Chapter 26: State-Issued Money
Updated: 4/13/20
How the faithful city has become a prostitute! She who was full of justice—she was full of righteousness, but now she is full of murderers. Your silver has become impure, your wine mixed with water. Your princes are rebels and companions of thieves; everyone loves bribes and runs after payoffs (Isaiah 1:21–23).
I have analyzed this passage in Chapter 3 of my commentary on the prophets. The prophet Isaiah’s ministry began around 740 B.C. He was preaching to the priestly city of Jerusalem. The nation had been split into two kingdoms in the brief reign of Rehoboam, the son of Solomon, two centuries earlier. The northern kingdom fell to Assyria in 722 B.C. The southern kingdom did not fall to Babylon until 587 B.C. So, Isaiah’s warning fell on deaf ears. Despite the fact that God brought an end to the northern kingdom within two decades of Isaiah’s initial warning, there was no long-term repentance in the southern kingdom.
The three sins listed in this passage indicated that they were related ethically. First, there was no justice enforced by the civil government. Second, there was monetary debasement. Silver coins were being debased by smelters who added cheaper “base” metals. This enabled the smelters of silver ingots to issue more of them than before. They looked the same, but they had less valuable metal than before. This was fraudulent. Other sellers understood that they were being defrauded by smelters, so they retaliated by lowering the quality of the goods they sold to smelters. The winemakers mixed in more water. Third, princes were companions of thieves. Everyone in power wanted a bribe to render judgment for or against someone. This violated the Mosaic law. “Never take a bribe, for a bribe blinds those who see, and perverts honest people's words” (Exodus 23:8). [North, Exodus, ch. 52] Bribery had become the way of life for the rulers in the southern kingdom.
Isaiah used the language of smelting to describe God’s coming wrath. “Therefore this is the declaration of the Lord God of hosts, the Mighty One of Israel: ‘Woe to them! I will take vengeance against my adversaries, and avenge myself against my enemies; I will turn my hand against you, refine away your dross as with lye, and take away all your dross’” (vv. 24–25). His use of dross here was spiritual. It was a metaphor. But the metaphor had to relate to actual practices. If the city’s silver was not debased, then his covenant lawsuit against them made no sense. The metaphor was effective only because the residents of Jerusalem were well aware of the monetary debasement that was going on. This debasement was creating parallel debasements in product quality.
This was a violation of the law governing honest weights and measures. The definitions of weights and measures that had prevailed before the nation’s spiritual debasement were not being enforced. This means that the civil government was ignoring widespread deception. It no longer protected common citizens. This was Isaiah’s general accusation.
A smelter mixed molten silver with a small molten quantity of a less valuable but hard metal. This way, the ingot would remain in use longer. Pure silver is soft. Pure silver ingots would suffer a wearing away of silver. Older ingots would sell at a discount. The average user would not know how much a pure ingot weighed. So, smelters have always added a small quantity of a cheaper hard metal. In the case of ingots, the look and feel of newer ingots are the same as older ones.
Over time, people would have known what to expect from a particular smelter’s ingots. These ingots would have historic value. They would be readily recognized. Rival smelters would have wanted similar acceptability for their ingots. They would have imitated the ratio of precious metal to base metal.
For any smelter to have increased the ratio of base metal to precious metal would have placed him at risk. Either the public would have demanded a discount when using his ingots or else a competitor would have warned the authorities. But this process of self-policing within the smelters’ guild no longer worked in the southern kingdom. The guild’s members were in collusion. They all debased their ingots at the same ratio. They were paying bribes to the civil government not to enforce the traditional definitions.
The historic value of the ingots was being undermined. The new ingots looked like the old ones, but this was an illusion. The total value of their twin alloys had declined. It would have taken time for the public to detect a small change in the ratio. The silver ingots still would have looked the same. The smelters would have been able to buy goods today at yesterday’s lower prices. They would have benefitted as consumers. The sellers would not have perceived the change immediately.
