Free Trade and the US

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One of the characteristics of the anti-globalisation movement personified by US President Donald Trump is its apparent opposition to free trade. Free trade is not only associated with the globalisation agenda of the liberal elite but is also held responsible for the shipping of jobs and production overseas where cheaper labour and cheaper raw materials can be exploited, leaving at home nothing but crumbling factories and swathes of unemployed workers. Hence a considerable part of Trump’s “America First” programme appears to be devoted to distinctly anti-free trade measures, such as increased protectionism and tax penalties for firms relocating jobs overseas.

What should be the reaction of Austro-libertarians to this phenomenon? Do we not believe that free trade is almost the very essence of freedom and the fountain of prosperity? Should we not oppose any attempt to restrain trade by either tariffs or regulations? On the other hand, what are we to do when such policies are seemingly associated with nothing but destitution and misery for a significant proportion of the population?

For libertarians to simply repeat like a broken tape that trade should be left “free” runs the risk of considering only surface phenomena while failing to examine deeper, underlying problems. In the first place, of course, the association of the globalising movement with free trade is patently false. Those behind this movement are not in favour of genuine free trade; rather, they promote a heavily managed trade environment – one governed by trade agreements, trade deals, and a complex myriad of rules and regulations which favour only large corporations and the politically well connected. Indeed, trade agreements and trade deals are the antithesis of free trade, the latter of which demands a complete absence of the state from any involvement in trade. The terms “free trade agreements” and “free trade deals” are therefore nothing more than meaningless doublethink. A grave mistake that the anti-globalisation movement is likely to make is to confuse political globalisation – the consolidation of and intensified co-operation between states and state institutions, which is a relatively new phenomenon – with economic globalisation, which is private institutions trading peacefully and voluntarily on terms agreed by themselves, a situation which has existed for centuries. Political globalisation should be opposed bitterly while economic globalisation and the expansion of the international division of labour should be promoted. The bigger problem, however, is the fact that free trade today, if it is genuinely free, is carried out in a context where there is a gross, underlying violation of private property rights – in other words where the players who are demanding freedom are benefitting from the curtailment of other people’s freedom. For instance, banks are restrained from being “free” by heavy regulation and oversight because their lending activities have the tendency to blow up bubbles which lead to crippling busts. However, the reason for this tendency is that banks are, simultaneously, legally privileged (by the ability to hold only fractional reserves) and economically privileged (by being the first parties to receive new money that is freshly printed central bank – money which is itself, of course, subject to legal tender laws and of which the central bank is legally privileged as the sole issuer). It would be a travesty for Austro-libertarians to respond to any call for increased bank regulation by pointing out that such regulations are a violation of freedom. While this is true in and of itself, the real problem is clearly the state’s monopoly money and its dissemination through fractional reserve banking. To take another example, entities that are endowed by the state with a monopolistic or quasi-monopolistic privilege are normally able to charge higher prices to their customers and to pay lower prices to their suppliers. If, in response to the resulting “obscene” profits and high prices, the state proposes to regulate the prices of the entity’s products or tax away a significant portion of its profits, Austro-libertarians pointing out the pitfalls of price control and the injustice of taxation would be speaking the truth as far is goes. However, they would be ignoring the bigger, underlying problem which is the entity’s monopoly privilege, and that what is really needed is to rescind this privilege in order to open up the market to genuine competition. Only in this context is the freedom of firms to set prices both legitimate and economically beneficial.

When it comes to free trade, part of the underlying problem that is easy to ignore is that, of course, US workers are burdened by minimum wage laws and employment regulations which, to any employer, makes them relatively more expensive than workers overseas who may not be burdened by such interventions. However, the bigger “macro” problem is the fact that trade today takes place with the exchange of state-issued, paper currency which can be expanded at will, rather than with “sound” money such as gold or silver. The added complication in the case of the United States is that it is, currently, the issuer of the world’s reserve currency. What we will see is that, even without minimum wage laws and employment regulations, this would cause jobs to vanish overseas.

When the entire world is trading with “sound” money such as gold the prices of labour in the US and overseas depend upon the relative supply and demand for gold and for labour in each location. In which circumstances could labour be cheaper overseas? (By “cheaper” we mean that wages are lower per unit of production and not per hour. Wages in developed countries are higher per hour because labourers there can produce more in each hour on account of the relatively high amount of capital goods per worker – more tools, machines, factories and so on. Wages in poorer countries may be lower per hour because each worker can produce less per hour, but in equilibrium they would not be lower per unit of production). If labour is cheaper overseas then it means there is a relatively higher supply of money and a relatively lower supply of labour in the US while there is a relatively lower supply of money and a relatively higher supply of labour overseas. Employers therefore divert more of their funds to employing workers overseas in order to take advantage of the lower wages. This, however, is simply the correction of a disequilibrium which will reach its own natural limit. As money leaves the US then money there will become relatively scarcer while the amount of labour will remain the same and so US wages will fall; the new money flowing into countries overseas, on the other hand, will cause wages there to rise. At some point wages both at home and overseas will equalise. Of course, if the reverse happens – that wages are higher overseas than in the US – then the opposite process will occur, with money being drawn out of overseas countries and coming home to the US to bid up wage rates there. All of this is part of the natural process of economising behaviour which seeks to employ resources across the world by directing them to their most highly valued use. Absent any further state interference such as minimum wage laws and onerous employment regulations, all workers, both overseas and at home, will end up employed at the same wage rate (per unit of production).

What happens, however, when we are trading not with “sound” money, such as gold or silver, but, rather, with a paper money which can be issued by the state at will? If the domestic state chooses to expand the supply of money then this will cause an effect similar to that we just outlined. The supply of money at home will increase causing local prices – including wages – to rise. Prices overseas, however, will not yet have risen on account of the fact that the new money has not yet reached there. This process takes places through the complicating factor of the exchange rates between currencies, which is itself, of course, a price and is subject to the same influences. If the US prints more money but the overseas country does not then the first firms to spend the newly printed money on foreign currency will benefit from the old exchange rate and will be able to obtain more foreign currency than they otherwise would have which they can then use for purchasing goods and labour from abroad. Firms will therefore divert more of their spending to importing resources and seeking foreign labour than they would domestic labour. For the majority of countries such printing of currency can have only a very limited effect. If the inflation is a one shot affair then, eventually, increased bidding for foreign currency with the newly printed money will cause the exchange rate to adjust, strengthening foreign currencies and weakening the domestic currency. Fewer units of foreign currency can be bought with the additional supply of domestic currency and so the attractiveness of foreign goods and services diminishes, vanishing entirely when the currencies reach purchasing power parity. Currencies reach a state of purchasing power parity when the exchange rate between currencies and between goods is harmonious. For example, if an apple costs two South African Rands or one US Dollar, then in a state of purchasing power parity one US Dollar would equal two South African Rands. At this point there is no additional benefit from buying goods and services from abroad than there is from buying them at home. If, on the other hand, the inflation is continuous then such continuation comes to be expected. This expectation of inflation will in and of itself cause a much quicker adjustment to the exchange rate than previously, thus nullifying, or at least blunting, the benefits to the recipients of the newly printed money, robbing them of the power to ship jobs and the supply of resources overseas. The only thing that is experienced is domestic price rises. Of course, if the continuous inflation becomes abusive then it sows the seeds of hyperinflation as bigger and bigger doses of inflation are required in order to “cheat” inflationary expectations until the inflation reaches such a degree that such cheating is no longer possible and price rises even begin to exceed the rate of inflation. By this point, needless to say, a country has a lot more to worry about that jobs being shipped overseas. Thus what we can see is that with both “sound” money and independently issued, national paper monies mechanisms exist which prevent a permanent loss of jobs and the sourcing of supplies from overseas.

