What Has Government Done to Our Money?

by Murray N. Rothbard

  WHAT HAS GOVERNMENT DONE TO OUR MONEY?

  MURRAY N. ROTHBARD

  Copyright © 1991, 2005, 2008 Ludwig von Mises Institute

  Copyright © 1963, 1985, 1990 by Murray N. Rothbard

  Copyright © 2005 Ludwig von Mises Institute, fifth edition

  All rights reserved. Written permission must be secured from the publisher to use or reproduce any part of this book, except for brief quotations in critical reviews or articles.

  Published by Ludwig von Mises Institute, 518 West Magnolia Avenue, Auburn, Alabama 36832.

  ISBN: 978-1-933550-34-3

  Contents

  I. Introduction

  II. Money in a Free Society

  1. The Value of Exchange

  2. Barter

  3. Indirect Exchange

  4. Benefits of Money

  5. The Monetary Unit

  6. The Shape of Money

  7. Private Coinage

  8. The “Proper” Supply of Money

  9. The Problem of “Hoarding”

  10. Stabilize the Price Level?

  11. Coexisting Moneys

  12. Money Warehouses

  13. Summary

  III. Government Meddling With Money

  1. The Revenue of Government

  2. The Economic Effects of Inflation

  3. Compulsory Monopoly of the Mint

  4. Debasement

  5. Gresham's Law and Coinage

  a. Bimetallism

  b. Legal Tender

  6. Summary: Government and Coinage

  7. Permitting Banks to Refuse Payment

  8. Central Banking: Removing the Checks on Inflation

  9. Central Banking: Directing the Inflation

  10. Going Off the Gold Standard

  11. Fiat Money and the Gold Problem

  12. Fiat Money and Gresham's Law

  13. Government and Money

  IV. The Monetary Breakdown of the West

  1. Phase I: The Classical Gold Standard, 1815–1914

  2. Phase II: World War I and After

  3. Phase III: The Gold Exchange Standard (Britain and the United States) 1926–1931

  4. Phase IV: Fluctuating Fiat Currencies, 1931–1945

  5. Phase V: Bretton Woods and the New Gold Exchange Standard (the United States) 1945–1968

  6. Phase VI: The Unraveling of Bretton Woods, 1968–1971

  7. Phase VII: The End of Bretton Woods: Fluctuating Fiat Currencies, August–December, 1971

  8. Phase VIII: The Smithsonian Agreement, December 1971–February 1973

  9. Phase IX: Fluctuating Fiat Currencies, March 1973–?

  Index

  * * *

  Case for the 100 Percent Gold Dollar

  Contents

  Preface

  Introduction

  Money and Freedom

  The Dollar: Independent Name or Unit of Weight?

  The Decline from Weight to Name: Monopolizing the Mint

  The Decline from Weight to Name: Encouraging Bank Inflation

  100 Percent Gold Banking

  Objections to 100 Percent Gold

  Professor Yeager and 100 Percent Gold

  The 100 Percent Gold Tradition

  The Road Ahead

  Notes

  I.

  INTRODUCTION

  FEW ECONOMIC SUBJECTS ARE more tangled, more confused than money. Wrangles abound over “tight money” vs. “easy money,” over the roles of the Federal Reserve System and the Treasury, over various versions of the gold standard, etc. Should the government pump money into the economy or siphon it out? Which branch of the government? Should it encourage credit or restrain it? Should it return to the gold standard? If so, at what rate? These and countless other questions multiply, seemingly without end.

  Perhaps the Babel of views on the money question stems from man's propensity to be “realistic,” i.e., to study only immediate political and economic problems. If we immerse ourselves wholly in day-to-day affairs, we cease making fundamental distinctions, or asking the really basic questions. Soon, basic issues are forgotten, and aimless drift is substituted for firm adherence to principle. Often we need to gain perspective, to stand aside from our everyday affairs in order to understand them more fully. This is particularly true in our economy, where interrelations are so intricate that we must isolate a few important factors, analyze them, and then trace their operations in the complex world. This was the point of “Crusoe economics,” a favorite device of classical economic theory. Analysis of Crusoe and Friday on a desert island, much abused by critics as irrelevant to today's world, actually performed the very useful function of spotlighting the basic axioms of human action.

  Of all the economic problems, money is possibly the most tangled, and perhaps where we most need perspective. Money, moreover, is the economic area most encrusted and entangled with centuries of government meddling. Many people—many economists—usually devoted to the free market stop short at money. Money, they insist, is different; it must be supplied by government and regulated by government. They never think of state control of money as interference in the free market; a free market in money is unthinkable to them. Governments must mint coins, issue paper, define “legal tender,” create central banks, pump money in and out, “stabilize the price level,” etc.

