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Economics

What is Money?

There exists a certain amount of confusion today about what money truly is, how it originated and who should produce it (the government or private individuals).  For this reason, it is useful to provide a brief summary of the origin or money and the differences between the various types of money.  In this manner it will become clear that money should only be produced by the market.

According to Ludwig von Mises [i], money evolved from the practice of indirect exchange.  Indirect exchange is where the seller of a particular good sells his good for another good, not for the purposes of consuming that that second good but because it is highly marketable.  In other words, now that he has obtained this highly marketable good, he has full confidence that he can now sell it to obtain the consumption goods he ultimately desires.  This highly marketable good is the common medium of exchange and is generally known as money.  There are secondary functions (store of value, measure of value, etc.) but these merely derive from the medium of exchange function.

The question remains, why is this good so highly marketable in the first place?  What original characteristics made it so desirable for people to use it as money?

To answer this question we must define what a good is.  Carl Menger[ii] identifies the following prerequisites for a good:

  • A human need for the item
  • Capacity for the item to satisfy this need
  • Human knowledge that the item can satisfy this need
  • Sufficient control of the item such that one can satisfy their need.

Absent one or all of these prerequisites the thing ceases to become a good.  Menger also notes that some items are treated by people as though they were goods even though they lack all four of these prerequisites.  This occurs when attributes are “erroneously ascribed to things that do not really possess them” or when “non-existent human needs are mistakenly assumed to exist”.  Menger called such items imaginary goods.

Next we must determine what makes a good valuable.  Menger[iii] makes it clear that there are two qualities that imbue a good with value.  The first is that it should be an economic (i.e. scarce) good.  In other words, the requirements (or demand) for a good must be greater than the quantity of the good available.  Second, men must be “conscious of being dependent on command of them for the satisfaction of our needs”.  To summarise, only scarce goods which we know can satisfy our needs have value.

Now we know what a good is and what gives it value, but what makes it useful as money?  According to Jorg Guido Hulsmann[iv], to be used as money the good must be marketable.  It must be a commodity; i.e. a valuable good that can be widely bought and sold.  One must know that if they sell their produce and receive this commodity in return, that they can instantly sell this commodity to obtain the goods they desire (i.e. food, clothing, etc.).

The monetary use of a commodity is derived from its non-monetary use. When we consider how money comes into being (through indirect exchange) we know this must be the case.  This is because (as Hulsmann[v] tells us) the prices initially being paid for a commodity’s non-monetary use allow one to estimate the future price for the commodity when it is resold.  This is the basis for its use in indirect exchange.

In the case of gold or silver, it is obvious that these commodities have a value independent of their monetary use. Gold has historically primarily been used as jewellery and today, like silver, it has many industrial uses that establish a non-monetary value.

Paper money

It is clear now that paper money established by government fiat cannot have any non-monetary value.  It is not a good (according to the definition by Menger) or a commodity that can be widely bought and sold.  No man desires paper money for its own sake.  It cannot satisfy any need of man.  As such, the quantity available infinitely exceeds the requirements for it.  It is valueless.  It is arguably, an imaginary good, as described by Menger.  Value has been attributed to it by the government even though none exists.

Paper money is useless to individuals and is only truly useful to the government which can use it to more easily tax us.  But if fiat currency has no value why then do people accept it in payment for goods and services rendered?

Over time people became accustomed to accepting “paper” money certificates having previously received and transferred warehouse receipts in the form of banknotes.  Nominally, these banknotes were backed by gold and people were generally confident of receiving gold from banks should they wish to redeem the banknote for such.  (In truth, however, banks, generally holding fractional reserves, strongly discouraged their customers from redeeming their banknotes).

Later, the practice of fractional reserve banking in which such banks issue banknotes only partially backed by specie was legalised.  In time only one bank (i.e. the central bank) was granted a monopoly on the issuance of banknotes governed by a gold standard in which each banknote can be exchanged for a fixed amount of gold.

