A few weeks ago I was discussing the nature of money and the economy with someone who seemed to fundamentally disagree with some basic tenants of how modern money works.
He asked me to read a book titled “What Has Government Done to Our Money?” to help me understand where I was going wrong.
I found the book online in an epub format (link is above), downloaded it to my Nook, and started reading.
The rest of this post is a critique of what I read.
The book seems to be built on two common concepts which the vast majority of people seem to have wrong. The book assumes money was created via a “free market”, which Anthropologists now tell us is not the case. The author also uses the phrase “free market” as it is commonly used these days, without regard to the fact that when Adam Smith used the phrase in his book on economics (which was the world’s first book on economics), he meant something quite different.
The Origin of Money
The author, Rothbard consistently refers to money as having been created to make barter more efficient. To facilitate what is called “indirect exchange”.
In this common and classical narrative, if two parties agree to trade one cow for 30 chickens and the one party lacks the cow, the trade doesn’t happen. It can’t. Something is needed to facilitate “indirect exchange”. Enter money.
The claim is that money is what allows for indirect exchange. The guy with the cow sold it previously to someone who wanted a cow, and now has money to give to the guy who has 30 chickens.
Then after some time, governments took control of money and messed things up.
Anthropologists have now helped us learn the classical narrative about the origin of money is wrong. Zero evidence has been found it ever occurred, and much evidence has been found that the origin of money is quite different.
Prior to the invention of money, a system of credit was used to facilitate transactions. If the two parties above wanted to trade one cow for thirty chickens, but the one guy doesn’t have a cow right now, the chickens were given for a future return of something worth 30 chickens. For example, a cow.
This worked because everyone lived in small communities and everyone knew their neighbors well. People didn’t travel. This pattern has been found in archeological evidence of Neolithic societies all over the world. The original form of “currency” was various informal systems of credit.
As societies grew larger and more complex, kingdoms formed. Kingdoms had (what was to them) very large boundaries and those boundaries needed to be protected from other kingdoms. Armies came into being.
Armies traveled. Villagers still (mostly) did not. Now the credit system used by the villagers broke down. Some stranger with a sword wants a chicken. Since he’s a stranger and you’re likely to never see him again, it’s unlikely he will ever pay you back. The old system of credit stopped working.
So how does the King provision the army? Through the invention of money and taxes.
Ancient Kings would claim ownership of the gold and silver mines in the kingdom. This was a common occurrence, and this reality alone indicates the idea of there being a free market in gold was unlikely to have ever occurred. Kings tended to control things as they deemed appropriate.
So, why would the King pay people in silver, and then take some back once a year? Why would that make sense? The King already owns all the silver.
Because it provisioned the army. The King paid his army in silver and taxed his subjects in silver. Now every subject needs some silver to pay their taxes. Now the subjects of the kingdom sell stuff to the soldiers in order to obtain money (aka tax credits) with which to pay their taxes to the King.
Archaeological evidence shows us money was not invented to facilitate barter or create indirect exchange. Money and taxes were created together as a means of the State provisioning itself from the larger economy with what it felt it needed.
This basic idea of States, Money, and Taxes going together is how money works today. Money, in addition to being a standard of value and a medium of exchange, is first and foremost the tax credits we need to pay out taxes.
This is not a statement of ideology. This is not a statement of what could be or what should be, but rather a statement of what is. What money is, why money exists, and how money works.
There is a really sick joke I’m going to tell, except it’s not a joke. It’s illustrative of why money exists.
England colonized a part of Africa where there were deposits of copper. They want the copper. They instruct the natives that they’ll need to work in the copper mines. The natives don’t see the sense in that. They’ve never needed copper and see no reason to mine it.
The English army commander explains they need to work for money in order to pay their taxes. They natives ask what taxes are. It is explained that taxes are the money they pay to the government (in this case the English) every year for government protection.
The natives, of course, ask “protection from what?”. Protection was never needed before the English arrived.
The very sick punch line is the natives need protection from the English. If the natives don’t pay their taxes, the English army burns their huts.
Again, this is a very sick joke, but it illustrates the relationship between governments, coercion, money, and taxes, that has existed since humans formed governments.
