Book Reviews

‘The system has spun out of control’

Book Review: The Death of Money: The Coming Collapse of the International Monetary System by James Rickards

The_Death_of_Money_Cover_ArtThe title will no doubt give Cobden Centre readers a feeling of déjà vu, but James Rickards’ new book (The Death of Money: The Coming Collapse of the International Monetary System) deals with more than just the fate of paper money – and in particular, the US dollar. Terrorism, financial warfare and world government are discussed, as is the future of the European Union.

Though he quotes F.A. Hayek a few times, the Austrian School gets only one mildly disparaging mention in the entire book. This seems odd for an author who devotes a whole chapter to the benefits of the gold standard. His first bestselling book, Currency Wars, argues that currency wars are not just an economic or monetary concern, but a national security concern for the USA.

Rickards relies on emerging Chaos theories of economics and markets (1) to buttress his arguments in favour of sound money and prudent – limited – government. He uses the same insights, twinned with years of Wall Street experience, to explain why the “coming collapse of the dollar and the international monetary system is entirely foreseeable.”

One of Rickards’ key arguments is that exponential increases in the total size of credit markets mean exponential increases in risk. The gross size of derivative markets is the problem, irrespective of false assurances about netting, he claims. Politicians and central bankers have by and large learnt nothing from recent crises, and are still “in thrall to bank political contributions.”

He makes the case for the US federal government to reinstate Depression-era restrictions on banking activities and for most derivatives to be banned. As a former Federal Reserve Chairman, Paul Volcker, said in 2009, “the only useful thing banks have invented in 20 years is the ATM” – a sentiment Rickards would probably be sympathetic to.

The chapter dealing with the Fed’s hubris and what investment writer James Grant calls our “PhD Standard” of macroeconomic management will be familiar territory for readers of this site. The Fed is trapped between the rock of natural deflationary forces of excessive debt, an ageing population and cheap imports frustrating its efforts to generate a self-sustaining economic recovery and the hard place of annualised inflation of 2%. Rickards quotes extensively from eminent economist and Ben Bernanke mentor Frederic Mishkin, who noted in a 2013 paper titled Crunch Time: Fiscal Crises and the Role of Monetary Policy that “ultimately, the central bank is without power to avoid the consequences of an unsustainable fiscal policy.”

More interesting is the author’s attempt to map out what-happens-next scenarios. The chapter about the on-going transformation of the International Monetary Fund into the world’s central bank, and Special Drawing Rights (SDRs) into a global currency, is particularly insightful. Though Rickards doesn’t say it, Barack Obama’s former chief of staff (and current Mayor of Chicago) Rahm Emanuel’s dictum about never letting a crisis go to waste seems to apply here: hostile acts of financial warfare would lead to calls for more international regulation, and to more government intervention and monitoring of markets. Observers of the EU’s crab-like advance over the last half century will be familiar with the process.

Indeed, my only quibble with this book is Rickards’ starry-eyed take on the EU – soon to be “the world’s economic superpower” in his view. Though he makes a good argument – similar to Jesús Huerta de Soto’s – that relatively-tight European Central Bank monetary policy is forcing effective structural adjustments in the eurozone periphery, as well as in eastern states that wish to join the euro, his endorsement of other aspects of the EU seem too sweeping.

The author talks of the benefits of “efficiencies for the greater good” in supranational government, and how subsidiarity makes allowances for “local custom and practice”. But, as the regulatory débacle surrounding the Somerset floods has shown recently, EU rule frequently licenses bureaucratic idiocies that destroy effective, established national laws. Regulatory central planning for an entire continent is, I’d say, just as suspect as monetary central planning for one country.

The continent’s demographic problems are probably containable in the short-term, as Rickards says. But mass immigration is driving increasing numbers of white Europeans to far-right parties. And while there is consistently strong public support for the euro in the PIIGS (Portugal, Ireland, Italy, Greece and Spain), he’s silent on the broader question of the EU’s democratic legitimacy. No mention of those pesky ‘No’ votes in European Constitution, Maastricht and Lisbon Treaty referendums – or of the Commission’s own Eurobarometer polls, which show more and more Europeans losing faith in “the project”.

No matter I suppose: the eurocrats will rumble on regardless. But what was that quote about democracy being the worst form of government apart from all the others?

All in all though, this is a great book – even for someone like me who’s not exactly new to the economic doom ‘n’ gloom genre. As Rickards says at the end of his intro: “The system has spun out of control.”

(1) For example Juárez, Fernando (2011). “Applying the theory of chaos and a complex model of health to establish relations among financial indicators”. Procedia Computer Science 3: 982–986.