This bank note monopoly would be reinforced with legal tender laws, put in place by the government.  Having taken control of money in this way, the government can “fiddle” the money supply in its favour by manipulating the gold standard (by arbitrarily fixing the exchange rate between bank notes and gold) until finally specie payments are permanently suspended.  At this point, the population has already become accustomed to paper money and whether or not it is backed by gold no longer seems important to them.  There is no significant protest of what is in effect, an appalling violation of property rights.  In the final stage, governments completely remove the gold backing from banknotes, granting them a new and powerful method of taxing the population.

Some critics argue that paper money has value not because of the government but because someone will always accept it.  This of course does not take in account the progression described above nor does it consider what would happen in a free market of money.  Were the government to cease its intervention in the money market people would attempt to hoard hard money (gold, silver, etc.) and spend only the paper money in an attempt to rid themselves of this worthless “currency”.  Everyone would want to spend the paper money and no one would want to accept it.  The value of paper money would quickly fall to zero in a free market.  Paper money has nominal value today because the government has full control of money production.

Misconceptions of money

Confusion concerning the difference between gold money and paper money is common.  To some money is money and what does it matter whether it is made of gold or paper?  Going further, some observers suggest that the best way to determine which money is superior is to allow fiat paper money and gold money to circulate in the free market and see what happens.  This is nonsense.  As we have seen above, paper money has no value and without government support would vanish very quickly.  Further, in a free market, there would be no such thing as fiat money.

A further misconception concerns the gold standard.  There are those who propose that our monetary problems would be solved if we would only return to a gold standard.  Often it seems that people confuse gold money with a gold standard.  They are not the same.  A gold standard is fundamentally a legal tender law established by the government.  It sets up an exchange rate between banknotes and specie (gold) which can be modified to suit the government and suspended at will (in times of war for example) in order to raise funds via inflation or protect favoured banks from bankruptcy.

There are those who consider money to be credit and vice versa.  While credit can conceivably serve as part of an indirect exchange (Hulsmann[vi]), it is not money per se.  It has certain disadvantages when compared to commodity money.  For example, credit is not homogeneous but can vary in terms of maturity, interest rate, amount, and of course the creditworthiness of the borrower.  Credit money is unlikely to be widely traded by individuals since it carries credit risk (i.e. the risk that the borrower will be unable of repaying the credit note).  Thus, it is unlikely that credit money will ever arise on the free market as the primary money.  Rather, it will remain the primary province of investors and money lenders.

Why should money be produced by the market and not the government?

Money should and can only be produced by the market.  The market will select the most efficient valuable commodity (gold, silver, etc.) as the optimal money.  This protects individuals from the costs of monetary manipulation by government (including the ultimate results we are witnessing now, the collapse not just of major banks but also the governments who are their clients).  Market selected money also reduces the likelihood and severity of the business cycle as it places a significant constraint on the fraudulent operations of fractional reserve banks.

Fiat paper money produced by the government represents a massive violation of people’s property rights and effectively amounts to fraud, counterfeiting and theft on a grand scale.  There can be no rational ethical or economic argument in favour of government intervention in money.  Fiat paper money is the tool by which government surreptitiously transfers wealth from the general population to itself or those whom it favours.

Can gold ever be inflationary?

Inflation is properly defined as an increase in the number of banknotes that is not backed by specie (i.e. gold).  Defined thus, we can see immediately that an increase in gold does not cause inflation or result in the business cycle.  As Murray Rothbard[vii] tells us and as discussed above, gold provides a non-monetary value in addition to its monetary value, and so an increase in gold implies an increase in the wealth of society (greater amounts of gold for industrial, medical or consumer purposes).  Will prices of other goods in terms of gold increase?  Possibly, but now we can see the confusion that can occur as a consequence of erroneously defining inflation as merely a rise in prices.  An increase in gold would be no more an issue than an increase in the supply of iron ore, oil or any other critical raw material.

