Thoughts, essays, and writings on Liberty. Written by the heirs of Patrick Henry.

“A people armed and free forms a barrier against the enterprises of ambition and is a bulwark for the nation against foreign invasion and domestic oppression.”     James Madison

December 19, 2008

A Primer on Money

by tarran

Money is critical to civilization. Without it, the capital improvements and complex economic processes are impossible, and there will be a very weak form division of labor. Money allows humanity to rise above the savagery of stone age existence. Yet most people don’t understand what money is, how it is created and how it can be abused by elites in a society to plunder the common men.

What is money?

Imagine you are a farmer. You want to purchase some shoes. You grow grain. To purchase shoes in a barter economy, you must find a shoemaker who wants some grain. If you want to purchase some eggs, you must find an egg farmer who wants grain. If you want to make a tractor, you have to find a tractor maker who wants to be paid in grain, or failing that, you have to find the tools and materials you need to build the tractor from scratch, finding suppliers who are willing to be paid in grain.
Of course, grain is perishable, so you can’t amass too much grain with which to pay for really expensive stuff. And of course, you are not likely to find a supplier who is willing to be paid in large amounts of grain since they fact the same problem. As a result, you will be limited to purchasing small items that are worth small amounts of grain.

All of these problems can be solved by trading your grain not directly for the stuff you want to consume, but for something that is
a) more long lasting than your grain
b) in wider demand than your grain

Whereas you might only find one shoemaker who is willing to trade shoes for your grain, you might find three shoemakers who are willing to trade shoes for this mystery substance. This allows you to chose the lowest cost supplier of shoes, who is willing to trade the most shoes for the least amount of your grain.

Additionally, you can stockpile this substance, storing it for later consumption, allowing you to save years of productions in order to purchase some very expensive item like a tractor.

Finally, if this substance is popular enough, you will be able to find many people willing to buy your grain by trading you this substance. This allows you to maximize the payment you get for your product.

Of course, given a choice between two substances that have these qualities, you will naturally choose the substance that has the best qualities you are looking for, choosing the more popular substance over the less popular one if you are looking for something to trade in the near term, and choosing the more durable item over the less durable one if you are looking to stockpile it.

If you are not a farmer, but a tractor maker, selling one tractor every few months, but needing to buy food daily you will of course have an additional quality you demand: you want something that is divisible.

Any human society where people engage in trade, some substance or small group of substances that are
a) homogeneous or fungible
b) durable
c) in wide demand

will come to dominate the trade. These substances are what we call money.

Inflation in a free market

Since money is merely a commodity that is widely demanded for trading purposes, it is produced like any other commodity. Farmers grow tobacco. Distillers distill whiskey. Chemists produce cocaine paste. Miners produce gold. The production is dictated by the demand for the commodity.

Of course, the larger the supply of money that is available for trade, the lower the price of the money in terms of other commodities. In other words, if the supply of gold expands, everything else being equal, the number of bushels of grain an ounce will purchase will go down. Of course, to a persons seeking to purchase things with the money, they see this as each bushel of grain having a higher price.

Rising prices erode savings. The faster the supply of a money commodity is increasing, the less useful it is as a way of saving. This reduction in the usefulness of the commodity translates into a reduced demand for it. The reduction in demand means that people will be less interested in trading other goods for it, which again results in a rise in prices, since a a grain seller will want even more of the stuff before he is willing to risk a trade.

There are two outcomes of rising prices due to inflation in a free market. The first is that production is reduced. As the money commodity becomes worth less, its production becomes less profitable. The production eventually slows until the effort involved in producing money is once again justified by the profit earned by selling it for other goods and services.

The second is that people look for more stable substitutes, and start switching to using alternate money-commodities for their transactions.

Deviation From Free Markets

Money standards
Of course, the producer of the money commodity would prefer that this not happen. Many would see an opportunity for great profit if they could produce the commodity as rapidly as possible without having to worry about people abandoning the money.
So they call for laws to force people to do business in that commodity. These laws are known as legal tender laws. These laws force people to settle debts in the commodities whether they want to accept them or not. The force is to the detriment of consumers and money users, who are forced to forego a better money in favor of the standard.
Taxation
Taxation can confine people to using a particular commodity just as legal tender laws do. If the government routinely levies taxes that are to be paid in fish-heads, for example, people will have to procure a certain number of fish-heads annually to pay the tax. The fish-heads being in wide demand, naturally they are used in indirect exchange. Other commodities are at a substantial disadvantage as far as their usefulness as a money.
Discriminatory Taxation
A government can also make alternate commodities even less popular by taxing transactions or saving in other commodities more heavily than the government approved money commodity. Her in the United States, for example, if you keep your savings in gold rather than in U.S. dollars, when you trade the gold for something else, you are levied a capital gains tax on the difference between the prices in dollars of gold on the day it was traded away and the day you acquired it.

The dangers of government control of the money supply

There are two properties that make governments especially destructive:

1)Governments are able to seize resources by force and to compel people to do buainess with them allowing them to continue economically unprofitable activities for far longer than free market enterprises.