There were limits to this practice. At some point, sellers of goods would have noticed the changes. Then they would have demanded more ingots per sale. This is why monetary inflation produces price inflation. But if the civil government refused to take action against this deliberate tampering with traditional measures, meaning the ratio between silver and the base metal, then sellers of other products would have sought similar arrangements with the corrupt rulers. They also decided to tamper with traditional measures in their associations of producers.
This was spiritual corruption. The religious leaders did not call the civil leaders to account. Yet this was the city of the temple. At the top, it was judicial corruption. In between, it was business corruption. The value of the nation’s goods was being reduced, yet the original product names still applied. This was a debasement of language. It was a debasement of the Mosaic law. Isaiah saw this. As a prophet, he brought a covenant lawsuit against the entire nation. This was the calling of every prophet. God raised up prophets when the priests were silent in the face of systematic corruption.
From the forbidden tree to the latest marketing deception, people have sought something for nothing.
Theft means attaining something for nothing. The victim has received nothing to compensate him for his loss. It is pure gain for the thief, pure loss for the victim. This is not a lawful market transaction. It is universally illegal. There is risk of being caught, tried, and convicted (Exodus 22:1–4). [North, Exodus, ch. 43]
The more common form of this sinful impulse is to buy something in exchange for something with less market value. If the thief can persuade the victim to make the exchange on the basis of false claims regarding the asset the thief is offering, the victim may decide to make the exchange. This is the impulse to gain ownership of something valuable at a price lower than the owner is willing to accept. The thief uses deception to persuade the owner that he is offering the owner something with a higher market value than a comparable item possesses. The owner makes the exchange, but then discovers that the asset that he has received is worth less in the marketplace than competing items of the same (low) quality. The seller used fraud to gain whatever he desired. He deliberately misled the buyer. He received something (a desirable asset) in exchange for something less valuable, plus fraud. It was not a pure loss for the buyer/victim, and it was not a pure gain for the seller/thief. But it is a little bit of something for nothing like what was promised.
Wherever such transactions are widespread, trust is limited. The circle of people within which people voluntarily trade is small. The division of labor is minimal. Specialization of production is minimal. Output per unit of resource input is minimal. People are poor. Until they can find trustworthy people to trade with, they will remain poor.
A way to extend the circle of reliable trading partners is with a common currency. A currency unit has gained the reputation of stable value over time and across borders. The smelter has maintained a stable mixture of gold or silver plus a harder base metal. The currency brings traders together.
Whenever the civil government asserts a monopoly over the minting of money, the monetary unit spreads across the state’s geographical jurisdiction. This strengthens the power of the state. But there is always a temptation for a future ruler to debase the currency. The inflating state buys goods, pays troops, and increases consumption, but it does so with money of depreciating value. The state wants something for nothing. It wants to consume, but it does not want to create a tax revolt by raising visible taxes. But the inflating state then finds that sellers raise prices. This reduces the state’s ability to obtain wealth from the population.
With the invention of coins in Lydia around 600 B.C., state-issued currency became common in the Middle East. The Greek city-states had their own coins. But as each city-state fell, a new coinage system replaced it.
There is nothing in economic theory that links money to state sovereignty. Money is a means of voluntary exchange. As long as producers of coins declare the ratio of precious metal to base metal, they should be allowed to offer their coins for sale. But this would mean establishing enforceable ownership of the design of the competing products. It would be a crime for a competitor to place the same mark on coins with more base metals in the mix: a trademark violation. It would be equally criminal for the producer to misinform the users.
From the days of Abraham, traders developed the use of touchstones by which gold purity could be tested. They protected themselves from fraud. Monetary units traded in proportion to the gold content of the ingots. It was not easy for a mint to debase its coinage and reap benefits. It was only with the advent of empire-based money that the desire to gain something for nothing became widespread. The Roman Empire’s coinage steadily depreciated after A.D. 200. The emperors could not afford to pay their troops with stable coinage.