The situation is different, however, where the issuer of the paper currency happens to be the issuer of the world’s reserve currency. This is the dubiously privileged position in which the US and the US Dollar finds itself today. For when a country is the issuer of the world’s reserve currency the price adjustment mechanisms that we outlined above, which prevent the permanent loss of jobs overseas, are disrupted.

The US Dollar became the world’s reserve currency partly as a legacy of the Bretton Woods gold exchange standard, where the US pyramided the issue of US dollars on gold and the rest of the world pyramided its currencies on the US dollar. Today, however, the US dollar owes it reserve status largely to the petrodollar system – the agreement of oil exporting countries, led by their lynchpin, Saudi Arabia, to price and sell oil in US dollars – and the resulting domination of US based financial networks. The upshot of all of this is that in order the buy oil (which everybody needs) and in order to engage in international commerce pretty much everybody everywhere must buy and hold a significant quantity of US dollar reserves. And as the demand for oil has increased over the past forty years so too has the demand for the US dollar. Thus there has existed a continuously buoyant demand for the holding of US dollars which is sufficient to outstrip the increase in any supply of those US dollars. This buoyancy of demand is also maintained and strengthened by the fact that several countries, most notably China, unit recently pegged their currency to the dollar in order to fuel export driven growth. In other words, they deliberately weakened their own currency by printing more of it to buy dollars, thus pushing up dollar demand and increasing Renminbi supply. Even though China has used most of those dollars to purchase US treasury bonds, thus nullifying the increase in demand for US dollars, it would still be the case that their own currency would emerge weaker (which if, of course, the entire point of the peg). This leads us onto the next problem and one that is most relevant to the recent past – that the reserve currency becomes a “safe haven” asset. The US dollar index, which tracks the value of the dollar against a basket of other currencies, has risen since 2011, particularly as a result of crises in the Eurozone which has served to weaken the world’s second most dominant currency, the Euro. Indeed, against the US dollar, every single major currency is lower than it was five years ago. This is something that US dollar doomsayers are yet to understand. Yes, the dollar is being printed into oblivion, but so too is every other currency; the dollar just happens to be the least rotten apple in the cart.

The effects of all this are that when the Federal Reserve prints fresh, US dollars domestic prices will rise. However, because the dollar is able to maintain its strength on the world stage vis-à-vis other currencies, holders of US dollars find themselves in the continued position of being able to source goods and services cheaper from abroad than they can at home. Indeed, for several decades now the US dollar has effectively been able to buy more than it is really worth. People happily hand over goods and services in exchange for the medium with which they can trade oil and engage in international commerce. Because the US can simply buy what it needs by printing a currency which everyone wants, the result has been to turn it into a giant consumer economy rather than a producer economy – an economy which has no need for jobs. After all, why not just put all of those jobless people on welfare that can be paid for with printed dollars which will buy them Chinese goods? Indeed, in spite of the resilience of the American entrepreneurial spirit, the US is, today, a very difficult place in which to be a producer. According to a ranking by the World Bank, the US was as low as the 51st best place in which to start a business, a paltry 39th best place in which to deal with building permits, ranked only 36th for the ease of obtaining electricity, registering property and for taxes, and 35th for trading across borders. Yet, in full congruence with what we have explained here, the US was, apparently, the second best place in the world in which to obtain credit! Other rankings tell much the same story, with Forbes placing the US at 23rd overall on their list of best places to do business at the end of 2016 – not too bad, you might say, until you realise that is was ranked first just ten years ago.

Needless to say, much of the global monetary situation may now be changing, particularly with moves by China – itself a big consumer of oil – to compete with the petrodollar system and to establish alternative clearing institutions for international commerce that are not reliant upon the US dollar. What we can see from all this, however, is that, on the one hand, to blame free trade for the flight of US jobs overseas is clearly incorrect; yet it is foolish and naïve for Austro-libertarians to defend free trade on the surface when the underlying property rights are far from free. The lesson to be learnt, therefore, is that when confronting issues that threaten our freedom, Austro-libertarians should remember to examine them on the deepest possible level and not simply react to what they see in plain sight.


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Negative Interest Rates

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Since the 2008 financial crisis, the policy of central banks to forcibly push down interest rates, followed by the rapid expansion of their balance sheets in order to attempt to “stimulate” economic growth has, to say the least, been something of an abysmal failure. Unemployment is still high, economic growth barely makes it any higher than a rounding error and real wage rates continue to stagnate as they have done for the past ten years or more. Benefitting only Wall Street, the new money has pushed stock markets to record highs and bond yields to record lows, so much so that owning these assets over the past five years has been the closest one can get to a sure bet. Main Street, however, having had to deal with the reality of the fact that the debt-fuelled consumption mania is no longer sustainable and that real savings to grow businesses are in short supply, continues to languish in what seems like a completely separate realm from the casino operations of the financial markets. With positive interest rates now as low as they can possibly go and with little to show for it, it is no surprise that the prospect of negative interest rates in order to force everyone to spend their way into a recovery is now a real one. Indeed, it is already very much a reality in Switzerland and Denmark.

The proposal for negative interest rates rests on a typical Keynesian plea that the government and central banks did not act “drastically enough” in attempting to defibrillate the economy back to growth. Contrary to understanding the lack of any meaningful recovery as a failure of their policies, they instead turn around and say “if it is this bad now then imagine how terrible it would have been had we done nothing at all!” The patient is therefore prescribed ever greater doses of bad medicine in spite of the fact that it is the medicine that is killing him. (Has it not also been said often that the definition of insanity is to repeat an act continuously with the expectation of a different outcome?) Indeed, the economy is so saturated with debt that only paying people to get deeper into it has any prospect expanding the volume of spending.