2)Governments, being controlled by people who have little incentive to take a long term view, and a great deal of incentive to use their offices for short-term personal gain

When governments seize control of the money supply, the result is usually disaster. They overproduce money, usually by debasing coinage. They force people to use the state approved currency to the exclusion of all else. In extreme cases they wreck the economy so badly that saving because impossible, and the economy reverts to a barter economy.

Today, the United States government has engaged in massive amounts of spending. They are not getting this money through taxation. Rather they are borrowing it, and a good porioin of what is being borrowed is money created by the Federal Reserve. The production costs of U.S. dollars being almost nonexistent, the Federal Reserve can continue to create money profitably through a Zimbabwe like hyperinflation. The Soviet Union and Nazi Germany were founded upon the ruins of nations whose economies had been strangled by government mismanagement of money. Will the United States similarly succumb to tyranny? Time will tell.

Recommended Reading

What has government done to our money? by Dr Murray Rothbard

Milton Friedman and the Case against Currency Monopoly by G Selgin

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5 Comments

  1. How long do you think it will be until some alleged “libertarian” calls you a gold-bug?

    Comment by David Z — December 21, 2008 @ 12:10 pm
  2. All the legislation is no good thing and the government guarantees are not good. But fractional reserve asset inflation creates a hot potato that needs to be passed on. Those houses that were inflated needed to stay inflated to justify the former loans and money creation. Since if the housing price tanked all the owners would have been insolvent. So the logic of it was that the houses had to be constantly offloaded.

    If you had an investor with a dozen houses clearly he was under pressure to offload them onto individuals to stem any cash flow stress he was under, before the prices went down, and so in fact a great deal of society would have been favoring ongoing asset inflation. But once it gets down to the poorer homeowner there is no-one left to unload to.

    We ought not be blaming the poorer people who are now being evicted simply because they were the ones caught with the hot potato.

    The answer is to get rid of the 77,000 pages of regulation and simply have a regulation getting rid of fractional reserve banking. So any on-call money has to stay at the bank. There has to be a strict segregation between on-call money and lent money.

    So you have on-call deposits and term deposits and no fudging between the two. That way the banking cartel cannot get together and pyramid ponzi-money on top of the cash. And the money supply then becomes equal to the cash. That’s dealt with one thieving party but then you really need to deal with the other thieves in this picture by fazing out fiat money in its entirety and phase to private monies backed by various commodities.

    Once you have this sort of hard money the investment dollars go to wealth-producing activities. Debt can produce wealth when its used to buy things that improve cash-flow. And this would be the effect. Since banks would have to borrow long and lend less long or they’d go broke. Or if they borrowed short they would have to lend shorter. This would mean that one of the priorities as to how they would allocate loans would be how quickly you could pay the loan back.

    Hard money would also mean that they couldn’t rely on asset inflation to back the loan up. This combination would in practice mean that the competitive and surviving banks would be interested in making loans for wealth creation.

    That is for people who were buying something in order to improve their cash flow. Since the banks now have a big priority on getting paid back faster to keep their assets on a shorter time frame than their liabilities. In practice that would mean a smart bank would tend to try and use these loans for wealth creation.

    Now they are just rip-off merchants who try to use debt for asset inflation and spending addiction.

    Which is one of the real reasons your manufacturing goes offshore.

    It might seem somewhat implausible that you can go in debt to improve cash-flow but what you must realize is that after a shake-out a lot of these things that you could buy with loan money would be a lot cheaper.

    Comment by Travis — December 22, 2008 @ 5:34 pm
  3. So you have on-call deposits and term deposits and no fudging between the two. That way the banking cartel cannot get together and pyramid ponzi-money on top of the cash. And the money supply then becomes equal to the cash. That’s dealt with one thieving party but then you really need to deal with the other thieves in this picture by fazing out fiat money in its entirety and phase to private monies backed by various commodities.

    Travis, this is actually less liberal (in the pro-liberty sense) than what it’s replacing. Fractional reserve banking exists so those holding the money can have some reason to do so. If I’m ZZ National Bank and I’m not allowed to lend out some of my “on call” deposits, as you term them, what reason do I have to hold these deposits at all? What incentive do I have not just to offer term deposits?

    People demand “on call” deposits, you say? Well, since I can’t make any money off them by lending some of them out, I need to recoup my operating costs by say, charging a 2% fee every month on each account. Don’t like having to pay $200 a month on the $10,000 you’ve got on call? Tough, I’ve got expenses.

    Now, why shouldn’t the depositor have a choice between my ZZ National Bank, where he has to pay to have money guaranteed there when you need it, or AAA Savings and Loan, where he knowingly risks not having his money during a bank run?

    Comment by Quincy — December 22, 2008 @ 10:40 pm
  4. 6s6Msv Thanks for good post

    Comment by johnny — December 29, 2008 @ 3:19 am
  5. Hey, you have a great blog here! I’m definitely going to bookmark you!

    Comment by crosamondgy41 — January 8, 2009 @ 6:02 am

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