A government expands the money supply in order to finance its deficits, or create a temporary economic boom, or fight a war, but then the prices for goods and services rise. Everyone in the “great auction” has more money to use in the bidding process, so prices rise. Then the public gets suspicious about the future value of money because they have seen the loss of purchasing power in the past. Sellers demand higher prices. Then the central bank is encouraged by politicians to accommodate the price inflation in order to keep the boom going (to keep the “auction” lively). The currency unit loses value because it has lost its historic value, which encourages people to discount sharply its future value.
The secret of retaining the public’s confidence in any currency unit is simple enough: convince users of the money that the issuers are responsible, reliable, and trustworthy. Government and its licensed agents (banks) have a monopoly of money creation. Private competitors are called counterfeiters. Sadly, in our day, it is very difficult to understand just what it is that counterfeiters do, economically speaking, that governments are not already doing. Fiat money is fiat money. (Perhaps the real legal issue ought to be the illegal use of the government’s trademark. Trademark infringement makes a much more logical case for government prosecution than counterfeiting.)
The question that policy-makers should ask themselves is this: “To avoid the necessity of imposing a totally new currency unit on a population, what can be done to convince people that the future usefulness of the currency in voluntary exchange will remain high?” Then they should ask this: “What can be done to improve the historic value of money in the future?” In other words, when people in a year or a decade look back at the performance of their nation’s currency unit, will they say this to themselves? “The money that I’m holding today buys pretty much what it bought back then. I think it’s safe for me to continue to accept this money in exchange for my goods and services, since people trust its buying power. I have no reason to believe that its purchasing power will fall in the future, so I can take the risk of accepting payment in this monetary unit today.” If people do not say this to themselves, then the money’s purchasing power is undermined. People will demand more money. Prices will go up, if they suspect that prices will go up. This, in turn, convinces more people that the historic value of their money has been unreliable, which then leads to higher prices.
Very rarely, a national government imposes a new currency unit on its citizens, and sometimes this works. One example is the introduction of the new German mark in November of 1923, which was exchanged for the old mark at a trillion to one. But normally the costs are so high in having people rethink and relearn a new currency unit that governments avoid such an imposition. Governments do this only after several years of hyperinflation in which the government’s own policies destroyed the purchasing power of the currency unit. At that point, the governments remove lots of zeros from their paper currencies. They can steal no more wealth from the public with the old currency, so they create a new currency.
The longest period of stable money in the history of man began with Constantine’s rule in what became the Byzantine Empire. This was the Eastern Roman Empire. He began issuing a gold coin, the solidus, in A.D. 312. For the next seven centuries, his successors did not tamper with the gold content of these coins. The coins became widely used. There was a reduction in gold content around 1025. The new coins had more silver. After that, there were further reductions until 1092, when a new coin, 85% gold, replaced the solidus, the hyperpyron nomisma. It became the empire’s main coinage for trade until 1204, when the crusaders captured Constantinople.
In a 1972 article in The Freeman, historian Charles Weber describes the dominance of the solidus coin in commerce.
During this very long period the solidus had little competition in the world except for the gold of the Islamic dynasties which originally started as imitations of the Byzantine solidus during the seventh century. The Ostrogoths in Italy also imitated the solidus in great quantities during the fifth and sixth centuries, but unlike the Islamic imitations, the Ostrogothic solidi bore the name and portraits of the Byzantine emperor and can be distinguished from the Byzantine pieces only by subtle stylistic differences. So familiar was the world with the solidus that we seldom find specimens with cuts to test the authenticity of the pieces; forgeries of them were evidently rare. Hoards of them have been found as far away as Scandinavia. Although we have no exact mint records from the Byzantine Empire, the mintage of the solidus was certainly enormous. As late as about 1950, common, worn solidi could be had for as little as about $12., not much more than twice their bullion value.
This system of stable money was one of the great gifts of Christianity to the world.
The first experiment in paper money was in China, beginning around A.D. 1000. The Chinese did not suffer from massive inflation. But, beginning around 1260, the victorious Mongol Empire began to use paper money. This was the yuan dynasty. The government inflated. There was a currency reform in 1272. The old paper money bills were exchanged at a ratio of 5 to 1. In 1309, there was another conversion. During that half-century, paper money had depreciated by 1000 percent. This was mass inflation.