Negative interest rates are, of course, a praxeological absurdity and could not come about through anything except government force. It is tantamount to placing a premium on future goods as opposed to present goods, so that the prospect of receiving £100 today is less valuable than receiving £100 in a year’s time. Practically, what this means is that, if you deposit £100 in the bank today with an interest rate of -5%, you will have only £95 in one year’s time. You are, therefore, quite literally paying the bank to borrow your money, a proposition absurd to anyone except a tenured professor of economics. Since when, to invert a popular proverb, has a bird in the bush been worth two in the hand? The idea, of course, is that you will be so keen to avoid the interest charges that you will cease to be an “evil” saver and rush out to spend all of your money as soon as you can. Thus the magical Keynesian multiplier will burst into life, restoring us to the land of milk and honey. What’s more, they hope that it will encourage a flurry of borrowing as all the excess reserves piling up in bank vaults (or, rather, on their computer screens) are now lent out to those eager to be paid to hold cash. Traditionally, of course, banks earn their revenue by paying depositors a lower interest rate than they charge to borrowers. With negative interest rates it seems as though the situation will reverse: the bank will make its money by charging its depositors more than it has to pay its borrowers.

Such a ridiculous idea does, of course, run into the unfortunate fact that every unit of money has to be in someone’s cash balance and if all cash balances attract a negative interest rate there can only be an incentive to borrow if the rate on your deposit account is less than the terms of the loan – in other words, you have to pay less to hold the cash than you get paid for taking out the loan. Further, if someone can only get rid of their cash by passing it onto someone else and that latter person can then only do the same then the logical end of the proposal is hyperinflation. That aside, however, what will be the likely effects of the introduction of such a policy?

The first likelihood is that, with bank deposits now charging an interest levy, holding hard cash under the mattress becomes an attractive alternative. In both inflationary and deflationary environments it will lose less and gain more than a bank deposit. Indeed, at first blush, libertarians should welcome this possibility. After all, it is free deposit banking that has resulted in people willingly stashing all of their cash in fractional reserve banks, enabling them to pyramid loan upon loan on top of them and thus causing the disastrous business cycle. When money consisted of gold or silver stored in full reserve banks it was natural for banks to levy a charge for this storage service. People could either choose to accept the charge in return for the safekeeping of their assets, or prefer to keep the cash in their own storage provisions at no cost. Viewed this way, negative interest rates give the appearance of a return to something more akin to cash handling as it would be in a libertarian world. Unfortunately, of course, the negative interest rate is an arbitrary figure and does not represent the true value of storage services to holders of deposit accounts, and having been accustomed to the provision of such services for free anyway a mass withdrawal will be the most likely response. Indeed, it would not be unsurprising if something akin to Gresham’s Law emerged where, legally, bank deposits and cash notes trade at par but where undervalued cash becomes hoarded and people keep only a minimum amount of overvalued bank deposits with which to use for their exchanges. Such an outcome would, of course, utterly defeat the purpose of negative interest rates which is to swell the volume of spending through electronic exchange. In other words, the point at which negative interest rates begin a flight into cash will mark the true limits of monetary policy in creating a spending splurge.

Needless to say, of course, the likely government response is to restrict cash holding with a view to eliminating cash altogether in order to concentrate as much money as possible in commercial bank deposits. Such an end has, in and of itself, been a cherished aim of government, as it permits oversight of and control over every single financial transaction. Under the guise of “combating terrorism” such restrictions have already been tightened recently in France, where, from September of this year, cash payments in excess of €1000 will be illegal. Similar restrictions have appeared, in the last few years, in Spain, Italy, Russia and Mexico. Where cash remains less restricted, any attempts to convert deposits into cash may be met with refusal and obstinacy, as a Swiss pension fund discovered recently when it attempted to switch its deposits to paper notes stored in a vault. Indeed all of this harkens back to the era when banks overinflated on a monetary base of redeemable gold. Back then, redemption in gold was restricted to concentrate people’s cash holdings in paper notes. Now, redemption in paper notes is restricted to concentrate cash holdings in deposits.

The likely reaction to this is that, with deposits and fixed income securities losing value in both nominal and real terms, people will abandon these assets in pursuit of safer stores of value – probably gold and silver. In other words, shorn of the ability to withdraw hard cash, people will keep on deposit only the amount they need to meet their current expenditures while the rest of their savings will be ploughed into harder assets. A flight out of debt instruments would trigger a deleveraging and usually, in such circumstances, the safe home for such funds would be cash. But if cash will also be subject to a negative interest rate and with no ability to withdraw paper notes, then movement of the money into gold would cause the gold price to rise. We would therefore have the peculiar effect of increasing asset prices during an era of deflation. Such are the ways in which monetary policy can turn the world upside down.

The likely effects of a negative interest policy as outlined here demonstrate the limits of a monetary policy that attempts to kick the economy back into gear through spending. You can print all of the money that you like; you can lower interest rates as far as they will go; you can make it impossible for people to withdraw their cash; but like the proverbial horse to water, you cannot force people to borrow and spend. In short, you cannot cheat the market with increasingly absurd tricks that would have baffled even the monetary charlatans of yesterday. Only liquidation of the existing debt and a return to sound money with interest rates determined by the supply of and demand for saved funds will create a proper, sustainable recovery on the path to prosperity.

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Fractional Reserve Banking – The Ethics and Economics

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Fractional reserve banking is a prime topic for study on the part of libertarians on the one hand and of “Austrian” economists on the other. For not only is the practice, in the way it is carried out today, deeply unethical it also creates macroeconomic instability and is one of the causes of economic crises such as that which we are enduring currently. This essay will explore in particular the ethical and economic consequences of the legal framework imposed by government fiat that breathes life into this practice, concluding that it is government that is at the heart of its unethical nature and causes the endurance of its bad effects.

What is Fractional Reserve Banking?

A bank engages in fractional reserve banking if it retains as reserves only a fraction of its liabilities that can be redeemed on demand – most often, this means money that is held in current or “checking” accounts where you are entitled to withdraw your money at a moment’s notice. If customers have deposited in the bank £10 million of cash and the bank’s reserve requirement (or its internal practice, depending upon the regulatory regime) is 10% then the amount of cash held by the bank for withdrawal by those customers is a mere £1 million. This may be easier to visualise when deposited money consisted not of paper but of gold and other precious metals. When you deposited your gold in a bank, you were issued with a paper warehouse ticket stating the amount of your deposit (say, 10oz) and the fact that you were entitled to withdraw it on demand. If your bank engaged in the practice of fractional reserve banking then only a portion of this gold would actually be in the bank ready for you to withdraw. Incidentally, these warehouse tickets were the origin of paper money – a £10 banknote issued by the Bank of England still states “I promise to pay the bearer on demand the sum of £10”, £10 originally meaning 10 pounds in weight of sterling silver. Indeed, all of the monetary denominations such as pounds, dollars, francs and marks were originally fixed weights of precious metal. These days, of course, the note is backed by no commodity whatsoever and statements of account at banks merely indicate a promise to pay the sum stated in paper money which has, to all intents and purposes, replaced metals such as gold and silver.