Money derivative creation in the modern economy

It isn’t often that a Bank of England Quarterly Bulletin starts “A revolution in how we understand economic policy” but, according to some, that is just what Money creation in the modern economy, a much discussed article in the most recent bulletin, has done.

In the article Michael McLeay, Amar Radia, and Ryland Thomas of the Bank’s Monetary Analysis Directorate seek to debunk the allegedly commonplace, textbook understanding of money creation. These unnamed textbooks, they claim, describe how the central bank conducts monetary policy by varying the amount of narrow or base money (M0). This monetary base is then multiplied out by banks, via loans, in some multiple into broader monetary measures (e.g. M4).

Not so, say the authors. They begin by noting that most of what we think of as money is actually composed of bank deposits. These deposits are created by banks when they make loans. Banks then borrow the amount of narrow or base money they require to support these deposits from the central bank at the base rate, and the quantity of the monetary base is determined that way. In short, the textbook argument that central bank narrow or base money creation leads to broad money creation is the wrong way round; bank broad money creation leads to central bank narrow money creation. The supposedly revolutionary connotations are that monetary policy is useless, even that there is no limit to the amount of money banks can create.

In fact there is much less to this ‘revolution’ than meets the eye. Economists and their textbooks have long believed that broad money is created and destroyed by banks and borrowers(1). None that I am aware of actually thinks that bank lending is solely or even largely based on the savings deposited with it. Likewise, no one thinks the money multiplier is a fixed ratio. It might be of interest as a descriptive datum, but it is of no use as a prescriptive tool of policy. All the Bank of England economists have really done is to describe fractional reserve banking which is the way that, these days, pretty much every bank works everywhere.

But there’s an important point which the Bank’s article misses; banks do not create money, they create money derivatives. The narrow or base money issued by central banks comprises coins, notes, and reserves which the holder can exchange for coins and notes at the central bank. The economist George Reisman calls this standard money; “money that is not a claim to anything beyond itself…which, when received, constitutes payment”.

This is not the case with the broad money created by banks. If a bank makes a loan and creates deposits of £X in the process, it is creating a claim to £X of standard money. If the borrower makes a cheque payment of £Y they are handing over their claim on £Y of reserve money. The economist Ludwig von Mises called this fiduciary media, as Reisman describes it, “transferable claims to standard money, payable by the issuer on demand, and accepted in commerce as the equivalent of standard money, but for which no standard money actually exists”. They are standard money derivatives, in other words.

Banks know that they are highly unlikely to be called upon to redeem all the fiduciary media claims to standard money in a given period so, as the Bank of England economists explain, they expand their issue of fiduciary media by making loans; they leverage. Between May 2006 and March 2009 the ratio of M4 to M0, how many pounds of broad money each pound of narrow money was supporting, stood around 25:1.

But because central banks and banks create different things consumer preferences between the two, standard money or standard money derivatives, can change. In one state of affairs, call it ‘confidence’, economic agents are happy to hold these derivatives as substitutes for standard money. In another state of affairs, call it ‘panic’, those same economic agents want to swap their derivatives for the standard money it represents a claim on. This is what people were doing when they queued up outside Northern Rock. A bank run can be described as a shift in depositors’ preferences from fiduciary media to standard money.

Why should people’s preferences switch? In the case of Northern Rock people came to doubt that they would be able to actually redeem their fiduciary media for the standard money it entitled them to because of the vast over issue of fiduciary media claims relative to the standard money the bank held to honour them. Indeed, when Northern Rock borrowed from the Bank of England in September 2007 to support the commitments under its broad money expansion it increased the monetary base just as the Bank of England economists argue.

But there are limits to this. A bank will need some quantity of standard money to support its fiduciary media issue, either to honour withdrawals by depositors or settle accounts with other banks. If it perceives its reserves to be inadequate it will need to access new reserves. And the price at which it can access those reserves is the Bank of England base rate. If this base rate is relatively high banks will constrain their fiduciary media/broad money issue because the profits earned from making new loans will not cover the potential cost of the standard/narrow money necessary to support it. And if the base rate is relatively low banks will expand their fiduciary media/broad money issue because the standard/narrow money necessary to support it is relatively cheap.

Some commentators need to calm themselves. As the Bank of England paper says, the central bank does influence broader monetary conditions but it does so via its control of base rates rather than the control of the quantity of bank reserves. The reports of the death of monetary policy have been greatly exaggerated.