The problem with paper money, whether unbacked fiat money or backed by gold or silver, is this: one bill cannot be distinguished from another. They all look the same. With a coin, there are ways of testing metal content. This is not the case with paper money. So, people have to trust the issuing government not to mass inflate the currency. In China before the Mongols, the governments and banks were generally reliable. The Mongols began inflating as soon as they took over.
In a free banking system, there are few government regulations. There is open entry for new banks. There are no legal reserve requirements. Enforcement is left to the market process. Bankers are suspicious of other bankers. If a bank’s notes come under suspicion, rival bankers can demand payment in silver coins or gold coins. This places a limit on the expansion of paper money notes. But when the government inflates, the general public has to serve as the policing agency. The government will not police itself. If the paper money is convertible into gold or silver coins, the public can go to their banks, hand over paper money, and walk away with precious metal coins. Convertibility into gold coins on demand is the primary means of restricting the issue of paper money. The inflating government either has to stop inflating the currency or else it has to declare a pure unbacked currency.
If the government declares that the currency is no longer backed by gold or silver, then the public can be confident that an era of monetary inflation is about to begin. That was the case in Western Europe after August 1914. The nations ceased honoring their contracts to redeem paper money in gold or silver coins. The next major period of monetary inflation in the West was during World War II. Finally, in the United States, monetary inflation expanded after President Nixon unilaterally abolished the last remaining trace of the international gold standard on August 15, 1971. The American public had not been able to exercise restraints on the government's expansion of money ever since March 6, 1933, when President Franklin Roosevelt made it illegal for Americans to own gold. Both presidents unilaterally abolished the gold standard of their day. Congress did not debate the issue.
Paper money became an important factor in various national economies after the development of banking. Banknotes were paper money, but they were under restraints by the threat of bank runs. From the fourteenth century onward, this was a threat to the West’s banks. By 1900, checks drawn on commercial banks were far more important in business and commercial transactions than paper money was. Checks, not banknotes, were the main form of money in large transactions. Digital money began to replace bank checks in the final third of the twentieth century in the West.
There were gold coins issued by the Holy Roman Empire as early as 1400. They did not circulate widely. The Spanish government issued the gold doubloon beginning in 1537. France issued the Louis d’or in 1640. This ended in 1792, the year before Louis XVI was executed. France issued gold coins from 1803 until 1914. The British issued the gold guinea from 1663 to 1814. Britain established a new gold standard in 1821. It introduced the gold sovereign. The United States began minting gold coins in 1795. It was only in 1857 that U.S. gold and silver coins became exclusive. The newly united Germany began issuing a gold mark in 1873. Coins were exchanged in terms of their gold content. This established fixed exchange rates. These were the outcome of voluntary exchange, not government fiat, i.e., exchange controls.
1. A Century of Gold
After the defeat of Napoleon in 1815, Western European governments began to move back to a gold coin standard. From then until shortly after the outbreak of World War I in August 1914, international trade benefitted from the extension of the gold coin standard throughout Europe and the Western Hemisphere. Gold redemption was abolished in the United States with the outbreak of the Civil War in the spring of 1861. Gold redemption was suspended late in 1861. A full gold coin standard was not reestablished until 1879. But the triumph of gold in the nineteenth century stands as a testimony to the effectiveness of a gold coin standard in restraining the expansion of central governments and in extending the division of labor across national borders.
