“It had
come to be accepted that the pigs, who were manifestly cleverer
than the other animals, should decide all questions of farm policy,
though their decisions had to be ratified by a majority vote.”
~ Orwell,
G. (1989 [1945]), Animal
Farm, S. 34.
The Starting
Point: Civilization Begins
The founder
of the Medici banking dynasty, Giovanni di Bicci de' Medici (1360–1429),
said to his children on his death bed: “Stay out of the public eye.”[1]
His words raise the question, "How much do bankers know about the
truth of modern money and banking?"
To develop
a meaningful answer to this question in the tradition of the Austrian
School of economics, one has to start right at the beginning, and
that is with the process of civilization.
Civilization
denotes the development through which man substitutes the state
of the division of labor and specialization (that is, peaceful and
productive cooperation) for the state of subsistence (that is, a
violent hand-to-mouth existence).
In his magnum
opus Human
Action (1949), Ludwig von Mises (1881–1973) put forward
a praxeological explanation of the process of civilization,
which helps us understand the course of its evolution.[2]
To Mises,
two factors are at the heart of the process of civilization:
(1) There
must be an inequality of wants and skills among people.
This is a necessary condition for people to want to seek cooperation.
(2) Man must
recognize that higher productivity is possible through a division
of labor. Mises thus assumes – as a necessary condition – a minimum
intelligence among human beings and a willingness to use this
intelligence in practical life.
Money Emerges
– Carl Menger's Theory of the Origin of Money
The inequality
of skills and wants, accompanied with the assumption of a minimum
intelligence, leads people to engage in the division of labor
and specialization. This, in turn, brings about the need for
interpersonal exchange.
The primitive
form of an exchange economy is barter. Barter has limitations, however.
For instance, under barter, exchange opportunities depend on a double
coincidence of wants.
Sooner or later,
people (assuming a minimum of intelligence) will realize that using
an indirect means of exchange is economically beneficial.
Using an indirect
means of exchange increases the opportunities for exchange, as the
double coincidence of wants is no longer a requisite for
making trading possible.
The indirect
means of exchange that becomes universally accepted is called "money."
In Principles
of Economics (1871), Carl Menger (1840–1921) theorizes
that money emerges spontaneously from market activities, and that
free market money emerges out of a commodity (such as precious metals).[3]
Mises later
showed with his regression theorem that this must
indeed be so, for praxeological reasons: Money must have
emerged out of a market; and it must have started out as
a commodity.[4]
Money Warehousing
Money is an
economic good like any other. As such, it will be economized,
like any other good.
People will
demand convenient ways of holding and exchanging their money proper.
With people
differing in individual time preference, there will be
savers (those who hold excess balances of money proper) and investors
(those who demand money proper in excess of their actual holdings).[5]
It is against
this backdrop that two kinds of money businesses would emerge in
the free market: deposit banking (or money warehousing) and loan,
or credit, banking.[6]
Deposit banking
offers custodian, safeguarding and settlement services to holders
of money proper. For instance, holders of money proper can deposit
their commodity money with a deposit bank against receiving a money
certificate (in the form of a banknote or a sight deposit).
Credit banks
would refinance themselves by obtaining genuine savings, that is
by issuing interest-bearing bonds. Savers will willingly exchange
their money proper against such return-yielding bonds.
The market
interest rate will be determined by the supply of and demand for
money proper, and so the equilibrium market interest rate will reflect
the societal time preference rate. In other words, In a
free market, there will quite naturally be a profession which we
may call “bankers”: some bankers will work in the money warehousing
business (or deposit banking), some in credit banking.
To be sure:
In a free market deposit banking and credit institutions will represent
legally separate entities, and so we would have the deposit
banker, and we would have the credit banker.
The Incentive
for Aggression
In a free
market, there are only three ways of acquiring property (that is,
in a non-aggressive way): homesteading (which actually denotes the
“first-user-first-owner principle”), production, and voluntary contracting.
In reality,
however, things may be somewhat different.
Franz Oppenheimer
pointed out that “There are two fundamentally opposed means whereby
man, requiring sustenance, is impelled to obtain the necessary means
for satisfying his desires. These are work and robbery, one's own
labor and the forcible appropriation of the labor of others.” [7]
The logic
of human action tells us that there is – in fact, there must
be – for the individual an economic incentive to aggress against
other peoples’ property. Two interrelated praxeological insights
explain this.