(1) “Banks create money. Literally. But they don’t do so by printing up more green pieces of paper. Let’s see how it happens. Suppose your application for a loan of $500 from the First National Bank is approved. The lending officer will make out a deposit slip in your name for $500, initial it, and hand it to a teller, who will then credit your checking account with an additional $500. Total demand deposits will immediately increase by $500. The money stock will be larger by that amount. Contrary to what most people believe, the bank does not take the $500 it lends you out of someone else’s account. That person would surely complain if it did! The bank created the $500 it lent you” – The Economic Way of Thinking by Paul Heyne, Peter Boettke, and David Prychitko, 11th ed., 2006, page 403. Perhaps the Bank of England economists need to read a better textbook?


John Butler: Bitcoin, the Monetary Touchstone

Click to download PDF

Click to download PDF

Is Bitcoin a sound form of alternative money? Does it provide a viable, alternative store of value with gold? These are questions that John Butler answers in his latest Amphora Report, which is reprinted below. This article offers a useful background to the thinking behind Bitcoin and it’s potential as a disrupter of fiat currencies.

BITCOIN: THE MONETARY TOUCHSTONE Created in 2008 by the mysterious ‘Satoshi Nakamoto’, in the past few months bitcoin has gone from a fringe financial technology topic to a mainstream media phenomenon. The debate is now raging as to whether bitcoin is, or is not, a sound form of alternative money. As the Amphora Report has, from inception, focused regularly on monetary theory and the financial market implications of activist central banking, in this edition I survey a handful of prominent, diverging views on bitcoin and then share some of my own thoughts. In brief, I believe that bitcoin’s ‘blockchain’ technology enables a low-cost payments system capable of disintermediating the banking industry, but I do not believe bitcoin presents a viable, alternative store of value on par with gold. In any case, bitcoin serves as a monetary ‘touchstone’ of sorts, distinguishing those who lean toward economic and monetary authoritarianism from those who favour market-based organisation instead.


Satoshi Nakamoto, the initially mysterious and now legendary creator of bitcoin, finally became a mainstream celebrity last week, having been ‘outed’ by US periodical Newsweek. Many who have followed the bitcoin story, however, find Newsweek’s claim rather dubious and instead believe that ‘Satoshi Nakamoto’ is a pseudonym adopted by either a single individual or team responsible for researching and publishing the original 2008 paper describing the specific, ‘blockchain’ algorithm behind bitcoin.

I have no strong opinion on Newsweek’s specific claims, nor on who, or what group, created bitcoin, although I am curious, for reasons that will become apparent. More important is to understand whether bitcoin could function as a sound, alternative money.

To begin, we need first consider why an alternative money would ever be necessary in the first place. Well, repeatedly throughout history, due to financial pressures, governments have chosen to debase their coins or inflate their paper currencies to service or settle their debts, by implication appropriating the wealth of prudent savers in the process. Wars, for example can be expensive and most large debasements in history have occurred either during or following major wars, in particular in those countries on the losing side of the conflict. But even the winners can succumb, as Rome demonstrated in the 3rd century or as the victorious WWI powers did in the 1920s and 1930s.

To continue reading, download the Amphora Report here (PDF): Amphora Report, Vol 5, 12 March 2014.


Speech to the Brazilian Chamber of Commerce in London

Last week I spoke to a small group in London about the current monetary situation and the outlook for gold. The speech lasts about 20 minutes and the video can be found here:



Do we have easy money?

This week marked the fifth anniversary of the 0.5% Bank of England base rate and the Bank of England’s Quantitative Easing program which has so far seen the Bank conjure up £375 billion of new base money and spend it on British government debt. It’s difficult to imagine money being any ‘easier’.

Or is it? At his Money Illusion blog this week, Scott Sumner asked

1.  Japan has had interest rates near zero for nearly 2 decades.  Is this easy money, despite an NGDP that is lower than in 1993?  Despite almost continual deflation?  Despite a stock market at less than one half of 1991 levels.  Despite almost continually falling house prices?  If it’s easy money, how much longer before the high inflation arrives?

2.  The US has had near zero interest rates for more than 5 years.  Is this easy money?  If so, how much longer until the high inflation arrives?  If rates stay near zero for 2 more years, and inflation stays low, will you still call it easy money?  How about 5 more years?  Ten more years?  Twenty? 

It is a key tenet of Market Monetarist thought that a low base rate or Fed funds rate is no indicator of whether money is ‘easy’ or not[1]. The correct indicator, they argue, is the growth rate of nominal GDP; if it’s slumping money is too tight, if it’s roaring on it’s too loose, and if it’s ticking along at some predetermined rate all is rosy in the monetary garden. As a result of this analysis Market Monetarists like Sumner believe the Bank of England’s low base rates and vast monetary base expansion do not indicate ‘easy money’. Are they right?