All of this ended with the outbreak of World War I. Richer members of the public had deposited their gold coins in local commercial banks. The governments allowed the banks to renege on their contracts. Banks refused to redeem paper money with gold coins. Then the governments and their central banks confiscated the gold that was in the vaults of the commercial banks. The governments used gold to purchase goods from outside the war zone, especially from the United States. This transfer of gold from the general public to continental European governments remained permanent. The gold standard was briefly restored in Great Britain from 1925 to 1931, but then Britain permanently went off the gold standard. Citizens could no longer demand gold in exchange for pounds sterling. The United States went off the gold coin standard at 1 AM, March 6, 1933, when President Franklin Roosevelt’s unilateral executive order made it illegal for Americans to own gold bullion in any form. On August 15, 1971, President Richard Nixon unilaterally abolished the 1944 Bretton Woods international agreement by refusing to honor the redemption of gold by foreign governments at $35 an ounce or any price. These events show that a gold standard that is guaranteed by the government is a government promise standard. It lasts only for as long as it convenient for politicians to restrain the expansion of the money supply. Once abolished, the gold standard is rarely restored. The case of Great Britain in the second half of the 1920s is the one exception. It did not last long. There was no one to guard the guardian.
When the state places its stamp on either a gold or silver coin, this appears to create a guarantee for the reliability of the currency. At least initially, people under the jurisdiction of a particular civil government trust the decisions of government policy-makers. The legitimacy that is subjectively imputed by citizens to the civil government is indirectly transferred to the coins that bear the stamp of the government. This makes it easier for the government to persuade individuals under its jurisdiction to accept coins in exchange for goods and services. When the coins become widely circulated in commerce, this increases the division of labor.
The state appears to be offering an important service free of charge. It supervises the issuing of currency. It collects the gold or silver, plus the base metals that will be used to harden the specie metals so they can be used as coins. The mint then releases the coins by handing them over to the government, which the government then spends into circulation.
The problem with this arrangement is the ancient one that is expressed by a question: “Who guards the guardians?”
2. Who Guards the Guardians?
There is an ancient question that every society must answer: “Who guards the guardians?” Or in more contemporary usage, “Who referees the referees?” The public needs an unbiased guardian to restrain the actions of those who hold a legal monopoly of money creation: the government.
The government can always change the law. Governments do this all the time. Under a government-enforced gold standard, whenever there is a major war, for example, governments used to suspend specie payments by banks. They also suspended civil liberties, and for the same reason: to increase the power of the state at the expense of the citizens. Post-war governments are frequently unwilling to reestablish pre-war taxes, pre-war civil liberties, and pre-war convertibility of currencies, long after the war is over. Civil libertarians have not generally understood the case for a gold standard as a case for civil liberties, despite the obvious historical correlation between wartime suspension of civil liberties and wartime suspension of specie payments.
When the authorities declare the convertibility of paper into specie metals “null and void,” it sends the public a message. “Attention! This is your government speaking. We are no longer willing to subject ourselves to your continual interference in our affairs. We no longer will tolerate restrictions on our efforts to guard the public welfare, especially from the public. Therefore, we are suspending the following civil right: the public’s legal right to call our bluff when we guarantee convertibility of our currency into gold coins. This should not be interpreted as an immoral act on the part of the government. Contracts are not moral issues. They are strictly pragmatic. However, we assure you, from the bottom of our collective heart, that we shall never expand the money supply, or allow the historic value of the currency to depreciate. It will be just as if we had a gold standard restraint on our printing presses. However, such a restraint is unnecessary, and besides, it is altogether too restraining.”
3. Paying for Guardians
In 1969, an editorial appeared in The Wall Street Journal, the most influential business news newspaper in the United States, and therefore the world. “The best way for a nation to build confidence in its currency is not to bury lots of gold in the ground; it is, instead, to pursue responsible financial policies. If a country does so consistently enough, it’s likely to find its gold growing dusty from disuse.” This was standard free market economic opinion in 1969, and remains so today.
It is quite true that a gold coin standard is expensive. We dig gold out of the ground in one location, only to bury it in an underground vault. People cannot do this for free. Wouldn’t it be more efficient, meaning less wasteful of scarce economic resources, just to forget about digging up gold? Why not keep the government or the central bank from expanding the money supply? Then the same ends could be accomplished so much less wastefully. “Save resources: trust politicians.”