The obvious question, then, is where on Earth has this money gone? If it is not in the bank then where is it? And more importantly, why is it not in the bank? Have the bankers taken your money and used it to purchase luxury consumption goods, hoping that you will never come back for it? Not quite; the answer is that the bank has loaned the money to borrowers, usually for the long term to people who wish to take out a mortgage, for example, in spite of the fact that all of the bank’s liabilities are payable on demand. In this practice of “borrowing short to lend long” the bank takes a gamble that two conditions will be met. First, that it will only ever need the fraction of deposits kept as reserves in order to meet the number of withdrawals by its depositors that are likely to be required at any one time; and second, that a sufficient number of the borrowers will pay back the money that has been lent out. The primary motivation for this is, of course, to earn interest on the sums lent. This is why most banks do not charge their depositors a fee for their services – they are using your money deposited to earn an income from other people.

Fractional Reserve Banking – Fraudulent or Legitimate?

The question of whether fractional reserve banking is fraudulent is a matter for debate in libertarian circles. Could not, for example, two persons agree to engage in the practice? If I know, for example, that my bank will only keep a fraction of the money as reserves and I know it is at risk of the bank’s insolvency then is there any breach of the non-aggression principle?

The answer to this question lies in the consequences of the terms upon which such an arrangement could be made and the also in the legal and regulatory context. There are two basic possibilities; either one’s deposit of money in a bank is a bailment, in which case the bank acts as a custodian of your money (like a warehouse or storage facility); or, the deposit takes the form of a loan to the bank and the bank is simply your debtor. In the former case, you retain proprietary title to the money and it is ring fenced from the bank’s own assets. If the bank goes bust then its creditors cannot get their hands on your money. Your bank statement is not a statement of account but, rather, an inventory of property deposited in the bank for safekeeping. In this scenario, but for one important qualification that we will mention below, the statement of account (or the warehouse ticket for gold deposits) is defined as the cash on deposit – in other words, it is the same thing. That is why people accepted paper tickets in trade when they were titles to gold. These transactions are not payments of money at all; they are transfers of the bank’s obligation to redeem cash on demand from one person to another. Because the obligation to pay is a full, proprietary title the transfer of this obligation is as good as the cash itself. Under this banking arrangement, fractional reserve banking would be fraudulent. If the bank loans out the money to a third party then it is required to grant full proprietary title over the money to the third party debtor in exchange for a promise to pay back the sum lent once the maturity date of the loan is reached. But the bank cannot legally divest itself of a title that is not in its possession. In essence the bank would be selling property which it does not own. It is exactly the same as me purporting to sell your house or your car to someone else and pocketing the cash – or a storage warehouse loaning out the furniture that you have deposited there for safekeeping. In practice, what happens is that the bank creates two simultaneous titles to the cash on deposit – one for you as the original depositor and one for the borrower. Both of you are under the delusion that you have exclusive title to the cash on deposit whereas in reality it could be claimed by the other person. In the second case, however, where the deposit takes the form of a loan to the bank, if this is agreed and understood by both parties in a genuinely free legal and regulatory environment then all well and good – there is certainly no breach of the non-aggression principle for libertarians to complain about. If the bank goes bust with it goes any claim to your money. However, one important aspect is that what is now in the depositor’s possession – a mere promise that you will receive payment in cash on demand rather than a full, proprietary title to cash – is a markedly different good from cash or a proprietary title to cash. Hence, we are now talking about two different goods – money on the one hand and a loan agreement on the other, something that is below the quality of money as the most marketable commodity. While it therefore may be a perfectly legal arrangement and people may be able to trade these loan agreements in exchange for goods and services (as we do today when we make electronic transfers) we would expect a loan agreement to trade at a discount compared to real money. Should this be doubted, even under full reserve banking the paper ticket to warehouse deposited gold was regarded as a distinct commodity by the trading public; when gold coins were stamped with a dollar value equal to the dollar value of a paper ticket, even though redemption of that paper ticket would guarantee payment of the same dollar value in coin, Gresham’s law came into effect and the paper tickets were traded while the coin was hoarded1. Under a system with genuine market pricing, therefore, we would expect warehouse receipts to gold to trade at a discount compared to real gold. If this is so then clearly loan agreements – far less secure than 100% warehouse receipts – would trade at a discount even lower than this.

All of this would be fine from a libertarian point of view and nobody can stop anyone else from accepting loan agreements freely in exchange for goods and services if that is what they want. The problem with today’s banking system, however, is that there is no genuine choice between these two arrangements. The fact that in today’s world “everybody” uses fractional reserve banks and “everybody” generally accepts mere loan agreements in settlement of debt without a premium does not mean that this arrangement has the full, unbridled consent of the public. First, legal tender laws force the public to accept as payment the government’s own monopoly brand of money and are unable to consider alternative media of exchange. Second, under the guise of “anti-money laundering” (in other words to try and stop drug traders, “terrorists” and other underground operations that are of the government’s own creation) the legal and regulatory regime has all but abolished cash transactions of any significant quantity, thus forcing people to direct their financial needs through banking institutions. Third, government schemes such as the Financial Services Compensation Scheme in the UK or Federal Deposit Insurance in the US (which basically means that the taxpayer is forced to foot the bill if the bank loses your money) provide a positive incentive to use these banking institutions and prevent either the hoarding of cash by the public or any “maverick” banker from splintering away and establishing a full reserve bank2. Fourth, these institutions have been completely cartelised under the aegis of the central bank, meaning that the only institution available for people to use for their banking amounts to little more than a single, fractional reserve bank splintered off into different brand names such as HSBC or Barclays in order to give the illusion of competition in the banking industry. Indeed, the force of government, either in the form of direct enforcement of fractional reserve banking or by forcing the taxpayer to bail out the consequences, has always been required to sustain the practice for any extended period of time as genuine competition between freely standing banks has always restricted their ability to issue large quantities of unbacked notes. The precise effectiveness of this point is debated between “Austrians”. The Mises-Rothbard orthodoxy emphasises that competing banks will swiftly call upon each other for redemption in the event that one bank takes possession of another’s notes. For example, if I deposited gold at Bank A and received for it a paper ticket stating that I had gold deposited in Bank A, I could use this paper ticket to buy goods and services from, say, a grocer. But if the grocer banks at Bank B, he will deposit my note from Bank A with Bank B, but Bank B will call upon Bank A to redeem its note in gold. Hence Bank A would be restricted from over issuing unbacked notes as whenever they fell into the hands of the customers of other banks those other banks would call upon Bank A for redemption in gold. Mises, moreover, also emphasised that the bank’s reputation with its own customers for being able to meet redemption on demand was a decisive limit upon the expansion of unbacked notes3. However, when all banks are issuing the same notes everywhere, with all gold deposited centrally in a monolithic bank (or no gold at all, as under our current regime) then this clearly isn’t possible and all banks would be able to expand together in concert. Later writers, however, have pointed out the importance of interbank lending in neutralising the effectiveness of banking competition, with banks that have over-issued notes borrowing from banks that are under-issued in order to meet redemption demands. In other words banks will not necessarily call upon each other for redemption and will seek instead to earn an interest profit through mutual lending4. However, all we need to conclude here is that people today do not have a genuine choice as to whether they should meet their financial needs through fractional reserve banks. We can, though, still see the difference between payments in cash and other methods of payment in certain limited circumstances. Debit and credit card payments are inherently less secure than hard cash and the risk to the merchant is that the card issuing bank will not honour the transaction after the customer has left with the goods – in just the same way as a deposit bank may be unable to honour a paper ticket to warehouse deposited gold. Acquiring banks and card issuers therefore levy a charge upon merchants in order to guarantee – or at least improve – the security of the transactions and some merchants pass this charge on explicitly to their customers as an additional fee. This results in two prices – a lower price for payment by cash and a higher price for payment by card. It is reasonable to assume also, therefore, that given a genuine choice people would also regard hard cash and deposits in fractional reserve banks as distinct goods of different value. Finally, if the lack of genuine consent of the public in using fractional reserve banks should be doubted, then try asking any banker whether he would be prepared to look his customers in the eye and tell them their money is not really in the bank. The experience of the present author suggests that this is enough to close a debate on the matter with bank employees who actually know how the system operates.