Well, first we have to define what we mean by ‘easy money’. It’s a rhetorical term rather than a textbook one so here’s my definition (which, if you don’t accept it, probably scuppers the following analysis so feel to substitute your own); money is ‘easier’ the more people who want credit can get it[2].

There are two points to make. First, the choice of ‘credit’ rather than ‘money’ is deliberate. When most of us ‘borrow money’ we are, in fact, accessing credit which is some derivative of, or claim on money. Secondly, a point I’ve made previously, economy wide aggregates often tell us little of interest or use. Often more useful and interesting is to disaggregate. Instead of looking at the availability of credit to the British economy look instead at the availability of credit to different bits of it.

Looked at like this we would have to say that for most businesses and individuals in the UK, despite the tripling of the monetary base since March 2009, credit is not easily available and money cannot be said to be ‘easy’. The most recent Bank of England lending report in January noted that “The rate of decline in the stock of lending to UK businesses eased slightly in the year to November compared to 2012. The annual rate of growth in the stock of secured lending to individuals rose slightly to 0.8% in the three months to November” –November’s fall in business lending being the biggest in six months.

But banks certainly do have ‘easy’ money. That tripling of the monetary base, as I wrote recently, has flowed onto their balance sheets and stayed there. The money multiplier has collapsed and growth of base money, M0, has not led to growth in broader monetary aggregates such as M4, which would influence nominal GDP. The open handed stance of the Bank of England isn’t showing up as ‘easy’ money as Market Monetarists see it because ‘easy’ money for banks isn’t translating into ‘easy’ money for the rest of the economy[3].

Do we have easy money? On my definition that depends on who ‘we’ is. Banks face little constraint on their ability to access credit from the Bank of England so for them the answer is yes. The rest of us who rely on those banks find it rather tighter.

[2] For fans of mathematical notation, if E is monetary ease and C is availability of credit then E=f(C)

[3] If we think of a river, with M0 pouring out of the spring at Threadneedle Street and the broad delta downriver being M4, banks’ demand for money has built a big dam stopping the river flowing. The Market Monetarist solution to this is to get the spring pouring out enough money that it flows over the top of this dam – in Quantity Theory notation to offset the decline in V stemming from banks’ increased money demand (which with downwardly sticky P would pull down y) with sufficient expansion of M.


Five years of disastrously low interest rates have left Britain addicted to cheap credit

The Bank of England

This article originally appeared in The Telegraph on 5 March 2014. It is reproduced by permission of the author.

Five years ago today, the Bank of England cut interest rates about as low as they can go: 0.5 percent. And there they have remained.

If rates have been rock bottom for five years, our central bankers have been cutting them for even longer. You need to go back almost nine years to find a time when real interest rates last rose. Almost a million mortgage holders have never known a rate rise.

And this is all a Good Thing, according to the orthodoxy in SW1. Sure, low rates might hit savers, who don’t get such good returns, but for home owners and businesses, it’s been a blessing.

Don’t just compare the winners with the losers, say the pundits. Think of the whole economy. Rates were set at rock bottom shortly after banks started to go bust. Slashing the official cost of borrowing saved the day, they say.

I disagree. Low interest rates did not save the UK economy from the financial crisis. Low interest rates helped caused the crisis – and keeping rates low means many of the chronic imbalances remain.

To see why, cast your mind back to 1997 and Gordon Brown’s decision to allow the Bank of England to set interest rates independent of any ministerial oversight.

Why did Chancellor Brown make that move? Fear that populist politicians did not have enough discipline. Desperate to curry favour with the electorate, ministers might show themselves to be mere mortals, slashing rates as an electoral bribe.

The oppostite turned out to be the case.  Since independence, those supermen at the central bank set rates far lower than any minister previously dared.  And the results of leaving these decisions to supposedly benign technocrats at the central bank has been pretty disastrous.

Setting interest rates low is simply a form of price fixing. Set the price of anything – bread, coffee, rental accommodation – artificially low and first you get a glut, as whatever is available gets bought up.

Then comes the shortage. With less incentive to produce more of those things, the supply dries up. So, too, with credit.

With interest rates low, there is less incentive to save. Since one persons savings mean another’s borrowing, less saving means less real credit in the system. With no real credit, along comes the candyfloss variety, conjured up by the banks – and we know what happened next.  See Northern Rock…

When politicians praise low interest rates, yet lament the lack of credit, they demonstrate an extraordinary, almost pre-modern, economic illiteracy.

