business calculation.

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Since prices do not all change uniformly and at the same speed, it becomes very difficult

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for business to separate the lasting from the transitional and gauge truly the demands

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of Consumers or the Cost of Their Operations.

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For example, accounting practice enters the cost of an asset at the amount the business

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has paid for it.

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But if inflation intervenes, the cost of replacing the asset when it wears out will be far greater

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than that recorded on the books.

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As a result, business accounting will seriously overstate their profits during inflation,

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may even consume capital while presumably increasing their investments.

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This error will be greatest in those firms with the oldest equipment and in the most

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heavily capitalized industries.

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An undue number of firms, therefore, will pour into these industries during an inflation.

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Similarly, stockholders and real estate holders will acquire capital gains during an inflation

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that are not really gains at all, but they may spend part of these gains without realizing

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that they are thereby consuming their original capital.

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By creating illusory profits and distorting economic calculation, inflation will suspend

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the free markets penalizing of inefficient and rewarding of efficient firms.

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Almost all firms will seemingly prosper.

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The general atmosphere of a seller's market will lead to a decline in the quality of goods

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and of service to consumers, since consumers often resist price increases less when they

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occur in the form of downgrading of quality.

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In these days of rapt attention to cost-of-living indexes, for example escalator wage contracts,

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there is strong incentive to increase prices in such a way that the change will not be

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be revealed in the index.

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The quality of work will decline in an inflation for a more subtle reason.

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People become enamored of get-rich-quick schemes, seemingly within their grasp in an era of

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ever-rising prices, and often scorn sober effort.

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Inflation also penalizes thrift and encourages debt, for any sum of money loaned will be

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be repaid in dollars of lower purchasing power than when originally received.

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The incentive, then, is to borrow and repay later, rather than save and lend.

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Inflation, therefore, lowers the general standard of living in the very course of creating a

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tinsel atmosphere of prosperity.

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Fortunately, inflation cannot go on forever, for eventually people wake up to this form

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of Taxation.

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They wake up to the continual shrinkage in the purchasing power of their dollar.

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At first, when prices rise, people say, well, this is abnormal, the product of some emergency.

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I will postpone my purchases and wait until prices go back down.

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This is the common attitude during the first phase of an inflation.

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This notion moderates the price rise itself and conceals the inflation further, since

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Thus the demand for money is thereby increased.

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But as inflation proceeds, people begin to realize that prices are going up perpetually

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as a result of perpetual inflation.

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Now people will say, I will buy now, though prices are high, because if I wait, prices

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will go up still further.

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As a result, the demand for money now falls, and prices go up more proportionately than

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the increase in the money supply.

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At this point the government is often called upon to relieve the money shortage caused by

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the accelerated price rise and it inflates even faster.

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Soon the country reaches the stage of the crack-up boom when people say, I must buy

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anything now, anything to get rid of money which depreciates on my hands.

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The supply of money skyrockets, the demand plummets and prices rise astronomically.

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Inflation falls sharply as people spend more and more of their time finding ways to get

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rid of their money.

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The monetary system has in effect broken down completely and the economy reverts to other

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monies if they are attainable, other metal, foreign currencies if this is a one country

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inflation or even a return to barter conditions.

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The monetary system has broken down under the impact of inflation.

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This condition of hyperinflation is familiar historically in the Assignats of the French

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Revolution, the Continentals of the American Revolution, and especially the German Crisis

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of 1923, and the Chinese and other currencies after World War II.

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A final indictment of inflation is that whenever the newly issued money is first used as loans

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to business, inflation causes the dread business cycle.

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This silent but deadly process, undetected for generations, works as follows.

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New money is issued by the banking system, under the aegis of government, and loaned

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to business.

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To businessmen, the new funds seem to be genuine investments.

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But these funds do not, like free market investments, arise from voluntary savings.

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The new money is invested by businessmen in various projects, and paid out to workers

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As the new money filters down to the whole economy, the people tend to reestablish their

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old voluntary consumption-saving proportions.

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In short, if people wish to save and invest about 20 percent of their incomes and consume

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the rest, new bank money loaned to business at first makes the saving proportion look

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higher.

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When the new money seeps down to the public, it reestablishes its old 20-80 proportion,

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and many investments are now revealed to be wasteful.

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Liquidation of the wasteful investments of the inflationary boom constitutes the depression

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phase of the business cycle.

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3.

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Compulsory Monopoly of the Mint

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For government to use counterfeiting to add to its revenue, many lengthy steps must be

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traveled down the road away from the free market.

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Government could not simply invade a functioning free market and print its own paper tickets.

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Done so abruptly, few people would accept the government's money.

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Even in modern times, many people in backward countries have simply refused to accept paper

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for Money and insist on trading only in gold. Governmental incursion, therefore, must be

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far more subtle and gradual. Until a few centuries ago, there were no banks, and therefore the

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government could not use the banking engine for massive inflation as it can today. What

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could it do when only gold and silver circulated? The first step, taken firmly by every sizable

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Government was to seize an absolute monopoly of the minting business.

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That was the indispensable means of getting control of the coinage supply.

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The king's or the lord's picture was stamped upon coins, and the myth was propagated that

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coinage is an essential prerogative of royal or baronial sovereignty.

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The mintage monopoly allowed government to supply whatever denominations of coin it,

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but not the public wanted.

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As a result, the variety of coins on the market was forcibly reduced.

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Furthermore, the mint could now charge a high price, greater than costs, senorage, a price

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just covering costs, brassage, or supply coins free of charge.

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Senorage was a monopoly price, and it imposed a special burden on the conversion of bullion

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to coin.

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Gratuitous coinage, on the other hand, overstimulated the manufacture of coins from bullion and

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forced the general taxpayer to pay for minting services utilized by others.

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Having acquired the mintage monopoly, governments fostered the use of the name of the monetary

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unit, doing their best to separate the name from its true base in the underlying weight

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of the coin.

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This, too, was a highly important step, for it liberated each government from the necessity

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of abiding by the common money of the world market. Instead of using grains or grams of

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gold or silver, each state fostered its own national name in the supposed interests of

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monetary patriotism—dollars, marks, francs, and the like. The shift made possible the

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The Preeminent Means of Governmental Counterfeiting of Coin, Debasement

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4.

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Debasement

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Debasement was the state's method of counterfeiting the very coins it had banned private firms

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from making in the name of vigorous protection of the monetary standard.

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Sometimes the government committed simple fraud, secretly diluting gold with a base

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In that way, government continually juggled and redefined the very standard it was pledged

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to Protect. The profits of debasement were haughtily claimed as senorage by the rulers.

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Rapid and severe debasement was a hallmark of the Middle Ages in almost every country

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in Europe. Thus in 1200 A.D. the French livre tournoi was defined at 98 grams of fine silver.

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By 1600 A.D. it signified only 11 grams. A striking case is the dinar, a coin of the

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Saracens in Spain. The dinar originally consisted of 65 gold grains when first coined at the

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end of the 7th century. The Saracens were notably sound in monetary matters, and by

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the middle of the 12th century the dinar was still 60 grains. At that point the Christian

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One king's conquered Spain, and by the early 13th century, the dinar, now called maravedi,

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was reduced to 14 grains.

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Soon the gold coin was too light to circulate, and it was converted into a silver coin weighing

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26 grains of silver.

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This too was debased, and by the mid-15th century the maravedi was only 1.5 silver grains,

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and again, too small to circulate 5. Gresham's Law and Coinage

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a. Bimetalism Government imposes price controls largely

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in order to divert public attention from governmental inflation to the alleged evils of the free

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market. As we have seen, Gresham's Law, that an artificially overvalued money tends to

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To drive an artificially undervalued money out of circulation is an example of the general

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consequences of price control.

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Government places in effect a maximum price on one type of money in terms of the other.

