Economics

Money out of thin air, mystical and dreamlike

“Indeed, the fact that central banks can create money out of thin air, so to speak, is something that many observers are likely to find surprising and strange, perhaps mystical and dreamlike, too  – or even nightmarish.”

— Jens Weidmann, president the Bundesbank, September 18, 2012

On September 18th, the London office of Deutsche Bank  — one of the most respected banks in the world, and a bellwether of elite opinion — published a Global Markets Research paper entitled Gold: Adjusting for Zero. It was written by two esteemed, mainstream analysts Daniel Brebner and Xiao Fu:

[G]old is not really a commodity at all. While it is included in the commodities basket it is in fact a medium of exchange and one that is officially recognised (if not publicly used as such). We see gold as an officially recognised form of money for one primary reason: it is widely held by most of the world’’s larger central banks as a component of reserves. We would go further however, and argue that gold could be characterised as ‘‘good’’ money as opposed to ‘bad’ money which would be represented by many of today’s fiat currencies.

The conclusion from our overview of gold functionality is that the key difference between good and bad money is scarcity (imposed supply discipline could be another way of describing this). Fiat currencies can be scarce but this scarcity may change on a whim which may both impact its tenure as currency and/or relegate it to being characterised as bad money. Gold is truly scarce, having a concentration of around 3 parts per billion in the Earth’s crust.

In 2011 Deutsche Bank enjoyed revenues of €33.2 bn. In 2009 Deutsche Bank was the largest foreign exchange dealer in the world, with a market share of 21%.  We have come a long way from the view of gold as an artifact of the “bleak” and “dystopian” (as characterized by the Wall Street Journal).

On the very same day of the Deutsche Bank report Herr Dr. Jens Weidmann, president of the Bundesbank, gave a speech entitled Money Creation and Responsibility.  The Bundesbank is the only member of the ECB’s governing board to oppose Mario Draghi’s sovereign debt purchase policy, a policy disturbingly like that of Bernanke’s “Buzz Lightyear” monetary strategy of QE “to Infinity and Beyond.”

Weidmann stated that “Concrete objects have served as money for most of human history; we may therefore speak of commodity money. A great deal of trust was placed in particular in precious and rare metals – gold first and foremost – due to their assumed intrinsic value. In its function as a medium of exchange, medium of payment and store of value, gold is thus, in a sense, a timeless classic.”

Most of his speech was devoted to recounting an iconic work of German (and world) culture, Goethe’s Faust, Part II.

Let me remind you briefly of the “money creation” scene in Act One of the Second Part of Faust. Mephistopheles, disguised as a fool, talks to the Emperor, who is in severe financial distress, and says

In this world, what isn’t lacking, somewhere, though? Sometimes it’s this, or that: here what’s missing’s gold”

In the commotion of the nocturnal masquerade ball, he persuades the Emperor to sign a document  – a document which Mephistopheles has reproduced over night and then distributed as paper money.

Those concerned are so overjoyed by this apparent blessing that they do not even suspect that things could get out of hand.

In the Second Part of Faust, the state can get rid of its debt to begin with. At the same time, private consumer demand rises sharply, fuelling an upswing. In due course, however, all this activity degenerates into inflation, destroying the monetary system because the money rapidly loses it value.

Even interpreting Weidmann’s remarks as mainly a critique of the ECB’s monetary promiscuity, his speech throughout treats the classical gold standard with respect, rather than — as with Mr. Bernanke — cheap disdain.

Weidmann’s praise for the integrity of gold, and indictment of paper, is not presented as a whimsical metaphor.  It is drawn from deep wells of German monetary scholarship:

The fact that Faust can indeed be interpreted in economic terms has been demonstrated, not least, by Professor Adolf Hüttl, who used to be Vice-President of the former Land Central Bank in Hesse. I am delighted that he is in attendance here today. Back in 1965, he wrote a very insightful article in the Bundesbank’s staff magazine about  “Money in the Second Part of Goethe’s Faust”.

In the mid-1980s, while teaching in Sankt Gallen, Professor Hans Christoph Binswanger – who I am pleased to say is also here today – took a similar line and brought out a book entitled “Money and Magic: a Critique of the Modern Economy in the Light of Goethe’s Faust”.

Indeed, the fact that central banks can create money out of thin air, so to speak, is something that many observers are likely to find surprising and strange, perhaps mystical and dreamlike, too  – or even nightmarish.

That both scholars he references attended this speech, and were acknowledged, gives a graceful reinforcement of Weidmann’s message.  And, had he cared to do so, Weidmann also could have underscored his message with Ludwig Erhard’s Wirtschaftswunder — and its crucial currency reform.

