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Money: A Semi Pictorial Fable

Econophile's picture




 

By Jeff Harding

The Daily Capitalist

We have forgotten what money is.

Money is really easy to understand, but most people have no idea what it is. We all understand that barter is an inefficient way to foster economic growth and money is a good thing for the economy. But money isn't a piece of paper.

Let me create a kind of fable to illustrate this. Please bear with me here. Think of this as an amusing weekend read.

* * * * *

Imagine an big isolated valley in a simple rural, pre-technology society, centuries past. People get up in the morning, farm, hunt, build homes, makes clothes, babies, cook meals, think of ways to defend the perfect valley, party, the usual stuff. Human nature being what it is, some people are better at some things than others.

Enter George. George hates farming and isn't very good at it. But he loves to tinker and invents the plow which makes him much better at farming even though everyone knows he stinks at it. His neighbor John notices George's sudden farming success and asks George to make him a plow. George says he doesn't have time, he needs to farm, save grain for the winter, yadda yadda yadda. John says "I'll give you some grain if you make me a plow." It didn't take George long to see the opportunity and now he just makes and sells plows, eats well, brings his kids into the family business, forgets farming, and life is good. Barter and specialization of labor is invented.

sack of wheat

What has happened here economically? Well, John had to save up some grain and not eat it to get the plow. This is called capital or real savings. Remember this; it's key.

Everyone hears about plows and George expands his business. He now has grain bursting from his barn. He notices that farmers have a lot of grain that year. He has so much grain that he can't trade the grain fast enough for stuff he wants, and it spoils. Not good for George.

Stack of wheat

George thinks about his problem and notices that everyone likes gold jewelry: it doesn't spoil, tarnish, rust, it's pretty, scarce, and easily workable. People seem to covet the stuff. He has an idea. He sends George Jr. out to trade as much of the excess grain as he can for gold. George then purifies it and makes round disks of uniform weight and size. Yes, coins. Be patient, I have a point.

coenwulf_anglo_saxon_gold_coin

You know what happens. He starts using coins to buy things he needs for his business, and because everyone trusts George, they recognize that gold is valued and they accept them in exchange for goods. Pretty soon the coins are spreading through the community and the economy grows. It's so easy to trade for other things by using the coins. George also makes a little bit on each coin he mints.

Remember that people had to save something from what they produced to acquire other goods. This real savings/capital is what makes the economy run. The gold is just a medium to trade real savings for goods.

Everything is great. Trade grows with other valleys, coinage expands at a rate equal to production of goods. Peace breaks out with old enemies because trade grows makes everyone's life better, and George prospers.

George has branched out into other businesses and sends out his many kids to buy raw materials needed to make his products: plows with metal tips, carts, leather shoes, jewelry, and the like. He sends his kids far and wide but it was risky carrying around a lot of gold in far places. So, knowing that everyone knows him and trusts him, he issues documents, certificates that say the bearer of the certificate is entitled to redeem a certain amount of gold coins. George stores the gold in a cave heavily guarded by his sons-in-law. George signs and seals each document and calls them "gold deposit receipts." People know that if George says he's got the gold, he does, and they accept them.

Click to Enlarge

George's kids spread the receipts around, sellers accept them, and he prospers even more. Pretty soon others see the advantage of gold deposit receipts, and they deposit their gold in George's cave and accept gold receipts. It worked out great and George realized he just created banking. The neat thing is that because the supply of gold was rather limited it was hard for George to flood the market with his paper receipts even if he wanted to. Other than supply and demand issues with goods, prices were stable.

George died and left his successful businesses to his kids; George Jr. gets the cave-bank.

Junior is smart too, but rather greedy. He is known to have a summer home in the mountains by the lake, and has lots of fine horses and carriages. Women find him attractive and he parties a lot. Junior thinks that the business isn't meeting his cash needs but he has a problem: gold can't be mined and minted any faster.

Junior has a great idea. He notices that people rarely cash in the gold receipts to take possession of their gold on deposit in the bank. What if, he thought, I start lending out the gold that’s just sitting there? He knew that people only demanded about 10% of the physical gold held at any one time. He realized he could lend more money than he actually had. “Eureka! I’ve figured out a new paradigm in banking. I’m going to call it ‘fractional reserve banking.’ This can’t fail!"

Junior began lending new “certificates” that said the Bank of George would pay the bearer in gold in the named denomination. He wasn’t saying it was a deposit receipt for a specific sack of gold coins, but that he would pay in gold when asked. He had one ton of gold deposited in the cave. He drew up certificates equal to five tons of gold—four more than he had—and proceeded to lend this new money to his customers. He increased the supply of money by 400%. There was no actual real savings or capital created by Junior. No one saved their production, created wealth, and deposited the gold equivalent in the bank; Junior just issued more pieces of paper.

50 dollar gold

People were pretty happy at first. The tanners, miners, builders, and quarry owners who first borrowed most of the money bid up the price of wages and resources like hides, lumber, stone, iron, copper, and wheat. Trade expanded rapidly with the new certificates floating around. Then people started to notice that prices were going up rather dramatically. By the time the new money worked its way through the valley, the farmers, cobblers, and workers, who were last in the money chain had to pay more for things like bread, housing, cloth, and shoes. Much more.

But ... some people noticed that gold coins would buy more than would the certificates. John's son Johnson brought his certificates into the bank and asked Junior to give him the gold coins. Junior tried to talk him out of it but Johnson was stubborn and got the coins. Other people noticed the same thing and ran to the cave to exchange certificates for gold. In fact, everyone ran to the bank to exchange the certificates for gold. Junior and the bank went bust because he issued certificates for 5 tons of gold but only had one ton. Had just invented inflation. From then on many people kept all of their money in gold. Johnson's family motto became, “In Gold We Trust.”

You might notice that more pieces of paper didn't create any wealth. Real savings, you recall, was some consumer good produced that someone didn't consume. They traded it for gold, a monetary commodity which retained its value. I mean, why would anyone trade their hard earned products for a worthless piece of paper? Just issuing more pieces of paper didn't do anything except raise prices. It certainly didn't create "wealth."

