Progressives, Cartelists, the FED, and trust busting

Murray Rothbard wrote about the vastly wealthy in America fooling the progressives and then re-writing history as to what happened in a small article in 1999. Here is a short portion of that article:

The Federal Reserve Act of December 23, 1913, was part and parcel of the wave of Progressive legislation on local, state, and federal levels of government that began about 1900. Progressivism was a bipartisan movement that, in the course of the first two decades of the 20th century, transformed the American economy and society from one of roughly laissez-faire to one of centralized statism.

Until the 1960s, historians had established the myth that Progressivism was a virtual uprising of workers and farmers who, guided by a new generation of altruistic experts and intellectuals, surmounted fierce big business opposition in order to curb, regulate, and control what had been a system of accelerating monopoly in the late 19th century. A generation of research and scholarship, however, has now exploded that myth for all parts of the American polity, and it has become all too clear that the truth is the reverse of this well-worn fable.

In contrast, what actually happened was that business became increasingly competitive during the late 19th century, and that various big-business interests, led by the powerful financial house of J. P. Morgan and Company, tried desperately to establish successful cartels on the free market. The first wave of such cartels was in the first large-scale business — railroads. In every case, the attempt to increase profits — by cutting sales with a quota system — and thereby to raise prices or rates, collapsed quickly from internal competition within the cartel and from external competition by new competitors eager to undercut the cartel.

During the 1890s, in the new field of large-scale industrial corporations, big-business interests tried to establish high prices and reduced production via mergers, and again, in every case, the merger collapsed from the winds of new competition. In both sets of cartel attempts, J. P. Morgan and Company had taken the lead, and in both sets of cases, the market, hampered though it was by high protective, tariff walls, managed to nullify these attempts at voluntary cartelization.

It then became clear to these big-business interests that the only way to establish a cartelized economy, an economy that would ensure their continued economic dominance and high profits, would be to use the powers of government to establish and maintain cartels by coercion, in other words, to transform the economy from roughly laissez-faire to centralized, coordinated statism. But how could the American people, steeped in a long tradition of fierce opposition to government-imposed monopoly, go along with this program? How could the public’s consent to the New Order be engineered?

Fortunately for the cartelists, a solution to this vexing problem lay at hand. Monopoly could be put over in the name of opposition to monopoly! In that way, using the rhetoric beloved by Americans, the form of the political economy could be maintained, while the content could be totally reversed.

Monopoly had always been defined, in the popular parlance and among economists, as “grants of exclusive privilege” by the government. It was now simply redefined as “big business” or business competitive practices, such as price-cutting, so that regulatory commissions, from the Interstate Commerce Commission (ICC) to the Federal Trade Commission (FTC) to state insurance commissions, were lobbied for and staffed with big-business men from the regulated industry, all done in the name of curbing “big-business monopoly” on the free market.

In that way, the regulatory commissions could subsidize, restrict, and cartelize in the name of “opposing monopoly,” as well as promoting the general welfare and national security. Once again, it was railroad monopoly that paved the way.

For this intellectual shell game, the cartelists needed the support of the nation’s intellectuals, the class of professional opinion molders in society. The Morgans needed a smokescreen of ideology, setting forth the rationale and the apologetics for the New Order. Again, fortunately for them, the intellectuals were ready and eager for the new alliance.

The enormous growth of intellectuals, academics, social scientists, technocrats, engineers, social workers, physicians, and occupational “guilds” of all types in the late 19th century led most of these groups to organize for a far greater share of the pie than they could possibly achieve on the free market. These intellectuals needed the State to license, restrict, and cartelize their occupations, so as to raise the incomes for the fortunate people already in these fields.

In return for their serving as apologists for the new statism, the State was prepared to offer not only cartelized occupations, but also ever-increasing and cushier jobs in the bureaucracy to plan and propagandize for the newly statized society. And the intellectuals were ready for it, having learned in graduate schools in Germany the glories of statism and organicist socialism, of a harmonious “middle way” between dog-eat-dog laissez-faire on the one hand and proletarian Marxism on the other. Big government, staffed by intellectuals and technocrats, steered by big business, and aided by unions organizing a subservient labor force, would impose a cooperative commonwealth for the alleged benefit of all.

And that transformation of a “roughly laissez-faire economy and society” to one of “centralized statism” came just in time to begin over a century of war and empire expansion that continues until this day. We have seen how the government can use the central bank to inflate money and pay for things they could never get with just taxes or borrowing (as bad as these two are). The main point of that Rothbard post is the idea that the progressives brought you the wonders of central banking which funds endless war and control by the rich.


Steven Horwitz Professor of Economics at St. Lawrence University tells us:

Like other legislation of that era, the Fed was a government intervention supported both by ideologically-motivated and well-meaning reformers and by the industry being regulated. Rather than being this as some sort of unique conspiracy to take control of the US monetary system, it was a story very similar to those found in the history of everything from railroad regulation, to meatpacking regulation, to the regulation of monopolies and trusts as historians from Gabriel Kolko onward have documented. Unique historical factors in the monetary system affected the particular form the Fed took, but its broad history places it squarely in the tradition of the Progressive Era. If the Fed is the product of some nefarious conspiracy, so is a whole bunch of other legislation passed around that time.

The Fed emerged not as a response to failures of a free market in banking, nor as the result of shadowy banking conspiracies, but instead as a response to the failures of the National Banking System (1863-1913) that preceded it. The US banking system has never been a free market, as the National Banking System (NBS) was itself a response to pre-existing state-level regulations on banking. Under the NBS, and many of the state systems that came before it, banks were subject to three major regulations: 1) limits on the ability of banks to operate branches; 2) minimum reserve requirements; and 3) requirements that banks that produced currency buy up certain bonds or other financial assets as collateral.

