31 March 2009
Some thoughts on money

This partly comes from my reading of Murray Rothbard’s “The Mystery of Banking” and a comment I left on Brian Micklethwait’s blog.

Two ideas.  What money really is and what we have come to understand as money.  And the connection?  What we have come to know as money is a perversion of a perversion of that original idea.

The original idea is simple enough.  Money is metal.  Sometimes gold, sometimes silver.  Sometimes cigarettes (which is not a metal at all) but that’s another story.  The point is that a metal like gold is very useful as money: it’s scarce, it’s consistent, it’s durable, it’s divisible.  And that, at root, is all you need.

Until you try to use it that is.  Say, you’re selling Mars Bars and some bloke tries to buy one of your Mars Bars with a lump of yellow metal which he claims to be gold.  How do you know it is what he says it is?  How do you know it hasn’t been mixed with something else, something cheaper?  Sure, there are some tests you can carry out but you need equipment and that is likely to be expensive and bulky and time-consuming to use.  Not really the sort of thing you want to be having to take down to Tescos.

The answer to this verification problem is, of course, coinage.  You take your metal down to the mint, they weigh it, melt it down, add some alloy and stamp it out with some pretty, hard to reproduce pattern.  In other words they brand it, in just the same way that Cadbury’s brand bars of Dairy Milk.  And with much the same effect.  Now everyone knows what they are getting.

At which point we get the first perversion.  Enter the state.  For reasons that are not entirely clear the state has always claimed a monopoly on minting coins.  Roman emperors have their heads on the currency.  It is not difficult to see why.  States always need to raise money.  There are two ways to do this.  The first is taxation.  But taxation is a pain.  You need agents and sometimes people shoot these agents.  The second is inflation.  You take a coin, you melt it down, you add some base metal and you mint two new coins.  Bingo, you’re twice as rich.  And states have been doing this since time immemorial.

The next perversion comes with storage.  If you’ve got a lot of gold you don’t really want to keep it at home - someone might steal it.  So, you take it down to a secure store - known at the time as a goldsmith’s.  And in return you are given a receipt.  Now obviously this receipt is a rather valuable piece of paper, so it has to have many of the properties of a coin - hard to reproduce pattern etc.  The point is that if the receipt is good enough the bearer has a choice.  Yes, he can use it to redeem his gold, or, he can use it as money in its own right.  It is literally as good as gold.

At which point we get the second perversion.  The goldsmith realises that his receipt is now being accepted as money.  This means that year on year only a small portion of the gold in storage will ever be redeemed.  So, he decides to print up some new receipts and lend them out in the hope that there will never be a time when he has to redeem all the receipts (or notes) at once.  On the face of it this sounds like fraud - but your high street banks are doing this every day (or rather were until the credit crunch struck).

Actually, this is a bit of an aside because the really important thing is what happens next.  The government gets involved.  It starts issuing its own notes - in Britain this began with the Bank of England in the 1690s.  Then it bans anybody else from issuing their own.  First by banning the practice within 65 miles of London and then everywhere else.

Now, from the state’s point of view this is not a perfect solution.  The notes are still redeemable for something real - namely gold.  So, what they do is to suspend redemption in time of war eg Napoleonic Wars, First World War, on an apparently temporary basis and then progressively put up ever greater barriers to redemption.  In the 1920s when Britain went back on the gold standard the kicker was that normal everyday citizens could no longer redeem their notes.

And then, as they did in Britain in 1931, they break the link with metal entirely.  The perversion of money is complete.

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  1. I could pick over bits of that, but yes that’s basically the gist of it I think.

    Money is a common medium of exchange - the form it takes, whether metal or paper or cigarettes depends on the context of use viz a more or less open society or, say, a gulag.

    Money is also the sole means of economic calculation. Since values refer to choices of individual people, money is the common tool for comparing our valuations of economic goods.

    A socialist society requires the abolition of money because it demands the abolition of individual choice and with it therefore, economic calculation.

    The verification process might also include the denominations used. Different denominations would help to distinguish parallel currencies. 

    Government involvement actually starts before your second perversion of fractional reserve, because, assuming we have more than one goldsmith issuing receipts, the one who adopted fractional reserve would have been run out of business (the reverse of Gresham’s Law) were it not the State mandating fixed ratios of exchange between the different metals.

    It’s great that you, Brian and Jonathan Pearce are blogging on free-banking!

    Posted by mike on 01 April 2009 at 03:16pm

  2. Nice summary of how we got where we are, Patrick.

    I have ordered that Rothbard book, by the way.

    Posted by Johanthan Pearce on 02 April 2009 at 06:34pm

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