Inflation is a result of some form of fraud (fractional reserve banking) or counterfeiting.  Consider the recent stories of tungsten filled gold bars – if true, then someone is getting something for nothing.  The buyer of the gold bars is paying in anticipation of receiving the value of a certain quantity of gold but in reality is receiving significantly less.  The buyer is receiving a “fraction” of the value he expects.  The value of this “gold” bar has been inflated and losses will result.  It follows therefore that losses will result from the fractional reserve system of banking, especially when the buyer of a gold certificate discovers that there is insufficient gold to cover the value of his certificate.

Conclusion

To conclude, we have found that the optimal money derives its value from its prior non-monetary use (i.e. that of being a valuable commodity).  Paper money has no prior non-monetary use and thus derives its value from government legal tender laws.  In other words, it has merely an imagined value.  In free market, there would be no fiat paper money.  Government has no place in the production of money.  Free money protects the population from the costs of fractional reserve banking and stunts the growth of government.  Furthermore, with free market gold money (or similar) inflation will be limited to the illicit activities of fractional reserve banks thus the length and depth of the business cycle will be greatly reduced.


[i] Ludwig von Mises, The Theory of Money and Credit (New Haven:  Yale University Press, 1953) 30-37.

[ii] Carl Menger, Principles of Economics (Ludwig von Mises Institute, 2007) 52-53.

[iii] Ibid. 114-115.

[iv] Jorg Guido Hulsmann, The Ethics of Money Production (Ludwig von Mises Institute, 2008) 23-24.

[v] Idem.

[vi] Ibid. 28-29.

[vii] Murray Rothbard, The Mystery of Banking (Ludwig von Mises Institute, 2008) 47-48.

23 comments to What is Money?

  • mrg

    I agree that the government should have nothing to do with money, and that unbacked paper money would be unlikely to emerge or survive in a free market.

    I don’t think fractional reserve banking is necessarily fraudulent, any more than gambling is fraudulent. It might be that it’s so dangerous to wider society that it should be banned anyway, but I think most of the danger comes from the combination of fractional reserve banking and central banking. Absent the central bank, competitive forces would keep reserve ratios in check. The only people at risk of reckless behaviour by Bank A would be holders of notes issued by Bank A. Holders of notes from the more responsible Bank B would not have their purchasing power diluted by the actions of bank A. For fear of losing their customers, we’d expect Bank A to behave more responsibly as well.

    I don’t think your narrow definition of inflation is very useful. What matters to holders of money is their purchasing power. To them, an increase in the gold supply is not beneficial or even benign – it means their purchasing power decreases. This is because the monetary value of gold far exceeds its non-monetary value. We’ve been round this loop before.

  • Paul Marks

    It is vital to understand that inflation is just prices going up in the shops (“purchasing power”) some of the most destructive inflations of history (such as that of the late 1920s (the Ben Strong inflation) or the Alan Greenspan inflation of recent years, have not been marked by prices going up much in the shops – the inflation is the increase in the money supply (regardless of “purchasing power”).

    However, there is also a vast difference between for example (if gold is money) a lot new gold being mined, and a credit-money bubble.

    If, for example, gold is money and a lot of new supplies of gold are found then the value of gold (in terms of goods and services) will indeed fall (all other things being equal) – but a boom-bust event will NOT be created.

    Such events (which so undermine faith in “capitalism” and cause such utter chaos in the capital structure of an economy) are caused by credit bubble scams.

    It is to call these scams “fractional reserve banking” that is “not useful”.

    If real savings are X Pounds – then lending X times ten Pounds is not “fractional reserve banking” (as an ordinary person would understand this term).

    Technically one hundred tenths is a “fraction” but it is not a fraction as the word is normally used.

    If a banker says “I am operating on the basis of ten pecent reserves” it is natural to think that what he is saying is “For every 100 Pounds of savings I have in my bank I am lending out 90 Pounds” NOT “I am lending out 1000 Pounds” (via various complex games between banks).