The first and third of these regulations were particularly problematic. The limits on branching varied. During the pre-Civil War years, branch banks of any kind were illegal – banks could only operate one office. During the NBS, interstate branching was illegal, as no state would allow branches of banks chartered in other states to open up in that state, and some states still prohibited banks from opening branch offices within their state. The result was a banking system with few inter-bank institutions and too many banks that were too small and not sufficiently diversified, and therefore overly prone to failure.

The bond collateral requirements were also a problem. Before the Civil War, they often served as a form of crony capitalism as some states required that banks buy the bonds of railroads and other nominally private enterprises instead of, or in addition to, government bonds to serve as collateral. In the NBS, federally chartered banks were required to buy federal government bonds as a way of financing the Civil War. Regardless of whose bonds were required, forcing banks to purchase bonds when they want to expand their issues of currency became a problem as the required bonds were sometimes found to be either worthless or in short supply. One result was periodic currency panics that continued throughout the century.

In this episode of twisted fate, we see the progressives built the very edifice that they would then spend more than a century decrying. Now that is irony. They were had by a shell game played by the most wealthy class in America and they lost even as everyone celebrated their apparent victory. The central factor that the progressives failed to understand is that the monopoly is a product of government privilege and does not arise via laissez-faire free market forces. The “leaders of industry” got tired of so many newcomers competing successfully with them and their business concerns and so looked to government to protect them.

Friedrich von Hayek won the Nobel Prize for his theory of the business cycle and that theory puts the blame for the boom-bust business cycle squarely on the shoulders of the government and its controlled banking system. When government encourages bank credit expansion through its central bank and control of the banking system, this causes price inflation as well as increasing malinvestments. Most importantly this credit expansion encourages unsound investments in capital goods and underproduction of consumer goods. In spite of this knowledge, most Americans still believe that the monopoly control of their money by government is somehow a “good thing”. The progressives were fooled into giving the government the means whereby they could finance a world wide empire as well as dominate the domestic economy to everyone’s disadvantage.

It was the same thing with the idea that the government needed to be in the “trust busting” business. This hoary old canard hangs on till this day and you will hear it anytime you talk to a progressive or even most public school educated Americans. They really think that without their protector government the corporations would grow without bound until only a few, or even just one, dominated the whole world. They simply don’t understand competition nor have they read the history of the USA in the 1800s and 1900s. If they did understand, they would realize that it is government itself that helps the largest corporations to grow and dominate us. (crony-capitalism)

Big-business interests did try in the late 1800s to establish predatory high prices and reduced production and failed to do so. They tried the mergers that modern liberals tell us would lead to their total control of the people without government to stop them; and yet, they tried and the large business interests all failed due to market forces.  In every case the merger collapsed due to competition just as Hayek, Rothbard, and Mises have demonstrate must happen. Even hampered by the intervention of government through protective tariffs the market nullified these attempts by private concerns to create monopoly. And so the state was called upon to do by force, coercion, and intimidation what the big business moguls could not do by themselves.

The American big business leaders knew well that governments can hand out monopolies. The knew about the English monopolies in the period just before the industrial revolution. As Rothbard has pointed out; the creation of monopolies reached its climax in the reign of Queen Elizabeth. He quoted the words of historian Professor S.T. Bindoff, “… the restrictive principle had, like some giant squid, fastened its embracing tentacles round many branches of domestic trade and manufacture,” and “in the last decade of Elizabeth’s reign scarcely an article in common use – coal, soap, starch, iron, leather, books, wine, fruit – was unaffected by patents of monopoly.”

In the 1900s, as in America today, we have seen that lobbyists use the lure of monetary gain to obtain government sponsors to fight for their petitions for grants of monopoly. The American businessmen knew that using the law to secure their place was far easier and safer than competition! And once granted their privileges the monopolists proceed to loot the public just like Ma Bell of old. Now don’t be fooled, today’s grants of monopoly are crafted to make it look like they are promoting competition even as they do the exact opposite. There are many “barriers to entry” into an industry and mountains of expensive regulations that hold down new competition and allow the businesses protected to whine about “government regulation” even as those very regulations protect them. The propaganda of the government, lobbyists, and big business is far more sophisticated than is was in the 1900s and the manipulators are still fooling the common man — especially the “progressives”.

Ironic evil is the evil good men do while they think they are doing good. Many well meaning but economically ignorant men and women have helped get the USA to this sad juncture in its history. I hope more people will study Austrian Economics and arm themselves with the knowledge of how the world really works. Ron Paul has tried his best to explain economics to the masses and has done a great job of it; but all of us need to study more and to tell our friends and family.

Basic Economics of Money and Inflation for the Distracted

Introduction and Medium of Exchange

Economics is often called “the dismal science” but it is not really dismal nor is it hard to understand. Economics can be made to look hard or boring but that is the job of government paid teachers and they do it to keep people from understanding how the state is screwing them over.

We are in hard economic times at present in the USA and some economists have called it a “recession”. It is called a “recession” because the word “depression” which was used for most of our history is so scary to the modern man, given “the great depression”, that we are afraid to use the word anymore. We are also seeing prices rise and that hurts everyone, but it hurts the poor the most. People wonder what causes these things, but before answering that large question one must first start with some basics and the first one might as well be “money”. So, what in the world is this thing called money? Why do we even need it? Have not many people called money the “root of all evil”?

