What Has Government Done To Our Money – Notes – Part 5

>> February 26, 2020

>> Blog Post #31

Access part 1, part 2, part 3, and part 4

Stabilize the price level?

  • Some people believe money should be a fixed yardstick that never changes. This would mean government intervention, in the form of money supply management, instead of freedom.
  • However, the tools to hedge against price fluctuation already exist. Should people who do not wish to use these tools be forced to suffer from government stabilization of prices?
  • Government intervention would distort the market.
  • People would not be able to change their cash balances in proportion of prices.
  • Increased productivity tends to lower costs and prices, redistributing some of these benefits to the entire population under the form of lower costs of living.
  • Money is not a fixed yardstick. It is a commodity serving as a medium for exchanges. Flexibility in its value, in response to consumer demand, is just as important as any other free pricing on the market  

Co-existing Monies

  • Recap of what has been established so far:
    • In a purely free economy,
    • Gold and silver are used as medium of exchange,
    • Gold and silver are minted by competitive private companies,
    • Gold and silver are exchanged by weight,
    • Prices are set freely by the market in response to customer demand and product supply levels,
    • Freedom of prices = freedom of movement for the purchasing power of the money unit,
    • The resulting free economy would not be chaotic,
    • The economy would move swiftly and freely.
  • The market could very well choose to only accept one form of money but has not so far.
  • Over the past centuries, gold and silver have both been used.
  • Silver has proven to be more practical for smaller transactions and thus remained in circulation.
  • The exchange rate between gold and silver is set by the market forces of supply and demand.
  • The exchange rate and purchasing powers of the two metals will always tend to be proportional.
  • The free market is eminently orderly.

Money Warehouses

  • Gold has to be stored somewhere as it is usually awkward and difficult to transport.
  • Certain firms will specialize on the market as gold warehouses.
  • The owner of the gold maintains his rights on the gold thanks to deposit receipts and he can claim them whenever he chooses to.
  • Money being used mainly for its exchange properties and not its physical properties, it will most likely be transferred rather than consumed, making money warehouses even more important that regular warehouses.
  • Transfer of warehouse receipts becomes more convenient than the physical exchange of gold over time.
  • As the market for money warehouses develops there are three limits to the use of money substitutions in the form of receipt transfers:
  • The extent to which people are willing to use the money warehouses – we call them banks – instead of physical cash,
  • The more exchanges are carried out between clients of different warehouses, the greater the need to physically move gold,
  • The degree of confidence that clients have in the trustworthiness of their banks.
  • Paper receipts are bank notes.
  • Bank deposits are open book accounts at the banks.
  • Instead of transferring paper receipts, the client has a book claim at the bank. He makes exchanges by ordering the bank to make a transfer somewhere else. This is a check.
  • Economically there is no difference between a bank note and a bank deposit. They both represent a claim of ownership of physical gold at the bank. They are both transferred as money substitutes.
  • Token coins are the same thing as bank notes except they are printed on base metal.

Now this section of the chapter is extremely important, and it is the kind of information that you rarely see in economics textbooks when you study economics at school.

What has happened to the money supply as a result of all these money warehouse operations?

  • If paper notes or bank deposits are used as money substitutes does that mean that the money supply has increased even though the stock of gold has remained the same? Certainly not as the money substitutes are just warehouse receipts for gold that is actually deposited.
  • When the gold is transferred in the form of a money substitute being exchanged, the gold no longer exists as part of the effective money supply, but as part of the money reserve, as it can be claimed at any time by the holder of the money receipt.
  • An increase or decrease in the use of money substitutes therefore exerts no change on the money supply. Only the form of the supply is changed, not the total.
  • Banks could very well function on this 100% reserve policy and charge fees for their services. Use of their services would depend on the demand that customers have for their services.

Rothbard then proceeds to ask questions about the evaluation of fractional reserve banking, which he calls one of the thorniest problems facing the monetary economist:

Would fractional reserve banking be permitted under a free economy or would it be prescribed as fraud?

  • Banks have historically rarely stayed on a 100% reserve basis for a long time.
  • Banks have always been tempted to use seldom moving reserved for their own benefits.
  • People do not care whether gold they redeem is exactly the same gold that they deposited. They just care about the purchasing value of it.
  • Banks are tempted to use other people’s money to generate a profit for itself.
  • If banks use customer’s money, the receipts are then partially invalidated. Some receipts no longer have any gold behind them. The bank therefore becomes insolvent as it could not meet its obligations if a customer decided to redeem that gold.
  • These are pseudo money receipts that are loaned by banks on the market. The pseudo receipts are indistinguishable from the real money receipts.
  • You therefore end up having more receipts than gold in the warehouse, which falsely increases the money supply on the market, creating inflation.
  • Inflation is any increase in the money supply on the market, which does not consist in the equal increase of the stock of the physical gold.
  • Fractional reserve banks are therefore inherently inflationary in nature.
  • Bank deposits are not IOUs like a loan would be as they do not come with the promise that the bank would reimburse you a certain amount of money at a future point in time. They are warehouse receipts that are supposed to be redeemable at any point in time by the customer.
  • Fractional reserve banks create money out of thin air. They are at all times in a state of bankruptcy, that is only revealed if all customers decide to simultaneously claim their warehouse receipts, resulting in a bank run.
  • No other businesses in the world are susceptible to the same phenomenon of a bank run as a normal business takes risks with their own money, not their clients’ money.
  • Morally in a truly free market, fractional reserve banking should not exist as it is fraudulent.
  • Late coming claimants in a bank run are left high and dry.
  • On bank sizes and numbers:
    • The more banks and the smaller their clientele, the large the need to keep large reserves in case their clients claim their gold,
    • The larger the customer base of a bank is, the more it can run fractional reserve banking.
  • As monetary expansion continues with fractional banking, people who understand the truth of the system will be encouraged to create anti-bank leagues to urge bank runs.
  • This will help reduce monetary expansion.
  • Note that this is not at all to limit credit which is a promise to deliver future value at a future date and does not falsely change the money supply.

Isn’t it insane how blunt the question is:

Would fractional reserve banking be permitted under a free economy or would it be prescribed as fraud?

Before I ever started taking an interest in Bitcoin, I would have never even imagined this question and yet I consider myself as being educated. Maybe I was just educated by the wrong people / textbooks.

The level of corporate / governmental fraud we live with is endemic. I certainly do not want to be last in line if there is a bank run. And you shouldn’t either. This is the promise that holding gold yourself offered for years and that owning bitcoin (only if you hold your bitcoin keys yourself) furthers as it is less cumbersome to self-custody. Get on board people!

On a final note, maybe bitcoiners are just the manifestation of that anti-bank league that Rothbard was describing in his book. Are bitcoiners then supposed to encourage bank runs? I’ll leave that question open for you to answer. You can always post your opinion in the comments’ section below.

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