Up next, fresh from his Auburn University gig across the street, yeah, but he is the
academic vice president of the Ludwig von Mises Institute, he's the editor of the quarterly
journal of Austrian Economics.
He runs our summer programs, which include the Rothbard Graduate Seminar, of course Mises
in this University and our Scholars Conference in the Spring, Professor of Economics at Pace University
and he's got a big book on money coming out very, very soon. It's called Money, Sound and Unsound.
He's going to tell you today what is sound money. Please help me welcome Joe Salerno.
Thank you, Doug.
We're going from cyberspace to the very mundane, everyday world of money.
Though we're much more interested in money, I think.
Let me start by sort of demonstrating sound money.
This is a silver coin from the Austro-Hungarian Empire.
That's the sound of sound money.
This is the physical embodiment, such as it is, of unsound money, okay?
Today I'll talk a little bit about the differences between the two.
Where does money come from?
Let me just briefly address that question so I don't have that much time.
Let's say I'm a caveman artist, primitive artist, and I've come up with this.
This actually was a sort of famous sculptor around here, and I would like to buy your cell phone, okay?
So I go to somebody and I ask them, can I have your cell phone?
And that person says, this is ugly, I don't want this.
I mean, who shoots an arrow down on a deer?
I mean, on the side or something like that, right?
So what would I do? Would I be stuck?
Could I still get a cell phone or something that's similar to a cell phone in primitive times?
Well, the answer is, if I'm ingenious, yeah, I think I could.
I notice everyone here has pencils and that pencils are widely used by students, people with cell phones.
Very generally acceptable.
What I could do was find the one person that was willing to,
So a lot of people have pencils in stores of pencils, willing to give me pencils for this, okay?
So now I found someone who gave me pencils. I don't want the pencils. I don't want to use all these pencils.
I don't like writing with pencils. I'm lefty, so all the graphite gets on my hand because I write backhanded, so I hate pencils.
But in any case, once I have the pencils, I can get what I desire. Let's say the cell phone.
Let's say I would give someone a thousand pencils for the cell phone.
You get the idea. Pencils then become a medium of exchange, something that I'm purchasing, not because I want to use it directly.
I may even hate the good, but because I want to pass it on to someone else who's willing to give me what I desire in return, that being a cell phone.
Now, in primitive times, it might be that somebody who is an egg farmer has a lot of eggs.
He approaches someone who makes shoes, he wants a pair of shoes, and that person is allergic to eggs, doesn't want the eggs, so what does he do?
Again, is he stopped? This is called a lack of coincidence of wants. Their wants don't coincide, okay?
I want what the shirtmaker has, but he doesn't want my eggs, okay?
Well, what happens then? I go to someone who does want eggs, and who has a commodity that everyone in the society uses, let's say wheat, which might be the case.
Everybody uses it to bake with, they use it for rituals and so on.
So I sell it for a number of bushels of wheat.
I then take the wheat and I go buy the shoes, a shirt and other things that I might want.
That's how money developed. It developed on the market.
There was no government, no government that called together, let's say King called together his wise men at some point and said,
You know, my people are suffering from a problem of lack of coincidence of wants.
Let's all get together, let's get our heads together and come up with something that people will use.
Let's say paper, okay?
Well, no one would use that paper because they wouldn't know the value of it.
Whereas wheat or pencils have a pre-existing value under barter, that is, under direct exchange.
So people wouldn't know how to value the pencils.
If more and more people were using pencils or wheat in that society, then others would see that they could achieve their ends, they could buy the goods that they desired, if they could just sell whatever they have, they're specializing in producing, for the wheat, for the pencils, okay?
So over time, you've got one or two goods growing up as what we call media, plural, media of exchange, things that were wanted to buy other things, not for their own direct use.
The goods that developed out of this centuries-long, millennium-long process on the market were the precious metals, gold and silver.
Gold primarily in the East and in Western Europe up until the late 18th century into the 19th century, or rather silver, and then gold later on in the 19th century in Western Europe.
So, what came out of this was money. Now, money grew up without any sort of government edict.
So, there's two kinds of money. Let me just explain the difference very quickly.
Given that money originated on the market, there's a second kind of money that we call the silver money or gold money or whatever.
Let me give you some very quick examples of exchange prior to gold and silver.
