Black Friday – Freeread

A Flawed Money System

June 20, 2011July 20, 2017 Joseph Dewey

This entry is part 25 of 31 in the series 2011B

Objection 2
Just look at the fiat money system we have now. It just doesn’t work. Every year the dollar is worth less than it was the year before and there are recessions and boom and bust cycles.

Answer: The money system that we now have is far from perfect and is not the one I advocate. There are three major problems with it.

First, all money placed into circulation is through loans at interest. If one borrows $100 and pays back $100 plus $10 in interest then $110 is taken out of circulation. To maintain the status quo the banks have to then loan out not $100 but $110. This system of creating money through interest bearing loans and then destroying it when the loans are paid forces the banking system to always be seeking new ways to create more money making for an unstable system that is difficult to control and predict.

Secondly, there are no controls placed on the amount of money that will be placed into circulation. If the money supply contracts, as it did with the Great Depression, then there is deflation. Money is not available for expansion and the people suffer greatly. If there is too much money added to the system there is inflation and the savings of the people lose value. Then there is always the possibility of hyperinflation that could destroy the value of money completely.

Thirdly, the money supply is controlled by the privately owned Federal Reserve, which loans money to our government at interest. Currently, interest from all sources amounts to around a half trillion dollars. It would make a lot more sense to merely create our own money with no interest. Then, if desired, we could use that half trillion to send every man, woman and child a rebate check of over $1500 a year. I say this as something that could be done not something I would recommend.

The current money system does bear a lot of responsibility for the inflation we have had but it is far from being the only factor in our various financial problems. Even with the best possible money system the economy can be challenged by speculators and outright crooks. There is a lot more to creating a stable economy than having a good money base.

Let me give just one example.
In September 1869 Jay Gould and Jim Fisk had a plan to make a killing on the gold market. Here’s how it went. They figured out that the amount of actual gold that was available in the whole country for investors to purchase was only about $5 million even though much more than that was traded on paper and also stored at Fort Knox. If they could buy a good portion of that circulating gold and hold on to it, creating a demand for more gold than would be available, they could drive its price up to $1000 or more an ounce. They moved ahead with their plan by buying large amounts of gold and holding on to it. Within weeks they drove the price of gold from $120 an ounce to $165.50.

There was just one potential problem and that was President Grant. As the price rose he could dip into the $100 billion worth of gold at Fort Knox and put it in circulation. They had people on the inside influencing Grant to not do this so they thought they had their bases covered. Grant, however, caught on to their scheme and decided to put $4 million worth of gold into immediate circulation. This move by Grant created what is called “Black Friday” (Sept 24th, 1869) when the price of gold dropped from $165.50 to $135 in one day. Since many people were buying on a margin they lost everything they had and many brokers went out of business.

Ironically, one guy who came out on top was Jay Gould who caught wind of Grant’s move and sold at around $165. This wasn’t the $1000 per ounce or more he had hoped for if Grant cooperated but he was happy to come out ahead in the end. His partner Fisk, and most gold investors, were not so lucky and lost everything.

If gold, the most stable of all metals, can be so easily manipulated by just two guys – with a great disaster only being prevented through the creation of a lesser disaster – then where is the hope of a stable economy with any currency?

Our current economic system is far from perfect. Almost everyone is not happy with it and has criticized it. Gold standard advocates are its harshest critics but they are far from being alone.

Where few have looked objectively is in comparing the current system to the systems of the past. Let’s take a brief look with an attempt to be objective.

The largest change in the money system occurred in 1913 with the creation of the Federal Reserve. For many this is seen as the year of infamy where the economic devil became incarnate.

Now the Federal Reserve System is not something I would create or endorse but neither am I that excited about returning to any system we had before 1913.
As I write this it has been 98 years after the creation of the Fed. 98 years before the Fed takes us back to 1815.

It is true that we made a lot of progress and innovation between 1815-1913 – more than at any time in the history of the world.

On the other hand, the progress since 1913 has been much more dynamic still, again more than anytime in the history of the world. Just compare life in 1869 with 98 years later to 1967 or 1913 to 2011. They are two different worlds indeed and the latter, despite the imperfections, would be picked by the vast majority as most desirable.