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Maximum price causes a shortage, disappearance into hordes or exports of the currency suffering

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the maximum price, artificially undervalued, and leads it to be replaced in circulation

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by the Overpriced Money.

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We have seen how this works in the case of new versus worn coins, one of the earliest

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examples of Gresham's Law.

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Changing the meaning of money from weight to mere tolly, and standardizing denominations

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for their own rather than for the public's convenience, the governments called new and

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worn coins by the same name, even though they were of different weight.

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As a result, people hoarded or exported the full-weight new coins and passed the worn

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coins in circulation, with governments hurling maledictions at speculators, foreigners or

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the free market in general for a condition brought about by the government itself.

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A particularly important case of Gresham's law was the perennial problem of the standard.

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We saw that the free market established parallel standards of gold and silver, each freely

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would be fluctuating in relation to the other in accordance with market supplies and demands.

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But governments decided they would help out the market by stepping in to simplify matters.

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How much clearer things would be, they felt, if gold and silver were fixed at a definite ratio,

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say 20 ounces of silver to one ounce of gold.

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Then both monies could always circulate at a fixed ratio, and far more importantly,

224
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Finally the government could finally rid itself of the burden of treating money by weight

225
00:20:13.720 --> 00:20:16.480
instead of by tally.

226
00:20:16.480 --> 00:20:22.720
Let us imagine a unit, the Ruhr, defined by Ruritanians as one twentieth of an ounce of

227
00:20:22.720 --> 00:20:23.800
gold.

228
00:20:23.800 --> 00:20:29.240
We have seen how vital it is for the government to induce the public to regard the Ruhr as

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00:20:29.240 --> 00:20:34.920
an abstract unit of its own right, only loosely connected to gold.

230
00:20:34.920 --> 00:20:39.520
What better way of doing this than to fix the gold-silver ratio?

231
00:20:39.520 --> 00:20:47.080
Then Ruhr becomes not only one twentieth of an ounce of gold, but also one ounce of silver.

232
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The precise meaning of the word Ruhr, a name for gold weight, is now lost, and people begin

233
00:20:53.420 --> 00:20:59.580
to think of the Ruhr as something tangible in its own right, somehow set by the government

234
00:20:59.580 --> 00:21:06.380
for good and efficient purposes, as equal to certain weights of both gold and silver.

235
00:21:06.380 --> 00:21:12.180
Now we see the importance of abstaining from patriotic or national names for gold ounces

236
00:21:12.180 --> 00:21:14.300
or grains.

237
00:21:14.300 --> 00:21:19.800
Once such a label replaces the recognized world units of weight, it becomes much easier

238
00:21:19.800 --> 00:21:25.720
for governments to manipulate the money unit and give it an apparent life of its own.

239
00:21:25.720 --> 00:21:32.760
The fixed gold-silver ration, known as bi-metalism, accomplished this task very neatly.

240
00:21:32.760 --> 00:21:38.480
It did not, however, fulfill its other job of simplifying the nation's currency.

241
00:21:38.480 --> 00:21:42.520
For once again, Gresham's Law came into prominence.

242
00:21:42.520 --> 00:21:48.800
The government usually set the bi-metallic ration originally, say 20 to 1, at the going

243
00:21:48.800 --> 00:21:51.080
rate on the free market.

244
00:21:51.080 --> 00:21:57.280
But the market ratio, like all market prices, inevitably changes over time, as supply and

245
00:21:57.280 --> 00:21:59.880
demand conditions change.

246
00:21:59.880 --> 00:22:07.020
As changes occur, the fixed bimetallic ratio inevitably becomes obsolete.

247
00:22:07.020 --> 00:22:11.120
Change makes either gold or silver overvalued.

248
00:22:11.120 --> 00:22:16.920
Gold then disappears into cash balance, black market or exports, when silver flows in from

249
00:22:16.920 --> 00:22:22.440
from abroad and comes out of cash balances to become the only circulating currency in

250
00:22:22.440 --> 00:22:23.440
Ruritania.

251
00:22:23.440 --> 00:22:29.520
For centuries, all countries struggled with calamitous effects of suddenly alternating

252
00:22:29.520 --> 00:22:31.320
metallic currencies.

253
00:22:31.320 --> 00:22:34.920
First, silver would flow in and gold disappear.

254
00:22:34.920 --> 00:22:42.480
Then, as the relative market ratios changed, gold would pour in and silver disappear.

255
00:22:42.480 --> 00:22:47.780
Many debasements, in fact, occurred covertly, with governments claiming that they were merely

256
00:22:47.780 --> 00:22:53.360
bringing the official gold-silver ratio into closer alignment with the market.

257
00:22:53.360 --> 00:22:59.760
Finally, after weary centuries of bimetallic disruption, governments picked one metal as

258
00:22:59.760 --> 00:23:03.040
the standard, generally gold.

259
00:23:03.040 --> 00:23:10.120
Silver was relegated to token coin status, for small denominations, but not at full weight.

260
00:23:10.120 --> 00:23:16.640
The minting of token coins was also monopolized by government, and since not backed 100%

261
00:23:16.640 --> 00:23:20.880
by gold, was a means of expanding the money supply.

262
00:23:20.880 --> 00:23:26.240
The eradication of silver as money certainly injured many people who preferred to use silver

263
00:23:26.240 --> 00:23:28.760
for various transactions.

264
00:23:28.760 --> 00:23:35.280
There was truth in the war cry of the bimetallists that a crime against silver had been committed.

265
00:23:35.280 --> 00:23:43.360
But the crime was really the original imposition of bimetalism in lieu of parallel standards.

266
00:23:43.360 --> 00:23:47.720
Bimetalism created an impossibly difficult situation, which the government could either

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00:23:47.720 --> 00:23:54.100
meet by going back to full monetary freedom, parallel standards, or by picking one of the

268
00:23:54.100 --> 00:24:01.280
two metals as money, gold or silver standard. Full monetary freedom, after all, this time,

269
00:24:01.280 --> 00:24:07.040
is considered absurd and quixotic, and so the gold standard was generally adopted.

270
00:24:07.040 --> 00:24:12.040
B. Legal Tender.

271
00:24:12.040 --> 00:24:18.240
How was the government able to enforce its price controls on monetary exchange rates?

272
00:24:18.240 --> 00:24:22.400
By a device known as legal tender laws.

273
00:24:22.400 --> 00:24:28.440
Money is used for payment of past debts as well as for present cash transactions, with

274
00:24:28.440 --> 00:24:33.600
With the name of the country's currency now prominent in accounting instead of its actual

275
00:24:33.600 --> 00:24:39.840
weight, contracts began to pledge payment in certain amounts of money.

276
00:24:39.840 --> 00:24:44.500
Legal tender laws dictated what that money could be.

277
00:24:44.500 --> 00:24:49.760
When only the original gold or silver was designated legal tender, people considered

278
00:24:49.760 --> 00:24:51.160
it harmless.

279
00:24:51.160 --> 00:24:55.800
But they should have realized that a dangerous precedent had been set for government control

280
00:24:55.800 --> 00:24:57.480
of money.

281
00:24:57.480 --> 00:25:04.760
If the government sticks to the original money, its legal tender law is superfluous and unnecessary.

282
00:25:04.760 --> 00:25:10.200
On the other hand, the government may declare as legal tender a lower quality currency side

283
00:25:10.200 --> 00:25:12.480
by side with the original.

284
00:25:12.480 --> 00:25:18.980
Thus, the government may decree worn coins as good as new ones in paying off debt, or

285
00:25:18.980 --> 00:25:23.520
silver and gold equivalent to each other in the fixed ratio.

286
00:25:23.520 --> 00:25:28.480
The legal tender laws then bring Gresham's law into being.

287
00:25:28.480 --> 00:25:33.800
When legal tender laws enshrine an overvalued money, they have another effect.

288
00:25:33.800 --> 00:25:37.320
They favor debtors at the expense of creditors.