First,
we know for sure that an earlier satisfaction is preferred over
a later satisfaction of wants; we also know for sure that a satisfaction
of wants associated with low costs is preferred over a satisfaction
of wants associated with high costs. In other words, individuals
try to achieve their ends with as little input as possible and in
the shortest period of time.
Second,
the process to civilization does not extirpate man’s inclination
to aggression. Individual A can be expected to aggress against B
(that is against B’s property) if and when he gets away with it
– that is, if the (expected) benefits for A from aggressing
against B will be higher than the (expected) costs he has to bear
by doing so.
It is the
individual’s economic incentive to aggress against other peoples’
property that is at the heart of the emergence of what is typically
called "government."
A government
can be understood as a territorial monopolist of compulsion: an
agency that engages in institutionalized property rights violations
and the exploitation – in the form of expropriation, taxation, and
regulation – of private property owners.[8]
To answer
the question, "What do bankers know about the truth about money
and banking?", it is necessary to take a closer look at the various
forms of government.
To start with,
one can make a distinction between governments with a low time preference
and governments with high time preference.
At one end
of the spectrum is, to borrow a criminal metaphor from Mancur L.
Olson (1932–1998), the roving bandit.[9]
The roving bandit represents a form of government that has a limited
interest in the welfare of society and, as a result, his theft
typically approaches 100 percent of society’s income.
The roving
bandit does not have to share in the damage his aggression causes
to society (in terms of lost income). The time preference of
the roving bandit is therefore relatively high. He takes as
much from his victims as possible, and there is next to no economic
incentive to restrain his stealing.
At other end
of the spectrum is the stationary bandit. Like the roving
bandit, he also holds the monopoly of coercion over his victims.
However, the
stationary bandit has an encompassing interest in society’s
welfare. He wishes to keep his victims producing: the more his victims
produce, the more there is to take for the stationary bandit.
Sharing in
society’s losses, the stationary bandit will make sure that his
thievery is limited. The higher the losses in production from thievery
are, the lower will be the level of aggression at which the stationary
bandit’s take is maximized. The stationary bandit’s time preference
will therefore be lower than the time preference of the roving bandit.
Taking a closer
look at the stationary bandit, one can make a distinction between
private ownership of government (feudalism/monarchy) and
public ownership of government (democratic-republicanism).[10]
The caretaker
of a privately held government maximizes the present value
of the total income which results from expropriating the property
of the ruled.
A monarch,
for instance, holds the monopoly of expropriation over his victims,
and his time preference will be, due to his encompassing interest,
relatively low.
In contrast,
the caretaker of a publicly owned government will maximize his current
income. His time preference will therefore be relatively high.
Public ownership
of government means majority voting. The majority of the people
decides about who will serve as the temporary caretaker of public
ownership of government.
The average
voter will support those politicians who are expected (rightly or
wrongly) to improve the voter’s economic situation. A voter has
every economic incentive to act in this way – irrespective of the
fact that the income he may obtain in this way results from expropriating
fellow citizens.
The caretaker
of public ownership of government, in turn, has an incentive to
secure the majority of the voters. He will favor policies of expropriating
the (typically few) high income producers to the benefits of the
(typically large group) of less productive or nonproductive people.
The important
insight here is as follows: public ownership of government will
lead to an ongoing erosion of the encompassing interest of the majority
of the people in the market income of society, or in other
words, society’s time preference will increase.
Government
Brings Fraudulent Banking
The rise in
society’s time preference is the central explanatory factor for
explaining the emergence of fraudulent banking, which is epitomized
by a pure fiat money regime.
We know that
the caretakers of publicly owned government wish to expropriate
resources from the public at large. This can be done most conveniently
by (1) obtaining control over money production, (2) replacing commodity
money with fiat money, and (3) producing money through credit expansion.
The banking
industry and the bankers are therefore the natural ally for government’s
planned thievery. In fact, those in government and the bankers will,
and logically so, collude for establishing a pure fiat money system.
Bankers realize
that they would earn additional revenue if and when they are allowed
to issue new money balances through credit expansion (or ex
nihilo): making loans beyond the amount of money proper available
to them.