True we’ve had inflation, but there have been adjustments to inflation. There’s also been deflation as well as inflation.

In 1913 a dollar was worth $22.82 of 2011 dollars. This value stayed fairly stable until World War I. Then it went down in value to $11.30 by 1920. In other words, the dollar lost half of its value. This effect on currency is pretty normal during war.

After 1920 instead of inflation we had deflation and the dollar increased in value. It was 1947, or 27 years later, before inflation could sink the value of the dollar below the 1920 value. That’s a stretch of time rarely equaled by the gold standard of history. Since then we have had a fairly steady rate of inflation until the dollar is now worth about 4.4% of what it was in 1913, or 8.8% of the 1920 dollar.

The average wage in 1914 was $627.00. That equals $14,167 in 2011. But the 2011 the median household income is around $50,000, which means we have achieved over three and a half times the income we had in 1914 through this imperfect Federal Reserve fiat system. If we go back to 1861 the contrast is even more pronounced. The income at that time was only $140 per year. That would buy about seven ounces of gold. In 2011 where gold is at an all time high of over $1500 per ounce seven ounces only equals $10,500. In 2001 you could buy seven ounces of gold for a mere $1897.

It is interesting to note other quality of life improvements. The average lifespan in 1913 was only 52.5 years. Now it is 77 years. Maybe they worked themselves to death – the average workweek was over 55 hours for much less money than is made today.

Over 60 times the number of babies died at birth and the hospitals were so bad that people were afraid to go there.

The three leading causes of death were: pneumonia and influenza, tuberculosis and diarrhea. These are now way down the list and have been replaced by heart disease, cancer and strokes.

Yes, our journey of progress has not been perfect but few would want to go back to the good old days.

If we have made such progress as improved standard of living, sending men to the moon, developing sophisticated computers, the internet and many time saving advances with a very flawed financial system just imagine what we could have done with a really good one.

Perhaps the major flaw blamed on the current money system is inflation, but most of our inflation has not been caused by the fiat system, but by government borrowing. If our Congress had the common sense of the average family they would stay within a budget and there would be little or no inflation.

“But,” says the fundamentalist, “if we were on the gold standard Congress would not be able to borrow like they do with fiat money.”

Bad argument. As soon as there was any major problem when on the gold standard they threw it out the window and borrowed bundles of money. This happened during the Civil war and World War I. The are also so many ways to create simulated money today that no possible gold standard could keep us out of debt. The only way to control our debt is to control Congress. If we have a perfect money system mixed with a drunken spending Congress there will be deficits.

Conclusion: Yes, the Federal Reserve fiat banking system is far from perfect, but neither has it been as bad as believed by many. It has served us as well as money systems in the past which also were far from perfect.

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Examining Fiat Money

June 19, 2011July 20, 2017 Joseph Dewey

This entry is part 24 of 31 in the series 2011B

Some may wonder why I have spent so much time dealing with the gold standard and fiat money. The reason is quite simple.

There are two kinds of people in the world as far as economic theory goes. Those who think about how it works and what is the best approach and those who do not, but just blindly accept the crumbs that fall from the table wherever they land.

Unfortunately, the majority of Americans are in the second category. Any economic influence on their voting is very superficial. A meaningless sound bite can influence them if it tugs at their emotional nature. If they lose their job, suffer a pay cut, lose a benefit, hear of a fat cat getting exorbitant pay, see a homeless person or are merely told a certain politician is out to take what belongs to them they will vote accordingly without doing any research into the cause of their grievance.

The first category (the thinkers) is concerned about the economy and at least do a little reading and thinking about how it works and how it could be improved.

A large portion of the students and thinkers of economic theory and how money works are believers in the gold standard and are strongly against most fiat money. Many of these are adherents to the Austrian School of economics which ironically has its strongest supporters here in the United States. They cannot stand even the mentioning of Keynes name and love the words of Mises, Hayek, Rothbard, Ron Paul and others.