Once upon a time people would use barter to obtain the goods and services they needed. That is, two individuals each possessing a commodity or a service that the other party needed would enter into an agreement to trade so that both would be better off than before the trade. It was not always simple even with just two people, consider if you had a horse and I had a dozen eggs — that does not seem to be a fair trade most of the time. This direct form of barter does not provide the transferability and divisibility that makes for efficient trading. Another example is the one if you have cows but want apples. Then you need to find someone who has apples and the desire for your beef. What if you find someone who has the need for beef but no apples and can only offer you shoes? To make the trade now the two of you need to go find a third party, or more people, who want to trade to see if something can be worked out. This is very confusing and inefficient.

What if most people wanted salt and you had extra salt? You could barter for needed goods by offering some of your salt for whatever you wanted or needed. If you wanted to get just enough beef for the week from the farmer in town, the two of you could decided on a fair exchange rate between salt and pounds of beef. This works if the farmer thinks that many other people, who have things he needs, also value the salt and will also take it in trade. In this way the salt would be traded just so he could trade the salt with others since everyone needs salt.

In the “new world” of colonial America colonialists used beaver pelts, tobacco, whiskey, dried corn, and other items as currency for transactions. These commodities were chosen for many reasons. These commodities were widely desired and easy to trade with, but just as importantly they were also durable, portable and easily stored. Tomatoes are the fruit of the gods, but they go bad so fast that one could not use the delicious tomato as a trading commodity.

Since these commodities were used to trade for goods and services, one could say that these commodities formed the basis for exchanges. Heck, one could even say that they were a medium of exchange“. That, by the way, is how most experts define the word “money”. What would be the best commodity to be used as money? One needs to look for the commodity that is easy to exchange and it needs to not deteriorate for long time periods. The commodity chosen also needs to be easy to carry around and store.

What did the ancient world decide to use for money? Gold and silver. Both metals last a long, long time as they don’t rust away like iron. Both metals have inherent value in the arts and in the jewelry trade. Both items are in sort supply so that the law of supply and demand does not diminish the value of either for the most part. Gold and silver do have problems. How much do you have in your sack? How to weigh it? How pure is that “gold” anyway? Gold dust is easy to divide up and that helps a bit, but it is still a pain to have to weigh out gold every time you buy a darned happy meal for the kids at that fast-food joint.

Money, Coins, and Inflation

Consider How Much things cost in 1974

Year End Close Dow Jones Industrial Average 616
Average Cost of new house $34,900.00
Average Income per year $13,900.00
Average Monthly Rent $185.00
Cost of a gallon of Gas 55 cents
Average cost new car$3,750.00
Samsonite Case $62.00

It would be very difficult to talk the new car dealership out of a new car for only $3,750 today! Why do prices rise? The progressive often says it is simply “corporate greed”. That answer is wrong of course, but what does cause prices to rise? To answer that we need to look at “money” more closely.

If you take a look at the “coins” in your pocket change you will see that the dime, quarter, and the half dollar all have little groves on them. That was to prevent anyone (the government most often) from clipping off a bit of the edge before passing it along. No one would do such a thing today of course since the “coin” in not really a “coin”, but rather it is a token. The US government stopped issuing “coins” in 1965. They issue tokens instead.

The “coin” was invented by the ancients to overcome the problem of how to trade conveniently in gold or silver. The real coin is a disk of precious metal, usually gold or silver. This coin has three things stamped on it; the weight of the coin, the fineness of the metal, and the name of the mint where it was manufactured. The name of the mint is called the “hallmark” and it became the “brand name” and naturally some brands were trusted more than others just like today. Notice that the object did not need any government backing as the object itself was of a certain value regardless.

The Romans had a silver coin called the Denarius. It was a 940 fine silver coin, which means it was 94% silver and 6% base metal for strength. The Romans had a welfare program as well as a warfare program and continually needed money, so when they collected taxes they started clipping off a bit of metal from each coin and minting new coins. The groves on a coin called “reeding” is there to prevent this sort of theft of metal. That was not enough so they started counterfeiting by melting the coins and adding base metal to reduce the silver content which allowed them to mint new coins from the stolen silver. This is called “debasing” the money. The Denarius went from 94% silver in 54 AD to under 50% by 200 AD and then to 1% silver by 250 AD and therefore became nearly worthless. It would have to take 94 coins to equal the silver content of one non-counterfeited coin.

The middle ages saw a mint in Czechoslovakia introduce and then produce a coin called a Joachimthaler that was popularly called a “thaler” because, hell, who can pronounce those Czech names anyway? It was a one ounce silver coin and became so popular, trusted, and demanded that the very name “thaler” came to mean the same thing as one ounce of fine silver. As language changes the name “thaler” became “daler” and later on it became “dollar”. The “Dollar” was defined in the mind of the people of Europe as one ounce of fine silver.

Paper Money and Inflation

We have seen how government counterfeited by debasing the precious metal content of the coins when the government took in coins via taxation. Now we will look at “paper money” and the debasing of that commodity.

Once upon a time when real gold and real silver were the coin of the realm, it was difficult to keep all of your money with you. Gold and silver are metal and they are heavy! It is also dangerous to haul around all of your money due to the robber that might take it from you. There were money warehouses where one could store his gold and silver, and these became known as banks. There was a fee for the storage and you got a receipt for the metal that you deposited in the bank. These receipts became known as “bank notes“.

Sometimes two men would arrive at a fair price on a trade and one would just give the other the correct amount in bank notes rather than go to the trouble of going to get the actual gold or silver from the money warehouse. With reputable banks this worked out very well indeed. Thus the idea of “paper money”, which was just trading receipts (which were just claim tickets or IOUs) became accepted.