For a fuller understanding of how this worked, watch the video below. David Graeber is an Anthropologist who teaches at the London School of Economics. The video below is where he is giving a talk about a book he wrote titled “Debt, The First 5,000 years”.
For the first 20 to 30 minutes, he talks about how various human cultures have equated debt with morality, after which he talks about the origin of money.
The Free Market
Throughout the book, Rothbard uses the phrase “the free market”.
Per Michael Hudson, who wrote a book that isn’t out yet titled “J is for Junk Economics”, Hudson states that the phrase “free market” today means the opposite of what Adam Smith and David Hume meant in their day.
Per Hudson, Smith meant the market should be free of “rent seekers”.
Rent was money paid due to ownership and not production. A person received rent because they owned land, or interest because the owned bonds, or dividends because they owned stock.
Per Hudson, Smith thought of these people as economic parasites who profited off the economy without adding value. They in fact extracted value from the economy, which is why they were considered economic parasites.
So in Smiths mind (per Hudson), the phrase “free market” meant free of excessive rent-seeking. So how is an economy made free of excessive rent-seeking?
Through government policy, government regulation, government intervention.
Then, after WW1, the phrase “free market” was defined to mean free of government regulation. Which in Smith’s view made the market free FOR rent seekers, not FROM rent seekers.
This freed up rent seekers to exercise what we would call Predatory Capitalism.
I learned of this on a podcast episode which I link to below.
On page 10, Murray Rothbard makes what David Graeber seems to consider to be the classical error about the origin of money.
“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 the bits of paper ‘money’”.
David Graeber, an anthropologist, has stated that zero evidence has been found that money was created to make barter more efficient, and in fact, much evidence has been found to the contrary.
Per David Graeber, the principal “medium of exchange” among what we would call primitive societies, was credit. Communities kept “ledgers”, however formal or informal, of who owed what to who. These “ledgers” were what facilitated what Rothbard is calling “indirect exchange”.
For more information on how this worked, watch the video linked to above.
Murray Rothbard also contradicted something he wrote earlier in the book.
He had just finished describing our belief how in various cultures various materials had been used as a medium of exchange. Tobacco, sugar, salt, cattle, nails, copper, grain, beads, tea, cowrie shells, and fishhooks. Then in the paragraph above, he claims “by everyone suddenly deciding to create money out of useless material”.
Rothbard later states “Thus, government is powerless to create money for the economy; it can only be developed by the process of the free market”. In the video linked to above, Graeber explains in simple terms, why this is not true.
Rothbard is talking about the value of minted coins being based on the amount of metal (i.e.: gold or silver) they contain. He says “Private minters can guarantee a coin at least as well as a government mint”.
While this is true in principle, humans started “cutting” metal coins with lesser value metals almost as soon as we started minting coins.
Later, when regional banks issued paper money as “Gold Certificates” or “Silver Certificates” redeemable for specified amounts of the base metal at the issuing bank, different banks used different reserve ratios.
As a result, merchants had to keep charts they updated regularly to know that a Silver Certificate issued by regional bank X was worth $A, which a similar Silver Certificate issued by regional bank Y was worth some multiple of $A. Maybe half, maybe twice, maybe whatever.
This was the direct result of different banks making individual decisions to use different reserve ratios.
Rothbard is talking in defense private coinage and he says “Moveover, all modern business is built on guarantees of standards. The drug store sells an eight ounce bottle of medicine, the meat packer sells a pound of beef. The buyer expects these guarantees to be accurate, and they are”.
Except of course, when they’re not. When companies lie, cheat, and commit fraud. As we know, fraud occurs.
Later he writes “But fraud is at a minimum, and that minimum, at least in theory, may be prosecuted”.
The 2008 financial collapse occurred because of fraud. Investment banks knowingly selling derivatives on bad mortgages where the derivatives had stellar ratings. Because the banks were paying the rating agencies, who preferred to give false stellar ratings over losing revenue.
In the 2008 financial crisis, the marketplace did not enforce fraud very well.
And still later “We can be sure that a minter’s customers, and his competitors, would be keenly alert to any possible fraud in the weight or fineness of his coins”.