They understand
that such fractional reserve banking is a fairly profitable
undertaking to them, and so the deposit as well as the loan banker
will be in favor of merging deposit banking with loan banking.
The temporary
caretakers of publicly owned governments are very much in favor
of fractional reserve banking, too. Being a first receiver of the
new money, government can expropriate resources from the natural
owners of things.
Having monopolized
the law, it will be relatively easy for government to declare fractional
reserve banking legal.
Engaging in
fractional reserve banking, however, is risky for the banker. He
knows that if and when his counterfeiting is detected, a bank run
may ensue, and he would be forced out of business, or worse.
For government,
bank failures are fairly undesirable, too. It would bring severe
political and economic problems. Most important, defaulting banks
endanger access to credit and money on easy terms.
Government
will therefore, greatly supported by the bankers, set up a central
bank, which will enable and greatly encourage all banks to
inflate the quantity of money in a combined effort.
Even with
a central bank in place, however, the risk of a bank run is not
entirely eliminated. What is needed is for the central bank to have
a monopoly over money production.
This is why
sooner or later commodity money will be replaced by irredeemable
paper, or fiat, money; and fiat money will be granted legal
privileges (such as, for instance, legal tender status).
To this end, government will make it legal for bankers to suspend
the redeemability of outstanding money certificates into money proper.
Collective
Corruption
One may wonder:
How do government and bankers get away with this – that is fraudulently
extracting resources from producers and contractors via issuing
inflationary money?
Is it a lack
of knowledge on the part of those who are on the losing end of the
counterfeiting money regime? Or are the costs of revolting against
a pure fiat money regime prohibitively high from the viewpoint of
the individual?
An economically
reasonable, that is praxeological, answer to this question can be
found with (what I call) “collective corruption.” [11]
Once government
intervenes in society’s (monetary) affairs, individuals will increasingly
develop a disposition for violating other peoples’ property.
By taking advantage
of governmental coercive action, an individual can reap the benefits
from aggressing against the property of others, while he has to
bear only a fraction of the damage his action does to society as
a whole.
He has every
incentive to act in this way; he would have to bear the losses of
whatever opportunity for violating other’s private property he passes
up.
A pure fiat
money system, once it has set into motion, will lead to collective
corruption on the presumably grandest scale.
As is well
known, government can secure its support by letting the public at
large (actually parts of it) share in the enjoyment of the receipts
fraudulently extracted from natural owners of things.
For instance,
government will offer reasonably-paid jobs (in particular for the
intellectuals and second-hand dealer of ideas). It will also provide
firms with public contracts (such as, for instance, for construction
and building projects).
With growing
government handouts, a growing number of people and businesses will
become economically and socially dependent on the continuation (or
even further expansion) of government activity.
Quite naturally,
resistance against a further expansion of government and the fiat
money regime – which necessarily means further violation of individuals’
property rights – will decline.
Clearly, bankers
play an important role in spreading collective corruption. It may
suffice here to say that a growing number of people will start investing
their lifetime savings into fiat-denominated bank deposits and bonds.
Sooner or
later people will develop a great interest in supporting government
and upholding the fiat money regime – by whatever means deemed necessary.
It Will End
in Hyperinflation
Collective
corruption, once it has become sufficiently widespread, will lead
to hyperinflation – meaning an accelerating increase in the quantity
of money, leading to an erosion, or even a total destruction, of
the purchasing power of fiat money.
Of course,
those in government and bankers have a common interest in avoiding
hyperinflation. They prefer a kind of inflation that goes on basically
unnoticed, a form of inflation that won't spin out of control.
However, once
collective corruption has become widespread and the banking and
financial industry has become highly important in terms of financing
government and serving as an important hoard for individuals' lifetime
savings, the pendulum has already been swung toward hyperinflation.
From praxeology,
we know for sure that a fiat money boom will ultimately end in depression.
We also know that efforts to escape depression by increasing the
quantity of fiat money even further will only postpone the day of
reckoning, and that it will raise the costs of the depression in
the future.
How will the
majority of the people respond to an approaching depression? If
and when people can expect to rank among the first receivers of
the newly created money (which is actually the case once collective
corruption has become sufficiently widespread), the answer appears
to be obvious.
The majority
of the people may expect to benefit from running the electronic
printing press, and they will prefer the running of the electronic
printing press over letting government and banks default. Under
such an incentive structure the fiat money system would end up in
hyperinflation.