In the USA the government issued a one dollar bank note called a Silver Certificate up until the 1960s. The government promised to redeem the paper bill with once ounce of fine silver upon demand. Until the 60’s the US Dollar was valued throughout the world as very good money and the phrase “sound as a dollar” meant that one was in good shape. In the 60s the US government started issuing fake coins (“token” is the technical term) that you can see in your own pocket today. The government also started issuing Federal Reserve Notes which were not backed by anything and could not be redeemed for Silver. Now you may wonder how this came to be. It was not just some experiment, rather it was necessary. You see, the US government had been engaged in a massive fraud and had issued far, far more Silver Certificates that it had silver to redeem the paper with. So, they changed the rules of the game by issuing paper backed by nothing. So what gave these pieces of paper any value at all? The “legal tender law” is what.

The idea of “legal tender” goes back to Kublai Khan who issued pieces of paper that said they were 20 ounces of gold! He passed a law that said if you refused to accept such a piece of paper you would forfeit your life. (the Khan’s were not very warm and fuzzy) Other governments after that time tried other versions of “legal tender” and the USA settled upon the idea that one accepts the unbacked paper for a debt or the debt is canceled. In other words, if I owe you $100 and offer US money for the debt you have to accept it or the debt is legally canceled! Neat, eh? This allows the US government to print up all the money they dare to print up. The only thing holding back the government from printing up Billion Dollar Notes by the truck load is the law of supply and demand leading to hyperinflation.

FDR stopped gold coins in the 30s, silver coins and paper Silver Certificates were done away with in the 60s, and the constitution says that all this is illegal. The document says the the government can not “make any Thing but gold and silver Coin a Tender in Payment of Debts”. But we don’t follow the constitution any more so few care about this small problem.

Paper Money and Runaway Inflation

We have looked at how governments could debase the currency and steal money even if the currency were gold or silver coins. This was a time honored way for the government to steal money to pay for wars and welfare, without high taxes which can lead to unwanted unrest among the population. Ah, but paper money, now there is a concept that turns out to be a wonderful concept for governments to loot the public. If a government prints more money, then the money already in circulation is worth less. With paper money not tied to any redeemable amount of precious metal, the government may print as much as it deems it needs to do. Heck, sometimes it prints too much money even if it has “promised” to redeem the paper currency for solid precious metal. Governments sometimes don’t tell the truth, perhaps you have noticed this.

Inflation is an increase in the money supply. Inflation leads to rises in price because the increase in the amount of money in circulation has made all the old money worth less than it did before. As an example, if I were selling apples for a dollar a piece today, and the rate of inflation were 10% then I would have to rise my price to $1.10 by the end of the year just to keep at the same level I was before. I have not raised my price in real terms; I have only kept up with inflation. So, how high can prices go? How fast can it happen? Has it ever happened in real countries on the planet earth before? Let us look to history for answers. Wikipedia has an excellent list of countries that have experienced hyper-inflation. See it here.

In Germany in 1914 the cost of a pound of butter was a little over one Mark. By 1918 the cost had risen to 3 Marks. By 1922 a pound of butter was 2,400 Marks, and the next year it went to 6,000,000,000,000 Marks. Yes, one pound of butter went from a Mark to six Trillion Marks in 9 years. One egg in 1914 was under a Mark and 9 years later it was 80 Billion Marks. This level of inflation is such a society killer that governments have tried to cause runaway inflation in the economy of their enemies during wartime.

In the 1920s the German government bragged about its efficiency at printing money. They had twelve printing operations running 24 hours a day pumping out new currency! How could anyone set a fair price for something? If I sold a farm for 3,000 marks to you one year, it might cost 3 Trillion to buy one like it a few years later! How can society run in this sort of chaos? I believe that most humans can understand the evils of runaway inflation. The only people who would want such a thing (mistakenly) are those so deeply in debt that forcing even a large debt to become mere pocket change is a “good thing to them personally”. (assuming they give up eating food that is)

Money, Inflation, and the Central Bank

Money is a crucial part of our economy and our society. Untold numbers of voluntary exchanges enable a division of labor in society. Everyone benefits because the division of labor allows for all of us to be much better off than we would be if we had to be self-sufficient which would reduce us to a pitiful standard of living.

As Rothbard noted:

Money is different from all other commodities: other things being equal, more shoes, or more discoveries of oil or copper benefit society, since they help alleviate natural scarcity. But once a commodity is established as a money on the market, no more money at all is needed. Since the only use of money is for exchange and reckoning, more dollars or pounds or marks in circulation cannot confer a social benefit: they will simply dilute the exchange value of every existing dollar or pound or mark. So it is a great boon that gold or silver are scarce and are costly to increase in supply.

But if government manages to establish paper tickets or bank credit as money, as equivalent to gold grams or ounces, then the government, as dominant money-supplier, becomes free to create money costlessly and at will. As a result, this “inflation” of the money supply destroys the value of the dollar or pound, drives up prices, cripples economic calculation, and hobbles and seriously damages the workings of the market economy.

The natural tendency of government, once in charge of money, is to inflate and to destroy the value of the currency.

So how does the American system of today work? In modern central banking in the USA, the central bank is called the “FED” The FED is granted by the force of law the monopoly of the issue of bank notes. These ‘bank notes’ are identical to the the government’s paper money. If the my bank needs to get cash for its customers, it must go to its own checking account at the FED which is, in effect, the bank’s own bank. It turns out that banks keep deposits at the FED in its checking account and these are its “reserves”. It may then leverage that amount by ten fold.