Too many politicians and central bankers believe cheap credit is a cause of economic success, rather than a consequence of it. We will pay a terrible price for this conceit.

Low interest rates might stimulate the economy in the short term, but not in a way that is good for long-term growth. As I show in my paper on monetary policy, cheap credit encourages over-consumption, explaining why we remain more dependent than ever on consumer- (and credit-) induced growth.

Cheap credit cannot rebalance the economy. By encouraging over-consumption, it leads to further imbalances.

Think of too much cheap credit as cholesterol, clogging up our economic arteries, laying down layer upon layer of so-called “malinvestment”.

“Saved” by low rates, an estimated one in 10 British businesses is now a zombie firm, able to service its debts, but with no chance of ever being able to pay them off.

Undead, these zombie firms can sell to their existing customer base, keeping out new competition. But what they cannot do is move into new markets or restructure and reorganise. Might this help explain Britain’s relatively poor export and productivity performance?

What was supposed to be an emergency measure to get UK plc through the financial storm, has taken on an appearance of permanence. We are addicted to cheap credit. Even a modest 1 per cent rate rise would have serious consequences for many.

Sooner or later, interest rates will have to rise. The extent to which low interest rates have merely delayed the moment of reckoning, preventing us from making the necessary readjustments, will then become painfully evident.

We are going to need a different monetary policy, perhaps rather sooner than we realise.


The German way of 1923

Book coverI chanced this morning on the superb collection of essays from Ludwig von Mises, The Causes of the Economic Crisis and Other Essays Before and After the Great Depression (PDF).

In his Stabilization of the Monetary Unit—From the Viewpoint of Theory written in 1923, he showed considerable foresight:

Only the hopelessly confirmed statist can cherish the hope that a money, continually declining in value, may be maintained in use as money over the long run. That the German mark is still used as money today [January 1923] is due simply to the fact that the belief generally prevails that its progressive depreciation will soon stop, or perhaps even that its value per unit will once more improve. The moment that this opinion is recognized as untenable, the process of ousting paper notes from their position as money will begin. If the process can still be delayed somewhat, it can only denote another sudden shift of opinion as to the state of the mark’s future value. The phenomena described as frenzied purchases have given us some advance warning as to how the process will begin. It may be that we shall see it run its full course.

Obviously the notes cannot be forced out of their position as the legal media of exchange, except by an act of law. Even if they become completely worthless, even if nothing at all could be purchased for a billion marks, obligations payable in marks could still be legally satisfied by the delivery of mark notes. This means simply that creditors, to whom marks are owed, are precisely those who will be hurt most by the collapse of the paper standard. As a result, it will become impossible to save the purchasing power of the mark from destruction.

And in 1946, he commented on using easy money and deficit spending to stimulate the economy after a long period of cheap credit (The Trade Cycle and Credit Expansion):

In discussing the situation as it developed under the expansionist pressure on trade created by years of cheap interest rates policy, one must be fully aware of the fact that the termination of this policy will make visible the havoc it has spread. The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptizing it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.

The Bank of England hopes to avoid all this by manipulating people’s expectations about inflation and GDP growth. I don’t think it can be done – too many commentators can see through it.

Nevertheless, they are going to give it a try. The best that can be said for it in the context of the German experience which Mises predicted and lived through is that at least if coming events are well understood, contemporary errors may at last produce the paradigm shift in economic thought necessary to put us on a more just and moral economic path.

This post originally appeared on


The Divinity School debate

“…the stoppage of issue in specie at the Bank [in 1797] made no real addition to the financial powers of the country. On the contrary, it diminished considerably the real efficiency of those powers, while it introduced a facility in money-transactions, which has cost the country more in real comfort, and will probably cost it more in lasting expense, than any circumstance that has ever occurred.”

“If there had been less facility, there probably would have been more utility in those transactions; money would have been more valuable and more valued. The [fixed income] stocks probably would have been lower in price, but certainly no less deserving of confidence. There would have perhaps been a larger discount on floating [short-dated] securities; but there would have been fewer complaints of the expense of living; and, above all, the country would have had the unimpaired glory of having resisted all dangers from without, as well as within, without the sacrifice or suspension of any one principle of public faith.”

