Tuesday, November 17, 2009

The Perils of Paper Money

The full implications of adopting a national fiat currency has not been well thought-out by the majority of the American citizenry. But we can clearly see the effect of rampant inflation with the soaring of gold and other commodity prices. It is my opinion that the purpose of the practice of issuing fiat (that is, imaginary) currency is to facilitate the theft of the nation's wealth, to provide a means for politicians to manipulate the economy, to usher in the collapse of the American economy, and to transition the world to communism, if the issuance of fiat currency is not in effect a form of communism already.

This grand theory is beyond the scope of this current post, but suffice it to say, that the adoption of paper currency and pursuant inflation of the money supply is ruinous to a country's economy. A few choice selections will illustrate this point and provide sources for the interested but otherwise uninitiated reader.

Once money ceases to be what Ludwig von Mises defined - "a store of wealth" - and is instead a manifestation of exchange-debt, then the collapse of the economy is imminent indeed. Money under a fiat system is no longer property and one is no longer entitled to a set amount of property (gold or silver, or specie currency) in exchange for it. This system is reflective of a point of view where the government owns the people and arbitrarily controls the value of their labor, as well as gives the government the ability to manipulate the economy for political purposes.

There have been variations of this theme throughout history. To demonstrate the perils of a paper money system, I can do little better here in a reasonable amount of space than to select one of a number of relevant passages from Murray Rothbard's A History of Money and Banking in the United States:

"Apart from medieval China, which invented both paper and printing centuries before the West, the world had never seen government paper money until the colonial government of Massachusetts emitted a fiat paper issue in 1690...

Suspecting that the public would not accept irredeemable paper, the government made a twofold pledge when it issued the notes: that it would redeem them in gold or silver out of tax revenue in a few years and that absolutely no further paper notes would be issued. Characteristically, however, both part of the pledge went quickly by the board: The issue limit disappeared in a few months, and all the bills continued unredeemed for nearly 40 years. As early as February 1691, the Massachusetts government proclaimed that its issue had fallen 'far short' and so it proceeded to emit £40,000 of new money to repay all of its outstanding debt, again pledging falsely that this would be the absolute final note issue.

But Massachusetts found that the increase in the supply of money, coupled with a fall in the demand for paper because of growing lack of confidence in future redemption in specie, led to a rapid depreciation of new money in relation to specie. Indeed, within a year after the initial issue, the new paper pound had depreciated on the market by 40 percent against specie.

By 1692, the government moved against this market evaluation by use of force, making the paper money compulsory legal tender for all debts at par with specie and by granting a premium of 5 percent on all payment of debts to the government made in paper notes. This legal tender law had the unwanted effect of Gresham’s Law (think 1933 gold seizures and 1971 closing of the "gold window"): the disappearance of specie circulation in the colony. In addition, the expanding paper issues drove up prices and hampered exports from the colony. In this way, the specie “shortage” became the creature rather than the cause of the fiat paper issues. Thus, in 1690, before the orgy of paper issues began, £200,000 of silver money was available in New England; by 1711, however, with Connecticut and Rhode Island having followed suit in paper money issue, £240,000 of paper money had been issued in New England but the silver had almost disappeared from circulation.

Ironically, then, Massachusetts’s and her sister colonies’ issue of paper money created rather than solved any 'scarcity of money.' The new paper drove out the old specie." (51-52)

I could continue to quote Rothbard's magisterial tome at length, but instead will recommend to anyone who has not done so to read the book online for free. It is one of those rare works that one can pick up and put down with ease. Each page has sufficient intellectual sustenance to digest for hours on end.

Of course, another work that illustrates the futility of manipulating the currency to create the illusion of generating wealth is Adam Smith's Wealth of Nations:

"In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, scarce any thing being less perishable than they are, but they can likewise, without any loss, be divided into any number of parts, as by fusion those parts can easily be reunited again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation.

Different metals have been made use of by different nations for this purpose. Iron was the common instrument of commerce among the antient Spartans; copper among the antient Romans; and gold and silver among all rich and commercial nations...

The use of metals in this rude state was attended with two very considerable inconveniencies; first with the trouble of weighing; and, secondly, with that of assaying them. In the precious metals, where a small difference in the quantity makes a great difference in the value, even the business of weighing, with proper exactness, requires at least very accurate weights and scales. The weighing of gold in particular is an operation of some nicety. In the coarser metals, indeed, where a small error would be of little consequence, less accuracy would, no doubt, be necessary. Yet we should find it excessively troublesome, if every time a poor man had occasion either to buy or sell a farthing's worth of goods, he was obliged to weigh the farthing. The operation of assaying is still more difficult, still more tedious, and, unless a part of the metal is fairly melted in the crucible, with proper dissolvents, any conclusion that can be drawn from it, is extremely uncertain. Before the institution of coined money, however, unless they went through this tedious and difficult operation, people must always have been liable to the grossest frauds and impositions, and instead of a pound weight of pure silver, or pure copper, might receive in exchange for their goods, an adulterated composition of the coarsest and cheapest materials, which had, however, in their outward appearance, been made to resemble those metals. To prevent such abuses, to facilitate exchanges, and thereby to encourage all sorts of industry and commerce, it has been found necessary, in all countries that have made any considerable advances towards improvement, to affix a public stamp upon certain quantities of such particular metals, as were in those countries commonly made use of to purchase goods. Hence the origin of coined money, and of those public offices called mints; institutions exactly of the same nature with those of the aulnagers and stampmasters of woollen and linen cloth. All of them are equally meant to ascertain, by means of a public stamp, the quantity and uniform goodness of those different commodities when brought to market.