Here’s how the counterfeiting process works in today’s world. Let’s say that the Federal Reserve, as usual, decides that it wants to expand (i.e., inflate) the money supply. The Federal Reserve decides to go into the market (called the “open market”) and purchase an asset. It doesn’t really matter what asset it buys; the important point is that it writes out a check. The Fed could, if it wanted to, buy any asset it wished, including corporate stocks, buildings, or foreign currency. In practice, it almost always buys US government securities.

Let’s assume that the Fed buys $10,000,000 of US Treasury bills from some “approved” government bond dealer (a small group), say Shearson Lehman on Wall Street. The Fed writes out a check for $10,000,000, which it gives to Shearson Lehman in exchange for $10,000,000 in US securities. Where does the Fed get the $10,000,000 to pay Shearson Lehman? It creates the money out of thin air. Shearson Lehman can do only one thing with the check: deposit it in its checking account at a commercial bank, say Chase Manhattan. The “money supply” of the country has already increased by $10,000,000; no one else’s checking account has decreased at all. There has been a net increase of $10,000,000.

But this is only the beginning of the inflationary counterfeiting process. For Chase Manhattan is delighted to get a check on the Fed, and rushes down to deposit it in its own checking account at the Fed, which now increases by $10,000,000. But this checking account constitutes the “reserves” of the banks, which have now increased across the nation by $10,000,000. But this means that Chase Manhattan can create deposits based on these reserves, and that, as checks and reserves seep out to other banks (much as the Rothbard Bank deposits did), each one can add its inflationary mite, until the banking system as a whole has increased its demand deposits by $100,000,000, ten times the original purchase of assets by the Fed. The banking system is allowed to keep reserves amounting to 10 percent of its deposits, which means that the “money multiplier” – the amount of deposits the banks can expand on top of reserves – is 10. A purchase of assets of $10 million by the Fed has generated very quickly a tenfold ($100,000,000) increase in the money supply of the banking system as a whole.

All economists agree on how this process works. They might disagree on the effects of this process, but all agree on the above process as described.

The US Dollar is worth about 1% of what is was in 1913 when the FED was established. This comes about because the FED continually produces more “money” and the law of supply and demand will mean that each dollar is worth less than it was before.

The 1974 Nobel Prize in Economic Science went to the Austrian free-market economist Dr. Friedrich A. von Hayek. It was for the Hayek theory of the business cycle that puts the blame for the boom-bust cycle squarely on the shoulders of the government and its controlled banking system and it completely absolves the free-enterprise economy from the blame.

When a government’s central bank causes the expansion of bank credit by inflating the money supple it causes price inflation. But that is not all it does; it causes malinvestments, unsound investments in capital goods, underproduction of consumer goods and many other errors in economic judgment which are caused by all the “easy money” coming into the economy. Then, when that “easy money” stops as it always does — a depression is the result. By the way, in the ’20s the economist von Mises warned of the coming depression which was being caused by the intervention of the government. His call was on target, was it not?


Money Velocity and Inflation

We have seen that the central bank is the main engine of inflation and that inflating the currency leads to higher prices and the boom-bust cycle. But we need to look a bit closer at how the inflationary cycle works. That means looking at a thing called “velocity”, or fast money!

Economists talk about “velocity” and they mean the speed at which money is changing hands. For example, imagine I sit 20 people around a table; each has a dollar and a pencil. Each buys a pencil from the guy to his left with his dollar. Every dollar was used one time and so “velocity” was one. Now imaging the same situation but there is only one dollar. Mr. Jones has that dollar and buys a pencil from the guy on his right and the guy on the right does the same all around the circle. Twenty pencils have been sold and one dollar was used 20 times. Hence, “velocity” is 20. So we see that a small amount of money can do the same job as a large amount of money given the right conditions. Professionals define “velocity” as M/PQ but that hurts my head to think about. This post is about understanding the concepts not hiding them in econ-speak.

The dollar responds to the law of supply and demand and when demand for the dollar falls then people are more willing to spend the dollar than hold it. They buy more goods and services and keep less dollars. On the other hand, if demand for the dollar rises then people then to buy less and keep more dollars. Get it? So, we see money demand is what causes changes in velocity. Economists look at “velocity” to figure indirectly the demand for dollars at a given time. Simple really.

Now we can look at the three stages of inflation. Let us imaging you want to buy a new aluminum mountain bike.

If the prices are stable (1) and the item has been the same for a long time, say $600, then there is no real hurry to get one and you hope that the price might fall a bit and you can pick up a bargain. But instead the price rise (2) to $650 and you decide to buy the darn thing before it can go up any more! Your good friend does the same and he was not even going to get one until Christmas! Then the price goes up steeply (3) to $1,000 and you buy another one as an investment because bikes look to be a better deal than holding dollars.

In the first stage the velocity was low and you held on to your dollars. In the second stage velocity has gone up and you spend dollars. Velocity is going up. In the third stage everyone is looking to get “stuff” and not hold dollars and velocity is way up. Velocity is always very high in the third stage of inflation. There are many examples of this that a person could look at; the USA in the 70s would be a good example. The depression of the early 80s was the correction from the economic mismanagement of the 70s. Remember that inflation goes through three stages, caused by money demand, and one can look at velocity to see what stage a country is in.

Fractional Reserve Banking

It is impossible to understand our modern economy without looking at our fractional reserve banking system, so let’s first see how the fractional reserve process works without a central bank.