Now leap forward in time. The village has become a big city in a large country. Johnson10 is old money rich because his family kept gold and invested wisely over the years. George's family went into banking and over the centuries blew up many times. George10 went into academia and studied a new kind of economics that said money was whatever the government said it was.

George10 eventually became the head of the government’s central bank. He once told his mentor, Friedman, that “we’ll never have an economic collapse again because I control money!” The first thing George10  did was to ban all forms of money as legal tender except the one that the central bank issued—”notes” called the dollar. The dollar was a piece of paper with numbers on it. The second thing he did was to sever the relationship of the dollar with gold or any other commodity. The government had a big army to back up the edicts of George10.

1000-dollar-bill

People everywhere in the country loved the dollar but had no clue what it represented. People seemed to want these pieces of paper a lot. They were pretty, green things, well made, and looked very official. People just stopped thinking about what money was.

George10   kept printing dollars whenever he thought the economy needed a boost. Things were great for a while, and then, as prices inflated he stopped printing and the economy crashed. The government decided to stimulate the economy and embarked on great new projects like dams, bridges, roads, stadiums, government buildings, and other things the leaders wanted. These projects cost billions and billions. The leaders said that the people were complaining and they couldn't keep raising taxes. "What do we do?" George said, “Leaders, you issue debt, I’ll buy it, and print dollars to pay you. Take the dollars and spend! The economy will recover and everything will be fine.” Which the government did. Pretty soon prices started going up and up and up and the central bank had to print more dollars to keep up with the demand.

Meanwhile, Johnson10 had a very nice business making gardening and farming tools. But his workers were getting poorer because inflation caused prices to go up and up. He couldn’t raise his prices fast enough to keep up with wage demands. He said to his workers, "Look, I can pay you in dollars, but wouldn’t you like gold instead?" He explained that the dollar was going down in value relative to gold, and gold would buy more. It didn’t matter what the government did to the money as long as they held gold. The workers liked that so he issued gold deposit receipts on the gold he held in a vault deep under his estate. Holders could come in and demand and receive gold in the amount of the receipts. The workers really liked this because the gold held its value and inflation didn’t bother them at all and they all prospered. People started using these receipts all around town.

George10  heard about this and had Johnson10 arrested because he violated legal tender laws. Johnson10  was convicted and thrown in jail and his gold was confiscated. Before he was hanged he gave a speech on the gallows:

Fellow citizens, you work every day for what? A piece of paper? That piece of paper isn’t wealth or capital. Like our ancestors ten generations back, real wealth was the wheat they produced and saved. They exchanged it for something of value: gold. Gold is money because people value it as a medium of exchange. You’ve forgotten what money really is and now you trade your labor and goods for pieces of paper worth nothing! Now George10  and his cronies print paper at will to pay for what the government wants. They use it to bail their friends out when they go bust. Their legacy is inflation, just another tax on your labor. Gold, my friends, is the only thing that can prevent the government from inflating the money supply and stealing your wealth. They are destroying our economy. Rebel and demand we go back on a gold standard and have real money. Don’t let …

There were murmurs of discontent in the crowd and George10 quickly pulled the trap door and Johnson10 was left hanging in the wind. They forgot all about Johnson10 in a few months because the government gave them some cash called a “rebate.”

* * * * *

P.S.


Obama note


P.P.S. I thought I would throw this in: the largest notes ever printed with the numbers written out. From the private collection of Econophile. Bought on e-Bay for $7.50.

 

zimbabwe-note

 


 

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Mon, 01/11/2010 - 11:21 | 189876 Anonymous
Anonymous's picture

I would agree with a former poster about the Stewart Crane "Wheat Receipt" speech. I came across it on the internet about 8 years ago and it was like getting hit upside the head with an oak table leg.

If you REALLY want to have an uncommon understanding of money and what it is, this speech is a MUST LISTEN.

Be warned, THIS IS THE RED PILL!

Sun, 10/18/2009 - 15:10 | 102777 Econophile
Econophile's picture

 

Thanks for all the comments, from kudos to jeers. This is a good discussion which is why I wrote the piece. While I believe many commenters have answered the questions brought up, I have a few points:

1. No one controls the gold market. Unless by government edict.

2.  Private banks and currencies are fine. Let them compete and see which store of value comes out on top. My guess it would be gold based.

3. For millennia gold has emerged to meet all the tests that make it best. Why reinvent the wheel? 

4. Fiat money will always fail because the temptation to inflate, along with economic ignorance, always seem to trump the "reasonable people in charge" assumption. This experience has taught people to value gold.

5. I thought I made it clear that inflation doesn't just "happen." It's a phenomenon of flooding the market with paper by the government. The Fed has many ways to do it.

6. You really can't cause inflation with gold as money, at least in modern times, because it's expensive to mine. Don't know about Spain, but it's possible they experienced inflation from New World gold and silver. Mises thought it could happen if a massive amount was dumped on the market. Rothbard disagreed. If someone had the Midas touch, then people would switch to something else: platinum, palladium? The reality is that there aren't any Lost Dutchman Mines out there.

7. There is enough gold to support the world economy. It is highly divisible. It is paper prices that change relative to gold, not the other way around. As currencies are devalued by inflation, it appears that gold is rising in price -- something you all know. As the dollar cheapens and gold "rises" it spurs the production of gold to meet increasing demand for it. It's happening right now.

8. Gold as currency doesn't make us poorer. Get these Mercantilist ideas out of your heads. It is "real savings" that is wealth. No one wants gold as gold (except for jewelry); they want what it buys. Don't confuse money with wealth. I need to write something on foreign trade and the dollar.

9. George wasn't a monopolist. Anyone was free to compete at minting coins and banking. Monopolies only exist because of government action. Otherwise competition corrects business errors.

10. JR, that is the ultimate compliment.

Barbaric relic indeed! It's paper that's barbaric.

 

Sun, 10/18/2009 - 22:36 | 103047 TumblingDice
TumblingDice's picture

the future anti-fiat party cold use a good writer like yourself.