The gold coin standard is the way that individual citizens, acting to increase their own personal advantage, can profit from any monetary inflation on the part of the monetary authorities. They can “buy low and sell high” simply by exchanging paper money for gold at the undervalued, official exchange rate, and hoarding gold in expectation of a higher price, or selling it into the free market at a higher price. Why is the price higher? Because individuals expect the government to go back on its promise, raise the official price of gold (that is, devalue the currency unit), or close the gold window altogether. Citizens can become future-predicting, risk-bearing, uncertainty-bearing speculators in a very restricted market, namely, the market for government promises. It allows those who are skeptical about the trustworthiness of government promises to take a profit-seeking position in the market. It allows those who trust the government’s promises to deposit their money in a bank. Each side can speculate concerning the trustworthiness of government promises concerning redeemability of the currency, or more to the point, government promises concerning the future stability of the currency unit’s purchasing power.
When we are told that it is inefficient to dig gold out of the ground, only to deposit it in a vault, we are not being told the whole story. Something is omitted. By tying the currency unit to gold—which is expensive to mine, as any monetary brake should be and must be—the body politic enlists a cadre of professional, self-interested specialists to serve as an unpaid police force: commodity speculators. This self-funded police force polices the trustworthiness of government monetary promises. The public can relax, knowing that a hard core of “greedy” capitalists is at work for the public interest, monitoring government budgets, central bank policies, and similarly arcane topics. By forcing a nation’s treasury to defend its promises in the capital markets, the guardians are guarded by the best guards of all: future-predicting, self-interested speculators whose job it is to embarrass those who do not honor contracts—monetary contracts.
4. Public Confidence
Critics of the gold coin standard tell us that the value of any currency is dependent on public confidence, not gold. But what the critics refuse to admit is that the existence of the civil liberty of redeemable money is an important psychological support of the public’s confidence in money. Even when the public does not understand the gold standard’s theoretical justification—an impersonal guard of the monopolistic guardians—citizens can exercise their judgment on a daily basis by either demanding payment in gold (or silver) or not demanding payment. Like the free market itself, it works whether or not the bulk of the participants understand the theory. What they do understand is self-interest: if there is a profit to be made from buying gold at the official rate, and selling it into the free market (including foreign markets) at a higher price, then some people will enter the markets as middlemen, “buying low and selling high,” until the government realizes that its bluff has been called, and it therefore is forced to reduce the expansion of the money supply.
I suggest this relationship: a government-guaranteed gold standard is to money what government-guaranteed health inspection is to prostitution. Both guarantees are subsidies to the providers. Both guarantees create the illusion of decreased risk.
When money fails, legitimacy is lost, too. Gold’s price is a test of political legitimacy: the value of a national currency. A rising gold price is a vote of reduced confidence in the state’s money. This is why governments after World War I began did everything they could to remove gold coins from circulation. Politicians wanted no public referendum on the legitimacy of the state. They allowed political voting. Political voting can be controlled. Gold coins cannot be controlled. So, they were abolished by law.
5. De-Monetization
In the early phase of government money, the state monetizes gold. It places its stamp on gold coins. It asserts sovereignty over money in the name of preserving the value of money by guaranteeing the fineness and weight of the coins. Then, in the empire phase, debasement begins. The state de-monetizes gold. It substitutes base metals, and then calls the new coins equally valuable. The free market assesses the truth of this claim, exchange by exchange. The result of the de-monetization of gold is the de-capitalization of the state. The state finds it more difficult to get the masses to accept its money.
The state’s gold standard is preliminary to eventual confiscation or debasement. The state’s promise of redemption on demand should not be trusted. This is why any call by conservatives for the state to adopt a gold standard is futile. First, no one will listen. Second, even if voters did understand the case for a limited state, they would not be able to limit the state by a state-run gold standard. A state-run monetary system becomes a debased standard.
This is why the free market is the only reliable source for the re-establishment of a gold standard. Honest money begins with these steps: (1) the revocation of legal tender laws that require people to accept the state’s money; (2) the enforcement of contracts; (3) laws against fraud, which fractional reserve banking is; (4) the repeal of the central bank’s government charter. The free market can do the rest.