Let us imagine we start a bank, called Stolen Booty, and invest $10,000 of cash to get the darn thing going. I now “lend out” $100,000 to some people, for whatever purpose they have in mind. But how can I “lend out” far more than I have? It works like this; with my original 10,000 I then open up a checking accounts that add up to $100,000 which I lend out to customers. I can charge a lower rate of interest than savers would charge if they were handing out money that they had worked for. I don’t have to save up the money myself, but simply can counterfeit it out of thin air. Before the 20th century, I would have issued bank notes, but the Federal Reserve now has a legal monopoly on the issuing of note issues. Since demand deposits at the Stolen Booty Bank function as equivalent to cash, the nation’s money supply has just, by magic, increased by $100,000. The inflationary, counterfeiting process is under way.

But without government support there are some severe hitches in this counterfeiting process. Firstly, why should anyone trust me? Why should anyone accept the checking deposits of the Stolen Booty Bank? Why do they not just use RedState Bank instead? Or a bank backed by the Koch Brothers? But even if I were trusted and able to con my way into the trust of the gullible, there is another severe problem. Since the banking system without a central bank is competitive the people I loaned money to would spend it (why else did they borrow it?) in various places and the bank notes would end up in a competitor’s bank. Say RedState Bank had $50,000 of my bank’s paper and decided to cash it since they don’t want any bank notes from other banks. Now what? I don’t have $50,000. I only have my original “reserves” of $10,000 so I am finished. Bankrupt. I am out of the money supply game and should go to jail.

As you can see under free competition without government support and enforcement there is very limited opportunity for fractional-reserve counterfeiting and this is why under “free banking” in the past the reserves were supposed to be 100% and were nearly that at all times in honest, respected banks.

Central Banking

The bankers themselves set out to get the government to cartelize their industry. This was by means of a central bank. Central Banking began with the Bank of England in the 1690s. Central banking came to the United States by the Federal Reserve System of 1913. The FED was greatly welcomed, in particular, by investment bankers such as the Morgans who by this time were moving into commercial banking as well. Banksters were in on this idea from the get-go.

Today the FED, our Central Bank, is granted the monopoly of the issue of bank notes. These bank notes are now identical to the government’s paper money and so is money in this country. A bank puts a deposit in the FED and then can issue up to 10 times that amount because we have a fractional reserve system. The FED backs this scheme by law as we have seen. By the way, the originally written or printed “bank notes” were, in fact, warehouse receipts for gold or silver kept in a warehouse as opposed to the intangible receipts of bank deposits today. Neat how we bastardized that term is it not?

Who benefits? This system was set up to inflate the money; but who benefits? Why the largest debtor benefits by making a debt smaller in real terms all the time. So who is the largest debtor in our country? Why the US government is. Coincidence? The banksters also benefit by getting the money first before the inflationary effect; plus the effects of the FED scheme mentioned above. But the benefits also include the minions of the central government who are paid by the central government with the looted wealth.

A few words on Rothbard

Murrray Rothbard was an economist, a political philosopher, historian, activist, essayist, and the prime mover in the 20th century for the libertarian movement. He was always entertaining to read; full of hyperbolic epithets and witticisms. He was the leader of the Austrian school of economic thought and he had such faith in free markets that he believed that there was no need to have any government at all. He believed that all government intervention was “not only ineffectual, but also pernicious and counterproductive.” Rothbard loved free markets to the extend that he regarded Milton Friedman and the rest of the Chicago School as a species of Keynesianism.

When Rothbard opposes all government intervention he truly meant all intervention. He faulted the radical reformers of the 19th century that we call “classical liberals” today for not finishing the job, but leaving government in control of all the “command posts” such as the currency and the army. Rothbard even defended the concept of private armies, private police agencies, and private courts.

Like von MIses, Rothbard believed that economics must be derived from axioms about individual human activity and deductions from them such as the obvious fact that people respond to incentives. Rothbard called economics “the logical analysis of the implications of human action.” Rothbard and the Austrian School rejected the equations and computer models of the Keynesians and other “mainstream” economists and argued that the key relationships of economics are not constant enough to be expressed in numbers. The Austrians are particularly skeptical about the possibility of precise predictions from econometric models and believe that only general predictions can be made with any degree of confidence.

The most famous example of the Austrian method may be von Mises’ conclusion in the 1920s that socialism could never work because no central authority could calculate and decide all the resource allocation decisions needed. The same calculations that are achieved automatically under laissez-faire capitalism by the price mechanism are impossible under socialism. Mises argued that the resource allocation calculations were far too complex and that no amount of computational power could solve it without market prices to tell the producers where to allocate resources. Mises’ analysis of socialism as early as the 20s was borne out by the economic failure of communism in the 20th century. Rothbard also predicted the failure of the USSR just before it happened even as the US CIA was handing out reports on how much stronger they were than the West.

Rothbard wrote that antitrust laws are aimed at a chimera and should all be abolished. The Austrian concept that monopolies can not exist in a truly free market and can only exist as a privilege granted by the State infuriates our fine leftist friends. They fail to see that the corporations they hate lobby government so hard for favoritism precisely because the government is the source of such power that it can make or break any business.

The Austrian School skepticism about macro-economic measurement precipitated a bitter conflict, led by Rothbard, between the Austrians and the Milton Friedman-style monetarists of the Chicago School. Rothbard argued that the monetarist idea of expanding the money supply at a fixed rate equivalent to the underlying growth rate of the economy would lead to disaster. Events later proved the Chicago boys wrong. Much later their agreement with the mainstream Keynesians on inflating the money supply helped to lead to the present day massive deficits.