All of this suggests that people do not wish their banking arrangements to be managed with fractional reserves, given a genuine choice. Indeed the entire backbone of Mises’ thesis in The Theory of Money and Credit is that money and what he called “fiduciary media” (notes issued unbacked by gold) are distinct concepts and where people trade fiduciary media at a par with money or backed notes they only do so because they believe that they are not fiduciary media and are, instead, fully backed notes with redemption on demand all but certain. Something to pull the wool over the public’s eyes is needed in order to achieve this. In our world today it is the force of government sustaining fractional reserve banking and compelling people to use it which is the illegal and immoral element. This should be the focus of libertarians in their moral opposition to its practice.

Fractional Reserve Banking and Economic Instability

In addition to the moral element concerning fractional reserve banking, the practice in the way it is carried out today is also economically destabilising. As we know from “Austrian” Business Cycle Theory, the creation of credit that is not supported by any real saving forces the economy onto a path of malinvestment that must collapse once the credit creation stops. Fractional reserve banking is the primary method through which this credit creation occurs. Nevertheless, once again this issue is intricately connected to the legal and regulatory framework in which fractional reserve banking operates and it is this factor that will be emphasised in the treatment below.

Let us posit a first scenario where banking consists of deposits of gold and precious metal in exchange for paper warehouse certificates, certificates that are a legal title to money and do not represent merely a loan to the bank that would permit the latter to do with the gold whatever it likes. If, therefore, A deposited 100oz of gold in a bank the bank would issue a 100oz paper ticket to A and the gold would remain locked up in the bank’s vault ready for A to come and collect at a point in the future when he deems fit. In this instance 100z of gold in the economy has been replaced by a warehouse ticket to 100oz deposited in the bank When this ticket is used and accepted in trade it is “as good as gold” and people will trade the paper as though it was gold, although, as we noted earlier, with the possibility that it may trade at a minor discount compared to the real thing. At this point, the money supply has not altered; rather 100z of money proper has been replaced by a 100z “money substitute”. In this environment, if the bank engaged in fractional reserve banking it would print new paper tickets which represent full, legal titles to gold without any corresponding increase in gold on deposit in its vault – in other words, pure fiduciary media, in Mises’ terminology. Let’s say that the bank lends an unbacked 100oz ticket to a borrower, B. There is now, therefore, 100oz of gold deposited in the bank but 200oz of paper tickets that can be exchanged in trade. The supply of equally homogenous money substitutes that are deemed to be as good as money and are traded as money has therefore doubled. This method of fractional reserve banking (which, we might recall, is also the fraudulent one) will therefore cause economic instability and lead to the business cycle as it has channelled a new supply of money unsupported by real saving through the loan market. The new supply will lower the interest rate on money and will incentivise borrowers to invest in longer term investment projects than are sustainable under the pool of available savings5.

Let us now examine a second scenario where banking does not consist of deposits of gold and precious metal in exchange for paper warehouse certificates but, rather, gold is deposited on loan to the bank that is redeemable on demand. The money is legally the bank’s to do with whatever it likes but the lender may call for redemption at any time, taking the risk that the bank may not have sufficient reserves to meet the redemption. Furthermore let us assume that this arrangement is entirely voluntary and agreed to, with no government impetus or the force of law compelling its use. If A therefore makes such a loan of 100oz to the bank he will receive a paper ticket or a statement of account stating that he has loaned money to the bank that is redeemable on demand. A may be able to trade these “loan agreements” either in paper ticket form or electronically – either way it doesn’t really matter as both would be a transfer between individuals of the bank’s obligation to pay. 100oz of gold has been deposited in the bank and a 100oz loan agreement has been released into the economy. If the bank now engages in fractional reserve banking and makes a loan of 100oz to B by creating out of thin air another paper ticket (that in and of itself constitutes only a loan agreement and not a proprietary title to hard money), we now have 100oz of gold still in the bank but 200oz of paper loan agreements to gold issued in the economy. On the face of it, it would again appear as though the money supply has expanded through credit creation. Wouldn’t this lead to economic instability and ultimately to the business cycle? However, this is unlikely to be the case. For the crucial aspect in starting the business cycle is that the interest rate on money is lowered through people’s inability to perceive money that represents genuine savings and money that has been created out of thin air. In this case, however, it is possible to distinguish between money proper and mere loan agreements to money that are redeemable on demand. An expansion of the latter does not lead to an expansion of the former. While the “interest rate” on the loan agreements may fall as a result of the their expansion, so too would their discount compared to money proper as the increasing abundance of these loan agreements makes the security of redemption less likely. The effect of the increased discount would be raise production costs to borrowers which would offset the reduction of interest rate and prevent the business cycle from occurring.