They're kind of interesting. Cattle were used in ancient Greece, leather in ancient Rome,
animal pelts, whiskey and tobacco leaves in the American colonies.
Wampum, which were strings of beads, were used by American Indians.
Dried fish were used in the Canadian maritime colonies.
Maize or corn was used in Mexico. Salt and iron farming tools were used in Africa.
Wives, believe it or not, were used in ancient Egypt.
So, don't bother me, or you may very well be a medium of exchange tomorrow.
And cigarettes were used in POW camps.
Okay, there's a famous article on all of this, but I don't really have time to go into that.
Okay, so we got gold and silver. Why do we get gold and silver?
Well, imagine iron was used, for example, in Africa. Imagine trying to purchase
a lawnmower with iron. Okay, you have to bring it,
which is about $300 a ton. If you're going to spend $300, you have to carry
You don't have to carry a ton of iron in your car to go to Lowe's or wherever else you're going to buy a lawnmower.
Well, the point is gold and silver were chosen for very specific reasons and they were chosen over time by individuals
who all more or less agreed that these had combined the qualities that made them a good minimum of exchange.
They were easily portable, that is, gold and silver had high value to weight ratios.
So if you want to buy a lawnmower, you only need to bring, you know, maybe a half an ounce of gold for the lawnmower, okay?
They're homogeneous. Every unit was like every other unit.
No matter where they were mined, every single unit was like every other. They were identical.
So there was no, people didn't have to worry about deciding the quality of these different units.
They were highly divisible. They could be divided into very small parts or coins without losing their value, okay?
okay something like diamonds and other precious gems were also used but they
weren't highly divisible once once you you try to divide a gem quality diamond
that would lose all its value okay cows weren't divisible another example okay if
it's the dairy cow you know you can't chop it up and so on they're highly
durable gold that what was mined before let's say Jesus of Nazareth walked the
of the Earth is still in existence today, and it's naturally scarce.
It can't be multiplied.
So all of these things make gold and silver natural media of exchange.
The market discovered these things and ensured that they did become money.
So those are commodity monies.
That is, we define a commodity money as something that develops from a useful commodity.
On the other hand, paper money is fiat money. Fiat comes from the Latin, which means let it be done, as in a government command or decree.
So a government puts fiat money into circulation, first by connecting it to the gold standard,
but then later on when it cuts the link and says that gold and paper are no longer convertible,
It then makes it legal tender, it passes a law that says this piece of paper is now legal tender for all debts, public and private, meaning including paying your taxes.
No one can refuse to accept dollars in the discharge of a debt that was previously contracted.
What's interesting though is that the face value of this dollar is much higher than the cost of producing it.
of Producing it. Whether you're producing a one dollar bill or a one hundred dollar bill, it costs four cents, whereas if you're producing an ounce of gold and you have a gold dollar, and the gold dollar, let's say, is twenty dollars in U.S. history, was equal to about one ounce of gold. So if that were the case, it was actually twenty dollars and sixty-seven cents, the gold in that ounce, subtracting out the cost of minting it, was about twenty dollars. So there was no
There's no incentive to multiply it. With commodity money, there's a natural constraint on the supply.
That natural constraint is the cost of producing it.
The fact that it's costly to produce, that it's scarce, it's difficult to find new sources of gold and silver, and so on.
So that restrains the supply.
That is not true of unsound money.
In the case of fiat money, the government earns 96 cents on every dollar that it produces.
But even more so in today's world where money is mainly created initially through the banking system,
it doesn't even cost four cents. It's simply a keystroke and an entry in cyberspace.
How does the Federal Reserve System or central bank create money?
In today's world, actually this morning and what time is it now? In New York, actually a few hours ago, between 9 o'clock and 12 o'clock in the morning, there's something called Fed time.
At that time, the Fed goes into the market through a network of computers, goes to the banks and asks them to give them prices, to give the Fed prices for government securities that it's selling.
So, if the Fed wants to buy, let's say, $50 million worth of government securities, it will buy those securities from the banks that offer those securities at the lowest price.
It's an auction.
Where does the Fed get the money to purchase those securities?
It simply writes a check on itself. It's permitted to do that. It writes a check on itself.
It's even simpler than that now in the electronic age. It doesn't just write a check on itself.
What it does is simply go to its computer, find the bank's account from whom it's buying the bond,
and let's say it's buying $10 million worth of bond from a given bank,
it would simply just add credit, $10 million to that bank's account.