Reply of Walter Boyd to a letter from a friend sent 9th January, 1801

‘The Future of Finance’ was a conference convened in May by the Knowledge Transfer Network with the support of, among others, the Institute for New Economic Thinking and Oxford’s Said Business School. As part of the programme, a debate was staged between the representatives of four ‘schools’ of economic thought – the Monetarists, as represented by the former ‘Wise Man’ Professor Tim Congdon; the Keynesians, as championed by Christopher Allsopp, formerly of the BoE’s MPC; the Complex Adaptive Systems approach of Professor Doyne Farmer of ‘Newtonian Casino’ fame, and the Austrians whose corner was fought by yours truly.

The following essay attempts to expand upon the arguments I made that night in what was obviously a much more concise form, together with some more general thoughts thrown up by the conference at large. Since the event in question was deliberately – if courteously – adversarial and given that it was consciously staged as a species of entertainment, rather than one of deep academic debate, it will be apparent that none of us protagonists were fully able to develop our views beyond what could be incorporated into a few minutes’ pitch to our audience.

Moreover, none of us were allowed any subsequent opportunity for further attack or rebuttal, but could only respond, in the round, to a sampling of questions posed by the audience. In the circumstances, if the arguments of my opponents seem in anyway superficial as I summarize them here, I trust they will be gracious enough to accept, by way of an apology, the acknowledgement that my own propositions on the night will have seemed no less denuded of context or justification than perhaps did theirs.

Their bloody sign of battle is hung out

Ladies and Gentlemen, if you have heard of us ‘Austerians’ at all, you probably have in mind a caricature of us as loony liquidationists, eager for a Bonfire of the Vanities in which to purge the sins of all those who seem to have enjoyed the late Boom rather more than we did as we paced up and down outside the party, weighed down with our sandwich boards on which were emblazoned the injunction, “Repent Ye now for the End is nigh!”

Naturally, I don’t quite see it like that, nor do I feel shy about proclaiming our virtues over those supposedly possessed by the Tweedledee and Tweedledum of macromancy – the monetarists and the Keynesians – whose alternating and often overlapping policy prescriptions have, in the immortal words of Oliver Hardy, gotten us into one nice mess after another.

The monetarists – or perhaps we should call them the ‘creditists’, since they are not often overly clear about the crucial distinctions which exist between money, the medium of exchange, and credit, a record of deferred contractual obligation – tend to be children of empiricism.  I hasten to add that, for an Austrian, there are few greater insults that can be bandied about: Mises himself once waspishly observed that the modern dean of monetarism, Milton Friedman, was not an economist at all, but merely a statistician.

To digress a moment, ‘money’ is different from ‘credit’ and the refusal to consider how, or in what manner is what leads to many errors, not just of thought but also of deed, for if there is one thing that modern finance is pre-eminently equipped to do, it is to transform the second into the first and thereby pervert the subtle webs of economic signalling which are so fundamental to our highly dissociated yet profoundly inter-dependent way of life.

We could of course come over all philosophical about money being a ‘present good’ – indeed, the archetypical present good – and about credit being a postponed claim to such a good. We could then go on to point out that, far from being a scholastic quibble, such a distinction is of great import to the smooth functioning of that vast assembly line which we call the ‘structure of production’ and that to subvert their separation is to call up from the vasty deep the never-quite exorcised demons of the ‘real bills’ fallacy and to begin to set in train the juggernaut of malinvestment which will soon induce a widespread incompatibility among the individually-conceived, yet functionally holistic schemes of which we are severally part and so lead us through the specious triumph of the Boom and into that grim realm of wailing and the gnashing of teeth we know as the Bust.

Later, we shall have more detail to add to this, our Austrian diagnosis of the role of monetized credit in the cycle, but for now let us instead point out that money is a universal means of settlement of debts and thus acts as a much-needed extinguisher of credit. In making this assertion, I have no wish to deny that the latter cannot be novated, put through some kind of clearing mechanism, and hence cross-cancelled, in the absence of money – as was the often nearly attained ideal aim at the great mediaeval fairs, for example – simply that the presence of a readily accepted medium of exchange greatly facilitates this reckoning. Furthermore, though a new crop of expositors has sprung up to make claims that credit is historically antecedent to money (though the plausible use of polished, stone axe-heads as a proto-money which was current all along the extensive Neolithic trade routes of 5,000 years ago might give us renewed cause to doubt this now-fashionable denial), this is hardly to the point in the present discussion.

Money may or may not have sprung up, as is traditionally suggested, to avoid the well-known problems of barter, but, however it arose, what it did do was obviate the even more glaring impediments of credit – namely that, as the etymology of the word reminds us, ‘credit’ requires the establishment of a bond of trust between lender and borrower, a trust whose validation is, moreover, subject to the vicissitudes of an ever-changing world by being a temporally protracted arrangement.