    Nor is this a “gamble”.

    If lending is greater than real savings then a credit bubble has been created (no “gamble” about it) and there WILL be a bust.

    Government intervention?

    By “suspension of cash payments” (and so on) – this, of course, makes everything worse.

    • mrg

      I’m open to the suggestion that the terms currently used are misleading, but what we today call “fractional reserve banking” need not be fraudulent.

      The problem is that we currently treat fractionally reserved bank balances as equivalent to real money (paper and coins, in our current system).

      Imagine competing banks in a free system, without a central bank …

      FullBank stores actual gold, and offers fully-reserved paper and electronic tokens that can be used to claim the gold.

      HalfBank also stores some gold, but the tokens it offers are gambling tokens. When you show up at the bank to claim your gold, a coin is flipped – heads you get it, tails you don’t.

      FluctBank also stores gold and offers tokens, but its reserve ratio fluctuates. Instead of saying that you’re guaranteed a 50-50 chance of getting your gold back, it tells you that it keeps reserves of between 10% and 100%, and that tokens are exchanged for gold on a first-come, first-served basis. If everyone decides to claim their gold at once (a run on FluctBank), some people will lose out.

      There’s nothing fraudulent about this as long as everyone understands the rules of the game, and nobody pretends that the different types of token are equivalent. We’d expect the market to decide an appropriate exchange rate between gold coins, FullBank tokens, HalfBank tokens, and FluctBank tokens.

      Would we enjoy working with such a system? I’m not sure. Would requiring full reserves be ‘simpler’; in some sense, yes. But there’s nothing inherently fraudulent about less-than-100%-reserve banking.

  • Paul Marks

    How much money is in a bank? In a commodity money system this is easy to find out – simply ask to see in the vaults (how much gold, if gold is the money, is physically in them).

    But it is not actually much different with fiat notes – as one could still ask how many fiat notes there are (physically in the vaults).

    If (for example) a cheque is written on an account in one bank and paid into another bank, it is not difficult to move the notes from one bank to the other (with various other transactions – NOT using a truck each time).

    If “broad money” (credit) is, somehow, getting bigger than the “monetary base” (whether this is a commodity – or fiat notes) then something is wrong (very wrong). It is not a “gamble” – it is a bubble, and the bubble will burst. Although (of course) in a fiat money system there will be strong political pressure to increase the monetary base to “save the financial system” (i.e. to save the bankers).

    There is no technical or technological reason why loans (credit, “broad money”) should expand the money supply – in an honest system loans are from REAL SAVINGS and the means of transporting the money from savers to borrowers (whether by truck, or by computer – a matter of transfering ownership of the money without moving its physical location) does NOT expand the money supply.

    The above now having been said….

    I have noticed a lot in recent years that the “medium of exchange” function of money is often stressed – but that the “store of value” function of money is not stressed (sometimes not even mentioned).

    Of course if money is not a store of value then the concept of savings loses its meaning and function (and the economy is doomed).

    Whether or not fiat money can work well as a STORE OF VALUE is another question.

  • Paul Marks

    Of course the word “not” (as in “not just prices going up in the shops”) was missing from my first comment.

  • Nick Heath

    Whilst I agree with everything you stand for, I think you need to take into account the current economic and political reality and devise a strategy for moving from fiat to real money. We need to present the case and develop a strategy for a move to real money in a logical and coherent way so that we get the public on-board and cause the minimum shock to our economy. It’s all very well (and of course necessary) making the academically rigorous case for free-market money, the real task will be turning this into reality.

    • Robert Sadler

      I think you need to take into account the current economic and political reality and devise a strategy for moving from fiat to real money.

      I need to do that? That sounds like a lot of work Nick, I hope you’re planning to help me with that!

      Jokes aside Nick, I am not sure that getting the public on board is the issue. The fact is, that the Gov’t and banks have no incentive to go back to using gold as money. They are the ones responsible for fiat currency and they would like it to stay that way.