289
00:25:37.320 --> 00:25:42.160
For then, debtors are permitted to pay back their debts in a much poorer money than they

290
00:25:42.160 --> 00:25:47.880
had borrowed, and creditors are swindled out of the money rightfully theirs.

291
00:25:47.880 --> 00:25:54.400
This confiscation of creditors' property, however, only benefits outstanding debtors.

292
00:25:54.400 --> 00:25:59.880
Future debtors will be burdened by the scarcity of credit generated by the memory of government

293
00:25:59.880 --> 00:26:03.280
spoliation of creditors.

294
00:26:03.280 --> 00:26:05.440
6.

295
00:26:05.440 --> 00:26:07.160
Summary.

296
00:26:07.160 --> 00:26:09.720
Government and Coinage.

297
00:26:09.720 --> 00:26:15.480
The compulsory minting monopoly and legal tender legislation were the capstones in government's

298
00:26:15.480 --> 00:26:21.480
The use of foreign coins was prevalent in the Middle Ages and in the United States down to the middle of the 19th century.

299
00:26:21.480 --> 00:26:27.480
Within each country, only the coin of its own sovereign could now be used.

300
00:26:27.480 --> 00:26:32.480
Between countries, unstamped gold and silver bullion was used in exchange.

301
00:26:32.480 --> 00:26:40.480
The use of foreign coins was prevalent in the Middle Ages and in the United States down to the middle of the 19th century.

302
00:26:40.480 --> 00:26:46.480
Between countries, unstamped gold and silver bullion was used in exchange.

303
00:26:46.480 --> 00:26:51.480
This further severed the ties between the various parts of the world market,

304
00:26:51.480 --> 00:26:57.480
further sundering one country from another and disrupting the international division of labor.

305
00:26:57.480 --> 00:27:03.480
Yet, purely hard money did not leave too much scope for governmental inflation.

306
00:27:03.480 --> 00:27:07.480
There were limits to the debasing that governments could engineer,

307
00:27:07.480 --> 00:27:13.160
and the fact that all countries used gold and silver placed definite checks on the control

308
00:27:13.160 --> 00:27:18.840
of each government over its own territory. The rulers were still held in check by the

309
00:27:18.840 --> 00:27:25.800
discipline of an international metallic money. Governmental control of money could only become

310
00:27:25.800 --> 00:27:32.040
absolute and its counterfeiting unchallenged as money substitutes came into prominence in recent

311
00:27:32.040 --> 00:27:49.040
The advent of paper money and bank deposits, an economic boon when backed fully by gold or silver, provided the open sesame for government's road to power over money, and thereby over the entire economic system.

312
00:27:49.040 --> 00:27:55.040
7. Permitting Banks to Refuse Payment

313
00:27:55.040 --> 00:28:09.040
The modern economy, with its widespread use of banks and money substitutes, provides the golden opportunity for government to fasten its control over the money supply and permit inflation at its discretion.

314
00:28:09.040 --> 00:28:17.040
We have seen that there are three great checks on the power of any bank to inflate under a free banking system.

315
00:28:17.040 --> 00:28:21.040
1. The extent of the clientele of each bank.

316
00:28:21.040 --> 00:28:27.120
2. The extent of the clientele of the whole banking system, that is, the extent to which

317
00:28:27.120 --> 00:28:34.560
people use money substitutes, and 3. The confidence of the clients in their banks.

318
00:28:34.560 --> 00:28:39.880
The narrower the clientele of each bank, of the banking system as a whole, or the shakier

319
00:28:39.880 --> 00:28:46.160
the state of confidence, the stricter will be the limits on inflation in the economy.

320
00:28:46.160 --> 00:28:53.360
Its privileging and controlling of the banking system has operated to suspend these limits.

321
00:28:53.360 --> 00:28:59.520
All these limits, of course, rest on one fundamental obligation, the duty of the banks to redeem

322
00:28:59.520 --> 00:29:03.100
their sworn liabilities on demand.

323
00:29:03.100 --> 00:29:09.120
We have seen that no fractional reserve bank can redeem all of its liabilities, and we

324
00:29:09.120 --> 00:29:13.640
have also seen that this is the gamble that every bank takes.

325
00:29:13.640 --> 00:29:19.160
And it is, of course, essential to any system of private property that contract obligations

326
00:29:19.160 --> 00:29:21.080
be fulfilled.

327
00:29:21.080 --> 00:29:25.780
The bluntest way for government to foster inflation, then, is to grant the banks the

328
00:29:25.780 --> 00:29:31.440
special privilege of refusing to pay their obligations, while yet continuing in their

329
00:29:31.440 --> 00:29:33.400
operation.

330
00:29:33.400 --> 00:29:39.040
While everyone else must pay their debts or go bankrupt, the banks are permitted to refuse

331
00:29:39.040 --> 00:29:51.720
The usual name for this is a suspension of specie payments.

332
00:29:51.720 --> 00:29:57.680
A more accurate name would be license for theft, for what else can we call a governmental

333
00:29:57.680 --> 00:30:03.140
permission to continue in business without fulfilling one's contract?

334
00:30:03.140 --> 00:30:08.820
In the United States, mass suspension of specie payment in times of bank troubles became almost

335
00:30:08.820 --> 00:30:14.580
is just a tradition. It started in the War of 1812. Most of the country's banks were

336
00:30:14.580 --> 00:30:21.060
located in New England, a section unsympathetic to America's entry into the war. These banks

337
00:30:21.060 --> 00:30:27.260
refused to lend for war purposes, and so the government borrowed from new banks in other

338
00:30:27.260 --> 00:30:33.980
states. These banks issued new paper money to make the loans. The inflation was so great

339
00:30:33.980 --> 00:30:39.180
that calls for redemption flooded into the new banks, especially from the conservative,

340
00:30:39.180 --> 00:30:43.920
non-expanding banks of New England, where the government spent most of its money on

341
00:30:43.920 --> 00:30:52.180
war goods. As a result, there was a mass suspension in 1814, lasting for over two years, well

342
00:30:52.180 --> 00:30:58.540
beyond the end of the war. During that time, banks sprouted up, issuing notes with no need

343
00:30:58.540 --> 00:31:05.500
to Redeem in Gold or Silver. This suspension set a precedent for succeeding economic crises

344
00:31:05.500 --> 00:31:14.500
– 1819, 1837, 1857 and so forth. As a result of this tradition, the banks realized that

345
00:31:14.500 --> 00:31:20.300
they need have no fear of bankruptcy after an inflation, and this of course stimulated

346
00:31:20.300 --> 00:31:27.200
inflation and wildcat banking. Those writers who point to 19th century America as a horrid

347
00:31:27.200 --> 00:31:32.920
example of free banking failed to realize the importance of this clear dereliction of

348
00:31:32.920 --> 00:31:37.400
duty by the states in every financial crisis.

349
00:31:37.400 --> 00:31:42.520
The governments and the banks persuaded the public of the justice of their acts.

350
00:31:42.520 --> 00:31:48.440
In fact, anyone trying to get his money back during a crisis was considered unpatriotic

351
00:31:48.440 --> 00:31:54.800
and a despoiler of his fellow men, while banks were often commended for patriotically bailing

352
00:31:54.800 --> 00:32:03.280
Many people, however, were bitter at the entire proceeding, and from this sentiment grew the

353
00:32:03.280 --> 00:32:09.800
famous hard-money Jacksonian movement that flourished before the Civil War.

354
00:32:09.800 --> 00:32:14.580
Despite its use in the United States, such periodic privilege to banks did not catch

355
00:32:14.580 --> 00:32:18.200
hold as a general policy in the modern world.

356
00:32:18.200 --> 00:32:21.140
It was a crude instrument, too sporadic.

357
00:32:21.140 --> 00:32:25.860
It could not be permanent, since few people would patronize banks that never paid their

358
00:32:25.860 --> 00:32:27.260
obligations.