  Historically, money was one of the first things controlled by government, and the free market “revolution” of the eighteenth and nineteenth centuries made very little dent in the monetary sphere. So it is high time that we turn fundamental attention to the life-blood of our economy—money.

  Let us first ask ourselves the question: Can money be organized under the freedom principle? Can we have a free market in money as well as in other goods and services? What would be the shape of such a market? And what are the effects of various governmental controls? If we favor the free market in other directions, if we wish to eliminate government invasion of person and property, we have no more important task than to explore the ways and means of a free market in money.

  II.

  MONEY IN A FREE SOCIETY

  1.

  The Value of Exchange

  HOW DID MONEY BEGIN? Clearly, Robinson Crusoe had no need for money. He could not have eaten gold coins. Neither would Crusoe and Friday, perhaps exchanging fish for lumber, need to bother about money. But when society expands beyond a few families, the stage is already set for the emergence of money.

  To explain the role of money, we must go even further back, and ask: why do men exchange at all? Exchange is the prime basis of our economic life. Without exchanges, there would be no real economy and, practically, no society. Clearly, a voluntary exchange occurs because both parties expect to benefit. An exchange is an agreement between A and B to transfer the goods or services of one man for the goods and services of the other. Obviously, both benefit because each values what he receives in exchange more than what he gives up. When Crusoe, say, exchanges some fish for lumber, he values the lumber he “buys” more than the fish he “sells,” while Friday, on the contrary, values the fish more than the lumber. From Aristotle to Marx, men have mistakenly believed that an exchange records some sort of equality of value—that if one barrel of fish is exchanged for ten logs, there is some sort of underlying equality between them. Actually, the exchange was made only because each party valued the two products in different order.

  Why should exchange be so universal among mankind? Fundamentally, because of the great variety in nature: the variety in man, and the diversity of location of natural resources. Every man has a different set of skills and aptitudes, and every plot of ground has its own unique features, its own distinctive resourc
es. From this external natural fact of variety come exchanges; wheat in Kansas for iron in Minnesota; one man's medical services for another's playing of the violin. Specialization permits each man to develop his best skill, and allows each region to develop its own particular resources. If no one could exchange, if every man were forced to be completely self-sufficient, it is obvious that most of us would starve to death, and the rest would barely remain alive. Exchange is the lifeblood, not only of our economy, but of civilization itself.

  2.

  Barter

  Yet, direct exchange of useful goods and services would barely suffice to keep an economy going above the primitive level. Such direct exchange—or barter—is hardly better than pure self-sufficiency. Why is this? For one thing, it is clear that very little production could be carried on. If Jones hires some laborers to build a house, with what will he pay them? With parts of the house, or with building materials they could not use? The two basic problems are “indivisibility” and “lack of coincidence of wants.” Thus, if Smith has a plow, which he would like to exchange for several different things—say, eggs, bread, and a suit of clothes—how can he do so? How can he break up the plow and give part of it to a farmer and another part to a tailor? Even where the goods are divisible, it is generally impossible for two exchangers to find each other at the same time. If A has a supply of eggs for sale, and B has a pair of shoes, how can they get together if A wants a suit? And think of the plight of an economics teacher who has to find an egg-producer who wants to purchase a few economics lessons in return for his eggs! Clearly, any sort of civilized economy is impossible under direct exchange.

  3.

  Indirect Exchange

  But man discovered, in the process of trial and error, the route that permits a greatly-expanding economy: indirect exchange. Under indirect exchange, you sell your product not for a good which you need directly, but for another good which you then, in turn, sell for the good you want. At first glance, this seems like a clumsy and round-about operation. But it is actually the marvelous instrument that permits civilization to develop.

  Consider the case of A, the farmer, who wants to buy the shoes made by B. Since B doesn't want his eggs, he finds what B does want—let's say butter. A then exchanges his eggs for C's butter, and sells the butter to B for shoes. He first buys the butter not because he wants it directly, but because it will permit him to get his shoes. Similarly, Smith, a plow-owner, will sell his plow for one commodity which he can more readily divide and sell—say, butter—and will then exchange parts of the butter for eggs, bread, clothes, etc. In both cases, the superiority of butter—the reason there is extra demand for it beyond simple consumption—is its greater marketability. If one good is more marketable than another—if everyone is confident that it will be more readily sold—then it will come into greater demand because it will be used as a medium of exchange. It will be the medium through which one specialist can exchange his product for the goods of other specialists.

  Now just as in nature there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability. It is clear that in every society, the most marketable goods will be gradually selected as the media for exchange. As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium which causes more marketability, etc. Eventually, one or two commodities are used as general media—in almost all exchanges—and these are called money.