      The only way we will go back to gold money is as a result of a massive shock to our economy. This is when the government is bankrupt and the currency fails. Before this point we must keep pushing the idea that the only way to prosperity is through unencumbered free markets. Gold money is a major part of this. Ideas topple governments – its our job to make sure people understand that freedom is the right idea.

      I also have an issue with having a “plan”. This sounds to me like something socialist governments do and there is no place in the free market for government planning. This is something that must happen on an individual basis. You can start this process yourself by withdrawing from currency and keeping your liquid wealth in gold (and certainly not as cash in the bank!). If enough people to do this then the termination of fiat currency will be accelerated. The first people to do this will be the wealthiest when fiat currencies finally collapse.

  • Robert Sadler

    mrg

    I’ll handle the fraudulence of fractional reserve banking in another post since it’s a weighty subject and would require some time…

    I don’t think your narrow definition of inflation is very useful

    It is the only definition. Simply defining inflation as an increase in prices is circular and adds nothing to our understanding of the cause.

    I don’t think holders of gold money have anything to fear from an increase in prices of goods relative to gold. The supply of gold increases by less than 0.5% per year. None of this is currently being used as money. Therefore we can be reasonably comfortable that people’s purchasing power will not be significantly impacted by annual increases in the supply of money. Furthermore, assuming an unencumbered free market, increases in productivity and wealth will more than offset any increase in the gold supply thus ensuring falling prices and a continued increase in people’s purchasing power.

    • mrg

      “I don’t think holders of gold money have anything to fear from an increase in prices of goods relative to gold”

      Once things settle down, I expect you’re right.

      In the transition to monetary gold we could expect some turmoil, as the current distribution of gold in the world (above and below ground) does not match the current distribution of wealth.

      We could also expect gold extraction to increase if gold were once more used globally as money. The more gold becomes worth in terms of other goods and services, the greater the incentive to dig for gold instead of producing other useful things.

      My point is simply that there’s nothing good about an expanding gold supply from the perspective of existing holders of gold, and it’s misleading to appeal to the non-monetary value of gold.

      • Robert Sadler

        My point is simply that there’s nothing good about an expanding gold supply from the perspective of existing holders of gold, and it’s misleading to appeal to the non-monetary value of gold.

        If I grant you that I still don’t think it’s an issue. Even if the supply of gold doubles (in response to monetary demand) it still won’t be anything like the monetary pumping by central banks. Further, unlike inflation (which involves the transfer of something for nothing) an increase in gold is more of “something”. Nobody will be defrauded. Prices will simply reset to account for the increased supply. Will your food bill priced in terms of gold be relatively more expensive ceteris paribus? Yes but this is a fact of life and relative prices change all the time. There is nothing you can do about that.

        And let’s say the worst happens and a gold laden meteorite strikes the Earth, carrying 10 times the amount of gold currently in circulation. In this case, the market will simply select an alternative for gold. Will this impact your wealth if it’s all in gold? Yes but life is risky and it certainly isn’t fair. Plus there are ways to deal with this eventuality if it is of major concern to you.

  • There seems to be a disconnect between the concept of gold as money and gold as a commodity. Few seem to realize, for instance, the close relationship between oil prices and gold mining. The overwhelming majority of gold is produced from placer deposits, gold separated from less valuable alluvial deposits. This involves the physical movement of large quantities of sand and gravel, now done by heavy equipment. The movement of X gravel to produce Y gold entails the use of Z diesel fuel. The change in price of only a few cents per gallon of diesel can determine the viability of a mining operation. If your mine produces $250K of gold per year but you spend $300K on fuel and equipment costs to produce that gold it will be your last year of working that mine, everything else being equal.

    Devising a strategy for moving to real money is unnecessary, since it’s simply going to happen, strategy or no. Some of us feel that the relationship between saved wealth and credit has been distorted by fractional reserve banking and fiat money. If we’re right, that such a situation cannot endure, it will be rectified without any sort of plan by anyone in power.