359
00:32:27.260 --> 00:32:33.300
And what's more, it provided no means of government control over the banking system.

360
00:32:33.300 --> 00:32:39.260
What governments want, after all, is not simply inflation, but inflation completely controlled

361
00:32:39.260 --> 00:32:41.920
and directed by themselves.

362
00:32:41.920 --> 00:32:45.540
There must be no danger of the banks running the show.

363
00:32:45.540 --> 00:32:51.700
And so, a far subtler, smoother, more permanent method was devised, and sold to the public

364
00:32:51.700 --> 00:32:57.220
as a hallmark of civilization itself, Central Banking.

365
00:32:57.220 --> 00:32:59.740
8.

366
00:32:59.740 --> 00:33:05.340
Central Banking, Removing the Checks on Inflation

367
00:33:05.340 --> 00:33:10.540
Central banking is now put in the same class with modern plumbing and good roads.

368
00:33:10.540 --> 00:33:15.380
Any economy that doesn't have it is called backward, primitive, hopelessly out of the

369
00:33:15.380 --> 00:33:22.260
and Swim. America's adoption of the Federal Reserve System, our central bank, in 1913,

370
00:33:22.260 --> 00:33:28.740
was greeted as finally putting us in the ranks of the advanced nations. Central banks are

371
00:33:28.740 --> 00:33:35.700
often nominally owned by private individuals, or, as in the United States, jointly by private

372
00:33:35.700 --> 00:33:42.900
banks, but they are always directed by government-appointed officials and serve as arms of the government.

373
00:33:42.900 --> 00:33:47.340
Where they are privately owned, as in the original Bank of England or the second Bank

374
00:33:47.340 --> 00:33:55.180
of the United States, their prospective profits add to the usual governmental desire for inflation.

375
00:33:55.180 --> 00:34:00.900
A central bank attains its commanding position from its governmentally granted monopoly of

376
00:34:00.900 --> 00:34:02.860
the note issue.

377
00:34:02.860 --> 00:34:06.580
This is often the unsung key to its power.

378
00:34:06.580 --> 00:34:12.420
Invariably, private banks are prohibited from issuing notes, and the privilege is reserved

379
00:34:12.420 --> 00:34:18.880
to the Central Bank. The private banks can only grant deposits. If their customers ever

380
00:34:18.880 --> 00:34:24.900
wish to shift from deposits to notes, therefore, the banks must go to the Central Bank to get

381
00:34:24.900 --> 00:34:32.120
them. Hence the Central Bank's lofty perch as a banker's bank. It is a banker's bank

382
00:34:32.120 --> 00:34:38.300
because the bankers are forced to do business with it. As a result, bank deposits become

383
00:34:38.300 --> 00:34:44.500
Some redeemable not only in gold but also in central bank notes, and these new notes

384
00:34:44.500 --> 00:34:50.620
were not just plain bank notes, they were liabilities of the central bank, an institution

385
00:34:50.620 --> 00:34:55.820
invested with all the majestic aura of the government itself.

386
00:34:55.820 --> 00:35:01.300
Government after all appoints the bank officials and coordinates its policy with other state

387
00:35:01.300 --> 00:35:02.300
policy.

388
00:35:02.300 --> 00:35:07.340
It receives the notes in taxes and declares them to be legal tender.

389
00:35:07.340 --> 00:35:12.540
As a result of these measures, all the banks in the country became clients of the central

390
00:35:12.540 --> 00:35:13.540
bank.

391
00:35:13.540 --> 00:35:18.520
In the United States, the banks were forced by law to join the Federal Reserve system

392
00:35:18.520 --> 00:35:22.560
and to keep their accounts with the Federal Reserve banks.

393
00:35:22.560 --> 00:35:27.480
Those state banks that are not members of the Federal Reserve system keep their reserves

394
00:35:27.480 --> 00:35:30.700
with member banks.

395
00:35:30.700 --> 00:35:35.780
Gold poured into the central bank from the private banks, and in exchange, the public

396
00:35:35.780 --> 00:35:40.900
got central bank notes and the disuse of gold coins.

397
00:35:40.900 --> 00:35:46.940
Gold coins were scoffed at by official opinion as cumbersome, old-fashioned, inefficient,

398
00:35:46.940 --> 00:35:53.620
and ancient fetish, perhaps useful in children's socks at Christmas, but that's about all.

399
00:35:53.620 --> 00:35:59.460
How much safer, more convenient, more efficient is the gold when resting as bullion in the

400
00:35:59.460 --> 00:36:03.020
mighty vaults of the central bank?

401
00:36:03.020 --> 00:36:07.940
Bathed by this propaganda, and influenced by the convenience and governmental backing

402
00:36:07.940 --> 00:36:14.260
of the notes, the public more and more stopped using gold coins in its daily life.

403
00:36:14.260 --> 00:36:20.180
Inexorably, the gold flowed into the central bank, where, more centralized, it permitted

404
00:36:20.180 --> 00:36:24.920
a far greater degree of inflation of money substitutes.

405
00:36:24.920 --> 00:36:29.380
In the United States, the Federal Reserve Act compels the banks to keep the minimum

406
00:36:29.380 --> 00:36:36.500
from Ratio of Reserves to Deposits, and since 1917, these reserves could only consist of

407
00:36:36.500 --> 00:36:39.940
deposits at the Federal Reserve Bank.

408
00:36:39.940 --> 00:36:43.660
Gold could no longer be part of a bank's legal reserves.

409
00:36:43.660 --> 00:36:48.100
It had to be deposited in the Federal Reserve Bank.

410
00:36:48.100 --> 00:36:53.740
The entire process took the public off the gold habit and placed the people's gold in

411
00:36:53.740 --> 00:37:00.780
and the none-too-tender care of the state, where it could be confiscated almost painlessly.

412
00:37:00.780 --> 00:37:05.660
International traders still used gold bullion in their large-scale transactions, but they

413
00:37:05.660 --> 00:37:11.100
were an insignificant proportion of the voting population.

414
00:37:11.100 --> 00:37:16.300
One of the reasons the public could be lured from gold to banknotes was the great confidence

415
00:37:16.300 --> 00:37:19.420
everyone had in the central bank.

416
00:37:19.420 --> 00:37:24.440
Certainly the central bank, possessed of almost all the gold in the realm, backed by the might

417
00:37:24.440 --> 00:37:29.020
and prestige of government, could not fail and go bankrupt.

418
00:37:29.020 --> 00:37:34.340
And it is certainly true that no central bank in recorded history has ever failed.

419
00:37:34.340 --> 00:37:35.980
But why not?

420
00:37:35.980 --> 00:37:41.940
Because of the sometimes unwritten but very clear rule that it could not be permitted

421
00:37:41.940 --> 00:37:43.740
to fail.

422
00:37:43.740 --> 00:37:49.380
If governments sometimes allowed private banks to suspend payment, how much more readily would

423
00:37:49.380 --> 00:37:54.740
Did it permit the Central Bank, its own organ, to suspend when in trouble?

424
00:37:54.740 --> 00:37:59.700
The precedent was set in Central Banking history when England permitted the Bank of England

425
00:37:59.700 --> 00:38:06.540
to suspend in the late 18th century and allowed this suspension for over 20 years.

426
00:38:06.540 --> 00:38:12.420
The Central Bank thus became armed with the almost unlimited confidence of the public.

427
00:38:12.420 --> 00:38:17.100
By this time, the public could not see that the Central Bank was being allowed to counterfeit

428
00:38:17.100 --> 00:38:23.140
at will and yet remain immune from any liability if its bona fides should be questioned.

429
00:38:23.140 --> 00:38:28.440
It came to see the Central Bank as simply a great national bank performing a public service

430
00:38:28.440 --> 00:38:33.560
and protected from failure by being a virtual arm of the government.