  Historically, many different goods have been used as media: tobacco in colonial Virginia, sugar in the West Indies, salt in Abyssinia, cattle in ancient Greece, nails in Scotland, copper in ancient Egypt, and grain, beads, tea, cowrie shells, and fishhooks. Through the centuries, two commodities, gold and silver, have emerged as money in the free competition of the market, and have displaced the other commodities. Both are uniquely marketable, are in great demand as ornaments, and excel in the other necessary qualities. In recent times, silver, being relatively more abundant than gold, has been found more useful for smaller exchanges, while gold is more useful for larger transactions. At any rate, the important thing is that whatever the reason, the free market has found gold and silver to be the most efficient moneys.

  This process: the cumulative development of a medium of exchange on the free market—is the only way money can become established. Money cannot originate in any other way, neither by everyone suddenly deciding to create money out of useless material, nor by government calling bits of paper “money.” For embedded in the demand for money is knowledge of the money-prices of the immediate past; in contrast to directly-used consumers' or producers' goods, money must have preexisting prices on which to ground a demand. But the only way this can happen is by beginning with a useful commodity under barter, and then adding demand for a medium for exchange to the previous demand for direct use (e.g., for ornaments, in the case of gold).1 Thus, government is powerless to create money for the economy; it can only be developed by the processes of the free market.

  A most important truth about money now emerges from our discussion: money is a commodity. Learning this simple lesson is one of the world's most important tasks. So often have people talked about money as something much more or less than this. Money is not an abstract unit of account, divorceable from a concrete good; it is not a useless token only good for exchanging; it is not a “claim on society”; it is not a guarantee of a fixed price level. It is simply a commodity. It differs from other commodities in being demanded mainly as a medium of exchange. But aside from this, it is a commodity—and, like all commodities, it has an existing stock, it faces demands by people to buy and hold it, etc. Like all commodities, its “price”—in terms of other goods—is determined by the interaction of its total supply, or stock, and the total demand by people to buy and hold it. (People “buy” money by selling their goods and services for it, just as they “sell” money when they buy goods and services.)

  4.

  Benefits of Money

  The emergence of money was a great boon to the human race. Without money—without a general medium of exchange—there could be no real specialization, no advancement of the economy above a bare, primitive level. With money, the problems of indivisibility and “coincidence of wants” that plagued the barter society all vanish. Now, Jones can hire laborers and pay them in... money. Smith can sell his plow in exchange for units of... money. The money-commodity is divisible into small units, and it is generally acceptable by all. And so all goods and services are sold for money, and then money is used to buy other goods and services that people desire. Because of money, an elaborate “structure of production” can be formed, with land, labor services, and capital goods cooperating to advance production at each stage and receiving payment in money.

  The establishment of money conveys another great benefit. Since all exchanges are made in money, all the exchange-ratios are expressed in money, and so people can now compare the market worth of each good to that of every other good. If a TV set exchanges for three ounces of gold, and an automobile exchanges for sixty ounces of gold, then everyone can see that one automobile is “worth” twenty TV sets on the market. These exchange-ratios are prices, and the money-commodity serves as a common denominator for all prices. Only the establishment of money-prices on the market allows the development of a civilized economy, for only they permit businessmen to calculate economically. Businessmen can now judge how well they are satisfying consumer demands by seeing how the selling-prices of their products compare with the prices they have to pay productive factors (their “costs”). Since all these prices are expressed in terms of money, the businessmen can determine whether they are making profits
or losses. Such calculations guide businessmen, laborers, and landowners in their search for monetary income on the market. Only such calculations can allocate resources to their most productive uses—to those uses that will most satisfy the demands of consumers.

  Many textbooks say that money has several functions: a medium of exchange, unit of account, or “measure of values,” a “store of value,” etc. But it should be clear that all of these functions are simply corollaries of the one great function: the medium of exchange. Because gold is a general medium, it is most marketable, it can be stored to serve as a medium in the future as well as the present, and all prices are expressed in its terms.2 Because gold is a commodity medium for all exchanges, it can serve as a unit of account for present, and expected future, prices. It is important to realize that money cannot be an abstract unit of account or claim, except insofar as it serves as a medium of exchange.

  5.

  The Monetary Unit

  Now that we have seen how money emerged, and what it does, we may ask: how is the money-commodity used? Specifically, what is the stock, or supply, of money in society, and how is it exchanged?

  In the first place, most tangible physical goods are traded in terms of weight. Weight is the distinctive unit of a tangible commodity, and so trading takes place in terms of units like tons, pounds, ounces, grains, grams, etc.3 Gold is no exception. Gold, like other commodities, will be traded in units of weight.4

  It is obvious that the size of the common unit chosen in trading makes no difference to the economist. One country, on the metric system, may prefer to figure in grams; England or America may prefer to reckon in grains or ounces. All units of weight are convertible into each other; one pound equals sixteen ounces; one ounce equals 437.5 grains or 28.35 grams, etc.