  • Gee, I think I see the problem.

    It’s all a misunderstanding of what money ‘is’ .

    And what ‘inflation’ is.

    The rest is easy.

    Means of exchange. Private property rights. BAD government.
    Free money markets and happiness ever after.

    What is inflation ?
    Your answer to your question is preposterous, as is your answer to those who question your answer. Squared.

    If I remember, they are -
    1. It is the only definition that really works for us. And
    2. It is the only one there is.

    Now, what about von Mises Theory, pg 126 I’m pretty sure?
    Inflation (general price increases) is what happens when there is more money than is used and useful – so as to cause an increase in the price of goods and services exchanged.

    Such would be that an increase in the amount of money that coincides with an increase in the amount of goods and services ‘exchanged’ would not, by definition, be inflation.
    And therefore, increases in the quantity of money is not, as claimed, inflationary.

    As to what is money.
    Well it’s probably worth noting that there is some debate about its evolution in both commerce and law.

    Suffice to say that today, in total reality, it is all based on law for modern economies. And if anyone thinks that anything will be different without a change to the law, then I am sure they are comfortable merely awaiting the impending crash.

    But without a replacement ‘plan’, yes that goes into law regardless of what it says, there will always be this law, always legal tender, always government initiative in the money system.

    That means you have to win on the basis of the alternative plans being presented. And, without a plan, well, good luck.

    For the Money System Common.

    • Robert Sadler

      Now, what about von Mises Theory, pg 126 I’m pretty sure?
      Inflation (general price increases) is what happens when there is more money than is used and useful – so as to cause an increase in the price of goods and services exchanged.

      I looked at your reference and found it had nothing to do with what you are saying here. I would however, like to draw your attention to pages 419 to 424 of Mises’s more recent book, Human Action:

      …[T]here can never be an excess or a deficiency of money… From the point of view of people eager to be enriched by such changes, the supply of money may be called insufficient…

      What many people today call inflation… is no longer the great increase… in the supply of money, but its inexorable consequences… there is no longer any term available to signify what inflation used to signify.

      Clearly, your ideas about what constitutes inflation are inconsistent with those of the economist you chose to site. My definition is consistent with the Rothbardian concept. Fundamentally though, both Mises and Rothbard agree that any supply of money is optimal. This renders your convenient definition of inflation invalid unless you can show me where both Mises and Rothbard are wrong. Certainly, the way you have argued it is far from convincing.

      But without a replacement ‘plan’, yes that goes into law regardless of what it says, there will always be this law, always legal tender, always government initiative in the money system.

      That means you have to win on the basis of the alternative plans being presented. And, without a plan, well, good luck.

      Planning is for the government, not for the free market.

  • Paul Marks

    Nick Heath – I used to agree with your position, however circumstances have changed. Radically changed.

    Think of a city – we both are on the wall fighting back invaders and suddenly I start shouting at you to pull back, to flee the city.

    “You coward Paul Marks” you cry and redouble your efforts to throw back the attackers on the wall…..

    But you have not seen what I have (perhaps by chance seen) – the enemy are now INSIDE the city, gates have been opened and the enemy have flooded in. The city CAN NOT be saved.

    You look (as I once did) for a path of reasonable reform to take us away from a possible economic collapse – and towards sanity.

    Howerver, things have now got to a point where economic collapse is already “baked into the cake” (various gates have been opened and the enemy have flooded in – outnumbering us 100 to 1). The present financial order CAN NOT be saved – so the looking for a reasonable path of reform is no longer a valid option.

    “But have you spotted some gap in the enemy – some route away from the city that the enemy have not covered, some position to withdraw to….”

    Now there is the problem…..

  • Paul Marks

    mrg.

    Although an evil Austrian School man I actually think there is an EMPIRICAL test that can decide between us.

    If you are correct (if no fraud, as an ordinary person would understand the word “fraud”, is taking place) then “broad money” (back credit) would never be bigger than the “monetary base”.