Sun, 10/18/2009 - 10:14 | 102610 trx
trx's picture

Thanks for an interesting story.

But I think we're missing a vital point.

The story starts with a fallacy-like statement: "Money is really easy to understand.

Well, it's not:

"The American put options embedded in most coin currencies, as well as paper

notes, are options poorly understood by the issuer or holder, almost undescribed

in the literature, and rarely considered with options in view. Even less frequently

recognized is a special barrier feature associated with these options. Since the

history of currencies most likely begins with the use of the underlying value of the

metal in the coin, the lack of research is surprising. The shift of most money to

electronic representation greatly increases the importance of these options. This

lack of attention is additionally surprising since the loss of the ability to redeem

a paper US dollar for its underlying value in silver (Silver Certi cate) occurred

within the last century. In fact, the value of modern currencies has recently

gone from deep in-the-money through at-the-money to again deep-in-the-money,

making the lack of sound analytical treatment all the more surprising." 

 

Please read this research paper, recently finished by a couple of my quant-friends; dr. Espen G. Haug and dr. John Stevenson:

http://docs.google.com/fileview?id=0B8kc6TKNaMLbOTcyYTljZWYtMDBkMi00ZjI1...

 

When it comes to the frustration on gold, it illustrates (in my view) another example of how economists underestimates the human psychology and behaviour.

Gold has an unique position in peoples mind, that's been inherited through generations for thousands of years.

We haven't forgotten what money is, but todays fractional system makes it almost impossible for anyone to know what it is.

And that's why more and more people are turning to the good ol' gold. 

 

* "By gold all good faith has been banished, by gold our rights are abused; the law itself is influenced by gold, and soon there will be an end of every modest restraint"

(Sextus Propertius)

* "Gold is a treasure, and he who posesses it does all he wishes to in this world, and succeeds in helping souls into Paradise."

(Christopher Columbus)

*  "The desire is not for gold. It's for the means of freedom and benefit." 

(Ralph Waldo Emerson)

* "A third force, developing itself more slowly, becomes more potent then the rest; the power of gold."

(John L. Motley)

* "The United States - the worlds super power - is failing on it's most basic level. And that's the basic rule; those who have the gold, rule."

(Gerald Celente)

 

Enjoy your Sunday, everyone!

Sun, 10/18/2009 - 09:52 | 102605 Anonymous
Anonymous's picture

The fable breaks down when one considers supply and demand for goods. In this case the supply and demand for grain. In a barter system supply provided must equal demand from a population else productive efforts are wasted. Supply can be increased but only at the rate of population growth. Enter productivity, or a machine that has the potential to greatly increase the supply of grain. Rather than producers having spare time to enagage in non-work activities it is assumed that producers will continue to work the same number of hours and produce more grain. George has grain bursting from his barn...why can't he sell it? Supply of grain is now >>> demand for grain. Stored grain now spoils. The bartering price of grain collapses. With so much grain available why would anyone want to exchange their gold for grain? In this scenario it is likely that the grain demands for all have been met, this includes owners of gold. If they exchange their gold for grain they are simply exhanging gold for a commodity that will spoil. Not a good trade...

Sat, 10/17/2009 - 23:49 | 102474 Anonymous
Anonymous's picture

My understanding is the value of the bonds that are sold to fund U.S. deficit spending are based on a form of value almost as tangible as gold -- the power of the state to tax it's citizens and their descendants.

It would be interesting to calculate Present Value of the Fed's ability to tax--input variables would include rate of taxation, change in rate over time, stability of government, etc. Whatever PV is, my guess is the national debt is already close to or has surpassed it.

As national debt exceeds the PV of the taxation income stream, debt and currency are devalued. Our creditors would seem to be increasingly aware of this and taking steps to lower their default risk.

LuftMensch

Sat, 10/17/2009 - 23:21 | 102457 ft65
ft65's picture

A far better hour lecture and explaination of this can be found in MP3 format of about 5 MB in size. It was made by Professor Stewart Crane back in the early 1970's and is called "Wheat Reciepts" Explains central banks and kingdoms and all. A fantastic bit of work, and should be a permanent link on ZH

 

Google: wheat receipts

Sat, 10/17/2009 - 19:42 | 102323 Anonymous
Anonymous's picture

Re: Gold as money

Gold isn't money either, you can have inflation in gold too (as Spain had when they brought their riches from their colonies in America).
Just for the sake or argument, I'm not defending fractional reserve or the Bernankes (Georges) of the world.

Sat, 10/17/2009 - 19:36 | 102313 Anonymous
Anonymous's picture

At first I enjoyed the story, but now I see that it is ridiculous. Clever, but ridiculous.

Other than the incorrect assertion of scarcity, there is no difference between "scarce" gold and "scarce" currency in the macro view.

Both are representations of an understood "value". The rate at which new gold can be found is metered. The rate at which currency can be created is also metered, though wholly by human choice rather than /partly/ by human choice as with gold.

There is nothing universally "correct" about the rate at which gold can be "created" (found) that ties it to human endeavor or human need for money.

The conclusions may be correct, but the story just doesn't work.

Sat, 10/17/2009 - 19:24 | 102303 Anonymous
Anonymous's picture

Then the Happy Valley is renamed Fantasy Valley because of all money being electronic.

Gone is the Gold into the computers necessary to keep track of it all. Finished is the coin maker and gold keeper and fire the guards too.

Spending and getting money electronically is painless, only when you overdraw something or the ATM does not work doe it matter.

Sat, 10/17/2009 - 17:46 | 102247 Anonymous
Anonymous's picture

Seeing as how there aren't anywhere near the number dollars in circulation, the analogy, allegory, metaphor, simile
is moot.

Most people use plastic cards, institutions use keypads,
and most 'purely cash' businesses and transactions, are extinct with the exceptions of casinos, self-serve car washes, and vending machines.

