Why The Money Monopoly is Evil

We are used to money being issued and controlled by the state – but if we look at its history we see that money originates from the free market. Without money, a reasonable division of labor would not be possible. If humans want to trade with each other, bartering is not practical. If I have apples and need eggs, I would need to find a person that wants to trade his eggs for apples at this very moment, which is not too likely. On top of that, we have to agree on a ratio of how many apples have the value of an egg or vice versa.

When humans still lived together in small groups, an informal credit economy developed. You would share goods with your neighbors and keep track of the debt each had with one another. In the long run, everyone would try to maintain an even balance and to give as much as one would get. If you infringed this unwritten rule by fleecing others, you would quickly become an outsider.

But such a system based on trust and social control no longer worked when humans began to live in bigger societies. To be able to trade with one another, a medium was invented to express the value of goods and services: money. In nomadic societies, the first choice for money was often cattle. This is why the Latin word for money, pecunia, was derived from the word for cattle, pecu. Throughout history many different goods were used as money, from arrowheads and seashells to cocoa beans and dried tiger tongues.

The Qualities of Good Money

Eventually, humans of different regions and countries started to use precious metals as money. They discovered independently of each other that some qualities of gold and silver make them especially useful as a medium of exchange. This is because precious metals are:

• scarce
• easy to transport and to store
• durable
• divisible
• hard to counterfeit
• fungible – which means that one piece is as good as any other one.

The most important quality for money is scarcity. Precious metals are rare and can only be extracted from the earth with significant effort. The scarcer a useful good, the more valuable it becomes. Therefore it is much more practical to use gold than the abundantly available iron – otherwise you would have to go shopping with a heavy pushcart. Another important quality of money is its durability: iron corrodes, gold doesn’t. So you can use it not only as a medium of exchange but also as a medium to store value over a long time.

Divisibility is another reason why cattle did not prevail as money: two halves of a cow simply won’t have the same value as a whole one. Diamonds also lose a lot of their value if you smash them into small pieces. Gold, however, can be divided without losing any of its value. By using gold, people have more ways to settle on a trade, even if they only have something less valuable to offer than a whole cow. 

Because of these special qualities, gold has served as the best form of money for thousands of years. As J.P. Morgan, one of the most successful bankers of the early 20th century, pronounced, “Only Gold is money, everything else is credit.”

Manipulation of Money

As long as money exists, kings and rulers have tried to manipulate it for their own benefits. They determined that gold could only be used in the form of special coins, usually ones carrying the king’s image. It became the state’s duty to guarantee the correct value and content of gold, so one did not have to weigh it. 

A popular way to manipulate coins was to file of a bit off the edges. In fact, the decorative edge patterns we see on coins today were originally introduced to prevent fraudsters from using shaved coins. Another way to cheat was to dilute gold or silver with less valuable metals. Often, the rulers themselves used these tricks to secretly steal citizens’ property. But their possibilities to manipulate money in creased by magnitudes when a new practical invention appeared: paper money.

Paper Money and Fractional Reserve

Originally, banknotes were nothing else than receipts for gold or silver that were stored safely in a bank vault. Carrying heavy coins was not very practical and quite unsafe, as street robbers could easily assault you. As a result, many people preferred to keep their gold in banks. For practical reasons, people started to use the receipt they received from the bank for the stored money as a means of payment. When buyer and seller were clients at the same bank, the gold did not even have to be moved when its owner changed. If they had accounts at different banks, the bankers were responsible for the gold’s secure transport. In both cases, the bank subtracted the amount of gold from one client’s account and added it to another one. One had to trust the bankers that they did this without cheating, but many saw this as the lesser evil than running the risk of being robbed. It also made international trade much easier.

Some smart bankers found out a new way to make money: they simply gave out more receipts than they had gold in their vaults, as it was very unlikely that all their customers would come to withdraw their funds at the same time. This enabled them to issue loans and charge interest for money that did not belong to them. In normal life this would be called deceit. In the financial world it is called “fractional reserve banking.” 

Governments legalized the fraudulent behavior of the bankers, and banks were granted the right to only keep a small part of their deposits and to speculate with the rest. In return, banks funded government wars.

But what to do if too many clients withdraw their money at the same time and the swindle gets debunked? To avoid such a “bank run,” a central bank was created as the “lender of last resort.” Its main function was to provide enough money to banks that got into trouble.

The Gold Standard

As paper money led to some financial bubbles and bankruptcies in the 18th and 19th century, Peel’s law of 1844 demanded that in Britain all bank notes had to be entirely backed by gold. Unfortunately, this ap plied only to physical banknotes, not to sight deposits on bank accounts, so the fractional reserve fraud could carry on.

Anyhow, due to the relatively strict rules for British banks and the dominance of the British Empire in world trade, many nations followed the British example and adopted a gold standard. Most national currencies had a fixed exchange rate to gold and therefore to each other.