    Banks (and other such) would simply lend out real savings – and a “fractional reserve” would mean (for example) that if a bank had a “reserve” of ten percent it would lend out 90% of the real savings that were entrusted to it (keeping 10% as a “reserve”).

    Is that what happens? Go have a look at the figures for yourself – go and haver a look at “broad money” (credit) over history and see whether, or not, it expanded (by banks and Central Banks) beyond the monetary base.

    So we end up dealing with “fractions” not of nine tenths (nighty percent) of savings being lent out – but ninty tenths (900 percent) being lent oput – or whatever (the exact numbers do not matter much).

    Your example MISSES THE POINT.

    As I said – it is a “not a gamble – it is a bubble”.

    People lending out money (savings) that, properly speaking, DOES NOT EXIST.

    That is the fraud – as a common man would understand the word “fraud”.

    But it does not matter (in terms of economics) whetehr we call it “fraud” or not (and thanks to the influence bankers had over certain key 18th and 19th century court judgements it is NOT legally fraud). What matters, for the purposes of economics, is simple.

    It is a bubble.

    The bubble MUST burst (not a gamble – a bubble).

    And Central Bankers (such as Ben Strong of the New York Fed in the 1920s, or Alan Greenspan of the central Fed in recent years) make the bubble BIGGER (not smaller) than the bankers would if left alone (because the Central Bankers delay the bust – “Alan Greenspan saves….” was a common headline in the financial press year after year, what he was actually doing was making the bubble BIGGER AND BIGGER, not “saving the world”).

    You like numbers (no harm in that) so I will give you some (arbitrary) numbers.

    If real savings are one billion Dollars then lending can be no larger than one billion Dollars – if lending is bigger than than, there is a bubble. And the bigger the gap is, the bigger the bubble is.

    And it does not matter if the money is gold, silver, or bits of paper with George Washington (or Queen Elizabeth’s) head on them.

    What matters is that (for example) people have only chosen to save 1% of their income – so TOTAL lending (to government and to private individuals and organizations) can not be greater than 1% of income. If lending is more than that – then there is a bubble.

    Alan Greenspan (in a backhanded sort of way) admitted that – by blaming “Chinese savings”.

    The problem is that he was saying something that was not true – indeed false on two levels.

    Firstly importing real saveings from overseas does NOT create a bubble.

    Think about it – if (for example) gold is money and gold comes in from overseas, prices may rise. But there is no bubble.

    And if fiat notes are the currency – then how did the Chinese save in Dollar notes?

    Only by getting them from the United States – so the bubble was NOT caused by the Chinese.

    “But Paul – most money is not notes, it exists only on computers….”

    Ah!

    So we are talking about a bubble – about “broad money”, bank credit (money that was never really saved – because it never really EXISTED).

    FRAUD – as any ordinary person would undertand the word.

    That is the answer to the ancient question (asked every time a bubble bursts – going right back to John Law and Richard Cantillion) “where did the money go?”

    The money did not go anywhere – because it NEVER REALLY EXISTED IN THE FIRST PLACE.

    Although some (normally wealthy and connected people – Richard Cantillion noted that) may end up with real assets after the boom-bust farce is done.

    By the way….

    The modern standard dodge (from Lord Keynes) is to call monetary expansion – “savings”, “just as real as any other kind”.

    I am sorry if what I am about to say violates the non aggression principle – but the correct response to such an “argument” is a smack in the mouth.

    It is like having your house robbed (ndeed burned as well) and the destroyer turns round to you and says…..

    “This pile of ash is a house, just as real as any other house”.

    And.

    “All your possessions [the ones he looted before he burned the house] still exist – it is just that I have them now, you have nothing to complain of”.

    Really it is not a time for a careful refutation – it is time for to knock the man to the ground (so hard that he will not be getting back up).