Let us now fast forward to the situation that we have today. Now, the paper ticket itself has replaced gold as the item that is deposited and as we stated above everyone is either forced or cajoled into using fractional reserve banks under the aegis of a single, central bank. The expansion occurs through the increasing of deposit balances on account – i.e. the numbers on your bank statement. If you deposit £100 worth of Bank of England notes in your account you can transfer the bank’s obligation to pay electronically. If the bank then creates a loan out of thin air by creating another deposit account, both you and the borrower then have the ability to spend these digits in the economy. But, unlike the difference between money proper and mere “loan agreements” that was plainly obvious in the second scenario we explored, here, nobody knows which of the digits being spent represents genuine savings and which have been conjured out of thin air. Hence, the interest rate on money will fall, longer term investment projects will be stimulated and the business cycle begins with its “boom” phase.

It could be alleged that the inherent instability of this arrangement could be countered with the “prudence” of the banker – the idea that an expert fractional reserve banker will be able to loan wisely to only those borrowers who are most trustworthy and will keep on hand enough reserves to meet redemption requirements. This is beside the point. Apart from the fact that it is the least prudent bankers and borrowers who post the highest profits during the boom phase, leaving any conservatives way behind, the fundamental problem for economic stability is that no inter-temporal transaction has occurred – in other words there has been no a trade of present goods for future goods. In normal saving and lending, in order to make loan to the borrower for, say, one year the lender must save for a year. The lender in this instance has given up consumption for one year and freed real resources in the economy to the borrower so that the latter may use these resources in an investment that will come to fruition at the maturity date of the loan in one year’s time, allowing the borrower to pay back the loan to the lender so that the lender can then purchase consumption goods that have come into existence as a result of the borrower’s year-long investment. This is what makes real, sustainable economic growth possible – the harmony of temporal interests over goods between those with short time horizons and those with long. With fractional reserve banking, however, no such harmony exists. The lender – that is, the depositor – does not want to relinquish consumption for a year. He maintains his cash balance in a demand deposit account because he wishes to call upon those funds for current consumption and not consumption in one year. He may, of course, leave the funds in his deposit account for a year but the crucial point is that at the outset this is not certain – he wants to be able to call on consumption goods at a moment’s notice when the time arises. The borrower, however, wants goods that he can invest for a yearlong production process, tying up those goods for that duration until the project comes to fruition. He cannot accept goods that someone else will want back in a shorter time. It is clear that both individuals cannot have their way and that one or the other must ultimately triumph because the same resources cannot be simultaneously consumed and invested. During the boom phase when credit expansion rises, it is the borrower who wins as his increased purchasing power allows him to purchase the resources and invest them in capital goods – hence there is, during the boom phase, a marked price inflation of capital goods as these borrowers take advantage of their newly found purchasing power and a relatively weaker price inflation of consumer goods as the latter become more scarce relative to the demands of consumers. Once the credit expansion stops and starves the borrower of fresh purchasing power, however, it is the lender’s preferences that rule the roost. Either the lender must be prepared to start saving and thus provide the resources to complete the borrower’s investment projects; or, if he is not so prepared and maintains a preference for consumption, then the borrower’s investments must be liquidated. Hence, in the bust phase we experience a heavy price deflation of capital goods as they are hastily sold off and a weaker, relative price deflation in consumer goods buoyed up by the fact that these goods are still in demand.

Conclusion

What we can see from all of this is that the destabilising effects of fractional reserve banking on the one hand and its illegal and immoral aspect on the other are two sides of the same coin. The fact that people do not know which units of currency in existence represent real, genuine savings and which have been conjured out of thin air as fiduciary media is the essence of both the fraudulent  and destabilising nature of fractional reserve banking. The government in bed with a monolithic banking system pulls the wool over everyone’s eyes for their own enrichment at the expense of wasteful malinvestments during booms, followed by unemployment, misery and taxpayer funded bailouts during busts. It is high time that the public realised the true nature of their fractional reserve banking system and anyone who cares for liberty is right to emphasise its odious nature.

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1As Ron Paul has suggested, it was this that resulted in a withdrawal of gold coin from circulation and its concentration as deposits in banks that made it easier for governments to confiscate them. It is for this reason that both Paul and, earlier, Mises urge the need for gold coins to be used physically in transactions. See Ron Paul, “The Political Agenda for the Real Gold Standard”, Ch. 7 in Llewellyn H Rockewell, Jr. (ed.), The Gold Standard – Perspectives in the Austrian School; and Ludwig von Mises, The Theory of Money and Credit, Part Four, Chapter III, “The Return to Sound Money”.

2We can also suggest that, as per Ron Paul’s analysis cited in note 1 above, that as electronic transfers and paper notes bear the same legal value, Gresham’s law comes into effect and the paper notes are stashed away in banks while electronic digits are traded.

3Ludwig von Mises, Human Action, The Scholar’s Edition, p. 436.

4See, for example, Nikolay Gertchev, “The Inter-bank Market in the Perspective of Fractional Reserve Banking”, Ch. 10 in Jörg Guido Hülsmann (ed.), Theory of Money and Fiduciary Media – Essays in Celebration of the Centennial.

5This expansion of credit is not likely to last for very long in a competitive banking environment that lacks deposit accounts. Not only, of course, could overexpansion call for redemption of the overissued notes in specie, but soon the economy would clearly be awash with paper tickets which reveal that something is amiss. Central banking, abolishing competition, would be needed to sustain the expansion of note issue and electronic transfers between deposit accounts would be needed to hide the expansion from plain sight. Ironically, therefore, monetary expansion or “printing money” these days involves a contraction and not an increase of circulating paper notes. As a note of historical interest, Peel’s famous Bank Charter Act of 1844 failed to control economic instability because, following the otherwise insightful Currency School of thought that was prevalent at the time, it concentrated only on banknotes and overlooked the role of deposit accounts in expanding the money supply.

Economic Myths #5 – Banking is Capitalist

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By both mainstream economists and the general public alike the cycle of “boom and bust” is believed to be a tendency inherent in any capitalist economy. The fact that the latest such cycle, resulting in the seemingly endless stagnation that we are enduring now, originated in the banking sector and that large banks and bankers ratcheted up huge earnings and bonuses only to cause disaster has implicated banking to represent the very worst aspects of capitalism, motivated by uncontrollable greed that ends in destruction.

Unfortunately this popular view of the mainstream could not be further from truth. In fact with its intimate ties to government and its special, legal privileges it is hard to imagine a less capitalistic industry than banking. Part of the deception – wilfully inflamed by politicians and their lackeys – is one that engulfs other industries subject to government meddling such as energy; that simply because the participants in the industry are private individuals or entities and are not officially part of the government means that the enterprise must be classified as part of the free market and saddled with all of the supposed flaws of that system. Very often however private companies and brands are simply the public facing part of what is essentially a government operation or a government controlled cartel. Britain’s railways, for example, are owned by Network Rail, a statutory corporation with no shareholders; the train operations are parcelled out into geographic monopoly franchises that are awarded to private bodies by the government. The network is, therefore, under the de facto control of the government. And yet when you are stranded for two hours on a crowded platform because of delays whose logo is it you see everywhere at the station? Whose name is embossed proudly along the side of the train that you’ve been waiting for and who – and, by extension, which economic system – gets all of the blame for the problems? This is just as true in the banking sector as it is in the railways. Banking is nothing more than a government run cartel operated in front of the public by private bodies.