In view of
what has been said above we can conclude: (1) If and when public
ownership of government takes hold, commodity money will be replaced
by fiat money. (2) Fiat money leads to collective corruption on
a grand scale. And (3), once collective corruption has become sufficiently
widespread, the fiat money regime will be destroyed by hyperinflation.
From what
has been said above it follows that we know that once a fiat money
system has been put in place, banks and bankers have joined – some
of them willingly and knowingly, some of them unknowingly – the
vast criminal enterprise that is the state.
Being self-interested
human beings, bankers can, and must, be expected to know a lot about
money and banking. In view of a rather dismal monetary history,
such a conclusion would also do much to explain Giovanni di Bicci
de' Medici’s dying words to his children: “Stay out of the public
eye.”
Notes
[1] Parks, T. (2006), Medici Money, Banking, Metaphysics and Art in Fifteenth-Century Florence, Profile Books Ltd, London, p. 3.
[2] "If and as far as labor under the division of labor is more productive than isolated labor, and if and as far as man is able to realize this fact, human action itself tends toward cooperation and association; man becomes a social being not in sacrificing his own concerns for the sake of a mythical Moloch, society, but in aiming at an improvement in his own welfare. Experience teaches that this condition – higher productivity achieved under the division of labor – is present because its cause – the inborn inequality of men and the inequality in the geographical distribution of the natural factors of production – is real. Thus we are in a position to comprehend the course of social evolution.“ Mises, L. v. (1996), Human Action, 4th ed., p. 160-1.
[3] See Menger, C. (2007 [1871]), Principles of Economics, Chapter 8, pp. 257–285, esp. 261–262: “The origin of money … is, as we have seen, entirely natural and thus displays legislative influence only in the rarest instances. Money is not an invention of the state. It is not the product of a legislative act. Even the sanction of political authority is not necessary for its existence. Certain commodities came to be money quite naturally, as the result of economic relationships that were independent of the power of the state.”
[4] See Mises, L. v. (1996), Human Action, p. 408–410; Mises, L. v. (1953), The Theory of Money and Credit, pp. 97 123.
[5] On the issue of time preference see Mises, L. v. (1996), Human Action, 4th ed., pp. 483 –
490; also Hoppe, H.-H. (2006), "On Time Preference, Government, and the Process of Decivilization", in: Democracy, The God That Failed, pp. 1 – 43.
[6] In this context see, for instance, Hoppe, H.-H. (2006), "How is Fiat Money Possible? – or, The Devolution of Money and Credit", in: The Economics and Ethics of Private Property, Studies in Political Economy and Philosophy, 2nd ed., pp. 175 – 204.
[7] Oppenheimer, F. (1922), The State, p. 24.
[8] See, for instance, Hoppe, H.-H. (2006), "On Monarchy, Democracy, and the Idea of Natural Order", in: Democracy, The God That Failed, p. 45; also Rothbard, M. N. (2002 [1973]), For a New Liberty, Chapter 3, "The State", pp. 45.
[9] See Olson, M. (2000), Power and Prosperity, Outgrowing Communist and Capitalist Dictatorships, Basic Books, esp. pp. 1–24.
[10] In this context see Hoppe, H.-H. (2006), "On Monarchy, Democracy, and the Idea of Natural Order", in: Democracy, The Gold That Failed, pp. 45–76, esp. 46–48. On democracy see Rothbard, M. N. (2004 [1970]), Power and Market: Government and the Economy, 4th ed., Chapter 2, 2.B., pp. 19–21, and pp. 233–245.
[11] See Polleit, T. (2011), Fiat Money and Collective Corruption, in: The Quarterly Journal of Austrian Economics, Vol. 14, No. 4, pp. 397–415.
February
2, 2013
Thorsten
Polleit [send him mail]
is chief economist of the precious-metals firm Degussa Goldhandel
GmbH. He is also an honorary professor at the Frankfurt School of
Finance & Management. He is an adjunct scholar of the Ludwig von
Mises Institute and was awarded the 2012 O.P. Alford III Prize in
Libertarian Scholarship. His website is www.Thorsten-Polleit.com.
Copyright
© 2013 by the Ludwig von Mises Institute.
Permission to reprint in whole or in part is hereby granted, provided
full credit is given.By Lewrockwell