    It is bad enough being robbed – without the robber being a smart-mouth and comming out with a lot of double talk about how he has done nothing wrong.

    I repeat – there is a simple empirical test.

    If banks (and other such) simply “put people’s savings to work” then bank credit (“broad money”) could never be bigger than the monetary base.

    Does it get bigger or not?

    And I also repeat that Central Banking (and so on) makes the bubbles BIGGER not smaller.

    • Paul
      Just curious.
      If bankers have savings of a billion dollars to lend, from where did the savings come?
      If no banker can create money out of thin air, then we would have no money.
      I’m not saying that bankers SHOULD create money out of thin air – it’s just that money is a ‘social construct’, and it needs it come from somewhere.
      No matter who creates it.
      It is a creation process.
      So, from thin air seems a likely source.

      • Robert Sadler

        If no banker can create money out of thin air, then we would have no money.

        This is an obvious fallacy. Money existed before bankers.

  • Paul Marks

    At the moment every major Central Bank in the world is pushing up the monetary base.

    Why?

    To try and save the credit-money bubble (bank credit – broad money).

    So with one part of the mind they insist there is nothing wrong with lending out money that never really existed (stuff that no one worked for, no one really SAVED), and yet with another part of their mind they are DESPERATE and will do ANYTHING rather than let the bubble (the bubble they pretend does not exist) burst.

    Because that would be the dreaded “massive deflation”.

    In the end….. there will be neither massive inflation or massive delfation.

    Because this entire farce of a “monetary and financial system” is going to fall apart of the next few years.

    It is already past the point of rational reform.

  • Paul Marks

    My apologies for the number of typos – an extreme level of typos (even by my standards).

  • waramess

    Paul Marks, this really is the clearest and most concise explanation of the credit crunch I have ever read. Brilliant

  • Spooner noted gold as money is maintained in equilibrium by the fact that almost all gold is minted into bullion after extraction, and in times of excess bullion (buying power drops) it is converted into “plate, decoration and jewelry,” with the most worn melted down first (keeping circulating bullion stocks fresh and not clipped). When coin values rise in purchasing power, out of this stock of plate, decoration and jewelry is melted back into circulating bullion coin. We see that happening today. The free market keeps precisely the right amount of gold as money on hand.

    One more thing often overlooked: what metals that prove to be anti-bacterial also tend to become coin… gold and silver to name two. Important that, in international trade. It would be interesting to have someone study whether or not it is just a coincidence that as currency replaced coin, and when and where it did, the bubonic plague spread.

  • Rob Thorpe

    A quick point I have made before….

    There is a difference between saying “any amount of money is optimal” in the long-run and in the short-run. In the long-run monetary effects will always work themselves out. But, in the short-run things are quite different.

    Above joebhed quotes Mises in a passage where he is describing the short-run and Robert Sadler quotes a passage where he is describing the long-run.

    I wrote about this a while ago….
    http://www.cobdencentre.org/2011/02/money-is-barren-but-occasionally-covers-us-in-dust/

    If any amount of money were optimal in the short-run then there could be no ABCT because injections of money could not cause changes in the capital structure.

  • Frank Deliquo

    While I agree with the general Austrian sentiment, I think there needs to be less focus on “paper money having no value”. Paper money is simply another form of credit, albeit one that we are forced to use to a degree. A trustworthy government or trustworthy central bank could in theory produce paper money that has value, just as an IOU from a trusted and honourable friend has value. I agree that there are no governments or central banks that are fully trustworthy, however at the same time, there are central banks that have not merely printed money to fund government deficits, and in fact have resisted the pressure to do so. These central banks have presided over relatively successful paper currencies (I say “relatively” because although they have all devalued dramatically over time, some have devalued more slowly than others).

    In any case, I think it would be helpful to the Austrian cause for Austrian proponents to be a little less dogmatic on this front.

    I have produced a primer on money that I hope sums up how modern money works, and I welcome comments on it: http://www.insofisma.com/wp2/what-is-money/

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