“So you think that money is the root of all evil? . . . Have you ever asked, what is the root of money?” --Francisco D’Anconia, Atlas Shrugged
Imagine a world without money. If I have a shovel and you a kerosene lamp, and we judge them equivalent in value, we can trade. The exchange is voluntary, and we both benefit. But if I have no shovel, and offer nothing else you prefer to your lamp, trading is more difficult. You could loan me the lamp until I acquire a shovel. This puts me in your debt, and puts you at risk. You may never see a shovel from me, or your lamp again. To reduce your risk I might give you something else, something you don’t need right now, such as a saw, as collateral. You return the saw when I deliver the shovel, or you keep the saw if I renege.
In a world without money places would arise for people to exchange goods. You’d bring goods you’re willing to trade for goods you want. To be successful, you’ll bring goods that others are likely to want. If you specialize in making kerosene lamps, and people at the exchange want kerosene lamps, you will do well, provided they bring items you want. But if they bring shovels, and you don’t want one, that’s a problem. Another problem is timing: The people come at the wrong time, when you’re not there.
In a world without money, these problems are solved by an entrepreneur who sets up a permanent place of exchange, a trading post, where people leave their goods with him with instructions to trade. They tell the proprietor what they will accept in trade, and he agrees to be on the lookout for such trades. You leave a few lamps with the proprietor. When you return to the post some time later, he tells you, “Good news sir, we were able to exchange four of your fine lamps, for the rope and cart springs you requested.” The trading post is a sort of economic time machine, allowing trades to take place over the course of time, whether you are there or not. Naturally, you have to compensate the proprietor for his part of the trade--you actually brought him five lamps, and he traded four for you, and kept or traded one for himself.
In a world without money, eventually the proprietor creates a form of money, offering “scrip”, printed notes with his mark, which he gives you in exchange for your goods, and which you can exchange for other items. He calls them Trading Post Bucks, or “Bucks” for short. This innovation lets you make trades in Bucks, and not just with the proprietor. Suppose the trip to and from the trading post takes a day, a day you’d rather spend making more lamps. You send your lamps to the post via a courier, who returns with Bucks, keeping a portion in exchange for the transport. A trip on a fine summer day may be worth one Buck, two in the winter. Perhaps the courier gives you Bucks for your lamps immediately, using Bucks he obtained in prior trades. You learn that your neighbor has a small wagon available for trade, which you and he judge to be worth ten of your lamps. Your neighbor has no need of lamps, certainly not ten, and in any case you have none on hand having just sent them all to the post with the courier. So you make this trade in Bucks, which your neighbor can use later at the post, or in trades with other neighbors.
Who determines the value of a Buck? It seems that the proprietor does, and a successful one will develop a keen eye for value, but in reality the local market determines the value of the items traded, and therefore the value of Bucks. A proprietor who consistently overvalues saws and undervalues lamps will develop a surplus of saws and shortage of lamps. Note too that the value of an item may change over time. If a second lamp maker starts bringing lamps to the post, unless the demand for lamps increases, the value of each will fall. A lamp that was worth one Buck last week might only be worth four-fifths of a Buck this week, and three-fifths of a Buck the next. This is perfectly fine in an open market—you just need to get smarter and find a way to make better lamps, or make them more efficiently than your competitor, or switch to making something else. Conversely, your main lamp competitor could move, fall ill, or retire, in which case the supply of lamps will decline, increasing the value of lamps. Until something else happens to change the situation. Nothing ever stays the same for very long, it seems, in a competitive open market.
Let’s stop for a moment to consider the source of value underlying the trades, the trading post, and Bucks. What is it? The answer is you—your skill, your time, and how you combine them with available materials to produce things that other people value. Lamps and saws and wagons don’t just spring into existence—you and your fellow traders create them. You are the impetus for whatever value lies in the things you create. Other people determine their absolute economic value. The value of what you create is therefore your economic value to the rest of the world.
A problem with Bucks is that they are of local value only. If you travel to another region, your Bucks will be worth nothing at a distant post, unless the proprietors have met and have established a means of trading between them.
Another problem with Bucks is that they will not survive the demise of the trading post. A raid, or a fire, or some act of God could wipe out the post and all its goods. The proprietor could become negligent, or greedy, or deranged. A counterfeiter might replicate the Buck, damaging or destroying its value.
The introduction of gold or silver solves many problems. Unlike Bucks, the value of gold and silver is recognized widely, within and beyond the universe of the trading post. The value of gold and silver stems from properties desired by its users. Both gold and silver are: Difficult to produce, all but impossible to counterfeit, easily recognized, durable, portable, and divisible. Unsurprisingly, once gold or silver become available, traders prefer it over scrip. As a medium for exchanging value, traders recognize gold and silver as a superior form of money to Bucks.
What about banking? A bank provides two key values to their customers. First, provided a bank has excellent security, it is a much safer place to keep gold and silver—safer than on your person or in your home. Second, the bank will loan a portion of your deposits, along with that of other depositors, to borrowers who in turn repay their loans with interest. The bank chooses borrowers who are likely to make good on the loans, so your deposits earn interest. The bank is careful not to make bad loans, or too many loans, and takes great pains to never be successfully robbed, in order to preserve the trust of its depositors. Of course the bank keeps some of the interest earned from loans for itself, as payment for the service it is providing to depositors and borrowers.
Well-run banks do well for their depositors and owners. Poorly-run banks lose their depositors’ money due to bad loans or robbery. Smart depositors do business with banks with good business reputations, they pay attention to what the bank is doing, and they back up their deposits with insurance from a reputable provider. (Or the FDIC, in the non-theoretical case of the USA circa 2015.)
