What Has Government Done to Our Money?

by Murray N. Rothbard

  [19] This is a corollary of Franz Oppenheimer’s brilliant distinction between the two basic alternate routes to wealth, production and exchange, which he called “the economic means”; and seizure or confiscation, which he called “the political means” Inflation, which I am defining here as the creation of money (i.e., an increase of money substitutes not backed 100 percent by standard specie), is thus revealed as one of the major political means. Oppenheimer defined the state, incidentally, as the organization of the political means” (The State [New York: Vanguard Press, 1926], pp. 24ff.).

  [20] It is a commonly accepted myth that the excess of wildcat banks in America stemmed from free banking; actually a much stronger cause was the tradition, beginning in 1814 and continuing in every economic crisis thereafter, of permitting banks to continue in operation without paying in specie.

  It is also a widespread myth that central banks are inaugurated in order to check inflation by commercial banks. The second Bank of the United States, on the contrary, was inaugurated in 1817 as an inflationist sop to the state-chartered banks, which had been permitted to run riot without paying in specie since 1814. It was a weak substitute for compelling a genuine return to specie payments. This was correctly pointed out at the time by such hard-money stalwarts as Daniel Webster and John Randolph of Roanoke. Senator William H. Wells, Federalist of Delaware, said that the Bank Bill was “ostensibly for the purpose of correcting the diseased state of our paper currency by restraining and curtailing the overissue of bank paper, and yet it came prepared to Inflict upon us the same evil; being itself nothing more than simply a paper-making machine.” Annals of Congress, 14 Cong., 1 Sess., April 1, 1816, pp. 267-70. Also see ibid., pp. 1066, 1091, 1110ff.

  As for the Federal Reserve System, the major arguments for its adoption were to make the money supply more “elastic” and to centralize reserves and thus make them more “efficient,” i.e., to facilitate and promote inflation.. As an additional fillip, reserve requirements themselves were directly lowered at the inauguration of the Federal Reserve System. Cf. the important but totally neglected work of C. A. Phillips, T. F. McManus, and R. W. Nelson, Banking and the Business Cycle (New York: Macmillan, 1937), pp 21ff, and passim. Also see O. K. Burrel, “The Coming Crisis in External Convertibility in U. S. Gold,” Commercial and Financial Chronicle (April 23, 1959): 5.

  For a discussion of the historical arguments on free or central banking see Vera C. Smith, The Rationale of Central Banking (London: King, 1936).

  [21] During the Panic the economist Condy Raguet, state senator from Philadelphia, wrote to a puzzled David Ricardo as follows: “You state in your letter that you find it difficult to comprehend, why persons who had a right to demand coin from the Banks in payment of their notes so long forbore to exercise it. This no doubt appears paradoxical to one who resides in a country where an act of parliament was necessary to protect a bank, but the difficulty is easily solved. The whole of our population are either stockholders of banks or in debt to them... An independent man, who was neither a stockholder or debtor, who would have ventured to compel the banks to do justice, would have been persecuted as an enemy of society...” Raguet to Ricardo, Apri1 18, 1821, in David Ricardo, Minor Papers on the Currency Question, 1809-23, ed. Jacob Hollander (Baltimore, Maryland: The Johns Hopkins Press, 1932), pp. 199-201.

  In 1931, for example, President Hoover launched a crusade against “traitorous hoarding.” The crusade consisted of the Citizens’ Reconstruction Organization, headed by Colonel Frank Knox of Chicago. And Jesse Jones reports that, during the banking crisis of early 1933, Hoover was seriously contemplating invoking a forgotten wartime law making hoarding a criminal offense. Jesse H. Jones and Edward Angly, Fifty Billion Dollars (New York: Macmillan, 1951), p. 18. It should also be noted here that the Hoover administration’s alleged devotion to retaining the gold standard is largely myth. As Hoover’s Undersecretary of the Treasury has declared rather proudly: “The going off [gold] cannot be laid to Franklin Roosevelt. It had been determined to be necessary by Ogden Mills, Secretary of the Treasury, and myself as his Undersecretary, long before Franklin Roosevelt took office.” Arthur A. Ballantine, in the New York Herald-Tribune, May 5, 1958, p. 18.