Thus, while money’s joint qualities of instantaneity and finality may confer decided advantages upon its users, its main virtue indisputably lies in the impersonal nature of its acceptance in trade for it is this which frees us from the limited confines of our networks of trust and kinship and so greatly magnifies the division of labour and deepens the market beyond all individual comprehension in a mutually beneficial, ‘I, Pencil’ fashion.

For its part, credit certainly may help us get by with less money, never moreso than when we have become drunk on its profusion and giddy at the possibilities this abundance seems to offer amid the boom. Then, we may truck and barter more and more by swapping one claim for another almost to the exclusion of the involvement of money proper but, as the great Richard Cantillon pointed out almost three centuries before Lehman’s sudden demise forcefully impressed the lesson upon us modern sophisticates once more,

…the paper and credit of public and private Banks may cause surprising results in everything which does not concern ordinary expenditure… but that in the regular course of the circulation the help of Banks and credit of this kind is much smaller and less solid than is generally supposed…

Silver alone is the true sinews of circulation.

This article is the first in a series. Continue to Part 2: Scylla & Charybdis.


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.


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.


Gold “bubble” bursting? – I don’t think so

Previously published at Paper Money Collapse on Wednesday, 4 October.

In today’s Financial Times Mark Williams argues that the recent correction in gold means the gold “bubble” is finally bursting. Unfortunately, he does not provide a single reason for why the 10-year bull market in the precious metal constitutes a “bubble”, nor why this rally must end now.

According to the narrative of this article, investing in gold must have always been quite an irrational endeavour. Such folly was simply made easier with the advent of liquid ETFs (exchange-traded funds), which made the gold market more accessible to the small investor and trader. From than on, an irrational rally must have just fed on itself. Quote Mr. Williams:

“By 2005, more and more investors tried to rationalise why gold was no longer a fringe investment. It was a hedge against a weak dollar, global turmoil, incompetent central bankers and inflation. As trust in the financial system declined, gold would naturally rise, they reasoned.”

How silly! How could they believe that?

So according to Mr. Williams, gold has been going up because….it had been going up before. The investors simply rationalized it with hindsight. But gold recently went down, and down quite hard. Measured in US dollars, gold is down 16% from its peak on September 5. And now it has to go down further, so reasons Mr. Williams. If people bought it because it was going up, they must now sell it because it is going down.

Toward the end of his article we get the usual bon mot – by now repeated ad nauseam by Warren Buffett – that gold does not produce anything, does not create jobs, and does not pay a dividend. Yawn.

Gold is money

To compare gold with investment goods is wrong. Gold is money. It is the market’s chosen monetary asset. It has been the world’s foremost monetary asset for thousands of years. It has been remonetised over the past 10 years as the global fiat money system has been check-mating itself into an ever more intractable crisis. Faith in paper money as a store of value is diminishing rapidly. That is why people rush into gold. It doesn’t replace corporate equity or productive capital. It replaces paper money.

At every point in time you can break down your total wealth into three categories: consumption goods, investment goods and money. If you buy gold as jewellery, it is mostly a consumption good. If you buy gold as an industrial metal to be used in production processes, it is mostly an investment good. However, most people buy gold today as a monetary asset, as a store of value that is neither a consumption good nor an investment good. Therefore, you have to compare it with paper money. That is the alternative asset.

The paper dollars and electronic dollars that Mr. Bernanke can create at zero cost and without limit, simply by pressing a button, equally do not produce anything, do not create jobs, and do not pay dividends either. Although, sadly, the reflationists and advocates of more and more quantitative easing – many of them writing for the FT – seem to think that this is what paper money does. Alas, it doesn’t. It only fools the public into believing that lots of savings exist that need to be invested, or that enormous real demand exists for financial and other assets. Expanding money is a trick that is beginning to lose its magic.

The dollars in your pockets do not generate a dividend, neither does the gold in your vault or your ETF. So why do you even hold money?

Because of uncertainty. You want to stay on the sidelines but want to maintain your purchasing power without spending it on consumption and investment goods in the present environment and at current prices.

Stocks, bonds and real estate have been boosted for decades by persistent fiat money expansion. Now that the credit boom has turned into a bust it is little wonder that people are reluctant to buy more of these inflated assets. (Some real estate and some stock markets are currently already deflating, which is urgently needed. But bonds are not. If there is a “bubble” at all, it is in government bonds, although that bubble seems to begin to deflate as well — one European sovereign at a time.)