Even a well-run bank can experience a bank run due to circumstances beyond its control. A local event—a tornado, a flood, an earthquake, or a military threat—may cause large numbers of depositors to withdraw their gold and silver. Since the bank has some of its deposits out on loan, as it must in order to earn interest for itself and its depositors, some of the depositors cannot be paid. This is where deposit insurance comes in. Provided the event causing the bank run is smaller than the totality of insurance coverage available, the depositors will be paid.
With proper care and attention, during your life you may accumulate many things of value. Some of these will be things you created yourself. Many others will be things you traded for, value for value. Some of these things will be on your person, in your home or on your property, and some may be entrusted to the care of others, such as a bank. The latter will be monetary assets, represented by gold or silver or their equivalents.
Before going on, let's make note of these key points:
- Over the course of your life, you will create and accumulate many things of value.
- The value of what you create is determined in an open market, through voluntary trades.
- An open market rewards value, punishes failure, and distributes risk accordingly.
This is where the Federal Reserve comes in. Wherever a fiat currency is used, someone or something needs to control its supply and distribution. Congress created the Federal Reserve in 1913 and gave it control of our currency. The Fed’s original mission was to prevent bank failures and maintain price stability. It created a system of central banks, established a board of governors to steer policy, and issued a new national currency, the Federal Reserve Note. The Fed laid down a framework of rules to keep individual banks out of trouble, and became a “banker’s bank”, a “lender of last resort” to prevent bank failures. More recently, the Fed has focused on three objectives: Maximum employment, stable prices, and moderate long-term interest rates.
So how has the Fed done? Its original mission was to prevent bank failures and maintain price stability. Maximum bank failures in one year before 1913 were 496 and afterward, 4,400. In the century before the Fed, wholesale prices fell 6%; in the century after they rose by 1,300%. A Federal Reserve Note valued at one dollar in 1913 is now worth about four cents.
How about maximum employment? The official unemployment rate is now 5.8%, having hit a peak of 10% as recently as January 2010. However the Bureau of Labor Statistics excludes from unemployment counts people with part-time jobs who want full-time jobs, and anyone else who it considers to no longer be in the labor force. The BLS ignores the fact that many people have either given up on finding a job, can’t find a job worth taking compared to welfare and other forms of relief, have fraudulently been put on disability, or have decided to stay in school or go back to school in a job-poor environment. If these people were counted in unemployment statistics, the unemployment rate would be closer to 15%. And that doesn’t include the 7% working part-time who would prefer a full-time job. So unemployment today, measured accurately, is somewhere north of 15%.
How about the current focus on stable prices? The Fed controls the money supply, and has a standing target of 2% annual inflation. Not zero percent, but 2%. That may seem small, but over the course of the average working career, that’s a loss of half the original value. Moreover, although the Fed claims that inflation today is about 2%, they’re using a skewed measure that excludes the cost of food, energy, and shelter—three of the largest costs most persons and families have.
The Fed creates inflation by printing money—not in the physical sense, but by increasing the assets of its central banks. This is an electronic transaction having nothing to do with an actual increase in the value of the banks. The central banks in turn lend this new money to their member banks, at a fractional interest rate. This is guaranteed profit for the central banks—although the interest rate is very small, the sums involved are enormous, making each bank a nice profit, and funding guaranteed bonuses for the central bankers.
The Fed tells us that it must inflate the currency because if it didn’t, we would risk currency deflation, which it says would be far, far worse. The Fed says deflation would lead to a deflationary spiral, in which people stop spending money once goods start becoming noticeably cheaper over time. According to the Fed, a deflationary spiral would trigger a massive depression. But deflation is a natural result of economic progress. A good example is the personal computer: $500 buys you a more powerful computer every year, and it has since the PC was invented. So the question is whether the Fed is actually terrified of something that isn’t all that scary, or if is pretending to be afraid as an excuse for creating inflation. If you consider who benefits from inflation—borrowers—and who the largest borrower on Earth is—the US government—the question answers itself.
How about interest rates? After holding a four-decade average between 6% and 8% with significant fluctuations, in 2008 the Fed dropped the rate close enough to zero to be openly termed ZIRP, for Zero Interest Rate Policy. Remember what happened in 2008? Years of easy money from the Fed birthed a giant housing bubble, which exploded in 2008. Afterwards housing prices crashed back to Earth, the stock market tanked, and unemployment soared. The Fed concluded from this that what the country needed most was even easier money! Not six percent, not four percent, but ZERO percent. And not for a year or two, but for six years and still counting. The only way to invest money and beat inflation in this market is the stock market, a computerized casino rigged by the biggest players with the help of the Fed. The goal of the average frugal person—to save money over a lifetime of work and live off the interest in retirement—has been completely destroyed by the Fed and ZIRP.
Let’s revisit the key points made earlier, in light of the economic system we have today, thanks mainly to the Federal Reserve:
- Over the course of your life, you will create and accumulate many things of value. Unfortunately the Feds actions have worked to destroy systematically much of the value you manage to create or accumulate. It has literally made you less valuable, economically.
- The value of what you create is determined in an open market through voluntary trades. Unfortunately the Fed has distorted the marketplace through monetary policy to punish savers, reward borrowers, and really, really, really reward central bankers.
- An open market rewards value, punishes failure, and distributes risk accordingly. Unfortunately the Fed has tilted the market to benefit a few insiders at the expense of the rest. If you happen to suffer as a result, that’s just too bad, you’re collateral damage.