431
00:38:33.560 --> 00:38:38.880
The Central Bank proceeded to invest the private banks with the public's confidence.

432
00:38:38.880 --> 00:38:41.360
This was a more difficult task.

433
00:38:41.360 --> 00:38:46.520
The Central Bank let it be known that it would always act as a lender of last resort

434
00:38:46.520 --> 00:38:52.960
to the Banks, that is, that the bank would stand ready to lend money to any bank in trouble,

435
00:38:52.960 --> 00:38:58.600
especially when many banks are called upon to pay their obligations.

436
00:38:58.600 --> 00:39:04.400
Governments also continued to prop up banks by discouraging bank runs, that is, cases

437
00:39:04.400 --> 00:39:10.040
where many clients suspect chicanery and ask to get back their property.

438
00:39:10.040 --> 00:39:14.840
Sometimes they permitted banks to suspend payment, as in the compulsory bank holidays

439
00:39:14.840 --> 00:39:17.480
of 1933.

440
00:39:17.480 --> 00:39:24.040
Laws were passed prohibiting public encouragement of bank runs, and as in the 1929 depression

441
00:39:24.040 --> 00:39:31.680
in America, government campaigned against selfish and unpatriotic gold hoarders.

442
00:39:31.680 --> 00:39:37.480
America finally solved its pesky problem of bank failures when it adopted Federal Deposit

443
00:39:37.480 --> 00:39:40.720
Insurance in 1933.

444
00:39:40.720 --> 00:39:46.040
The Federal Deposit Insurance Corporation has only a negligible proportion of backing for

445
00:39:46.040 --> 00:39:48.860
the bank deposits it insures.

446
00:39:48.860 --> 00:39:53.540
But the public has been given the impression, and one that may well be accurate, that the

447
00:39:53.540 --> 00:39:59.880
federal government would stand ready to print enough new money to redeem all of the insured

448
00:39:59.880 --> 00:40:00.960
deposits.

449
00:40:00.960 --> 00:40:06.880
As a result, the government has managed to transfer its own command of vast public confidence

450
00:40:06.880 --> 00:40:12.420
to the entire banking system, as well as to the central bank.

451
00:40:12.420 --> 00:40:17.200
We have seen that by setting up a central bank, governments have greatly widened, if

452
00:40:17.200 --> 00:40:22.800
not removed, two of the three main checks on bank credit inflation.

453
00:40:22.800 --> 00:40:29.000
What of the third check, the problem of the narrowness of each bank's clientele?

454
00:40:29.000 --> 00:40:33.720
Removal of this check is one of the main reasons for the central bank's existence.

455
00:40:33.720 --> 00:40:39.840
In a free banking system, inflation by any one bank would soon lead to demands for redemption

456
00:40:39.840 --> 00:40:46.040
by the other banks, since the clientele of any one bank is severely limited.

457
00:40:46.040 --> 00:40:50.960
But the central bank, by pumping reserves into all the banks, can make sure that they

458
00:40:50.960 --> 00:40:55.800
can all expand together and at a uniform rate.

459
00:40:55.800 --> 00:41:01.760
If all banks are expanding, then there is no redemption problem of one bank upon another,

460
00:41:01.760 --> 00:41:06.720
And each bank finds that its clientele is really the whole country.

461
00:41:06.720 --> 00:41:12.520
In short, the limits on bank expansion are immeasurably widened, from the clientele of

462
00:41:12.520 --> 00:41:16.820
each bank to that of the whole banking system.

463
00:41:16.820 --> 00:41:22.180
In addition to removing the checks on inflation, the act of establishing a central bank has

464
00:41:22.180 --> 00:41:25.400
a direct inflationary impact.

465
00:41:25.400 --> 00:41:29.720
Before the central bank began, banks kept their reserves in gold.

466
00:41:29.720 --> 00:41:35.880
Now gold flows into the central bank in exchange for deposits with the bank, which are now

467
00:41:35.880 --> 00:41:42.360
reserves for the commercial banks. But the bank itself keeps only a fractional reserve

468
00:41:42.360 --> 00:41:49.520
of gold to its own liabilities. Therefore, the act of establishing a central bank greatly

469
00:41:49.520 --> 00:41:54.640
multiplies the inflationary potential of the country.

470
00:41:54.640 --> 00:41:59.800
The establishment of the Federal Reserve in this way increased three-fold the expansive

471
00:41:59.800 --> 00:42:03.440
power of the banking system of the United States.

472
00:42:03.440 --> 00:42:08.560
The Federal Reserve System also reduced the average legal reserve requirements of all

473
00:42:08.560 --> 00:42:17.840
banks from approximately 21 percent in 1913 to 10 percent by 1917, thus further doubling

474
00:42:17.840 --> 00:42:24.880
Directing the Inflationary Potential, a Combined Potential Inflation of Sixfold.

475
00:42:24.880 --> 00:42:34.640
9. Central Banking, Directing the Inflation Precisely how does the central bank go about

476
00:42:34.640 --> 00:42:40.640
its task of regulating the private banks? By controlling the bank's reserves, their

477
00:42:40.640 --> 00:42:47.020
deposit accounts at the central bank. Banks tend to keep a certain ratio of reserves to

478
00:42:47.020 --> 00:42:52.500
to their total deposit liabilities, and in the United States, government control is made

479
00:42:52.500 --> 00:42:57.420
easier by imposing a legal minimum ratio on the bank.

480
00:42:57.420 --> 00:43:03.700
The central bank can stimulate inflation then by pouring reserves into the banking system,

481
00:43:03.700 --> 00:43:10.980
and also by lowering the reserve ratio, thus permitting a nationwide bank credit expansion.

482
00:43:10.980 --> 00:43:17.460
If the banks keep a reserve deposit ratio of 1 to 10, then excess reserves above the

483
00:43:17.460 --> 00:43:24.140
required ratio of $10 million will permit and encourage a nationwide bank inflation

484
00:43:24.140 --> 00:43:26.820
of 100 million.

485
00:43:26.820 --> 00:43:31.780
Since banks profit by credit expansion, and since government has made it almost impossible

486
00:43:31.780 --> 00:43:39.120
for them to fail, they will usually try to keep loaned up to their allowable maximum.

487
00:43:39.120 --> 00:43:45.360
The Central Bank adds to the quantity of bank reserves by buying assets on the market.

488
00:43:45.360 --> 00:43:50.840
What happens, for example, if the bank buys an asset, any asset, from Mr. Jones, valued

489
00:43:50.840 --> 00:43:53.080
at $1,000?

490
00:43:53.080 --> 00:43:59.180
The Central Bank writes out a check to Mr. Jones for $1,000 to pay for the asset.

491
00:43:59.180 --> 00:44:04.360
The Central Bank does not keep individual accounts, so Mr. Jones takes the check and

492
00:44:04.360 --> 00:44:07.200
deposits it in his bank.

493
00:44:07.200 --> 00:44:12.920
This bank credits him with a $1,000 deposit and presents the check to the central bank,

494
00:44:12.920 --> 00:44:18.640
which has to credit the bank with an added $1,000 in reserves.

495
00:44:18.640 --> 00:44:25.120
This $1,000 in reserves permits a multiple bank credit expansion, particularly if added

496
00:44:25.120 --> 00:44:30.560
reserves are in this way poured into many banks across the country.

497
00:44:30.560 --> 00:44:36.120
If the central bank buys an asset from a bank directly, then the result is even clearer.

498
00:44:36.120 --> 00:44:43.080
The bank adds to its reserves and a base for multiple credit expansion is established.

499
00:44:43.080 --> 00:44:48.820
Undoubtedly the favorite asset for central bank purchase has been government securities.

500
00:44:48.820 --> 00:44:53.880
In that way the government assures a market for its own securities.

501
00:44:53.880 --> 00:44:59.440
Government can easily inflate the money supply by issuing new bonds and then order its central

502
00:44:59.440 --> 00:45:02.080
bank to purchase them.