The supporting pillar of this government cartel is the central bank. Although this body is not always government owned it possesses a key legal privilege which is to be the sole producer of the nation’s money supply. Since 1971 (but in practice much earlier) all of this money in the world has been paper money, irredeemable and unbacked by any precious metal or market-chosen commodity. This is a very hefty privilege indeed for who wouldn’t want to have the legal ability to just print the very thing that can be exchanged for valuable goods and services? The central bank can manipulate interest rates (the most important prices in the economy) and control the volume of money either by changing the reserve requirements of the commercial banks or by making open market purchases (usually of government bonds but since 2008 pretty much any asset) with freshly printed cash. At the very bedrock of the banking system, therefore, is an institution that is blessed not by the voluntary purchases and exchanges of individuals but rather by the aegis of government. This institution would not exist in a genuine, capitalist economy as its powers rely not upon free exchange but upon government enforcement. Money would not be a centralised, government issued ticket on worthless paper nor would anyone have monopoly control over its production. Rather, money would be a commodity such as gold or silver. No one would be able to simply wave a wand and make gold appear in the way that central banks can make paper money appear, nor could anyone simply do the equivalent of no productive work in order to purchase valuable assets. Rather they, like anyone else, would have to earn their money through productivity that serves consumers. The volume of money in the economy would be regulated not by the central bank’s fiat but by the demand for freshly mined gold from the ground. Interest rates would be set by the demand for and supply of loanable funds and not by the arbitrary decree of monetary policy.

The reason why private banks appear to be the epitome of greed is that they are the channel through which the central bank’s deeds flow. They are the recipients of new money from open-market operations and of new loan-issuing powers when reserve requirements are altered. Credit expansion under the business cycle therefore affects the banking industry first and it is this industry that demonstrates the largest paper gains – all of those huge profits and hefty bonuses – and, consequently, the most catastrophic losses when the inflation stops. And yet the only method of making the fraudulent and destabilising fractional reserve system work, at least for a time, is the monopoly issuance of paper money by a central authority, robbing people of the ability to redeem notes that are over-issued and allowing the banks to inflate continually in concert. Furthermore, under this system banks are endowed with a special legal privilege in that they do not have to time their assets in line with their liabilities. When the disaster of “borrowing short” to “invest long” finally unravels who is that steps in to save the day? Why, the cartel-managing central bank of course, in its role as a lender of “last resort”, permitting the private banks to privatise their gains and socialise their losses. Once this fact – recognised in the US as the infamous Greenspan put – is understood by the private banks it will serve only to inflame risky and reckless business ventures. After all, why bother with prudence when you know that someone else will mop up the mess? None of this would be possible in a genuine, capitalist economy where each bank would have to suffer its losses and take full responsibility for its risky ventures.

This short description indicates that banking is woefully far from being a capitalist industry. Rather it is an industry that is well and truly in bed with government, relying on government for its profits, for the sustainability of its operations and for the absorption of its losses. “Private” banks they may be but a part of the free market? Absolutely not!

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Money – the Root of all (Government) Evil?

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In addressing the evil and parasitic nature of the state, libertarians focus on many of the state’s specific characteristics in order to demonstrate its destructive effects upon civilisation – whether it is nationalised industries, market interference, the minimum wage, anti-discrimination and egalitarian pursuits, the business cycle, or whatever, there is a treasure trove of libertarian literature available that explains and elaborates the deleterious effects of these particular state endeavours. However, a less addressed question is which of these areas, if any, are the most important? Which of them amount to mere nuisances that can be circumvented or otherwise put up with and which, if any, of them amount to a significant transfer of wealth and power to the state with seemingly permanent effects? Furthermore, is there any one issue that libertarians should stress above all others if we are to deliver a real and significant puncture to the state’s ever-inflating balloon?

One prime candidate for this title is war and international conflict. With war comes every glittering prize that the state could ever dream of – mass mobilisation of labour and industry towards a common purpose dictated by the state; control of all markets; mass propaganda; control of communications; suspension of free speech and possibly of habeas corpus; and not to mention the bogeyman of the supposed enemy to which to channel the attention and hatred of the average citizen. Indeed Murray Rothbard, relatively in his career, recognised that while libertarians had some very profound things to say about the state’s mismanagement of, for example, the post office, focussing on war was the real key to unravelling the state’s power and oppression of the population.

Nevertheless, while a permanent and lasting degree of state power and control is enabled by war there is another contender for the top spot. That is the government’s control of money and, specifically, the ability to create an endless supply of paper money distributed to itself and its favoured outlets, as opposed to the rigour and discipline imposed by a “hard money” standard such as gold. Ultimately it is the state’s ability to fund itself that is at the root of all of its other absorption of power and control – even war.

In order to demonstrate this let us look at what the situation would be if government was constrained by a denationalised, “hard” money such as gold. In the first place, government would be wholly reliant upon the tax receipts of its individual citizens for funding and would be unable to resort to extensive deficit spending or inflation. The plainness and visibility of that confiscation places a much lower limit upon the state’s coffers. Put simply, when too much money is taken out of your hands physically you are likely to revolt much sooner. Indeed, in the past, war itself was an expensive operation and battling kings often struggled to raise funds to maintain campaigns. Strategic brilliance was often not accomplished by an all-out destruction of the enemy but, rather, by out-manoeuvring your opponent and preserving for as long as possible expensively-trained soldiers and equipment. In many cases funding had to come from external sources. The genesis of the aristocracy was in those who were rewarded with titles to the conquered land in return for funding the war – in other words the ruler had to parcel out parts of the new territory to those who had helped him grab it. Indeed even the English parliament itself and the Magna Carta­ – famed as the genesis for two cardinal principles of liberty, no taxation without consent and no trial without due process – resulted in part from the reliance of the king upon his relationship with the barons for support and funding. Hard money therefore not only physically restricts the amount the state can spend but has been the indirect cause of the enshrinement of restrictions upon the state’s despotic power.