Our fiat system has morphed from precious metals and gems to paper, and from there to digits that miraculously appear
and disappear in our checking, investment and savings accounts, e.g my hundreds of trades last year amounted to over a million dollars and not one cent of cash, a fleck of gold or silver changed hands.

Sat, 10/17/2009 - 20:35 | 102367 Anonymous
Anonymous's picture

Because, in those millions of trades, not one bit of productive capacity was added to the economy. Your trades had a net benefit to the economy of ZERO.

This kind of gambling is assisted by the ease of creation of money.
If gold or its substitutes were enabled for trading, the amount of trading would be reduced, and the risks taken in the large number of trades substantially reduced.

Sun, 10/18/2009 - 07:02 | 102563 Anonymous
Anonymous's picture

How do we now define 'production'?

Does a CPA contribute any productive capacity, at the obscene rate of $500.00 an hour by preparing tax returns, auditing corporations? Does a lawyer in the justice department contribute any productive capacity by suing an employer because his employee was too stupid to wear a helmet?

By that logic---- of adding productive capacity---- our 'service' industry, which constitutes over 75% of the efforts expended in this country by the 200,000,000 million employed here, none contribute to productive capacity and do not provide a net benefit to the economy. This has bothered me for some time and I cannot seem to get a good answer as how we have an economy at all with 75% of us
living, breathing, amusing ourselves, putting in time in offices worldwide that, seemingly, do nothing to add net benefits.

Your point about gold seems right.

Sat, 10/17/2009 - 16:32 | 102207 Lndmvr
Lndmvr's picture

It also comes down to property rights. If there only was a way to stop taxation of land bought then anyone could defend thier right to do as they wish with whom they wish. As long as the bastards can charge property taxes, we are screwed.

Sat, 10/17/2009 - 16:09 | 102189 Anonymous
Anonymous's picture

Regardless of the medium, money is not the problem, it's the people who control it. The control and eventual destruction of a currency (which always seems to happen) is the fault of the people in charge of it, it has nothing to do with the particular form of value representation.

Those who think Gold can't or wouldn't be controlled by "the powers that be" are kidding themselves and are forgetting the history of the World. Notice also, that it's not exactly easy to produce a FRN, though its done, it's not a cheap proposition. I suspect that producing fake Gold coins that the masses would eventually trade as money, would be easier.

All money, whether Gold, Silver, or FRNs depend on belief, the belief that someone else will want it. It is OTHER people that give YOUR pieces of Gold, Silver or paper any value.

On the other hand, George had wheat, which in a pinch can be eaten and will provide sustinance, all the Gold in the world will not feed you, unless there is SOMEONE ELSE out there that has food and is willing to trade it for your Gold.

History does tell us that precious metals endure in the worst of times, but "Past Performance Is Not A Guarantee Of Future Returns".

Sat, 10/17/2009 - 15:59 | 102176 MinnesotaNice
MinnesotaNice's picture

That was just great!

Sat, 10/17/2009 - 15:41 | 102153 i-m a dinner jacket
i-m a dinner jacket's picture

Isn't this a little bit like creationist economics?

People certainly value physical gold more than perhaps-unsafe promissory notes for gold, and I'm not against a revived role for metals & other commodities, but this fundamentalist only-yellow-metal-is-real stuff is just silly.

In the parable above I would pinpoint the moment when the happy valley really starts to go wrong as the moment when the issue of currency is monopolised, not the moment when some paper stands in for some physical goods, metallic or otherwise.

Forget this insistence on metal - instead allow any institution that wants to to issue currency, and see which ones gain acceptance.

Sat, 10/17/2009 - 18:05 | 102259 brodix
brodix's picture

Banks used to issue their own currency. The problem is still one of regulation, since the eventual tendency is to issue more than they have reserves.

 Every innovation of civilization starts as private enterprise, but at some point the patent eventually runs out and it becomes part of the public sphere. Political power originated as leadership ability and eventually became instituted as monarchy. Since those who first invented the concept of money are long lost in the mists of history and responsibility for the stability of the currency has been transfered to the public, it seems that rights to the rewards from managing this currency should be public income, thus reducing the need for taxation. Like democracy, it would be a bottom up process, with local communities responsible for incorporating their own banks and these banks serve as shareholders on larger regional consortiums, with these providing support and direction to a national bank that would be responsible for issuing currency. Hopefully the understand that over-issuing this money only results in reducing the value of that in circulation, the natural conservative tendencies of this grass roots structure would limit it to necessary growth.

Sat, 10/17/2009 - 15:27 | 102148 iconoclast63
iconoclast63's picture

For those of you who are defendng the fractional reserve system, you underestimate the parasitic affect of compounding interest. When bankers are afforded the power to create deposits and loan them to the community, don't forget, the deposits they create are principal ONLY, the interest tribute is to be extracted from the economy as a whole, with the result that all real wealth ultimately ends up in the hands of the bankers. It is the desperate measures the productive class must take to satisfy the interest payments that insures the "boom/bust" cycle to continue ad infinitum. Remove the burden of interest from currency and you will have destroyed the banking industry and created something much closer to a stable economic system.

 

Whether gold or a basket of other commodities or even debt-free government fiat currency is the answer are details to be worked out once it is finally understood and agreed that bankers should NEVER be allowed to create deposits and loan them into ciruclation.

Sat, 10/17/2009 - 14:55 | 102125 kevinearick
kevinearick's picture

to be fair, I should have went farther:

trust, in this universe, depends on the ability

to adapt, not just regardless of maket vicissitudes,
but to take advantage of market vicissitudes.
Equally, it depends on the ability to identify
non-performing assets and recycle them back into
productive assets.

E to MC becomes m1c1 + m2c2 becomes e1 + e2,
and so on.

The system that best leverages participation wins.

Left to its own devices, physical capital, is inert.

Democracy requires nothing more than the instrument
in your head, which creates the necessary induction.
Proper alignment is everything.

 

Know your banker.

Sat, 10/17/2009 - 18:07 | 102260 tip e. canoe
tip e. canoe's picture

maybe better yet, be your own banker.