Good money is not only a counsel of rectitude.  It is critical path to restoring vibrant prosperity and social health.   Erhard (as previously noted here) reprised the characterization of Pietrre and Rueff in his memoir Prosperity Through Competition.  Germany’s economic miracle

began as the clocks struck on the day of currency reform.  Only an eye-witness can give an account of the sudden effect which currency reform had on the size of stocks and the wealth of goods on display.  Shops filled with goods from one day to the next; the factories began to work.  On the eve of currency reform the Germans were aimlessly wandering about their towns in search of a few additional items of food.  A day later they thought of nothing but producing them.  One day apathy was mirrored in their faces while on the next a whole nation looked hopefully into the future.

A counsel of “good money,” as gold is referred to by Deutsche Bank, is an essential part of the recipe for the revival for all, and especially Mediterranean, Europe.  Rueff is a soulmate to Weidmann, his legacy a powerful authority for the Bundesbank’s opposition to the ECB’s easy money policies.

As recalled to this columnist by Rueff’s greatest living disciple, Lewis Lehrman (whose institute I professionally serve), Rueff, in his 1952 speech to the Committee for Action and Economic Expansion, reproduced in The Age of Inflation (Henry Regnery and Company, Chicago, 1964, pp. 62-64), also extols Goethe:

[I]t was Germany which gave the world its greatest money theorist—Goethe. He was, to be sure, no economist, yet it was he who in Faust (Part II) clearly demonstrated that inflation was and could only be an invention of the devil.  … He then fully sets forth the theories of exchange media and fully employment. …But in his commentary on the festivities, the Herald foresees an unhappy outcome. … Nothing is missing: the technical formula, the political advantages, the social consequences. The poet was indubitably more clear-sighted than are most economists; he understood and clearly demon-started (sic, delightfully) that inflation was the work of the devil because it respected appearances but destroyed reality.

Green shoots of respect for the classical gold standard are beginning to pierce the decaying concrete of Neo-Keynesianism monetary theory all over the world.  The gold standard’s purpose is by no means to privilege the wealthy and prejudice workers or debtors.  The purpose of gold is to unwind the Faustian bargain throttling our economy and stifling job creation.   The purpose of the gold standard is to propel the world economy into a new era of vibrant, widespread prosperity.  And as Goethe, as if to cheer on future advocates of gold, wrote  in in the concluding pages of Faust, Part II: Whoever strives, in his endeavour,/ We can rescue from the devil.

This article was previously published at Forbes.com.

8 comments to Money out of thin air, mystical and dreamlike

  • Paul Marks

    Even if no Central Bank held gold – indeed even if no Central Bank existed, gold would still be money.

    Gold would be money as long as buyers and sellers voluntarily made a choice to use it as money (i.e. as store of value and medium of exchange – something can hardly be a very good medimu of exchange if it is not a store of value). The same as if they used another commodity (such as silver) for this purpose).

    Gold is indeed a commodity – but this is not a vice, it is a virtue, in relation to its use as money.

    A physical commodity (not a “standard”, or shares in a gold mining company – or whatever) is the least unsatisfactory form of money.

  • The issue isn’t fiat currency versus commodity money, it’s the power of the state to control the medium of exchange, no matter what it might be. If individuals wish to employ gold as a store of value and medium of exchange that is their perogative as free men. Competition among forms of money would weed out the least desirable, a circumstance that seems to be acceptable in other arenas, why not money?

  • Mike Krolikowski

    The problem with gold is its rarity. There is not and there can never be enough of it circulating as money to stimulate the production of the needs of more than 7 billion people (to be brief : money -> production -> commodities).
    For most of human history production and circulation of goods was local, consumption was by the producer himself or his slaves and the little gold there was, was sometimes enough. This is no longer possible since the might of Venice and the development of its banking system permitted trade, production and human needs to explode.
    The problem today is not the form of money but who has the power to create it and what they do with it
    It is said that excessive money creation results in inflation. The money supply in the European union is in continual increase in proportions that are greater than the sum of increased production and government deficits. Where is that money going to? Not to production, absorbing unemployment or satisfying the market demand. Europeans are starting to starve in a situation w reducing production -> creating unemployment-> vicious circle of austerity.
    The bankers are not interested in the needs of the populations that is why money creation should be public and publicly controlled. If inflation set in when money was over created, whether in the context of Goethe above or the story of John Law, it was because the bankers used it to speculate, not because the people purchased their needs.
    If money was created and distributed to the the needy they would immediately put it into productive circulation and there is no reason why the money be created for this reason be more than the needs of production it has to finance.
    Banking is one of the most regulated activities in the world and it is still insufficiently regulated, and not for the interests of the common good.
    If money creation was strictly regulated and the money put into the hands that need it that would be a way out of the social crisis hitting Europe at the moment. Only the authorities independent from the wills and whims of the private bankers can do this. Money is too important to us all to be manipulated by private interests
    The problem of money is a problem of who has the mastery over it.