In more recent times, however, the ability to provide funding from a non-stop printing press has permitted the state to expand its activities without having to account for them through tax receipts. People do not see the money disappearing from their pay packets or from their bank accounts; all they see is the prices they have to pay for goods and services rising and squeezing their purchasing power, a fact that can be easily blamed on greedy businessmen and shareholders. It is possible for a libertarian to be sympathetic with the view that as long as you know how much the government is taking from you then it has a reasonable degree of tolerability. But when government resorts to the smoke and mirrors trick of robbing not the money in your hand but, rather, its purchasing power then it must be opposed emphatically. In comparison to earlier conflicts, the wars of the twentieth century were so prolonged and destructive precisely because government could resort to the printing press. Had they relied solely upon tax receipts “war-weariness” would have set in much sooner among the population and they would have demanded a swift end to hostilities. Hence all of the overreaching effects of the state’s engagement in war flows directly from its ability to control the supply of money. If we wish to end the consequences of war upon the state’s metastasised growth then we need to attack the root of its ability to fund it.

It is true, of course, that there may be something of a chicken and egg story when it comes to war and paper money. Does paper money cause government to engage in war or does war cause government to print paper money? Either way, however, even if government was previously respectful of a hard money standard which it does not abandon until the outbreak of a war, it is this power of printing paper money in and of itself that fuels the extent of its belligerence. And in any case, the ease with which government can suddenly suspend a hard money standard only comes about because they have arrogated to themselves monopolistic control of the operation of money issuance. It would be much harder for government to print un-backed notes and force their acceptance when others are issuing notes fully redeemable in gold. Whatever comes first, however, either the paper money or the war and the growth of the state power, if you wish to prevent the flood then you must turn off the taps.

In more peaceful times hard money also disciplines the citizenry into realising that government is not the fountain of all wealth. The state has grown so much under democracy because, apart from the veneer of legitimacy that popular elections lend to the state, politicians are able to bribe the electorate with endless goodies that they do not believe that they have to pay for. The resulting borrowing and inflation – now reaching an eye-watering level in the West – which does not touch the citizen directly gives the impression of government as an endless stock of resources, the only difficult task being to elect someone who will give them to you rather than worrying about the more trifling matters of production and enterprise. Indeed, public discourse rarely seems to acknowledge the fact of scarcity, usually focussing on single issues and concluding with an explosion of outrage about how government isn’t “doing more” to combat the alleged societal ill. The more difficult question of the expense that we would endure, what should be given up as a result and which goods cannot be brought into being because of the new expenditure diverted to cure the problem complained of is overlooked. To the citizen there is always more money, more resources and more of everything that government can acquire from somewhere other than himself. However, in exactly the same way as a hard money standard would induce “war-weariness” in belligerent times so too would it induce “state-weariness” in peaceful times. People would soon tire of having their pay packets robbed to fund goods for other people; and people would soon realise that many of the things they would otherwise want from government for free simply cannot be afforded and must be worked for by themselves.

Let us turn next to the whole problem of the business cycle. Although panics existed before the advent of modern central banking many of these occurred precisely because hard money rules were casually abandoned, with issuing institutions expanding the volume of credit beyond the stock of monetary gold and government happily stepping in and relieving them of the obligation to redeem their notes in specie. But whatever the characteristics of pre-central banking business cycles it is undeniable that they reached a depth, severity and prolongation in the twentieth century that was not seen before. There are two reasons for this. First, government’s enhanced control over the supply of money induces a more serious degree of malinvestment than would otherwise be the case where the supply of money is checked by the stock of redeemable gold. In both of the biggest collapses of the last one hundred years – 1929 and 2008 – credit expansion ran for the best part of a decade or more. The longer the false signals towards entrepreneurs are continued the more they will borrow and invest in unsustainable capital projects and the further those projects go the more difficult they will be to unwind. When the bust finally comes, therefore, the situation is far more serious than it otherwise would have been. This brings about the second factor – that it lends credibility to the argument that the government should step in and “do something” to combat the malaise. The reason why the Great Depression endured for years (and why we are still enduring the current one) is not because of the initial collapse – it is because government did everything it could to maintain the existing structure of production, wages and prices. Fittingly enough President Hoover often invoked the language of war in describing the threat of the downturn and the culmination of this in the New Deal – the complete cartelisation of industry and agriculture into a fascistic economy – was achieved by the resurrection of World War One era departments and programmes. It is supremely ironic that government-caused depressions give rise to ever more invasive government intrusions, an irony that turns truly into tragedy when we consider that what followed the Great Depression was the carnage and destruction of World War II. With the current belligerence of the US in provoking tension with Russia and China another war is something that cannot be ruled out as a result of the present crisis; and we all know how destructive war is to freedom.

What we can see therefore is that government control of money is a prime contender for the top spot of issues that libertarians should consider as the most serious when combatting threats to liberty. If this should be doubted then one has to question why the mystery of central banking and its ability to pull the monetary strings from a shady, secretive outlet has been a political non-issue for decades. Politicians only bring into debate the relatively “easy” problems that do not upset the apple cart. While they are keen to oust their immediate, political opponents they never provide the public with any serious choice that would restrict the power and growth of government as a whole. At least democracy – another cause of government growth and legitimacy – gets praised and lauded from time to time, if only ever to justify the government’s military crusades against foreign tyrants. But before the last few years central banking and monopoly issuance of money was hardly even mentioned – not even to give it a blessing. It seems as though government is fine with brainwashing its citizens into embracing the justice of elections by voting but it is far too scared to even make them aware of its power over money. Although this is now beginning to change and there is a greater enquiry into and scrutiny of the US Federal Reserve (not least because of ex-Congressman Ron Paul’s emphasis of the issue) the acceptance of and absence of discussion of these evil institutions has pervaded for too long. This is where government would be truly and irredeemably hurt. It could enact as many reams of invasive and destructive legislation as it liked, yet they would be of zero threat if government was starved of funding to enforce them.

It is appropriate to end with the words of Ludwig von Mises who recognised everything we have been saying here in his first major treatise on the subject of money:

Defense of the individual’s liberty against the encroachment of tyrannical governments is the essential theme of the history of Western civilization. The characteristic feature of the Occident is its peoples’ pursuit of liberty, a concern unknown to Orientals. All the marvellous achievements of Western civilization are fruits grown on the tree of liberty.

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the non-observance of old customs by kings. The postulate of sound money was first brought up as a response to the princely practice of debasing the coinage. It was later carefully elaborated and perfected in the age which—through the experience of the American continental currency, the paper money of the French Revolution and the British restriction period—had learned what a government can do to a nation’s currency system.

[…]

Thus the sound-money principle has two aspects. It is affirmative in approving the market’s choice of a commonly used medium of exchange. It is negative in obstructing the government’s propensity to meddle with the currency system.

The sound-money principle was derived not so much from the Classical economists’ analysis of the market phenomena as from their interpretation of historical experience. It was an experience that could be perceived by a much larger public than the narrow circles of those conversant with economic theory. Hence the sound-money idea became one of the most popular points of the liberal program. Friends and foes of liberalism considered it one of the essential postulates of a liberal policy1.

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1 Ludwig von Mises, The Theory of Money and Credit, p 414.