  [22] Currently, the worst example of government aid to banks is the highly popular deposit insurance—for this means that banks have virtual carte blanche from government to protect them from any redemption crisis. As a result, virtually all natural market checks on bank inflation have been destroyed. Query: If banks are thus protected from losses by government, to what extent are they still private institutions?

  [23] The other very important difference, of course, is that I advocate 100 percent reserves in gold or silver, in contrast to the 100 percent fiat paper standard of the Chicago School. One-hundred percent gold, rather than making the monetary system more readily manageable by government, would completely expunge government intervention from the monetary system.

  [24] I want to make it quite clear that I do not accuse present-day bankers of conscious fraud or embezzlement; the institution of banking has become so hallowed and venerated that we can only say that it allows for legalized fraud, probably unknown to almost all bankers. As for the original goldsmiths that began the practice, I think our opinion should be rather more harsh.

  [25] It is usual to reckon the acceptance of a deposit which can be drawn upon at any time by means of note or checks as a type of credit transaction and juristically, this view is, of course, justified; but economically, the case is not one of a credit transaction. If credit in the economic sense means the exchange of a present good or a present service against a future good or a future service, then it is hardly possible to include the transactions in question under the conception of credit. A depositor of a sum of money who acquires in exchange for it a claim convertible into money at any time which will perform exactly the same service for him as the sum it refers to has exchanged no present good for a future good. The claim that he has acquired by his deposit is also a present good for him. The depositing of money in no way means that he has renounced immediate disposal over the utility that it commands.” Mises, The Theory of Money and Credit, p. 268. What I am advocating, in brief, is a change in the juristic framework to conform to the economic realities.

  [26] Professor Beckhart has recently called our attention to the long-standing and successful practice of Swiss banks of issuing debentures of varying maturities, and the recent adoption of this practice in Belgium and Holland. While Beckhart contemplates debentures for long-term loans only, I see no reason why banks cannot issue short-term debentures as well. If business needs short-term loans, it can finance them by competing with everyone else in the market for voluntarily saved funds. Why grant the short-term market the special privilege and subsidy of creating money? Benjamin H. Beckhart, “To Finance Term Loans,” New York Times, May 31, 1960.

  [27] A bailment may be defined as the transfer of personal property to another person with the understanding that the property is to be returned when a certain purpose has been completed... In a sale, we relinquish both title and possession. In a bailment we merely give up temporarily the possession of the goods.” Robert O. Sklar and Benjamin W. Palmer, Business Law (New York: McGraw-Hill, 1942), p. 361.

  Nussbaum surely begs the question when he says “Only in a broad and non-technical sense may the relationship of the depository bank to the depositor be considered a fiduciary one. No trust proper or bailment is involved. The contrary view would lay an unbearable burden upon banking business” (italics mine). But if such banking business is improper, this is precisely the sort of burden that should be imposed. This is but one example of what happens to jurisprudence when pragmatic considerations of “public policy” supplant the search for principles of justice. Arthur Nussbaum, Money in the Law, National and International (Brooklyn, N.Y.: Foundation Press, 1950), p. 105.

  [28] On warehouse receipts as bailments, cf. William H. Spencer, Casebook of Law and Business (New York: McGraw-Hill
, 1939), pp. 661ff.

  Perhaps a proper legal system would also consider all “general deposit warrants” (which allow the warehouse to return any homogeneous good to the depositor) as really specific deposit warrants,” which, like bills of lading, establish ownership to specific, earmarked objects.