The late 19th and early 20th century were periods of immense economic growth. International trade increased. Prices remained stable, in the USA they even dropped. Wealth in the developed world grew steadily, partially as a result of the international gold standard.

But when the First World War started in 1914, all warring nations abolished the obligation of their central banks to redeem gold for bank notes – otherwise, the war would have lasted for only a few weeks. Central banks could then print unrestricted amounts of money to cover the high costs of warfare. Had the gold standard been in place, their gold reserves would have expired in no time.

Hyperinflation and World Economic Crises

The citizens paid for the huge bills resulting from the war. In Germany and many other countries hyperinflation decimated people’s savings. By November 1923, one US dollar was equivalent to the insane price of 4,210,500,000,000 German Marks. Some nations tried to return to a common gold standard, but their attempts failed. In 1924 Britain reintroduced the gold standard, but the British currency was overvalued due to the increase of paper money during the war. This became a high burden for the British economy and caused an economic crisis in Britain. This crisis was, however, dwarfed by the global economic crisis, which began on October 24th, 1929, or “Black Thursday.”

This crisis is a classic example of Ludwig von Mises’ theory of business cycles, which states that a boom caused by cheap loans will inevitably be followed by a bust. When investors can borrow money for an interest rate below the natural rate as defined in a free market, they will invest into ventures that are not really lucrative. Sooner or later this will show and must be adjusted, sometimes painfully.

According to Mises, the boom of the “Roaring Twenties” was the result of the US Federal Reserve Bank and its policy of easy credit. When it became obvious that the economic boom was built on sand, the economy crumbled. Unfortunately, the view of the Austrian School – which identified centralized intervention as the root of the crisis – did not prevail at the time.

Instead, the theory of British economist John Maynard Keynes guided popular opinion and governmental response. According to Keynes, increased government intervention is necessary during times of economic crisis. He claimed that governments should fund economic stimulus plans by creating debts.

Keynes and the “New Deal”

Politicians embraced Keynes’ theory as it gave them scientific justification to increase governmental power. Throughout the 1930s, state intervention in the economy became the rule. This was especially damaging in the Soviet Union and in National Socialist Germany, but even in the USA economic freedom was severely reduced. Owning gold was made illegal for US citizens in 1933. President Franklin D. Roosevelt’s policy of state intervention stood in stark contrast to the free market policies of former US administrations. In accordance with Keynes’ theory, he spent huge amounts of money to “stimulate the economy.” These measures gained him short-term popularity among voters, but it expanded the state apparatus to a size that became harmful to individual liberty. In fact, Roosevelt’s so-called New Deal did not end the crisis, but prolonged it, as Austrian economist Murray N. Rothbard demonstrated in his book America’s Great Depression.

Bretton Woods and the End of the Gold Standard

At the Bretton Woods conference in July 1944, the USA and its war allies created the post-war financial order. The US dollar became the anchor currency for the world, with the US government guaranteed other central banks that they could sell their US dollar reserves for gold at a fixed rate. Thus, the Bretton Woods system established an indirect worldwide gold standard.

This system worked well for a while, but when the US started to print more and more dollars to fund the Vietnam war, its weakness became obvious. The USA did not have enough gold to redeem for all the dollars circulating in the world. When several governments, especially the French, exchanged increasing amounts of their dollars for gold, the US gold reserves began to shrink to alarmingly low levels. On August 15th, 1971, President Nixon abolished the gold backing of the dollar. That was the beginning of the end for the Bretton Woods system, which was formally canceled in 1973.

Since then, currencies are no longer backed by anything. Unbacked currencies are called Fiat, which has nothing to do with the Italian car brand, but is derived from the Latin expression for “let there be.” Fiat currencies only exist because the state proclaims them to be “legal tender.” Without a government forcing people to accept it, no one would work for a piece of paper.

Fiat currencies have been the worldwide norm since 1971. In a fiat money system, money can be created in two ways. It can be issued by a central bank, which has the exclusive right to print banknotes and mint coins. The central bank then lends money to commercial banks for an interest rate it defines itself. 

Money can also be created by commercial banks. The state has granted them the privilege to generate new money each time they issue credit.

Loans from Nowhere

In the age of gold- and silver-backed money, a loan could only be given if someone had saved enough money to issue one. The lendee would ask a bank to act as a middleman in a transaction between him and someone else in return for interest. Today, a loan can be given without being backed by anyone’s savings. When a bank lends money to someone, it is newly created money. The bank only has to deposit a small fraction of each loan (in the US it is around 3%) as a security at the central bank.