Sun, 10/18/2009 - 00:22 | 102510 kevinearick
kevinearick's picture

when people ask me what they should do with their investments, I ask them:

would you walk out into the street and give a perfect stranger $20 to invest for you?

No. So, why would you trust anyone with your life's savings? And why would you give someone else your money so they can make 20%, and give you 2%?

basic literacy is a real problem.

Sat, 10/17/2009 - 18:36 | 102270 Narcolepzzzzzz
Narcolepzzzzzz's picture

Maybe that's the future of banking - cut out the middleman.

http://www.youtube.com/watch?v=D4vA6yDkr0A

Sun, 10/18/2009 - 21:27 | 102999 tip e. canoe
tip e. canoe's picture

ya mon, zopa rocks.   0.05% default rate so far.

Sat, 10/17/2009 - 14:45 | 102119 Stevm30
Stevm30's picture

Thanks for this.  There two major problems with our current regime:
1. Fractional reserve banking, which is inherently unstable and of 0 benefit to anyone except bankers.
2. Government monopoly of money, which prevents competition from keeping the central bank honest.

Either one of these alone would be self correcting.  If you only had fractional reserve banking, but no monopoly, then bank runs would cause some banks to go under, and new banks would open that would play off the fears of investors, with innovations such as "3rd party audits" "public disclosure of reserve ratios" or "no fractional reserve policy"

The Fed was created by bankers in 1913 to prevent bank runs, so that the public would never think to question the soundness of their money (but we must!)  It's much more visible to you if your relative loses everything when their bank goes under, than if they lose 20% of their money in the course of a couple years through inflation.

If the government had a monopoly but there was no fractional reserve, then that would work just as well since it would basically be a storehouse of gold and silver for the population.

Sat, 10/17/2009 - 15:22 | 102145 sgt_doom
sgt_doom's picture

Brilliant points, Stevm30, but I take exception with only one comment: ".. Fed was created by bankers in 1913 to prevent bank runs.."

While this is the official cited reason, please keep in mind that also in 1913 we were presented with the federal income tax and the oil depletion allowance as well.

As long as the state or the corporation is allowed to monopolize capital and land, there will never be economic democracy.

Thus spoke Henry George, a truly great economic genius, and today J.W. Smith (ied.info) carries on his legacy.

Sat, 10/17/2009 - 18:05 | 102258 tip e. canoe
tip e. canoe's picture

thanks for the ied.info link sgt.

big fan of henry george here.  sometimes i let my mind wander to wonder what NYC would be like now if he would have been elected mayor instead of two-face teddy.

then a cab almost runs me over and i snap out of it...

Sat, 10/17/2009 - 14:44 | 102116 Hammer59
Hammer59's picture

George Jr... the lazy one who inherited a sound system, only to ruin it.  You said he was greedy, and partied alot. Did his last name happen to be Bush?

Sat, 10/17/2009 - 14:14 | 102104 kevinearick
kevinearick's picture

money is as good as the people backing it up.

trust.

Sat, 10/17/2009 - 14:06 | 102099 Anonymous
Anonymous's picture

This is correct in an ethics guided system transacted by morally disciplined actors. Not the case anymore.

Money is now what the state says it is, with a value which can be arbitrarily fixed to accomodate the wishes of a tyrant.

Money is no longer free actors creating value for their personal prosperity and the bounty of the public weal. Money is now a heavily gamed device whereby the powerful silently access the economic inputs of all players without their consent and surreptitiously confiscate portions of wealth restrained only by their audacity and ultimate fear of revolution.

State issued money is unbacked by anything other than state power and enforcement. The people are compelled to use it for legal transactions and may accept no substitutes. It is an article of power and dominion over the people which the sovereign exercizes with rigour.

Money is the control mechanism whereby the state funds its open and clandestine policies and selects winners and losers in a mixture of planned/free industrial policy. When greed and the insatiability of power run amok, and the financial system experiences a bust, then is when the planned economy and military adventurism combine.

Money is extraction of energy from the sun via the human inputs of labour in harvesting photosynthetic crops, mining elements from the universe's creation, bring goods and services to bear for one's fellow beings. Government distorts its pure purpose in order to redirect the multivariate forms of packaged energy/matter which human beings value, to reward by edict and not by the merit of wisdom, prudence, industry, and thrift.

Gov't uses money soften the distinctions among men by redistribution to make society more "harmonious" and lessen the class distinctions. It is used too to subordinate mankind, make them yield to overwhelming state control, and to submit to the rule of law which they determine.

Remember Ben Hur's famous quip? "We keep you alive to serve this ship. Row well, number 47, row well and live"

Money is the transmission mechanism whereby the state extracts the energies from the confined governed to power their warcraft. In return, they allow them to live subject to the whim of their rule and strategies for use of that vehicle.

Sat, 10/17/2009 - 14:05 | 102098 Anonymous
Anonymous's picture

Outstanding econophile!!!
Following along the gold based monetary system....

If you factor in economies of scale, invention, innovation (think computers) you get a gradual steady deflation (further rewarding savings) and low interest rates. Think 1875 to 1905. I-E=savings (profit). Rising living standards. The two biggest drags under the expense part of the equation are interest and taxes. Both "locked in" by TPTB. In my life its been "lever up" (and pay up) or fall behind and as you accumulate more paper income the tax share gets larger and larger (pay up or get locked up). Nobody seems to talk about the handicap to real economic progress just from interest and the progresive income tax. The only growth sectors remaining in our system are finance and government as the parasites consume the beast. John Law's descendents are laughing all the way to the bank. Whats next? Probably guillotines. After Obama's gold seizure executive order. Do they think they can run that game again? Crater the currency; the markets; middle class retirement savings and buy up all the assets on the cheap. The ultimate Madoff scheme. I sniff the wind and smell anger--a lot of anger. Banksters and statists against the millions of armed gold savers. Are you kidding? We've become slaves and we're sick of it. We need a do-over. Oh, and brodix, gold is divisible and goes a long way--think small and store of value. Like 300 new gold dollars for a shiny new Porsche.