Rothbard attacked the idea that fractional reserve banking, the system by which banks lend out more than their reserves, is anything but inherently fraudulent. He called it an economic crime. The Great Bailout of 2008 showed the dangers in not following Rothbard’s advice of forcing the banks to maintain full reserves, plus a rigorous gold standard. Ron Paul also preached that message in his campaigns echoing the message of the departed Rothbard. (and Mises too) Rothbard argued that a gold standard and full reserve banking should always result in a gradual and beneficent deflation as technology improved productivity like actually occurred in the 19th century. He noted the sharply lower prices for manufactured goods and the vast increase in the general standard of living back in the 1800s.

Murray Rothbard was also an activist. From founding the CATO think tank, to working with the early Libertarian Party, to heading up the Mises Institute, he was always interested in how the people could use the system against itself to promote freedom and liberty.

There is so much more that one could say about Rothbard and his life, but I am not the one to do that. It just so happens that Justin Raimondo who is the editorial director of wrote a wonderful biography of Murray Newton Rothbard called An Enemy of the State: The Life of Murray N. Rothbard. I read the Kindle edition found it to be a wonderful look at a great man’s life. Raimondo did a great job. I highly recommend giving this book a read.


From the Inside Flap of the book:

Although libertarianism entered the American political vocabulary sometime in the 1970s, and is now one of the categories of political thought right up there with liberalism, conservatism, and all the other “isms,” the story of the movement’s founder has never been told–until now. This is the first biography of Murray N. Rothbard, the intellectual godfather of libertarianism and the author of twenty-eight books, hundreds of articles, and a social theorist whose writings encompass not only economics but philosophy, political economy, history, and virtually all the realms of social thought.

As an economist, he not only carved out a place for the insights of the “Austrian” (or pure free market) school on American shores, but also expanded and elaborated on the innovations of his mentor and teacher, Ludwig von Mises, the dean of the Austrian school.

As a political economist, he mapped out the contours of a truly free society, based on natural law and the concept of self-ownership. As a historian, he rescued the hidden history of liberty, and exposed the underbelly of the power elite. As a student of economic history, he traced the development of economic ideas and showed the way forward to a new way of looking at the evolution of thought – and of human society. As a teacher to a whole generation of libertarian scholars and activists, Rothbard was not only a source of ideas but of inspiration. He was an innovator who fought for his vision of the world, pioneering liberty at a time when they were neither popular nor understood. He dared to speak truth to power– and never shied away from controversy.

AN ENEMY OF THE STATE charts the intellectual odyssey of a man who went from the Old Right to the New Left, traveling through Ayn Rand’s circle as well as William F. Buckley’s before winding up at a position that transcends the traditional categories of Left and Right — and point in an entirely new direction. His life was an intellectual adventure — and an important chapter in the history of ideas. To anyone with an interest in the history of ideas in our time, AN ENEMY OF THE STATE is a must.

How to move to free banking

We live in a democracy that has turned into a worldwide empire which has been funded by the money creation magic of the Federal Reserve System since the early 20th century. This counterfeiting operation allows for the debasement of the public’s money at the whim of the politicians in charge. This system also allows for the USA to field men and material any place on the planet to fight against any foe, real or imagined. To end the wars, to end the continuing boom/bust cycle, to end the impoverishment of the people, and to regain a measure of freedom we must end the Fed. Entire books have been written on why we should end the Fed. Read some Murray Rothbard or Ron Paul to see arguments for the abolition of the Fed. Today I just want to speak to a political plan to end the Fed.

If we suddenly found ourselves living in a libertarian laissez-faire  world then our answer might be one thing, and if we found ourselves living in a market anarchy where the non-aggression axiom ruled then our answer might be another thing. But we live in an empire and I want to discuss how this empire might end the Fed without a major violent or non-violent revolution. If the people of the US came to realize that the Fed was hurting them in many ways and that the time had come to unwind the Fed and the cartelized banking system; we would need a method to do so. That seems impossible in some ways, but it has been discussed in many places by many economists.

First, there is the debased money system of today.

The essence of a gold standard is that the monetary unit (the “dollar,” “franc,” “mark,” etc.) is defined as a certain weight of gold. Under the gold standard, the dollar or franc is not a thing in itself, a mere name or the name of a paper ticket issued by the State or a central bank; it is the name of a unit of weight of gold. It is every bit as much a unit of weight as the more general “ounce,” “grain,” or “gram.” For a century before 1933, the “dollar” was defined as being equal to 23.22 grains of gold; since there are 480 grains to the ounce, this meant that the dollar was also defined as .048 gold ounces. Put another way, the gold ounce was defined as equal to $20.67.

The “dollar” today would have to be re-defined to mean a certain number of gold ounces. It would be far less than 23.22 grains of gold, but simple arithmetic would suffice to calculate whatever the number should be in this modern age. Since the democratic administration is printing money by the boatload today there is no reason to run the numbers. When we get serious then it would be require stopping the creation of new money out of thin air and then the calculations necessary to convert to a gold standard without destroying the present economy or causing any more pain than necessary could be performed.

The Federal Reserve System will need to be liquidated and so we will need to pay off its debts. This means buying back all dollars with some amount of gold or other commodity money. Gold makes the most sense since the USA has gold that was supposed to be backing the money in circulation in the first place. So, we can select a new definition of the “dollar” sufficient to pay off all Federal Reserve liabilities at 100 cents to the dollar. As stated above, this is a simple arithmetic calculation. It might be that we have to make the definition of a dollar such that it is equivalent to gold at $4,000 per once. If so, then so be it. With such a redefinition the entire Federal Reserve stock of gold could be minted by the Treasury into gold coins. These gold coins could replace the Federal Reserve Notes now in circulation. In transition the banks could hold Federal Reserve Notes knowing that they are convertible upon demand at the treasury for physical gold — after all it will take the treasury some time to mint all those coins. The US could issue Treasury Notes for the gold to replace the Federal Reserve Notes if that was more acceptable by the public. Under this plan the return of the gold standard, the abolition of the Federal Reserve, and the abolition of the FDIC would all be accomplished simultaneously to the betterment of the citizens of the USA.