503
00:45:02.080 --> 00:45:06.580
In addition, the central bank undertakes to support the market price of government securities

504
00:45:06.580 --> 00:45:12.780
at a certain level, thereby causing a flow of securities into the bank and a consequent

505
00:45:12.780 --> 00:45:15.520
perpetual inflation.

506
00:45:15.520 --> 00:45:21.000
Besides buying assets, the central bank can create new bank reserves in another way, by

507
00:45:21.000 --> 00:45:22.720
lending them.

508
00:45:22.720 --> 00:45:27.600
The rate which the central bank charges the banks for this service is the re-discount

509
00:45:27.600 --> 00:45:28.600
rate.

510
00:45:28.600 --> 00:45:38.600
Clearly, borrowed reserves are not as satisfactory to the banks as reserves that are wholly theirs since there is now pressure for repayment.

511
00:45:38.600 --> 00:45:50.600
Changes in the re-discount rate receive a great deal of publicity, but they are clearly of minor importance compared to the movements in the quantity of bank reserves and the reserve ratio.

512
00:45:50.600 --> 00:46:02.600
When the central bank sells assets to the banks or the public, it lowers bank reserves and causes pressure for credit contraction and deflation, lowering of the money supply.

513
00:46:02.600 --> 00:46:07.600
We have seen, however, that governments are inherently inflationary.

514
00:46:07.600 --> 00:46:13.600
Historically, deflationary action by the government has been negligible and fleeting.

515
00:46:13.600 --> 00:46:26.600
One thing is often forgotten. Deflation can only take place after a previous inflation. Only pseudo receipts, not gold coins, can be retired and liquidated.

516
00:46:32.600 --> 00:46:41.600
The establishment of central banking removes the checks of bank credit expansion and puts the inflationary engine into operation.

517
00:46:41.600 --> 00:46:48.400
It does not remove all restraints, however. There is still the problem of the central bank itself.

518
00:46:48.400 --> 00:46:54.400
The citizens can conceivably make a run on the central bank, but this is most improbable.

519
00:46:54.400 --> 00:46:58.800
A more formidable threat is the loss of gold to foreign nations.

520
00:46:58.800 --> 00:47:05.600
For just as the expansion of one bank loses gold to the clients of other, non-expanding banks,

521
00:47:05.600 --> 00:47:12.400
So does monetary expansion in one country cause a loss of gold to the citizens of other countries.

522
00:47:12.400 --> 00:47:20.800
Countries that expand faster are in danger of gold losses and calls upon their banking system for gold redemption.

523
00:47:20.800 --> 00:47:25.100
This was the classic cyclical pattern of the 19th century.

524
00:47:25.100 --> 00:47:29.300
A country's central bank would generate bank credit expansion.

525
00:47:29.300 --> 00:47:31.000
Prices would rise.

526
00:47:31.000 --> 00:47:40.000
And as the new money spread from domestic to foreign clientele, foreigners would more and more try to redeem the currency in gold.

527
00:47:40.000 --> 00:47:49.000
Finally, the central bank would have to call a halt and enforce a credit contraction in order to save the monetary standard.

528
00:47:49.000 --> 00:47:56.000
There is one way that foreign redemption can be avoided, inter-central bank cooperation.

529
00:47:56.000 --> 00:48:08.000
If all central banks agreed to inflate at about the same rate, then no country would lose gold to any other, and all the world together could inflate almost without limit.

530
00:48:08.000 --> 00:48:19.000
With every government jealous of its own power and responsive to different pressures, however, such goose-step cooperation has so far proved almost impossible.

531
00:48:19.000 --> 00:48:27.000
One of the closest approaches was the American Federal Reserve Agreement to promote domestic inflation in the 1920s,

532
00:48:27.000 --> 00:48:33.000
in order to help Great Britain and prevent it from losing gold to the United States.

533
00:48:33.000 --> 00:48:39.000
In the 20th century, governments, rather than deflate or limit their own inflation,

534
00:48:39.000 --> 00:48:45.000
have simply gone off the gold standard when confronted with heavy demands for gold.

535
00:48:45.000 --> 00:48:52.000
This, of course, ensures that the central bank cannot fail, since its notes now become the standard money.

536
00:48:52.000 --> 00:49:01.000
In short, government has finally refused to pay its debts, and has virtually absolved the banking system from that onerous duty.

537
00:49:01.000 --> 00:49:08.000
Pseudo receipts to gold were first issued without backing, and then, when the day of reckoning drew near,

538
00:49:08.000 --> 00:49:14.000
the bankruptcy was shamelessly completed by simply eliminating gold redemption.

539
00:49:14.000 --> 00:49:23.000
The severance of the various national currency names, dollar, pound, mark, from gold and silver, is now complete.

540
00:49:23.000 --> 00:49:28.000
At first, governments refused to admit that this was a permanent measure.

541
00:49:28.000 --> 00:49:32.000
They referred to the suspension of specie payments,

542
00:49:32.000 --> 00:49:38.000
and it was always understood that eventually, after the war or other emergency had ended,

543
00:49:38.000 --> 00:49:41.000
the government would again redeem its obligations.

544
00:49:41.000 --> 00:49:55.000
When the Bank of England went off gold at the end of the 18th century, it continued in this state for 20 years, but always with the understanding that gold payment would be resumed after the French wars were ended.

545
00:49:55.000 --> 00:50:01.000
Temporary suspensions, however, are Primrose paths to outright repudiation.

546
00:50:01.000 --> 00:50:09.000
The gold standard, after all, is no spigot that can be turned on or off as government whim decrees.

547
00:50:09.000 --> 00:50:18.000
Either a gold receipt is redeemable or it is not. Once redemption is suspended, the gold standard is itself a mockery.

548
00:50:18.000 --> 00:50:25.000
Another step in the slow extinction of gold money was the establishment of the gold bullion standard.

549
00:50:25.000 --> 00:50:35.000
Under this system, the currency is no longer redeemable in coins. It can only be redeemed in large, highly valuable gold bars.

550
00:50:35.000 --> 00:50:41.000
This, in effect, limits gold redemption to a handful of specialists in foreign trade.

551
00:50:41.000 --> 00:50:49.000
There is no longer a true gold standard, but governments can still proclaim their adherence to gold.

552
00:50:49.000 --> 00:50:56.000
The European gold standards of the 1920s were pseudo-standards of this type.

553
00:50:56.000 --> 00:51:02.000
Finally, governments went off gold officially and completely in a thunder of abuse

554
00:51:02.000 --> 00:51:07.200
against foreigners and unpatriotic gold hoarders.

555
00:51:07.200 --> 00:51:12.040
Government paper now becomes the fiat standard money.

556
00:51:12.040 --> 00:51:16.780
Sometimes treasury rather than central bank paper has been the fiat money, especially

557
00:51:16.780 --> 00:51:20.180
before the development of a central banking system.

558
00:51:20.180 --> 00:51:25.580
The American Continentals, the Greenbacks and Confederate notes of the Civil War period,

559
00:51:25.580 --> 00:51:31.200
the French Assignat, were all fiat currencies issued by the treasuries.

560
00:51:31.200 --> 00:51:37.280
And whether treasury or central bank, the effect of fiat issue is the same. The monetary

561
00:51:37.280 --> 00:51:43.120
standard is now at the mercy of the government, and bank deposits are redeemable simply in

562
00:51:43.120 --> 00:51:45.800
government paper.

563
00:51:45.800 --> 00:51:52.640
11. Fiat Money and the Gold Problem

564
00:51:52.640 --> 00:51:57.720
When a country goes off the gold standard and on to the fiat standard, it adds to the

565
00:51:57.720 --> 00:52:04.200
The number of monies in existence. In addition to the commodity monies, gold and silver,

566
00:52:04.200 --> 00:52:11.040
there now flourish independent monies, directed by each government, imposing its fiat rule.