Sat, 10/17/2009 - 13:26 | 102071 Anonymous
Anonymous's picture

I think that if an ounce of gold were twenty dollars, like in the old days, each bushel of wheat would cost maybe twenty cents. Perhaps a car would cost $2000. We would be very careful about spending and become great savers instead of great consumers.
We would not import more than we export, because our gold would be precious to us and it would be clear that we were getting poorer as our gold flowed out of the country.
Government would not be able to tax and spend, because it would be clear to everyone that their gold was all ending up in the hands of the elite and their cronies.
The downside is that we would be poorer. We would not be driving SUV's and Benz's, or living in 10,000 sq. ft. homes. We would probably spend more time at home enjoying our families and neighbors, working in our gardens, and walking to the local school, baker, butcher, and grocer. In many parts of Europe, that is the way life is, and I do appreciate the advantages.
However, in their case, they are poor because the government takes their money, not because they are hoarding their gold.

Sat, 10/17/2009 - 13:23 | 102069 JR
JR's picture

Henry Hazlitt, you have a contender for your brilliant performance in Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics —Jeff Harding!  Thank you, Econophile: you have exposed the mystery and deception and illusion of the magical money machine—the Fed.  Zero Hedge is changing the modern world of economics by exposing its orthodoxy of economic nonsense. 

As G. Edward Griffin says, “[R]emove the big-spending internationalists from office and replace them with men and women dedicated to sound money and national independence…"

But the first step that must precede an abrupt abandonment of the Fed, which could result in chaos and play into the hands of the globalists who would welcome "a rescue from the IMF/World Bank," says Griffin, "is to convert our present fiat money into real money…”

Sat, 10/17/2009 - 13:00 | 102057 Anonymous
Anonymous's picture

I enjoyed the story.

What if George's Cave Bank had no gold to pay on the people that held the notes wanting their money in gold coin?

If times were hard and inflation came into the picture, would not that one ton of gold in George bank need increasing to say... 10 ton to keep up with the flow of money?

If a Egg went from one george dollar to 10 george dollar and keep rising because the Government of George kept raising rates?

If a wage earner cannot make enough wages each week to keep up with his family's basic needs then wage earner wont buy any eggs for meals in the morning right?

What happens if the valley became filled with mountains of rotting eggs? You think the costs of egg will drop back to one george dollar.

Somewhere I think the system is deeply broken. If so, the dollars we are holding is worthless and the gold inaccessible. What then?

Sat, 10/17/2009 - 12:12 | 102026 brodix
brodix's picture


The problem apparent in your fable, is that there is far more tangible wealth in the economy, such as wheat and plows, than can be effectively denominated in gold. Therefore whomever controls the gold supply would control all commerce. The result would lead to conflicts over control of the gold supply, if we were to go back to gold backed currency. The problem is that money is a medium of exchange which people must believe is a store of value in order to accept it, whether it is gold, or paper. Politicians inflate the currency and bankers inflate credit. There has to be some system of regulation by which both can be controlled. Otherwise we just have variations of boom and bust, like growing up and then growing old......Maybe nature is trying to tell us something deeper?

Sat, 10/17/2009 - 13:56 | 102091 Anonymous
Anonymous's picture

Exactly, that's why gold has to be freely available for trade. And it's also why some form of FRB must be in existence.

Sat, 10/17/2009 - 17:17 | 102226 brodix
brodix's picture

Possibly currency would function as the executive and banking as the legislative. So you would have a national currency to provide broad interchangeability, while banking would be adjunct to local governance. Since the taxpayer has proven overwhelmingly responsible for maintaining the value of the currency, then why wouldn't the rewards from managing it be public income as well? By incorporating it at the local level, profits would be returned to the communities which generated them and this would maintain stability and support for the system. There would also be broader layers, state, regional and national, for larger economic processes. The local banks would be shareholders in the broader ones, serving as a form of legislature to these bigger entities, as well providing an interconnected network.

 

Another large problem is the system of public financing, where enormous bills, stuffed with enough goodies to gain sufficient support, are rammed through the system. That's not budgeting. The process of budgeting is to prioritize needs and desires, then decide where to draw the line between what can be afforded and what cannot. In the US, some years ago, there was a discussion about the "line item veto," where the president could delete any item he wished from spending bills. Obviously this would remove all power of the purse from the legislature and likely be unconstitutional. In the spirit of actual budgeting, a possible solution would be to break these bills down to their constituent lines and then have every legislator assign a percentage value to each line and then re-assemble them in order of preference. The president would then draw the line at what would be funded. This would divide responsibility, allowing the legislature to prioritize, while giving the president final authority over total spending. Since making the cut would be graded on a curve, there would be much less incentive to trade favors and the percentage system would allow legislators to fine tune their granting of favors to other legislators and lobbyists. Since may local projects wouldn't be funded on a national level, this is where the circulation of wealth back into the local communities, by a local public banking system, would be necessary. 

Sat, 10/17/2009 - 13:51 | 102083 Anonymous
Anonymous's picture

This is why a pure gold "standard" will not work. In addition what do you do about the primary causes of Bretton Woods' break down (other than it being flaw to begin with), namely printing more money than you have in gold to back it up, this causing France to redeem $ for the gold? Thus sending all your gold overseas and poof you are poor again.

I say repeal legal tender laws, and allow competing currencies. If its paper, it should be payable in a specific weight (preferable metric) of a specific commodity. There should be no artificial pegs of one commodity to another (15:1 AG/AU is absurd). The market will decide that will become money regardless of what you or I think of it's value. Competition is resistant to manipulation.

Lastly, the amount of money in the economy is always enough...prices adjust. The "not enough gold" is the argument of the central bankers who are compelled to steal your wealth.

Sat, 10/17/2009 - 20:25 | 102350 Anonymous
Anonymous's picture

There are unique situations in which there is "not enough gold". Particularly when that gold is hoarded or managed by a single group.

Entire regions of the US often faced hard times, early in the republic, because gold was not available. Many regions subsisted on barter, limiting otherwise large potential productive capabilities.

