In my posts about the gold standard, fractional reserve banking, and money, one theme comes up again and again in comments: money is built on trust, and must have value backing it.
My question is: why in the world would you want the government involved in money?
People seem to take it as a given that governments have to be the ones who make money. But that’s not so, at all.
The other day I told the long and interesting story of how money came to be. In short, the original barter system cried out for a common medium of exchange to lubricate the workings of commerce — because, say, a lawyer who wanted to buy eggs from a farmer could not count on the farmer wanting his legal services at the same moment. So people sought to exchange their goods and services for commodities that others would readily accept. Naturally, people sought the most desirable commodities that would be widely accepted, durable, divisible, scarce, and otherwise suitable as a medium of exchange. Most societies settled on gold and silver as the medium of exchange containing the best mix of characteristics required for a medium of exchange. The longer version is here.
There are two things about gold and silver at this point. First: their value was measured in weight. Most commonly used currencies were originally defined by the weight of gold they represented. A dollar represented a bit less than 1/20 of an ounce of gold. A British pound was roughly 1/4 of an ounce of gold. And so forth. Critics call this valuation of the dollar “arbitrary” — but once you knew the weight of the gold a particular unit would buy, you knew what it was worth.
Second: nothing about any of this required government. Entrepreneurs could coin money, and provide a service by standardizing the weights of coins upon which people could rely. Indeed, there are many examples in history, including in the United States, of private coinage.
But then, government took over. Tom Woods explains the process by which this happens:
First, society adopts a commodity money, as described above. (As I noted above, for ease of exposition we’ll choose gold, but it could be whatever commodity the market selects.) Government then monopolizes the production and certification of the gold. Paper notes issued by banks or by governments that can be redeemed in a given weight of gold begin to circulate as a convenient substitute for carrying gold coins. These money certificates are given different names in different countries: dollars, pounds, francs, marks, etc. These national names condition the public to think of the dollar (or the pound or whatever) rather than the gold itself as the money. Thus it is less disorienting when the final step is taken and the government confiscates the gold to which the paper certificates entitle their holders, leaving the people with an unbacked paper money.
This is how unbacked paper money comes into existence. It begins as a convertible substitute for a commodity like gold, and then the government takes the gold away. It continues to circulate even without the gold backing because people can recall the exchange ratios that existed between the paper money and other goods in the past, so the paper money is not being imposed on them out of nowhere.
My, that is a dramatic flourish, that reference to government confiscating gold. That could never actually happen in America, though. Right?
Wrong. It already happened. A mass confiscation of gold by government took place in this country in 1933. Did you know that? It happened when FDR issued Executive Order 6102. (And you thought Obama’s executive orders were bad!)
FDR’s gold confiscation meant private owners were obliged to take their coins, bars or gold certificates to a bank, and exchange them for dollars at the prevailing rate of $20.67 per ounce. Over the next year, the president then raised his official gold price to $35 per ounce, effectively cutting 40% off the dollar in a bid to stoke inflation and spur the economy.
It continued to be illegal to own gold in the U.S. (without a special license) from 1933 to 1974, at which point we were safely off the gold standard. Which is not to say you can’t own gold nowadays. You can get it for the reasonable price of under $1300 an ounce!
Nowadays, currencies are not tied to gold in any manner. That is due to government’s taking over control of the money supply.
And guess what? Oddly enough, governments all over the world have run up unsustainable debt. Go figure.
Also, inflation has taken place on an unprecedented scale. Coke was 5 cents in 1886. And it was 5 cents in 1959 — and all 70+ years in between. There’s even a Planet Money episode about it. The reasons for the stability of the price are varied, including a quirky and unwise contract, and the size of coin slots in vending machines. But, ultimately, the thing that pushed Coke off its 5-cent price was abandoning the gold standard, and the resulting inflation. It took a few years, but the prices of the inputs eventually rose to such a degree that Coke had to raise its price.
If unsustainable debt and runaway inflation don’t sell you on fiat money, how about the bank bailouts? Those were pretty awesome, right? And impossible without fractional reserve banking and the abandonment of the gold standard.
BONUS ANTI-FED RANT: I still haven’t gotten to the natural brake that the gold standard places on runaway inflation — for that, stay tuned! — but the point of this post is to show that government control of the money supply is neither necessary nor desirable. If you still think the steady hand of the Fed is the best thing since sliced bread, let me offer this: Ben Bernanke making a fool of himself. The audio peters out after a few minutes, but give it a couple three minutes and get your guffaw muscles ready.
As Tom Woods notes in Rollback: Repealing Big Government Before the Coming Fiscal Collapse, Bernanke told a gathering of academics in January 2007:
Together with the knowledge obtained through its monetary-policy and payments activities, information gained through its supervisory activities gives the Fed an exceptionally broad and deep understanding of developments in financial markets and financial institutions. . . .
In my view, however, the greatest external benefits of the Fed’s supervisory activities are those related to the institution’s role in preventing and managing financial crises.
In other words, the Fed can prevent most crises and manage the ones that do occur.
Finally, the wide scope of the Fed’s activities in financial markets — including not only bank supervision and its roles in the payments system but also the interaction with primary dealers and the monitoring of capital markets associated with the making of monetary policy — has given the Fed a uniquely broad expertise in evaluating and responding to emerging financial strains.
The bubble burst later that year. Heckuva job, Benny.
The Fed did a lot to create the housing bubble. And this is the fool who you want to put in charge of your money? Rather than trusting the distributed intelligence of the market to set interest rates, you want them to be determined by a clown like this?
End the Fed. End government control over our money. Let’s return to a true free market where individual decisionmakers determine prices, interest rates, and other important factors of the economy.
Stop the rule of the know-it-alls who end up knowing nothing.
It can be done. But first you have to understand why. That’s why I took the time to write this. And if you made it this far, great. I hope this post and other recent posts are causing some of you to look a little differently at government and its relationship to our money. Please let me know if that applies to you.