Flexible money is a euphemism for the government’s ability to increase the money supply. The degree of flexibility is determined by the political process, not by the direct response of those affected, namely, individual citizens who would otherwise have the right to demand payment in gold. Flexible money means monetary inflation.
Civil libertarians instantly recognize the danger of “flexible administrative law,” or “flexible censorship,” or “flexible enforcement of speed traps.” Yet they have great difficulty in recognizing precisely the same kind of evil in “flexible monetary policy.” The threat comes from the same institution, the civil government. It comes for the same reasons: the desire of the government to increase its arbitrary exercise of monopolistic power over the citizenry, and to limit public resistance.
The inflationary implications of “flexible monetary policy” can be seen in a revealing exchange between Dr. Arthur Burns, the Chairman of the Federal Reserve System, America’s central bank, and Congressman Henry Reuss, Chairman of the Banking Committee of the United States House of Representatives in 1976. This was during the decade of the highest peacetime price inflation in American history. Dr. Burns had overseen this period of monetary inflation. The Federal Reserve was responsible for it.
DR. BURNS: Let me say this, if I may: the genius of monetary policy—its great virtue—is that it is flexible. With respect to the growth ranges that we project for the coming year, as I have tried to advise this committee from time to time—and as I keep reminding others, including members of my own Federal Reserve family—our goal at the Federal Reserve is not to make a particular projection come true; our goal is to adjust what we do with a view to achieving a good performance of the economy. If at some future time I should come to this committee and report a wide discrepancy between our projection and what actually happened in the sphere of money and credit, I would not be embarrassed in the slightest. On the contrary, I would feel that the Federal Reserve had done well and I would even anticipate a possible word of praise from this generous committee.CHAIRMAN REUSS: You would get it, and the word of praise would be even louder and more deeply felt if you came up and said that due to the change in circumstances you were proving once again that you were not locked on automatic pilot and were willing to become more expansive if the circumstances warranted. Either way you would get praise beyond belief.
“Praise beyond belief!” What government would want anything less? The state’s solution: take the monetary system off “automatic pilot,” and turn it over to those whose short-run political goals favor a return of the inflation-generated economic boom, once the boom has worn off because the central bank has not accelerated the output of fiat money. When this verbal exchange took place, I was Congressman Ron Paul’s research assistant. Dr. Paul was a member of the House Banking Committee. He was the only defender of the gold standard on the committee. He had been on the committee for only a few weeks, having been elected in April in a special election. The central bank’s policy of monetary inflation continued for another three years. When it ended under a new chairman, the United States experienced two major recessions: 1980 and 1981–82. That was the result of slowing the monetary base’s inflation. I explain why in Chapter 35 on the business cycle.
Politically, there is a great deal of flexibility in monetary affairs. Few people even pretend to understand monetary affairs, and most of those who do really do not understand the logic of the gold coin standard. The logic is very simple, very clear, and universally despised: it is cheaper to print money than it is to dig up gold.
Fiat money is indeed more flexible than gold, especially in an upward direction. Fiat money allows the government to spend newly counterfeited money into circulation. It allows those who gain early access to the newly created fiat money to go out and buy up scarce economic resources at yesterday’s prices—prices based on supply and demand conditions that were being bid in terms of yesterday’s money supply. But this leads to some important problems.
1. Yesterday’s prices will climb upward to adjust for today’s money supply.2. People will begin to have doubts about the stability of tomorrow’s prices.
3. Producers and sellers of resources may begin to discount the future purchasing power of today’s dollar (that is, hike today’s prices in anticipation).
4. The government or central bank will be severely tempted to “accommodate” rising prices by expanding the money supply.
Flexible money is state-issued and state-controlled money. It is not a restraint on state spending, unlike a gold coin standard or silver coin standard. It leads to greater state spending and rising prices.
In the industrial West, the last major hyperinflations came in the aftermath of World War I. Germany, Austria, and Hungary all suffered hyperinflations from 1921 through 1923. But then the central banks stabilized the money supply. Each of these national economies recovered rapidly.