  As Jevons, noting the superiority of specific deposit warrants and realizing their relationship to money, stated: “The most satisfactory kind of promissory document... is represented by bills of lading, pawn-tickets, dock-warrants, or certificates which establish ownership to a definite object. The important point concerning such promissory notes is, that they cannot possibly be issued in excess of the goods actually deposited, unless by distinct fraud [italics mine]. The issuer ought to act purely as a warehouse-keeper, and as possession may be claimed at any time, he can never legally allow any object deposited to go out of his safe keeping until it is delivered back in exchange for the promissory note... More recently a better system [than general deposit warrant] has been introduced, and each specific lot of iron has been marked and set aside to meet some particular warrant. The difference seems to be slight, but it is really very important, as opening the way to a lax fulfillment of the contract... Moreover, it now [with general warrants] becomes possible to create a fictitious supply of a commodity, that is, to make people believe that a supply exists which does not exist... It used to be held as a general rule of law, that any present grant or assignment of goods not in existence is without operation” (Money and the Mechanism of Exchange, pp. 206-12; see also p. 221).

  [29] A bank that fails is therefore not simply an entrepreneur whose forecasts have gone awry. It is business whose betrayal of trust has been publicly revealed. Furthermore, a rule of every business is to adjust the time structure of its assets to the time structure of its liabilities, so that its assets on hand will match its liabilities due. The only exception to this rule is a bank, which lends at certain terms of maturities, while its liabilities are all instantly payable on demand. If a bank were to match the time structure of its assets and liabilities, all its assets would also have to be instantaneous, i.e., would have to be cash.

  [30] The Science of Wealth, 3d ed. (Boston: Little, Brown, 1867), p. 139. In the same work, Walker presents a keen analysis of the defects and problems of a fractional-reserve currency (pp. 126-222).

  [31] See Mises Human Action, pp. 439ff. Mises’ position is that of the French economist Henri Cernuschi, who called for free banking as the best way of suppressing fiduciary bank credit: “I want to give everybody the right to issue banknotes so that nobody should take banknotes any longer” (ibid., p. 443). The German economist Otto Hübner held a similar position. See Smith, Rationale of Central Banking, passim.

  [32] In short, our projected legal reform would fully comply with Mises’ goal: “to place the banking business under the general rules of commercial and civil laws compelling every individual and firm to fulfill all obligations in full compliance with the terms of the contract (Human Action, p. 440). Another point about free banking: to be tenable it would have to be legal for 100 percent reserve partisans to establish “Anti-Bank Vigilante Leagues,” publicly calling on all note and deposit holders to redeem their obligations because their banks were really and essentially bankrupt.

  [33] Cf. Walker, pp. 230-31. In A Program for Monetary Stability, p.108, Milton Friedman has expressed sympathy for the idea of free banking, but oddly enough only for deposits; notes he would leave as a government monopoly. It should be clear that there is no essential economic difference between notes and deposits. They differ in technological form only; economically, they are both promises to pay on demand in a fixed amount of standard money.

  [34] The totally neglected political theorist Isabel Paterson wrote as follows on the “compensated” or “commodity dollar” scheme of Irving Fisher, which would have juggled the weight of the dollar in order to stabilize its value: “As all units of measure are determined arbitrarily in the first place, though not fixed by law, obviously they can be altered bylaw. The same length of cotton could be designated an inch one day, a foot the next, and a yard the next; the same quantity of precious metal could be denominated ten cents today and a dollar tomorrow. But the net result would be that figures used on different days would not mean the same thing; and somebody must take a heavy loss. The alleged argument for a ‘commodity dollar’ was that a real dollar, of fixed quantity, will not always buy the same quantity of goods. Of course it will not. If there is no medium of value, no money, neither would a yard of cotton or a pound of cheese always exchange for an unvarying fixed quantity of any other goods. It was argued that a dollar ought always to buy the same quantity of and description of goods. It will not and cannot. That could occur only if the same number of dollars and the same quantities of goods of all kinds and in every kind were always in existence and in exchange and always in exactly proportionate demand; while if production and consumption were admitted, both must proceed constantly at an equal rate to offset one another” (The God of the Machine [New York: Putnam, 1943], p. 203n).

  [35] Leland B. Yeager, “An Evaluation of Freely-Fluctuating Exchange Rates,” unpublished Ph.D. dissertation, Columbia University, 1952.