Yet prior to 1863, in the US, regional banks created Gold and Silver Certificates with seemingly arbitrary reserve ratios, and our collective work around is that shops needed to track the value of each Certificate on a chart that was updated at regular intervals (weekly, I think).
My issue with the quotes phrase earlier in this paragraph, is we know it to not be true.
Rothbard is talking about the supply of money. In this example, he uses Gold as money. He correctly states that if the supply of gold increases, the supply of money has increased, but the supply of goods and services has not. Therefore the “cost” of goods and services decreases as the “price” of money falls due to the increased supply.
He then says “We come to the startling truth that it doesn’t matter what the money supply is. Any supply will do as well as any other supply”.
But don’t Economists of the Austrian school state that we can’t “just” print more money? Yet if it doesn’t matter what the money supply is, why can’t we just print more money?
Per the logic earlier in this paragraph, it should not matter.
Rothbard writes “Furthermore, improved standards of living come to the public from the fruits of capital investment. Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers”.
If “free market” means free from predatory capitalism, I can see how this would be true. However, when “free market” means free from the mechanisms that hold predatory capitalism in check, that is clearly not the case.
Simply examine the US economy over the past 40 years.
Page 23 and 24
Rothbard is writing about the use of two metals as money in the same economy. He writes “It is not necessary, however, for the government to step in and save the market from its own folly in maintaining two moneys”.
Why is this “folly”? If it’s what the “free marketing” does, why is it not “freedom”?
Rothbard seems to be promoting the value of a 100% banking reserve requirement. In doing so he seems to ignore the fact that fractional reserve banking was created in (or perhaps by) a “free market”.
It was not created through government intervention.
Per this Q&A forum (where sources are cited, a balance sheet from the London branch of the Medici Bank shows that a significant number of the bank’s debts corresponded to demand deposits. In 1477. Apparently, for the Medici Bank, it did not go well.
For the record, in the United States, uniform reserve requirements were established in 1863, when the national bank was first established. Prior to that, regional banks, chartered by State governments, set their own reserve requirements.
Some States set no reserve requirements (which if government intervention is the opposite of freedom is maximum freedom).
If “the market” does not impose a 100% reserve requirement on banks (see above), how would this be done? If government interference is bad, how COULD this be done?
Rothbard writes “Inflation, being a fraudulent invasion of property, could not take place on the free market”.
However, he previously wrote, “Inflation may be defined as any increase in the economy’s supply of money not consisting of an increase in the stock of the money metal” (page 28).
We also know that fractional reserve banking (i.e.: an “increase in the economy’s supply of money not consisting of an increase in the stock of the money metal”) started in a market unencumbered by government intervention, what he refers to as a “free market”.
His contradicts himself.
Rothbard writes “”But if the government can find ways to engage in counterfeiting – the creation of new money out of thin air – it can quickly produce its own money without taking the trouble to sell services or mine gold”.
This ignores the anthropological evidence that money did not originate to make barter more efficient (the indirect exchange idea from earlier) and he ignores the anthropological evidence that money has always originated from the states need (or desire) to provision the military.
Rothbard writes “… but they should have realized that a dangerous precedent had been set for government control of money”. This statement seems to fall back on the false premise that money came into existence to facilitate barter. The indirect exchange he describes earlier in the book.
It ignores the fact that archeologists have determined that narrative to be false. In the ancient world, the following seem to have always occurred together: armies, state controlled money, and taxation. In all of human history, in every even semi-complex society, money has always been state controlled.
This is not a statement of what could be or what should be, but rather of what actually occurred, and occurs today.
Further down the page, Rothbard writes “For then debtors are permitted to pay back their debts in a much poorer money than they had borrowed, and creditors are swindled out of the money rightfully theirs”.
In economic practice, ancient societies where money originated had regular instances of debt forgiveness. The Bibilical jubilee is the best known example.
The rulers seemed to understand that excessive debt was a drain on the economy. When too many people were in debt bondage, the king couldn’t raise and provision an army.
So at various intervals, consumer debt was decreed to not exist. The idea was that people who make loans should assume some level of risk and be careful not to make loans to people who can’t pay.