  • Paul Marks

    This argument against gold was refuted by Rothbard (and others) many years ago. The idea that there “is not enough gold” is simply wrong (as is the idea that increasing the amount of money increases the amount of real wealth – “the people need more money” is a cry that leads to boom-bust and it benefits, in the end, wealthy interests – the very wealthy interests that “cheap money” people denounce).

    However, if you do not like gold fine – use silver or any other commodity that buyers and sellers VOLUNTARILY AGREE TO USE (no legal tender laws and so on).

    Money is far too important to be controlled by governments. People themsleves must choose what commodity they wish to use as money.

  • Mike Krolikowski

    Thanks for these remarks,

    Rothbard and others will be checked out but the name is not mentioned on the Cobden centre list of authors. This said, the idea that there is or is not enough gold in the world is quite as secondary as is the idea there is not enough money, in whatever form it takes, Gold , silver, bank notes, bamboo rods or sea shells (these last two being just as honourable as the others).
    This is not the problem with money. The problem is, what is it, who controls it and to what ends?
    Money is not a commodity like others because in the economic circuits it flows in the opposite direction to the others which go : production -> distribution -> consummation (being brief of course). Money flows like water, it goes where it is easiest to go (unfortunately in this case, not necessarily to the lowest point, it is not influenced by gravitational forces)
    Money is the symbol of an agreement by two entities to make an exchange, however sophisticated the conditions of that exchange may be. What’s more, money being only a symbol the exchange is only superficially between these two entities. More profoundly money is the expression of the participation of these two entities in an economic system that permits production -> distribution -> consummation, or should do.
    The domains of economics or finance are inadequate to explain this money phenomena, The domains of anthropology, psychology and sociology have something to say about money too. Money is the crystallisation of a vast and complex social contract between all the individuals (physical and moral) using the same currency and is thus too important to be governed by private interests who use it to their own benefit, causing boom and bust situations. It is not those who need the money who cause these situations. It is the banks that have busted the 25% of the Greeks who are on the dole and started to cause hunger and need of social services in what was not very long ago a wealthy continent.
    The people really do not have enough money. The speculators are drawing it all their way. 80% of the worlds population lives on less than 1.50€ a day and 95% of that is spent on food, whereas, 98% of the worlds financial activity is speculation, not production.
    When immigrant workers send their remittances to their families that money is used directly to provide daily bread. With that money the baker can buy a bible or a bottle of cognac (or both) as he sees fit and the money goes round. Some countries are dependent on these remittances for a good part of their income. In this case money is going where it is needed and it is not causing boom -> bust processes.
    As for people freely choosing which money to use as a universal commodity ; I don’t think they care as long as they can get their daily bread, their bible or their cognac with it. Previously mentioned baker will accept any money that permits that. However, what convinces our baker that he can in security accept the form of money offered? It is the knowledge that the whole of the society in which he lives also accepts that commodity in cases of exchange.
    If the society accepts that it is because somewhere there is a guaranty on the commodity. The most credible and longest withstanding historical guaranty is a government guaranty, everybody without even knowing it exists, accepts it.
    Governments have always guaranteed money in three principal ways : 1) Insisting that taxes be paid with this money ; 2) guaranteeing bank deposits up to a given maximum (usually quite important) and 3) making money ‘legal tender’, legal tender being that which cannot be refused in payment of a debt, including private debt. No money that does not have these guarantees can replace one that has, its not the money the people want, its the government guaranty. So money is very definitely a government affair. It is to be hoped that the governments be the legitimate and democratic expression of the people, effectively a rare thing, that can be discussed elsewhere, but this supposition is made here.
    The original point is that money is being controlled by the wrong people with the wrong intentions so obviously it is having the wrong results, for the populations, not for the speculators. These people tell us that any other system is boom or bust. Possible, but so is theirs and they never take the trouble to defend their position in argument. They simply say, with disdain, its wrong and pass on to other things. Why should a system of boom and bust run by the people be less legitimate than that run by the speculators? On the contrary.

  • Paul Marks

    “speculators” Mike?

    That is the Bill O’Reilly view of the economy.

    High oil prices? Speculators.

    Economoic collapse? Dealing in “fraudulent mortgage paper”.

    And on and on.

    There is a reason why Comrade Barack Obama will consent to be interviewed by Bill (but not, for example, by Neil Cavuto – who has worked for Fox just as long as Bill has). Bill does not know much about economic matters.

    Hopefully you are not like him.

    Regulations against “engrossing and forestalling” (and so on) were refuted (utterly) by Edmund Burke (and others) centuries ago.