People want to preserve spending power for when the bizarrely inflated debt edifice has finally been liquidated and things are cheap again. But policymakers and their economic advisors do not want that to happen (“Oh no, that dreadful deflation! No! Anything but a drop in prices!”) and they are using the printing press to avoid, or better postpone the inevitable at all cost, even at the cost of destroying their own paper money in the process. And that is why you cannot hold paper money and have to revert to eternal money: gold.

Gold versus paper money

Mr. Williams quotes the market value of the world’s largest gold ETF, GLD, at $65 billion at present, apparently considering this already proof of how mad things have become in the world of gold investing. Well, consider this: in just the first 8 months of the year 2011, Bernanke created $640 billion – out of thin air – and handed it to the banks. Since the collapse of Lehman Brothers, the Fed has created reserve dollars to the tune of $1,800 billion, or more than twice as much as the Fed had created from its inception in 1913 up to the Lehman collapse in 2008. Or, if you like, 27 GLDs at present market value. The money supply in the M2 definition has gone up also by $1,750 billion since Lehman. Mr. Williams, why is anybody still holding these absurd amounts of paper cash? Isn’t that the more interesting question rather than the tiny amounts that they hold in the form of physical gold?

The biggest owner of gold is allegedly the United States government. I say ‘allegedly’ because they have not done a proper audit for a while. Supposedly, the U.S. has 261 million ounces of gold in their vaults at Fort Knox. At current market price that is a market value of $423 billion. Bernanke created more paper money between last Christmas and last Easter!

And those who, like Mr. Buffett, feel like joking that the entire stock of gold fits under the Eiffel tower – ha! ha! ha! – let they be reminded that the trillions that Mr. Bernanke created fit on the SIM cards in their mobile phones. It is all electronic money – and when Mr. B turns into a monetary Dr. Strangelove and goes bonkers with those nuclear buttons, there will be much more fiat money around.

Let me be clear on this point: the fact that money today consists of paper or is even immaterial money and consists of no substance at all is, no pun intended, immaterial to me. It doesn’t matter. As an Austrian School economist, the concept of “intrinsic value” that some gold bugs cite in defence of gold money is meaningless to me. Money does not need a substance to be money. The problem with modern money is not its lack of substance but its perfectly elastic supply. The privileged money producers create – for political reasons – ever more of it. That is the problem. And that is why the market remonetises gold. Nobody can produce it at will.

Here is Mr. Bernanke again:

“The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost…We conclude that under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

But to Mr. Williams, paper dollars are now a safer bet than gold:

“Fears of a Greek default and eurozone turmoil are now prompting investors to buy US dollars – which many are starting to see as a safer bet than the euro or volatile gold.”

Hmmm. Safer? Are you sure?

What’s next for gold?

Mr. Williams may, of course, be right in predicting that the gold price may go down from here. For that to happen the faith in paper money has to be restored, at least to some degree. The printing presses have to stop and liquidation must be allowed to proceed. And that is precisely what happened under Fed chairman Volcker in 1979. That is what caused the previous correction in the gold “bubble”.

The question is this: How likely is this now?

In my view the present sell-off in gold is the result of the market going through another deflationary liquidation phase, yet at the same time the central bankers seem reluctant to throw more money at the problem. The ECB is buying unloved Italian sovereign bonds rather joylessly at present, and Bernanke seems for the time being happy to reorganize his bond portfolio rather than to print more money. Alas, I don’t think it will last. I am fairly confident it won’t last. They won’t have the stomach to sit tight.

Pressure is already building everywhere for more quantitative easing. Ironically, on the very same page of the FT, on which Mr. Williams argues that the gold bubble has burst, Harvard economist Kenneth Rogoff presents his case that this time is not so different, and that we can simply kick the can down the road once more by easing monetary policy, just as we have done for decades. In China, in Europe, everywhere, just print more money. And I already made ample references to Martin “Bring-out-the-bazooka” Wolf, who desperately urges the central banks to print more money.

Will the central bankers ignore these calls, as they should? I don’t think so. Remember, the dislocations are now astronomically larger than they were in 1979. The system is more leveraged and much more dependent on cheap credit. In the next proper liquidation, sovereign states and banks will default – no central banker will be able or willing to sit on his hands when that happens. But in order to postpone it (they won’t avoid it) they need to print ever more ever faster.

We are in a gold bull market for a reason, and a very good reason indeed. Unless the underlying fundamentals change (or policy changes fundamentally), I consider this sell-off in gold rather a buying opportunity.