The reward for this risk is the interest on the loan.
After WW1, the basic ideas of how economies were rewritten to start favoring creditors, and after WW2, that idea became further entrenched in our culture.
This idea that “debt bondage” is a drag on an economy is being seen today.
The 2008 financial crisis was triggered to excessive amounts of bad mortgage debt which was fine, from the perspective of the creditors, as their risk was very low, those mortgage debts being guaranteed by the US federal government.
Today, student loan debt is delaying the entrance of millions of millennials into the adult consumer economy, as their student loan payments are very high. Their ability to buy cars and houses is delayed years behind what their parents experienced.
The idea that creditors must be paid back at all costs and debtors who do not are confiscating creditor property is in historical terms new and seems to have been very damaging to economies around the world.
Beyond the 2008 mortgage crisis and the current student loan debt load hampering the entry of millennials into the adult consumer economy, what some call debt bondage are constricting the economies of Greece, Puerto Rico, and Venezuela.
Rothbard writes “Invariably, private banks are prohibited from issuing notes, and the privilege is reserved to the Central Bank. The private banks can only grant deposits. If their customers ever wish to shift from deposits to notes, therefore, the banks must go to the Central Bank to get them”.
This may be a cast of me not understanding what they mean by “notes”, but if notes mean currency backed by gold and/or silver where there is not enough gold and/or silver to redeem all the notes, the issuing of notes by Regional Banks occurred in the US prior to a National Bank even existing (which occurred in 1863).
Today, banks get their money from the Central Banks, and banks issue notes in the form of loans. If I’m understanding correctly, Rothbard is saying that between 1913 (when the Central Bank was created), and some date between 1913 and today, that banks that were not the central bank did not issue “notes” or currency in excess of the gold or silver on deposit.
If so, where can I learn more about this?
Rothbard writes “It became clear to governments that they could not afford to allow people to own and keep their gold. Government could never cement its power over a nation’s currency, if the people, when in need, could repudiate the fiat paper and turn to gold for their money”.
The Gold Reserve Act of 1933 outlawed most private possession of gold as stated. The book was published in 1962. In 1974, President Gerald Ford signed a bill legalizing private ownership of gold coins, bars, and certificates. The US went off the gold standard in 1971, but nothing prevented people from resuming to use gold for transactions subsequent to 1974.
The ideas in the book predict that should happen, as gold is infinitely superior to fiat currency as a form of money. It didn’t happen.
Page 49, further down
Rothbard writes “Hyper-inflation occurs when the public realizes that the government is being on inflation, and decides to evade the inflationary tax on its resources by spending money as fast as possible while it still retains some value”.
I’m not sure how many people believed that to be true in 1962, but today we know that is NOT what causes hyperinflation. If it was, we would have experienced hyperinflation many times over in past decades.
It is now understood that hyperinflation occurs when supply collapses.
Rothbard writes in relation to different countries using different fiat currencies “In a world of fiat moneys, each country has its own money. The international division of labor, based on an international currency, has been broken, and countries tend to divide into their own autarchic units. Lack of monetary certainty disrupts trade further. The standard of living in each country thereby declines”.
Since the US went off the gold standard, foreign trade has increased drastically. Living standards in the US are now falling, but it’s easy to see the cause is not lack of trade, but rather the increasingly unequal distribution of the fruits of our national productivity.
When writing about the American economy from 1815 – 1914, Rothbard writes “One of the reasons for the growth and prosperity of the United States has been the fact that we have enjoyed one money throughout the large area of the country”.
This is flat out not true.
While it IS true that the US was nomically on a gold standard, regional banks issued gold certificates in excess of the gold reserves they had. What is known as “fractional reserve banking”, which itself was created without government intervention, started as a result of BANKS seeing advantages, in the 12th century.
The various regional banks in the US defined their own reserve requirements, which were generally known, but not regulated. As a result, a defined sum of money from bank X and money from bank Y would NOT buy the same “basket of goods”.
It can not truthfully be said “the United States enjoyed one money throughout the large area of the country” prior to 1863. As that is when the US National Bank was established.