Most of the reserves that banks hold in those really fancy safes that you saw,
I was in a bank yesterday because they messed up my debit card.
They told me they were going to send the number forward, and they didn't do it.
And they had the very impressive vault partially open, and everybody's whispering, and everything looks so somber and sober.
But of course, very little money is in there, very little of the reserves.
And the reserves are only 10% of the money that you deposit. The other 90% is out on loan.
but even that ten percent okay very little in the vault very little in the
ATMs most of it is in cyberspace at the Federal Reserve Bank in in the region so
in this case would be most of the bank reserves are at the Atlanta Fed
okay so what we we get from this is that it's very easy to create new money when
and you have a fiat money standard.
So we want to compare the control on the money supply process under commodity money and that
under fiat money.
Under commodity money, the supply of money depends on the cost of production, the mining,
the refining, the minting of the coins in relation to the demand for money.
So just like any other good, like iPods, cars, McDonalds, hamburgers, the supply of money
under the commodity standard is limited by market forces.
On the other hand, under fiat money, it is not so limited.
The Federal Reserve system is the only agency that is legally permitted to create new money.
So it has a monopoly of the supply process.
Not only that, because money, fiat money, unlike other goods is almost costless to produce,
unlike other monopolists who want to restrict the amount they sell to so they can keep the
prices high, the exact opposite incentive operates with the Fed.
That is, they want to increase the money supply.
There are a number of reasons for that.
One is that government puts pressure on the Federal Reserve system to finance its deficits
by printing up new money and buying the bonds.
The bonds represent what the government wants to borrow, to spend over and above what it's taking in taxes, okay?
The other point about that is that the government gets to spend that new money first, or the people it subsidizes,
the farmers, you know, that are getting big subsidies, or the defense contractor from whom it's buying military equipment.
They get the new money first, or the government gets the new money first, and that's before prices have risen.
By the time you or I, I live in New York, get that new money, it might be a year later, 18 months later, after most prices in the economy have gone up and real income has already been redistributed from us to the government and its favorites.
Let me just give you an example of what we're saying is this.
The value of money, the amount of goods and services it can purchase,
which is the other side of the coin of prices and how high prices are,
that is determined under commodity money by supply and demand.
Just like the number of apples in the economy,
the number of automobiles in the economy and so on,
are tightly constrained by profit motives,
The supply of money is also constrained by profit motives and its value is determined by competitive processes.
That is not true of fiat currency.
So, here's an example of, I hope I have it here, yeah, this is what we mean when we say
The Value of Money
So very quickly, if you have the price of goods, so it's a dollar per Coca-Cola, ten
dollars for a pizza, a hundred for an iPod and so on, that's the price of goods.
The value of money is really just the inverse of that.
We invert, a price is always a ratio, it's dollars per unit.
We invert that ratio and we find that the purchasing power of a dollar in this economy
is one coke per dollar or it can purchase one-tenth of a pizza per dollar or one-hundredth
of an iPod and so on.
The key point is that whenever prices rise, okay, in this case I've doubled them, whenever
When prices rise, notice what happens to the purchasing power of money, it gets reduced, that is, the dollar shrinks because of rising prices.
Now, not all rising prices are bad. If goods become more scarce for some reason, there's no problem with prices going up and adjusting supply and demand.
However, if prices are rising because the government is creating new money, then that sets in process, really a process of robbery.
that is allocating money or real income to the people who get the new money first
and who can pay, buy things at the low prices
and that money is coming out of the pockets of people who are buying goods later on
after they've received the new income.
Because at that point, prices have already risen
and so for that year or year and a half, their dollar has been worth less
until their incomes have caught up to the rising prices.
So it's a secret tax, it's a surreptitious way, undemocratic way
of taxing people who hold money, of shifting money from one group to another group, shifting income.
So that is one of the effects of inflation. One of the effects of inflation is that it increases prices and in doing so reduces the purchasing power of money.
It is not inflation itself. Inflation is defined and should be defined as an increase in the quantity of money in the economy.
in the Economy. Now let me give you, let's compare unsound with sound money, commodity money with fiat money.
There's 1790, right after the U.S. Republic was founded,
all the way to your left.
This is the price level. The index number is around 10 there,
based on 1982 prices.
So it's around 10. Notice that up until 1913,
Right? This blip here, about there.