567
00:52:11.040 --> 00:52:16.360
And just as gold and silver will have an exchange rate on the free market, so the market will

568
00:52:16.360 --> 00:52:23.560
establish exchange rates for all the various monies. In a world of fiat monies, each currency,

569
00:52:23.560 --> 00:52:28.440
If permitted, will fluctuate freely in relation to all the others.

570
00:52:28.440 --> 00:52:33.040
We have seen that for any two monies, the exchange rate is set in accordance with the

571
00:52:33.040 --> 00:52:38.880
proportionate purchasing power parities, and that these in turn are determined by the respective

572
00:52:38.880 --> 00:52:43.480
supplies and demands for the various currencies.

573
00:52:43.480 --> 00:52:49.200
When a currency changes its character from gold receipt to fiat paper, confidence in

574
00:52:49.200 --> 00:52:55.960
When its stability and quality is shaken, and demand for it declines. Furthermore, now

575
00:52:55.960 --> 00:53:02.080
that it is cut off from gold, its far greater quantity relative to its former gold backing

576
00:53:02.080 --> 00:53:08.980
now becomes evident. With a supply greater than gold and a lower demand, its purchasing

577
00:53:08.980 --> 00:53:15.500
power and, hence, its exchange rate quickly depreciate in relation to gold. And since

578
00:53:15.500 --> 00:53:22.380
Since government is inherently inflationary, it will keep depreciating as time goes on.

579
00:53:22.380 --> 00:53:27.100
Such depreciation is highly embarrassing to the government, and hurts citizens who try

580
00:53:27.100 --> 00:53:29.280
to import goods.

581
00:53:29.280 --> 00:53:34.460
The existence of gold in the economy is a constant reminder of the poor quality of the

582
00:53:34.460 --> 00:53:41.600
government paper, and it always poses a threat to replace the paper as the country's money.

583
00:53:41.600 --> 00:53:46.440
Along with the government giving all the backing of its prestige and its legal tender laws

584
00:53:46.440 --> 00:53:53.280
to its fiat paper, gold coins in the hands of the public will always be a permanent reproach

585
00:53:53.280 --> 00:53:58.080
and menace to the government's power over the country's money.

586
00:53:58.080 --> 00:54:06.080
In America's first depression, 1819-1821, four western states, Tennessee, Kentucky, Illinois

587
00:54:06.080 --> 00:54:11.880
Illinois and Missouri established state-owned banks issuing fiat paper.

588
00:54:11.880 --> 00:54:17.400
They were backed by legal tender provisions in the states and sometimes by legal prohibition

589
00:54:17.400 --> 00:54:20.320
against depreciating the notes.

590
00:54:20.320 --> 00:54:26.580
And yet all these experiments, born in high hopes, came quickly to grief as the new paper

591
00:54:26.580 --> 00:54:30.660
depreciated rapidly to negligible value.

592
00:54:30.660 --> 00:54:33.560
The projects had to be swiftly abandoned.

593
00:54:33.560 --> 00:54:39.960
Later, the greenbacks circulated as fiat paper in the North during and after the Civil War.

594
00:54:39.960 --> 00:54:47.560
Yet in California, the people refused to accept the greenbacks, and continued to use gold as their money.

595
00:54:47.560 --> 00:54:57.160
As a prominent economist pointed out, in California, as in other states, the paper was legal tender and was receivable for public dues,

596
00:54:57.160 --> 00:55:01.560
nor was there any distrust or hostility toward the Federal Government.

597
00:55:01.560 --> 00:55:06.560
But there was a strong feeling in favor of gold and against paper.

598
00:55:06.560 --> 00:55:14.560
Every debtor had the legal right to pay off his debts in depreciated paper, but if he did so, he was a marked man.

599
00:55:14.560 --> 00:55:21.560
The creditor was likely to post him publicly in the newspapers, and he was virtually boycotted.

600
00:55:21.560 --> 00:55:25.560
Throughout this period, paper was not used in California.

601
00:55:25.560 --> 00:55:33.560
The people of the state conducted their transactions in gold, while all the rest of the United States used convertible paper.

602
00:55:33.560 --> 00:55:41.560
It became clear to governments that they could not afford to allow people to own and keep their gold.

603
00:55:41.560 --> 00:55:52.560
Government could never cement its power over a nation's currency if the people, when in need, could repudiate the fiat paper and turn to gold for their money.

604
00:55:52.560 --> 00:55:58.560
Accordingly, governments have outlawed gold holding by their citizens.

605
00:55:58.560 --> 00:56:06.560
Gold, except for a negligible amount permitted for industrial and ornamental purposes, has generally been nationalized.

606
00:56:06.560 --> 00:56:15.560
To ask for return of the public's confiscated property is now considered hopelessly backward and old-fashioned.

607
00:56:15.560 --> 00:56:21.560
12. Fiat Money and Gresham's Law

608
00:56:21.560 --> 00:56:29.560
With fiat money established and gold outlawed, the way is clear for full-scale, government-run inflation.

609
00:56:29.560 --> 00:56:38.560
Only one very broad check remains, the ultimate threat of hyperinflation, the crack-up of the currency.

610
00:56:38.560 --> 00:56:43.560
Hyperinflation occurs when the public realizes that the government is bent on inflation

611
00:56:43.560 --> 00:56:47.560
and decides to evade the inflationary tax on its resources

612
00:56:47.560 --> 00:56:52.560
by spending money as fast as possible while it still retains some value.

613
00:56:52.560 --> 00:57:01.560
Until hyperinflation sets in, however, government can now manage the currency and the inflation undisturbed.

614
00:57:01.560 --> 00:57:04.560
New difficulties arise, however.

615
00:57:04.560 --> 00:57:11.560
As always, government intervention to cure one problem raises a host of new unexpected problems.

616
00:57:11.560 --> 00:57:16.560
In a world of fiat monies, each country has its own money.

617
00:57:16.560 --> 00:57:26.560
The international division of labor, based on an international currency, has been broken, and countries tend to divide into their own autarkic units.

618
00:57:26.560 --> 00:57:34.560
Lack of monetary certainty disrupts trade further. The standard of living in each country thereby declines.

619
00:57:34.560 --> 00:57:40.560
Each country has freely fluctuating exchange rates with all other currencies.

620
00:57:40.560 --> 00:57:46.960
A country inflating beyond the others no longer fears a loss of gold but it faces other unpleasant

621
00:57:46.960 --> 00:57:52.800
consequences. The exchange rate of its currency falls in relation to foreign currencies.

622
00:57:53.440 --> 00:57:59.200
This is not only embarrassing but even disturbing to citizens who fear further depreciation.

623
00:57:59.920 --> 00:58:05.760
It also greatly raises the costs of imported goods and this means a great deal to those

624
00:58:05.760 --> 00:58:15.760
In recent years, therefore, governments have moved to abolish freely fluctuating exchange rates.

625
00:58:15.760 --> 00:58:20.760
Instead, they fixed arbitrary exchange rates with other currencies.

626
00:58:20.760 --> 00:58:27.760
Gresham's law tells us precisely the result of any such arbitrary price control.

627
00:58:27.760 --> 00:58:31.760
Whatever rate is set will not be the free market one,

628
00:58:31.760 --> 00:58:36.760
Since that can only be determined from day to day on the market.

629
00:58:36.760 --> 00:58:43.760
Therefore, one currency will always be artificially overvalued and the other undervalued.

630
00:58:43.760 --> 00:58:49.760
Generally, governments have deliberately overvalued their currencies for prestige reasons

631
00:58:49.760 --> 00:58:52.760
and also because of the consequences that follow.

632
00:58:52.760 --> 00:58:59.760
When a currency is overvalued by decree, people rush to exchange it for the undervalued currency

633
00:58:59.760 --> 00:59:07.760
Foreign currency at the bargain rates. This causes a surplus of overvalued and a shortage of the undervalued currency.