But what about “fractional reserve banking” I can hear you ask. No bank would have any “FDIC Insurance” to back it and its ability to lend money that it does not have would be greatly curtailed by the people themselves who would choose “reputable” banks and institutions. Many other market forces come into play, but this essay is not the place to discuss them all. Suffice it to say that the end of the Fed would greatly improve the actions of the private banks since there would be no government bank just for bankers.

As Murray Rothbard once observed:

Inflation, credit expansion, business cycles, heavy government debt, and high taxes are not, as Establishment historians claim, inevitable attributes of capitalism or of “modernization.” On the contrary, these are profoundly anticapitalist and parasitic excrescences grafted onto the system by the interventionist State, which rewards its banker and insider clients with hidden special privileges at the expense of everyone else.

Crucial to free enterprise and capitalism is a system of firm rights of private property, with everyone secure in the property that he earns. Also crucial to capitalism is an ethic that encourages and rewards savings, thrift, hard work, and productive enterprise, and that discourages profligacy and cracks down sternly on any invasion of property rights. And yet, as we have seen, cheap money and credit expansion gnaw away at those rights and at those virtues. Inflation overturns and transvalues values by rewarding the spendthrift and the inside fixer and by making a mockery of the older “Victorian” virtues.

And end to the Fed would be a major step in the right direction of bringing the government under control. It would not solve everything of course, but this would be a major step toward liberty.

What about Banking?

Banking is hard to understand for most of us since the word “bank” covers so many different activities. During the Renaissance era there were “merchant-bankers” who started out as merchant businesses who then extended credit to their own customers.They lent money from their own savings and cash flow to others for the interest on said loans and that activity became more profitable than the underlying business. This led to some of the great “banking houses”.

Just like the “merchant-bankers” of old, today’s banks can be productive and beneficial to the masses when they lend their own savings and capital. In no way does this activity lead to the boom/bust cycle. See von Mises for details on that. If a bank takes in money (what is money is a whole other discussion) on a CD or other non-demand deposit and then lends it out so that that depositor earns interest and the bank a profit then there is nothing wrong with that. It is a valuable function and devoid of any fraudulent activity. Even the “investment banking” houses can be beneficial as they (or once did) take their own capital and invest or loan it out to others thereby underwriting businesses, corporations, start-ups, and research. The major problem with these houses was that they handled the underwriting of government bonds which led to their involvement in politics. Big money and national politics is a volatile mixture. They manipulated governments to extract money via high taxes from the masses to assure the investment houses that the government bonds would be paid off — and then that led to even worse activities.

The main problem with our current banks is that they are “fractional-reserve” banks. If I set up a bank and take in 10 million dollars in deposits, I know that there will not be a need for that much cash at any one time. So, I’ll lend some of that money out to earn interest. So far, so good. But what happens now is that the bank will lend out 100 million and so 90 million has been created by the magic of fractional reserve banking. As Mises, Rothbard, and many others have pointed out, that is inflationary and leads to the boom/bust cycle that harms us all — but the poor the most. However, under free competition without government support and enforcement the bank has a big problem. What if most of that 90 million was lent out to people who put it into other banks? These banks would make demand for the money and show my bank to be bankrupt. So, there will only be limited scope for fractional-reserve counterfeiting unless I can get the government to help me out. And they will! The Fed! Yes, the greatest counterfeiting gang in history will cure my woes.

The possibility of other banks demanding funds that a bank would not have gave rise to a drive by the bankers themselves to get the government to cartelize their industry. A central bank chartered by the government itself and given certain monopoly powers is the means by which banks can be safe in their money creation frauds. Central Banking began with the Bank of England in the 1690s so you can see that this is not a new idea at all. The United States was chained by the banking cartelists with a central bank called the Federal Reserve System in 1913.  The Federal Reserve System (Fed) is granted the monopoly of the issue of bank notes. These notes are now identical to the government’s paper money and are the monetary “standard” in the country.

People use physical (paper mostly) cash as well as bank deposits and so the private bank has to go to the Federal Reserve to draw down its own checking account with the Fed to satisfy its need for any physical paper money or coins. The Fed is the “bank of the banks”. It is also the lender to the banks which greatly helps in the inflationary creation of new “checkbook” money out of thin air.

All economists agree on the mechanics of this process. They disagree on the moral or the economic aspects of the process; but not on how it works. The general public is not educated into the mysteries of banking and so thinks that their money is “in the bank”. It is true that the candidacy of Ron Paul did help to shed some light on the issue. Now more common folks understand the problem a little better.

The Federal Reserve, backed by the awesome force of the US government, acts as the creator and enforcer of a gigantic banking cartel. The Fed bails out banks in trouble, and it centralizes and coordinates the banking system so that the banks many jointly engage in money creation out of thin air — the inflation process. The Fed protects the banks from being shown to be bankrupt at all times.

This system has looted the American public. A dollar in 1913 is now worth about 2 cents! Hyper-inflation is a real possibility these days with the Fed creating a Trillion a year or more. Can you say “Zimbabwe” children?

Next time — how to end this evil system.