There has been only one case of monetary hyperinflation leading to price index hyperinflation in the post-World War II era in any Western industrial nation above the equator: the State of Israel. Price inflation was around 13% in 1971. It was over 100% in 1979. It hit 133% in 1980. It was almost 200% in 1983. Prices quadrupled in 1984. At that point, the central bank reversed its policy and reduced monetary inflation drastically. Prices rose about 185% in 1985. In 1986, prices rose about 19%. The country’s economy survived. I took a tour group to the State of Israel in 1984 to see the effects of inflation. There were no signs of disruptions. People were in shops in Jerusalem. Shop owners increased their prices in the local currency. People adjusted their budgets accordingly. Stores also accepted major foreign currencies. Tourism brought buyers with stable money to spend.
Hyperinflation cannot last long. When price inflation goes above 25% per annum, it does not take long for alternative currencies to be used in monetary transactions. The more rapid the hyperinflation, the more rapid will be transitions to alternative currencies. The official currency is no longer trusted. No one will lend money in the declining currency because of fear of expropriation when the currency falls even more rapidly in purchasing power. So, hyperinflation is not a solution to the problem of long-term government debt.
Governments in the West have promised old-age retirement security and low-cost medical care for people in their retirement years. These obligations extend out at least two generations. Hyperinflation cannot solve the problem of central governments’ looming inability to meet the obligations that have been promised to retirees. Hyperinflation lasts a few years at most. Then there is a currency reform. In the meantime, Western governments’ obligations to pensioners continue to accelerate. They are a matter of demography.
There is nothing in the Bible that authorizes the civil government to create money, authorize money, or in any way manipulate the money supply. I am unaware of any principle of political theory, Christian or otherwise, that clearly establishes state sovereignty over money as a principle of civil government.
Because money is the central institution in a market society that enjoys a high division of labor, the control of money provides the controlling agency with more influence over the economy than the control of any other aspect of the economy. The history of civil government is a history of the misuse of power. Only in the rarest of occasions have societies found ways to restrict the expansion of centralized power over the lives of individuals and institutions. The Roman Empire from the time of Augustus until the mid-third century was a period of relatively stable money. The key monetary unit was the silver denarius. It was a tax coin. With the fall of pagan Rome to Constantine in the early fourth century, the longest period of monetary stability in man’s history began. The gold solidus was also a tax coin. Rulers did not tamper with the gold content of this coin. It was even imitated outside the Byzantine Empire: solid gold counterfeits. This was unique in human history.
Biblical state sovereignty does not involve the creation of money. Because civil governments have asserted this sovereignty for over two millennia, the general public is unable to think of money apart from state power. Virtually everyone assumes that there is some innate ability of politicians and bureaucrats to regulate the money supply on behalf of the general population. The public does not see state issued money as a threat to their wealth, the stability of the economy, and the predictability of money’s long-term purchasing power.
The history of civil government has been a history of monetary debasement. Politicians do not want the public to recognize the extent of the state’s confiscation of wealth belonging to the public. Direct taxation of income did not become widespread until the era immediately preceding World War I. Taxation in the form of sales taxes was common, but it was always limited. Any increase in taxation was immediately noted by buyers and sellers of the taxed goods. So, monetary inflation enabled state planners to extract wealth from the marketplace in a more subtle manner. In the long run, this has led to monetary inflation. In the century following the creation of the Federal Reserve System, prices in the United States rose 25-fold. The steady erosion of the purchasing power of the United States dollar, with the exception of the Great Depression of the 1930s, has been constant.
This is the problem of guarding the guardians. Politicians and bureaucrats are capable of bringing negative sanctions against counterfeiting of all kinds, but there is no institution that can bring negative sanctions against a civil government when it becomes the most influential counterfeiting agency of all. The solution to this problem is simple to describe: separate the sovereignty of the state from the authority to create money. The state enforces weights and measures, which includes the money supply. The state enforces contracts, and this reduces the ability of private counterfeiting through the fractional reserve banking system. I cover this in the next chapter.
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The complete manuscript is here: https://www.garynorth.com/public/department196.cfm