634
00:59:07.760 --> 00:59:12.760
The rate, in short, is prevented from moving to clear the exchange market.

635
00:59:12.760 --> 00:59:18.760
In the present world, foreign currencies have generally been overvalued relative to the dollar.

636
00:59:18.760 --> 00:59:26.760
The result has been the famous phenomenon of the dollar shortage, another testimony to the operation of Gresham's law.

637
00:59:26.760 --> 00:59:34.760
Foreign countries clamoring about a dollar shortage thus brought it about by their own policies.

638
00:59:34.760 --> 00:59:39.760
It is possible that these governments actually welcomed this state of affairs.

639
00:59:39.760 --> 00:59:47.760
For A, it gave them an excuse to clamor for American dollar aid to relieve the dollar shortage in the free world.

640
00:59:47.760 --> 00:59:52.760
And B, it gave them an excuse to ration imports from America.

641
00:59:52.760 --> 01:00:01.760
Undervaluing dollars causes imports from America to be artificially cheap and exports to America artificially expensive.

642
01:00:01.760 --> 01:00:06.760
The result? A trade deficit and worry over the dollar drain.

643
01:00:06.760 --> 01:00:16.760
In the last few years the dollar has been overvalued in relation to other currencies and hence the dollar drains from the United States.

644
01:00:16.760 --> 01:00:31.760
The foreign government then stepped in to tell its people, sadly, that it is unfortunately necessary for it to ration imports, to issue licenses to importers and determine what is imported according to need.

645
01:00:31.760 --> 01:00:37.760
To ration imports, many governments confiscate the foreign exchange holdings of their citizens,

646
01:00:37.760 --> 01:00:48.760
backing up an artificially high valuation on domestic currency by forcing these citizens to accept far less domestic money than they could have acquired on the free market.

647
01:00:48.760 --> 01:00:55.760
Thus, foreign exchange, as well as gold, has been nationalized, and exporters penalized.

648
01:00:55.760 --> 01:01:04.760
In countries where foreign trade is vitally important, this government exchange control imposes virtual socialization on the economy.

649
01:01:04.760 --> 01:01:14.760
An artificial exchange rate thus gives countries an excuse for demanding foreign aid and for imposing socialist controls over trade.

650
01:01:14.760 --> 01:01:22.760
At present, the world is enmeshed in a chaotic welter of exchange controls, currency blocks,

651
01:01:22.760 --> 01:01:40.760
In some countries, a black market in foreign exchange is legally encouraged to find out the true rate, and multiple discriminatory rates are fixed for different types of transactions.

652
01:01:40.760 --> 01:01:47.000
Almost all nations are on a fiat standard, but they have not had the courage to admit

653
01:01:47.000 --> 01:01:55.000
this outright, and so they proclaim some such fiction as restricted gold bullion standard.

654
01:01:55.000 --> 01:02:01.640
Actually gold is used not as a true definition for currencies, but as a convenience by governments,

655
01:02:01.640 --> 01:02:08.040
for a, fixing a currency's rate with respect to gold makes it easy to reckon any exchange

656
01:02:08.040 --> 01:02:15.440
in terms of any other currency, and gold is still used by the different governments.

657
01:02:15.440 --> 01:02:21.520
Since exchange rates are fixed, some item must move to balance every country's payments,

658
01:02:21.520 --> 01:02:24.300
and gold is the ideal candidate.

659
01:02:24.300 --> 01:02:30.340
In short, gold is no longer the world's money, it is now the government's money, used in

660
01:02:30.340 --> 01:02:32.480
payments to one another.

661
01:02:32.480 --> 01:02:38.840
Clearly, the inflationist's dream is some sort of world paper money manipulated by a

662
01:02:38.840 --> 01:02:44.880
world government and central bank, inflating everywhere at a common rate.

663
01:02:44.880 --> 01:02:48.160
This dream still lies in the dim future, however.

664
01:02:48.160 --> 01:02:53.220
We are still far from world government, and national currency problems have so far been

665
01:02:53.220 --> 01:02:58.660
too diverse and conflicting to permit meshing into a single unit.

666
01:02:58.660 --> 01:03:02.420
Yet the world has moved steadily in this direction.

667
01:03:02.420 --> 01:03:07.940
The International Monetary Fund, for example, is basically an institution designed to bolster

668
01:03:07.940 --> 01:03:15.620
national exchange control in general, and foreign undervaluation of the dollar in particular.

669
01:03:15.620 --> 01:03:21.820
The fund requires each member country to fix its exchange rate and then to pool gold and

670
01:03:21.820 --> 01:03:28.180
dollars to lend to governments that find themselves short of hard currency.

671
01:03:28.180 --> 01:03:31.300
13.

672
01:03:31.300 --> 01:03:34.060
and Money.

673
01:03:34.060 --> 01:03:39.120
Many people believe that the free market, despite some admitted advantages, is a picture

674
01:03:39.120 --> 01:03:41.780
of disorder and chaos.

675
01:03:41.780 --> 01:03:43.380
Nothing is planned.

676
01:03:43.380 --> 01:03:45.700
Everything is haphazard.

677
01:03:45.700 --> 01:03:49.740
Government dictation, on the other hand, seems simple and orderly.

678
01:03:49.740 --> 01:03:52.740
Decrees are handed down and they are obeyed.

679
01:03:52.740 --> 01:03:58.340
In no area of the economy is this myth more prevalent than in the field of money.

680
01:03:58.340 --> 01:04:03.340
Seemingly, money, at least, must come under stringent government control.

681
01:04:03.340 --> 01:04:09.340
But money is the lifeblood of the economy. It is the medium for all transactions.

682
01:04:09.340 --> 01:04:16.340
If government dictates over money, it has already captured a vital command post for control over the economy,

683
01:04:16.340 --> 01:04:20.340
and has secured a stepping stone for full socialism.

684
01:04:20.340 --> 01:04:26.340
We have seen that a free market in money, contrary to common assumption, would not be chaotic.

685
01:04:26.340 --> 01:04:35.900
What then have we learned about government and money?

686
01:04:35.900 --> 01:04:41.760
We have seen that over the centuries government has step by step invaded the free market and

687
01:04:41.760 --> 01:04:45.820
seized complete control over the monetary system.

688
01:04:45.820 --> 01:04:51.940
We have seen that each new control, sometimes seemingly innocuous, has begotten new and

689
01:04:51.940 --> 01:04:54.080
further controls.

690
01:04:54.080 --> 01:04:59.240
We have seen that governments are inherently inflationary, since inflation is a tempting

691
01:04:59.240 --> 01:05:04.260
means of acquiring revenue for the state and its favored groups.

692
01:05:04.260 --> 01:05:10.600
The slow but certain seizure of the monetary reins has thus been used to a. inflate the

693
01:05:10.600 --> 01:05:17.240
economy at a pace decided by government, and b. bring about socialistic direction of the

694
01:05:17.240 --> 01:05:19.360
entire economy.

695
01:05:19.360 --> 01:05:29.360
Furthermore, government meddling with money has not only brought untold tyranny into the world, it has also brought chaos and not order.

696
01:05:29.360 --> 01:05:35.360
It has fragmented the peaceful, productive world market and shattered it into a thousand pieces,

697
01:05:35.360 --> 01:05:45.360
with trade and investment hobbled and hampered by myriad restrictions, controls, artificial rates, currency breakdowns, etc.

698
01:05:45.360 --> 01:05:51.160
It has helped bring about wars by transforming a world of peaceful intercourse into a jungle

699
01:05:51.160 --> 01:05:53.960
of warring currency blocks.

700
01:05:53.960 --> 01:06:01.040
In short, we find that coercion in money as in other matters brings not order, but conflict

701
01:06:01.040 --> 01:06:01.960
and chaos.