When the Fed came into existence, prices were pretty stable.
They were the same in 1900 as they were in 1800.
There's ups and downs, and some of those ups were caused by going off
commodity money onto fiat money to pay for the Civil War and the Revolutionary War.
But then look what happens.
If we fight World War II, prices continue to rise.
They go down during the Depression, then they begin to rise as we fight World War II.
Then in 1971, President Nixon reneged on the solemn pledge made at Bretton Woods in 1946
by the US government to convert all foreign held dollars into gold.
In 1971, in August, he went on television and closed the gold window, quote unquote.
At that point, look what has happened. When the last link with gold was cut,
and the dollar is a pure fiat currency the index number is around 225 that is
from around 1900 1913 on up to that point prices rose by about that that's
around 10 and I believe it is it rose by about 23 times okay so the dollar was
is worth a nickel compared to what it was worth back before the Fed came onto the scene, the central bank.
We didn't go off the gold standard right away, but the Fed began manipulating the money supply.
In fact, let me just mention right now something I wanted to mention at the beginning.
How do we define sound money? There's two components to sound money.
Sound money is money that consists of a commodity chosen by the market, like gold or silver, but there's a second part.
and whose supply and value are completely independent of the government.
So, the sound money program is just like a sound education policy, sound religion policy, sound newspaper policy, sound internet policy.
There must be a complete separation of the state from money, just as there is from education, religion, internet and everything else.
So, those are the two components. Now, you can have sound, pretty sound money, as we did even in 1913, if the Fed came in until maybe 1931, you can have pretty sound money, but the government can begin getting involved, encouraging banks to expand the money supply, even on the basis of gold, telling banks that they'll bail them out. So we had, that's a quasi-semi-sound money. So you don't want the Fed, you don't want the government doing anything.
having any involvement whatsoever in money.
Now when they do get involved in money, many bad things can happen, one of which, let me
just go back to what I was saying here, one of which is hyperinflation, okay?
And actually before I show you a little, or go into a little spiel about hyperinflation,
I do want to show you what, from 1790 to about 1913, that's where I ended it.
You can see that prices were going up and down, but not by very much, the index number
is nine, it goes up to eighteen, that's during the Revolutionary War, I'm sorry, that's during
the era when we had the first US bank, which was kind of a proto-central bank, okay.
And during the Civil War, you see prices going up, but when we went back on the gold standard, the price level always came back.
So notice that in 1790, the price level was just about what it was in 1913 or so.
So what happens when governments get involved in, let's say, intensively increasing the money supply, increasing it at very rapid rates?
What we call hyperinflation, and let me just say a few words about hyperinflation because
inflation is bad enough, but inflation always tends to feed on itself if it's not stopped.
And one reason why politicians don't like to stop inflation, on the one hand it's very
unpopular when prices start going up, but if you do stop it, during the inflationary
process you have fooled people into making investments by lowering the interest rate
below its natural level. Investments that they would have not made if that new money
was not injected into the economy through the credit markets. So when we had the housing
bubble that popped a few years back, that housing bubble was stoked, was encouraged,
was more or less shaped by the inflation that we had from about 2002 to 2005, where interest
The rates were kept very low and a lot of money was being created. In fact, from the end of 2001 to 2005, the Fed was creating one billion new dollars per week.
That's sort of a rough back of the envelope calculation. Every day, by simply buying government bonds in the market, writing checks on itself, wiring unsound money through cyberspace.
But when you stop that, what do you get? You get what we have now, a recession.
So politicians are always juggling on sound money.
You know, should I let the inflation go a little further or should I stop it now and have a recession?
They don't want the inflation or the recession in the year leading up to an election.
There's been studies done showing that the American public has about a one-year memory back.
If times were good for the past year, you wouldn't tend to lose votes as the party in power because of the economy.
However, if times were bad in the past year, then you will lose a significant number of votes as a result.
So what you want to do is to keep the Fed inflating up to the point where you get re-elected,
and then afterwards you would like to have the recession, before inflation gets out of hand, early in your administration.
because recessions last 9 months or 16 months and it's over by the second half of your administration.
So that's what politicians face.
Now, in the U.S., even though it's not a sound money country, we have people who are very aware of inflation,
we have the media continuously commenting on it.
So we can't get away with a whole lot of inflation.
But other countries, that wasn't true, especially earlier in the century.