In periods of recession, your concept of "there's always enough money" is true - several regions have printed or coined "money" that is used as a form of currency in the local economy. As recently as the 1970's and 1980's, Ithaca, NY was using a homemade form of currency to help bolster their economy.

Gold should be the basis of currency, but there has to be some flexibility in order to prevent abuse of the currency over gold (the problem we faced with Bretton Woods, and are facing now without gold).

Sun, 10/18/2009 - 20:52 | 102979 tip e. canoe
tip e. canoe's picture

"As recently as the 1970's and 1980's, Ithaca, NY was using a homemade form of currency to help bolster their economy."

ithaca hours still holding strong in 2009:
http://www.ithacahours.org/

Sat, 10/17/2009 - 12:35 | 102043 Anonymous
Anonymous's picture

Insiders short gold derivatives almost two to one
right now. Derivatives, like paper, far outnumber
physical gold and things. That suggests deflation.

JubileeProsperity.com

Sat, 10/17/2009 - 12:08 | 102022 Anonymous
Anonymous's picture

Nicely explained Econophile.

I still don't understand why gold has any "inherent" value beyond what it costs to mine and mint. "Rarity" adds some value I suppose.

But you say that gold is real money "because people value it as a medium of exchange." Is the fiat dollar not valued as a medium of exchange?

I fail to see how the substitution of gold for grain in your example is that different from the subtitution of dollars for gold. In both cases, the question is simply one of faith that the value will be accepted and respected by trading partners.

Couldn't the original George have used little intricately-printed peices of paper, miniature works of art that others covet and cannot reproduce? Could the villagers decide that rather than another pair of gold earings, they'd like one of these novel little printed works in exchange for their grain? Couldn't George insure that these little printed works of art were just as rare or rarer than gold? In that case, couldn't printed paper have become the original exchange currency?

In your story, the problem isn't gold versus paper - the problem is fractional reserve banking.

Just my thoughts. Excellent post though. Thanks!

Sat, 10/17/2009 - 21:56 | 102410 Anonymous
Anonymous's picture

GOLD AND SILVER HAS "INHERENT" VALUE FOR THE SIMPLE REASON THAT FOR THOUSANDS OF YEARS MANKIND WOULD INVARIABLY STOOP DOWN TO PICK IT UP.IT HAS ALWAYS HAD VALUE TO PEOPLE,WHEREAS FIAT CURRENCY HAS ALWAYS MET IT'S END AT THE HANDS OF HYPERINFLATION, THROUGH GOVERNMENTS GONE WILD. AMERICA'S FIAT $ IS MARCHING INEXORABLY DOWN THE SAME PATH.WIEMAR GERMANY WAS PRINTING 1 BILLION MARK NOTES, AND NEAR THE END NO GERMAN WOULD STOOP TO PICK THEM UP, BUT THERE WOULD HAVE BEEN A STAMPEDE AND PEOPLE TRAMPLED TO DEATH OVER A GOLD OR SILVER COIN LAYING IN THE STREET.
WHAT GOOD DOES IT DO, WHAT HAS ONE ACCOMPLISHED BY PAYING OFF HIS MASTERCARD WITH HIS VISA CARD? YOU CANNOT EXTINGUISH A DEBT WITH A DEBT. YET ALL FRN'S ARE DEBT INSTRUMENTS, NOTES, EVIDENCE OF DEBT.
MONEY IS NOT ONLY A MEDIUM OF EXCHANGE BUT A STANDARD OF VALUE. NOTHING CAN BE SUCH A STANDARD WHICH DOES NOT HAVE INTRINSIC VALUE, OR WHICH IS SUBJECT TO FREQUENT CHANGES IN VALUE.FROM THE EARLIEST HISTORY OF CIVILIZED NATIONS,WE FIND PIECES OF GOLD AND SILVER USED AS MONEY.THESE METALS ARE SCATTERED ALL OVER THE WORLD IN SMALL QUANTITIES;THEY ARE SUSCEPTIBLE OF DIVISION,CAPABLE OF EASY IMPRESSION,HAVE MORE VALUE IN PROPORTION TO WEIGHT AND SIZE, AND ARE LESS SUBJECT TO LOSS BY WEAR AND ABRASION THAN ANY OTHER MATERIAL POSSESSING THESE QUALITIES.IT REQUIRES LABOR TO OBTAIN THEM;THEY ARE NOT DEPENDENT UPON LEGISLATION OR THE CAPRICES OF THE MOB; THEY CANNOT BE MANUFACTURED OR DECREED INTO EXISTENCE, AND THEY DO NOT PERISH BY LAPSE OF TIME.THEY HAVE THEREFORE,NATURALLY, IF NOT NECESSARILY,BECOME THROUGHOUT THE WORLD A STANDARD OF VALUE.
IN EXCHANGE FOR PIECES OF THEM, PRODUCTS REQUIRING AN EQUAL AMOUNT OF LABOR, ARE READILY GIVEN.WHEN THE PRODUCT AND THE PIECE OF METAL REPRESENT THE SAME LABOR, OR AN APPROXIMATION OF IT,THEY ARE FREELY EXCHANGED.THERE CAN BE NO ADEQUATE SUBSTITUTE FOR THESE METALS.
ART.1 SEC. 10 OF THE U.S. CONSTITUTION STATES ABSOLUTELY,UNEQUIVOCALLY, AND WITHOUT ANY EXCEPTION ALLOWED,AND EXPRESSLY PROHIBITS, ANY STATE FROM MAKING ANYTHING BUT GOLD AND SILVER COIN A TENDER IN PAYMENT OF DEBTS.( THE SUPREME LAW OF THE LAND CANNOT BE CHANGED BY OR THROUGH LEGISLATION, IT MAY ONLY BE CHANGED THROUGH A SPECIFIC PROCESS OF AMENDMENT AND RATIFICATION BY THE SEVERAL STATES. I.E. THE PROHIBITION AMENDMENT AND THE REPEAL OF IT... ANY SO CALLED LAW PASSED THAT IS NOT IN PURSUANCE OF THIS ARTICLE AND REPUGNANT TO IT,IS NULL AND
VOID AND UNENFORCEABLE.)
"HE WHO FORGETS HISTORY IS DOOMED TO REPEAT IT"

Mon, 10/19/2009 - 00:21 | 103097 I am a Man I am...
I am a Man I am Forty's picture

As an engineer, I was trained in college to hand write in all capital letters and always thought it looked good, but for some reason it doesn't have the same effect when typed on a computer.  I think more people will read your posts if you chill the fuck out on the caps.  Just a suggestion.

