“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.”