For in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been originally contained in their coins. The Roman As, in the latter ages of the Republic, was reduced to the twenty-fourth part of its original value, and, instead of weighing a pound, came to weigh only half an ounce. The English pound and penny contain at present about a third only; the Scots pound and penny about a thirty-sixth; and the French pound and penny about a sixty-sixth part of their original value. By means of those operations the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and to fulfil their engagements with a smaller quantity of silver than would otherwise have been requisite. It was indeed in appearance only; for their creditors were really defrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor, and have sometimes produced a greater and more universal revolution in the fortunes of private persons, than could have been occasioned by a very great public calamity." (See Ron's cited passage James 5:1-6).

Finally, one can touch upon the comparisons of the decline of the American republic and the collapse of the Roman empire, which vary from the superficial to the profound. A sober, and quite sobering, synopsis can be found in Ludwig von Mises' lecture "The Rise and Decline of Civilization":

"What had taken place? What was the problem? What was it that caused the disintegration of an empire which, in every regard, had attained the highest civilization ever achieved before the eighteenth century? The truth is that what destroyed this ancient civilization was something similar, almost identical to the dangers that threaten our civilization today: on the one hand it was interventionism, and on the other hand, inflation. The interventionism of the Roman Empire consisted in the fact that the Roman Empire, following the preceding Greek policy, did not abstain from price control. This price control was mild, practically without any consequences, because for centuries it did not try to reduce prices below the market level.

But when inflation began in the third century, the poor Romans did not yet have our technical means for inflation. They could not print money; they had to debase the coinage, and this was a much inferior system of inflation compared to the present system, which--through the use of the modern printing press-can so easily destroy the value of money. But it was efficient enough, and it brought about the same result as price control, for the prices which the authorities tolerated were now below the potential price to which inflation had brought the prices of the various commodities.

The result, of course, was that the supply of foodstuffs in the cities declined. The people in the cities were forced to go back to the country and to return to agricultural life. The Romans never realized what was happening. They did not understand it. They had not developed the mental tools to interpret the problems of the division of labor and the consequences of inflation upon market prices. That this currency inflation, currency debasement, was bad, this they knew of course very well.

Consequently, the emperors made laws against this movement. There were laws preventing the city dweller from moving to the country, but such laws were ineffective. As the people did not have anything to eat in the city, as they were starving, no law could keep them from leaving the city and going back into agriculture. The city dweller could no longer work in the processing indus­tries of the cities as an artisan. And, with the loss of the markets in the cities, no one could buy anything there anymore...

There are enormous differences between present-day conditions and those that prevailed in Rome, in that the measures that caused the disintegration of the Roman Empire were not premeditated. They were not, I would say, the result of reprehensible formalized doctrines."


Anonymous said...

Gosh, Reason, you're so fuckin' smart.

Reaganx said...

It should also be added that gold-backed money that existed in the 17th through 20th centuries was midway between the "real" gold standard (i.e. gold without any paper notes) and unbacked paper. Since such bank notes were not FULLY backed, they were also fraudulent and resulted in damage (though less damage than unbacked paper money). The government and state-controlled or state-protected banks also manipulated such notes.
Another thing- I guess inflation is not the main problem of paper money. Probably boom-and-bust cycles, which are a separate problem (they result from the government's manipulation of the money supply), are even more disastrous. We're witnessing the end of one of such cycles now.

Reaganx said...

By the way, Rothbard, though he plagiarized Rand's political philosophy without giving her any credit and wasn't very nice to her overall (to put it mildly), was still a great economist and any of his books is a very entertaining and interesting read.

Reasonsjester said...

A. Nony Mouse:

The point isn't to seem smart, in fact most of this entry is simply sourcing other people's ideas on the subject. Sometimes people who read books, written by people whom they agree with and disagree with, do that.

That being said, are you feigning some intellectual insight into the matter that I haven't considered? Perhaps you can write a response, "The Merits of Paper Money," instead of resorting to the weak play of unexplained sarcasm?

(I myself am sarcastic from time to time, but I always explain myself, even if cryptically.)

Reasonsjester said...

ReaganX, I have some problems with Rothbard personally, but I love the way he writes economic history.

Reaganx said...

Re Rothbard- Yes, that was my point, my sentiments exactly.