Sat, 10/17/2009 - 17:40 | 102242 vanderrook
vanderrook's picture

Anon,

I'm continually amazed by how many people still equate some arbitrary value to gold as if this commodity were picked out of a hat, and that a Federally OWNED frn is just as good.

You say "rarity" adds some value I suppose". That is a good start.

Scarcity makes it valuable, you can't print it all day.

Durability makes it a damn near permanent store of value; it will survive floods and fire and reckless gov'ts. Four thousand year old coins are dug up to this day- it's durable, paper isn't.

It's divisible like paper, but paper has none of gold's other caracteristics.

It's transportable- same as above.

 

Not many other commodities have all of these advantages, and it has taken people thousands of years of various experimentation with mediums of exchange to come to this conclusion, over and over again.

 

As a result of the last point- it is forever recognizable. Also very important.

Sat, 10/17/2009 - 15:10 | 102139 KevinB
KevinB's picture

Gold doesn't require faith. So long as women like pretty shiny things, and so long as men like women, gold will be valued.

The advantage that gold has over the printed art works is gold is fungible. The art works are not; over time, one piece of art might appreciate, while another might depreciate.

Finally, the problem with paper is that no government, anywhere, at any time, has been able to resist the temptation to debase the currency. It's happened with coins as well (see John Law, "clipping" of coins, etc.), but it's more obvious and easier to find out than when it happens with paper.

Sat, 10/17/2009 - 13:54 | 102088 Anonymous
Anonymous's picture

There are some answers to this. Gold has MARGINAL value due to its rarity. Each ounce of gold, beyond the first, has increasing marginal value because less of it will be in circulation due to its limited quantity.

Paper, on the other hand, lacks this marginal value. If I take one piece of paper out of circulation, others don't gain in value UNLESS there is a belief (which must be supported by action) that more will not be printed. Otherwise Gresham's Law takes effect (bad money drives out the good).

At some point, bad money just makes everything bad, and people shift to the "good" money - gold, silver, etc. Their marginal value gives intrinsic worth to reserve.

Oddly, the Yap coins are also a good currency - you can't move them easily, they are rare, and they represent something of value in the culture. Of course, you could go quarry another one, but it's costly and time consuming, so you better hope there's alot of demand for it.

FRB has a place in the economy. It's important to allow people to borrow against reserves (even in a gold based economy, this has to happen). The problem isn't whether you allow it - it's how much leverage you allow to exist. Clearly we have exceeded normal amounts are sitting on a tipping point.

Sat, 10/17/2009 - 18:46 | 102277 Anonymous
Anonymous's picture

i agree with some of what you state but you are
confused about marginal value....

constant marginal utility is the money property
you seek in a proposed money. i.e. each additional
increment of money does not devalue it in the
eyes of the market. of all monies gold has a very
nearly constant marginal utility.

crackpot ideas for using energy, food, or
paper as money fail spectacularly in this regard.

or another way of stating the point about marginal
utility is to speak of the marketability of gold....
by which we mean that the spread of the gold price
on bid/ask in the wholesale market remains
small even as large quantities appear in the
marketplace...

the hoardability of gold to which you obliquely
refer is the operation whereby holders of gold
refuse to dishoard because the interest rate is
not sufficient to cover risk of lending it....this
is the same as saying that capital has gone into
hiding or worse is in flight....

gold will always trump frn for the very reason
that its supply is not arbitrary....and gold's
value does not depend upon any subjective,
primitive, or emotional perceptions.

regarding the supply of gold, it must be granted
that sometimes there are momentary supply anomalies
such as happened during the california gold rush....
however, these blips resolve and return to the
mean....

one interesting theory just published is the impact
of yamashita's gold on gold supplies especially
at the lbma.....quantification of this fabulous
cache of gold is hard to pin down but has been
believed to be suppressant to the price of gold
over the past 20 years as it has been laundered
at the lbma....it would still be national government
intervention but adds a new twist to the standard
central bank manipulation stories (which i generally
believe)....

Sat, 10/17/2009 - 20:19 | 102347 Anonymous
Anonymous's picture

Constant marginal utility - for gold?

I'm not sure we're discussing the same thing. Paper money has constant marginal utility. The value is 1, each additional one I make equals 1.

Gold doesn't have constant marginal utility because it is limited in quantity. Each additional ounce which is not "hoarded" has increased value. I wasn't referring obliquely to "hoarding" at all. Point is, gold must be held by someone - assuming it is not held entirely by the government.
So the value of this gold, spread across the population, will vary based on the value each person holding it has within the various economic circumstances they face based on region, interest rate, or economic activity.

As a result, the marginal utility of this gold will increase based on need - particularly by region or economic activity. Paper money won't face this issue, because if one region needs "money", but doesn't have enough gold (and the gold is not forthcoming based on whatever reasons it is being held elsewhere - could be a variety of reasons), then printing money can overcome the shortfall.

This is one reason why fiat currencies were created to begin with. Gold, during periods of massive and rapid growth, has not been able to support currency needs.

Sat, 10/17/2009 - 11:51 | 102005 Anonymous
Anonymous's picture

I've always wanted to write something like this. It's well done.

Here's the catch, though. I have no problem with fractional reserve banking. The only problem with it is management. If leverage exceeds expectations (which happens when lenders get greedy or money gets too easy), that's when you have problems.

There is a level to which FRB can work and maintain stability. Just like a gold-based economy, there will be boom and bust. The problem is assuming you can reverse a bust when it just has to reverse itself.

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