    A “speculator” does not create a problem in currency (or anything else) a “speculator” is like a canary in a coal mine – he tells you that there is a problem (a problem that he did NOT make).

    Even that ……. George Soros did not CREATE the folly of Britain being in the ERM (he profited from the folly of the people who put the British Pound in the ERM).

    By the way – if you do not like specualtion….

    Then GET RID OF GOVERNMNET FIAT MONEY.

    Government fiat money might have been designed for speculators to profit from.

    Whereas real commodity money (for example real gold-as-money not a “gold standard”) is very hard for speculators to profit from.

    As Ludwig Von Mises (and so many others) were fond of pointing out – the very moves that interventists make to “undermine speculation” in fact encourage it.

  • Mike Krolikowski

    Don’t know who Bill O’Reilly is, must be somebody from down Paul Marks’ way, but I do have in common with him that I don’t know much about economic matters. Then again, most of the economists who are allowed to jabber on don’t seem to know more than I do. In some cases I suspect them of knowing a lot less. Anyway, such knowledge was not a criteria for posting on this forum, the only requirements were to be intelligent and civil (see above). Being civil is OK I think I can do that, being Intelligent is more difficult but I’ll do my best with the 80 I.Q. that I boast of, and I’ll try to use long words and Latin.

    The contradictions of the markets do not give the speculators ‘et al’ the right to kick the people when they are down just because they have the possibility. There is no moral obligation to make a profit out of other peoples weaknesses, on the contrary. These so called ‘problems’ in the system are only problems because the speculators use them in their own interest which is contrary to the common interest. If Soros made a profit out of the ‘so called’ weakness(‘and others) of the system it’s because he chose to do so, he’s not a hero he is a villain, many of the weaknesses are only weaknesses because of the speculative attacks that they attract but no system is without weaknesses and all systems even have a right to have them without fear of being subject to attack. Weaknesses often have no importance if nobody is attacking them. This puts a Dolly Parton song to mind, see http://www.youtube.com/watch?v=pa10TC7MrdI&feature=related
    It’s not because the lights are out in your street that ruffians have a right to come there to mug you. The solution to stopping the muggings is not handing over your wallet (although it is quite understandable to do that), it is calling the pertinent authority to repair the lights and preventing the muggers coming along.
    The speculators are not the chirpy little canaries who stop chirping because of the gases, they are the mine owners (shareholders in the multinationals) who are sending the men down into dangerous shafts because these men have the weakness of needing the jobs.
    A few years ago (circa, 2008 – 2010) world food prices rose between 20% and 60% causing hunger riots in many developing countries(see previous post mentioning percentage of income devoted to the purchase of food). The speculative money that no longer had confidence in other speculative sectors because of a ‘so called’ crisis, went to the commodities markets thus pushing the prices up. Very good for the farmers in the developed countries but putting some products out of the grasp of a billion (no exaggeration) of the world’s poorest. Before the speculators shifted their attention to cereals there was no problem for the canaries in the third world. speculation created the problem and this is not a rare event, they are all following each other around like sheep.

    By the way if Paul Marks thinks that speculation can be eradicated by some kind of gold standard or metal gold currency it would be interesting to hear the reasoning or to be directed to some document that elaborates on this idea, we might have something to really talk about.

    Getting back to Basics :
    Money is a wonderful means to produce enough goods for everybody’s needs and distribute them efficiently to all who use them. This is the eradication of poverty (sounds simple and it is). Whatever money system is used is unimportant as long as it works. Paul Marks likes gold, I can see the charms of fractional reserve, there are certainly others, different propositions must be confronted.

    Does anybody really believe the current financial system can solve the world’s poverty problems?
    Is there anybody out there who thinks that those who are currently running the world’s financial system are the right people to do it in the common interest?

    There is no need to have knowledge of economics to have an opinion. The economists must understand they are there to give the people the economic tools necessary to achieve THE KIND OF ECONOMY THE PEOPLE VOLUNTARILY AGREE THAT THEY WANT and not to sanction, by their so called expertise, what they and the elites they work for want.

  • Paul Marks

    Mike – there is nothing in your comment that defends your position.

    As for your lack of knowledge of economics.

    Well you are correct – most “economists” know nothing about the subject either.

    To develop your knowledge….

    Start with Henry Hazlitt’s “Economics In One Lesson” and then go on to Ludwig Von Mises’ “Human Action”.

    However – if you want to start with modern works….

    You could start with works like “Housing: Boom and Bust” by the Thomas Sowell, and “Meltdown” by Thomas Woods.

    Or (even more recent works) “Where Keynes Went Wrong” by Hunter Lewis, and “Paper Money Collapse” (by D.S.).