So I do want to talk a few minutes about the worst thing that can happen with an unsound money, and that's hyperinflation.
Let me just talk a little bit about the German hyperinflation, which you may or may not have heard about.
During the German hyperinflation, which occurred, got very bad from 1922-23, here's the prices of German newspapers.
okay they start off at about one-third of a mark in January 1921
it tripled by May of 22 they increased eightfold in the in the five or six
months
October then they started going up much more rapidly
okay so from February 23rd a German newspaper cost
100 marks that's 300 times more than it cost back in
in about a year before by September was 10 times as high
and then it doubled in one month, and then from October 1st to October 15th it went up 10 times, then in 14 days it went from 20,000 marks to a million marks for a newspaper.
Now all other prices are going up in the same way. So think about an automobile going up from $20,000, which is an automobile today, to a million dollars in two weeks.
That's what a hyperinflation is like, and then by November 9th it was $15 million, and then eight days later it was $70 million for a newspaper.
$70 million marks. Additionally, the mark was about 25 cents. The mark was worth about 25 cents.
By the end, it took one trillion marks to buy one dollar, whereas before it only took four.
Okay, let me say a few things about the hyperinflation.
Towards the end, the price
of a full dinner the night before wouldn't even buy you a cup of coffee the next day.
Prices were going up
hourly, okay. German workers
were demanding to get paid first every week,
then every day, then twice, and three times a day. At the end they were getting paid three times a day.
They had their family, their wives, their children, parents, show up at factory gates.
They would give them money and they would just rush out and spend it as quickly as they could.
The government had taken over all 2,000 printing plants in the country.
They were running 24 hours a day printing money, okay?
Almost all the money that was being printed was 1 billion mark notes at the end.
That's how high prices were.
At the end they ran out of paper. So, this is initially a 1,000 mark note.
What's stamped across it? One milliard marks.
A milliard is a billion in some European countries.
We're just stamping them.
What were the banks doing at the end? The banks were not counting.
They were weighing the money, because they were all billion-dollar marks
to put into your account.
Professors like me and teachers, since they got paid,
and civil service, they were getting paid every two weeks or every month,
Women, when they went to the grocery stores, would take their money in wheelbarrows, laundry baskets or suitcases, and what would happen would be that the thieves, they couldn't carry them into the stores because you couldn't maneuver down the aisles and stuff, so they would leave them outside and the thieves would run by and just dump the money out and just take the laundry baskets out of the store.
Women, when they went to the grocery stores, would take their money in wheelbarrows, laundry baskets or suitcases.
And what would happen would be that the thieves, they couldn't carry them into the stores because you couldn't maneuver down the aisles and stuff.
So they would leave them outside and the thieves would run by and just dump the money out and just take the laundry basket because it was worth more than all the marks in it.
The greatest one in history though, greatest inflation in history was the Hungarian inflation occurred in 1946 after World War II.
Initially it took one dollar to buy 3.38 pengos. By 1946 it bought, a dollar could buy 500 million trillion pengos.
okay so people who had let's say a hundred thousand let's say let's say
338,000 pengos in the bank was about $100,000 by the end that was even worth
a fraction of a penny okay and then of course we have the Zimbabwean inflation
hyperinflation and we're running a little over here but I wanted to show a
couple of interesting pictures of that we have a minute or two more yeah okay
Here's some interesting pictures I found on the internet, and I'll end it with this.
Okay, there's ten million dollar notes, ten million Zimbabwean dollar notes.
notes, okay, now to give you an idea of that ten million dollar note is worth about ten
dollars, ten dollars is worth ten of those actually, okay.
Here's a kid just going to get some candy from the store, okay.
This guy's going to the supermarket, this is worth, this person, no, this guy's going to the supermarket, I'm sorry, he's going to the supermarket, I'm sorry.
This pile of money is worth, actually, $100, that pile of cash there.
At the end they had two hundred and fifty million dollar notes, and here's, let's see, here's a hundred million dollar note, and here's how much you can buy below it.
Here's a hundred million dollar note, and there's what you can buy, three eggs.
Finally, here's a guy just paying for his restaurant meal.
And finally, here's a grocery bill. That'll be it. I think it's $1,243,000,000. I paid at the Amsterdam Cafe. Anyway, that's without inflation. Okay, I will stop there. Thank you very much.