This system is so absurd that most people would not believe it: while a borrower needs to work hard to pay back his loan and the interests on it, a bank can create new money out of thin air by the push of a button. A borrower may lose the house he has bought for a mortgage if he defaults. A bank can simply write a bad loan off. If it runs into financial problems, it is usually bailed out with taxpayers’ money. When new money comes into the world, new debt arises with it, which has to be paid back with an interest. This vicious circle leads to ever-growing piles of debt. Only the wealthy and the banks benefit from this system. For everybody else, saving money or accumulating a fortune becomes increasingly difficult.

Inflation

Inflation is defined as the increase of the money supply in an economy. It derives from the Latin word inflare, meaning, “to blow up.” When the money supply grows faster than the amount of goods and services in an economy, prices usually increase. We tend to call this price increase inflation, but economically this is incorrect. When news programs report on the “inflation rate,” what they are really referring to is a price index measured by a rather arbitrarily compiled basket of goods. Due to increased productivity and global division of labor, the prices of consumer goods in this basket should have fallen. Instead, the effect of monetary inflation keeps prices the same or only causes moderate increases. You can see the price-raising effect of monetary inflation in the ever-increasing prices of real estate and shares, which are not part of the basket, and therefore not recorded by the so-called “inflation rate.” You will hardly ever hear about real inflation, which is the growth of the money supply. For example, in the USA the money supply has grown from about 500 billion dollars in 1971 to nearly 12,000 billion dollars in 2015.

The Cantillon Effect

Inflation leads to growing social inequality. This is caused by the Cantillon effect, named after the economist Richard Cantillon. He demonstrated that those close to the source of the newly created money – governments, banks and big companies that are well connected to government institutions – have a huge advantage to those who receive the money later. The privileged ones can buy goods and services at the old prices before inflation takes effect. When the money trickles down to those who earn salaries or live on pensions, prices have already increased, they can buy less for their income. Additionally, their savings lose value, as the central bank maintains interest at artificially low rates. Today, the interest on savings is even lower than the official “inflation rate,” let alone the real one. Only few people benefit from a system like this, and it is at the expense of many others.

The Cantillon effect has resulted in an ever-growing gap between the super-rich and the average citizen. The growing divide between the “1%” and the rest of us is not capitalism’s fault, as people with little of knowledge of economics claim. Quite the contrary, it is caused by our monetary system, which has nothing to do with capitalism or a free market economy. You will find the idea of a centralized monopoly on money and a state-run central bank in the Communist Manifesto by Karl Marx and Friedrich Engels. As most Marxist ideas, it has done a lot of damage. Allowing a central authority to control money and define its price makes as much sense as letting a central planning institution fix the prices for consumer goods. The Austrian School has proven that the free market should determine the price of every good, including money.

Government Debts

Since the dollar is no longer backed by gold, the purchasing powers of all major currencies have plummeted. Today it would cost 15 dollars to purchase the same amount of goods as you could buy with a single dollar in 1971. At the same time, governments’ debts have skyrocketed. The US debt has grown from about $400 billion dollars in 1971 to more than $20,000 billion dollars in 2015.

This is no coincidence. Borrowing fiat money is much easier for politicians than borrowing real money backed by gold or silver. The state issues bonds, which are backed by nothing other than the government’s ability to tax people. These bonds are either sold to the central bank for freshly created money, or to wealthy people who consider them a relatively safe investment. By debasing the currency or by lowering the interest rate, the central bank can easily reduce the burden of interest on the government’s budget. In extreme cases the debt can be wiped out by a hyperinflation or a currency reform, as it happened in Germany after its lost wars.

But normally, more and more debt is piled up, which will probably never be paid back. Interest rates are being paid by tax revenues or even by taking up new loans. Every company with this kind of fiscal policy would be sued because of a delayed filing of insolvency. But rules for politicians are different. They are not accountable for the debt they cause, they simply saddle the next generation with it.

The End of the Fiat Money System

It is much easier for politicians to fund their promises towards their voters and sponsors by incurring debt and using the hidden tax of inflation than to risk unpopularity by officially raising taxes. But the long-term damages this causes to a society are substantial. A fiat money system inevitably leads to a distribution of wealth from the bottom to the top. Taxpayers and savers are gradually expropriated for the benefit of those who already have money and power.

The system of unbacked, debt-based money that has ruled the world since 1971 is harmful and evil. It is the main cause for financial crises, growing government debts and the increasing gap between rich and poor. It should be abolished immediately. But that is not so easy.

Very powerful institutions, such as banks and governments, have a vested interested to keep it alive. There is a superior option to fighting against this system: building a new one. This new system needs to be so much better than the existing one that more and more people start using it, until one day the old system becomes obsolete. 

That is what decentralized, stateless money such as Bitcoin or Steem is all about.

This article is an excerpt from my book "A Beginner's Guide to Bitcoin and Austrian Economics". I will also publish original content in the future, but this topic is so important that I wanted to share it with the Steemit community as soon as possible. 

If you upvote and share this post and let me know about it by sending me an email, you will get the whole book as a PDF.