  [36] Ibid., pp. 9-17

  [37] Professor Yeager indeed concedes that an independent money for each person or firm would be going too far. “Beyond some admittedly indefinable point, the proliferation of separate currencies for ever smaller and more narrowly defined territories would begin to negate the very concept of money.” But our contention is that the “indefinable point” is precisely definable as the very first point that fiat paper enters to break up the world’s money. See Leland B. Yeager, “Exchange Rates within a Common Market,” Social Research (Winter 1958): 436-37.

  [38] Other criticisms by Yeager are really, as he recognizes at one point, criticisms of any plan for 100 percent banking, fiat or gold. There is, for example, the problem of how to suppress new forms of demand liabilities that might well arise to evade the legal restrictions. I do not think this an important argument. Fraud is always difficult to combat, and indeed continues in numerous forms to this day (as does all manner of crime). Does this mean that we should give up outlawing and punishing fraud and other crimes against person and property? Secondly, I am sure that the practical problems of law enforcement would be greatly reduced if the public were to receive a thorough education in the fundamentals of banking. If, in short, 100-percent-money advocates were allowed to form Anti-Bank Vigilante Leagues to point out the shakiness and immorality of fractional-reserve banking, the public would be much less inclined to evade such restrictions than it is now.

  [39] Pace the Mises-Hayek theory of the trade cycle, which was shunted aside but not refuted by the Keynesian Revolution.

  [40] Report of the Subcommittee on Monetary, Credit, and Financial Policies of the Joint Committee on the Economic Report, 81 Cong., 2 Sess. (Washington 1950), pp. 41ff.

  [41] The conservative economic historians of the late nineteenth century saw Jackson as an ignorant agrarian trying to destroy capitalism and calling for inflation against the central bank. The progressives of the Beard school took much the same approach, except that they applauded the Jacksonians for their alleged anti-capitalist stand. The most recent Bray Hammond-Thomas Govan school have again shifted their praise to the Whigs and the Bank of the United States, which they view as essential to a modern credit system as against the absurdly hard-money views of the Jacksonians.

  [42] During the Panic of 1819, for example—several years before Thomas Joplin’s enunciation of the currency principle in England—Thomas Jefferson, John Adams, John Quincy Adams, Governor Thomas Randolph of Virginia, Daniel Raymond (author of the first treatise on economics in the United States), Condy Raguet, and Amos Kendall all wrote in favor of either a pure 100 percent gold money, or of 100 percent gold backing for paper. See Murray N. Rothbard, “The Panic of 1819: Contemporary Opinion and Policy,” Ph.D. dissertation (Columbia University, 1956
). John Adams considered the issue of paper beyond specie as “theft,” aid Raymond called the practice a “stupendous fraud.” Similar views were held by the important French ideologue and economist, and friend of Jefferson, Count Destutt de Tracy. Cf. Michael J. L. O’Connor, Origins of Academic Economies in the United States (New York: Columbia University Press, 1944), pp. 28, 38.

  [43] Failure of the British currency school to realize this Led to the discrediting of Peel’s Act of 1844, which required 100 percent reserve for all further issue of bank notes, but left bank deposits completely free.

  [44] On Carroll, see Lloyd W. Mints, A History of Banking Theory (Chicago: University of Chicago Press, 1945), pp. 129, 135ff., 155-56; and especially the collection of Carroll’s writings, Organization of Debt into Currency and Other Papers, Edward C. Simmons, ed. (Salem, N.Y.: Ayer, 1972).

  [45] Isaiah W. Sylvester, Bullion Certificates as Currency (New York, 1882). On parallel standards, also see Brough, Open Mints and Free Banking, passim. For Brough’s attack on the disruption caused by independent currency names, see ibid., p. 93.

  [46] Thus Groseclose: “The practice of the goldsmiths, of using deposited funds to their own interest and profit, was essentially unsound, if not actually dishonest and fraudulent. A warehouseman, taking goods deposited with him and devoting them to his own profit, either by use or by loan to another, is guilty of a tort, a conversion of goods for which he is liable in... law. By casuistry which is now elevated into an economic principle, but which has no defenders outside the realm of banking, a warehouseman who deals in money is subject to a diviner law: the banker is free to use for his private interest and profit the money left in trust...