Most of these are good people of above average intelligence that have not considered the idea that there are several types of fiat money and it is possible to create a fiat system that brings as much stability as gold and even more prosperity.

Any workable money system has diminished chances of implementation when many thinking people are in opposition to it and it gains added power when a high percentage support it.

I have thus spent considerable time explaining the disadvantages of gold as well as presenting fiat systems of the past which have worked which tells us that we can put together one for the future that can serve us well. Actually this is an understatement. I believe we can put together a system that will bring prosperity that the world has never seen before.

In contemplating this I reflect back to a statement that Bobby Kennedy used when running for President.

“Many people see things as they are and ask why. I dream of things that never were and ask, why not?”

Our world has never had a perfect or near perfect money system, but that does not mean that we have to repeat the mistakes of the past, or even repeat the best of the past. We have the intelligence and the will to create anew a system that is better than anything that has existed before. There is no area of life where a breakthrough advantage is needed more than in our currency system. It hasn’t improved much in over 3000 years so it is about time for progress to be made.

Creating a better way was the attitude of the Founding Fathers when they founded this Republic and its Constitution. They didn’t just take the best of the past and recreate it. Instead they took the best working elements of past government and added new elements to create a government that was “a dream of things that never were.”

I don’t expect a lot of gold standard people to accept my writings right away but a few will at first and more will follow. If these ideas circulate among them they will be forced to discuss them logically without first just dismissing them as Keynesian or doomsday economics. In addition I hoped to reach many who do not have set opinions who can see the reasoning in that which I present.

First let us examine some of the problems many have with considering the use of fiat money.

Objection 1: Fiat money is not backed up by anything. It is created out of thin air. Real money is composed of metallic coins or is paper backed up by a commodity, preferably gold or silver.

Answer: This conclusion is not exactly true. If one only looks on the surface it may seem that fiat money is created out of thin air with no backing but such is not the case. If the dollar were really backed by nothing then it would be worth exactly nothing. This is obviously not the case because we purchase groceries, clothing, pay mortgages, buy cars and many other things with fiat money.

Our money obviously has value. Where does this value come from?

The most common answer is faith – pure faith. If one thinks about this answer he can soon conclude that this is far from the correct answer. Let me illustrate. If we find a person with no faith in the dollar and send him to the store to buy some bread does his zero faith take away value from the money so he cannot buy the bread? No. Even though he has no faith in the money the value is not diminished. His money will purchase just as much as the guy with lots of faith in the dollar.

If faith does not create the value then what does? Aristotle brings us closer to the answer. He stated:
“…Money exists not by nature but by law….There must then be a unit, and that fixed by agreement.”
Aristotle (Ethics, 1133)

This gets us closer to the truth. Money is created by law through a fixed agreement. This seems more reasonable than faith alone but it doesn’t give the full story. It doesn’t explain why fiat or any other kind of money has value.

If we could just create money by passing laws and making agreements then let us all agree that everyone will receive a million dollars in money each year and there will be no inflation.

We all know that would not work, don’t we?

Faith, law and agreements are all ingredients that help create the power of money, but what is the core principle? What gives a fiat dollar its purchasing power?

The answer lies in this question? What gives a gold backed dollar its purchasing power?

It’s gold you say? But what produced the gold?

It was human labor.

Money has also been backed by many other commodities such as houses, wheat, tobacco and Indian Wampum. What produced these products?

Adam Smith explains:
“Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only.

Labour … is the only universal, as well as the only accurate, measure of value, or the only standard by which we can compare the values of different commodities, at all times, and at all places … By the quantities of labour, we can, with the greatest accuracy, estimate it, both from century to century, and from year to year.”

Labour was the first price, the original purchase – money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased.
Adam Smith The Wealth of Nations, Book I, Chapter5

Benjamin Franklin agrees with this: “The riches of a country are to be valued by the quantity of labor its inhabitants are able to purchase, and not by the quantity of gold and silver they possess.

“All wealth is the product of labor.”
John Locke

“Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration.”
Abraham Lincoln

Thou, O God, dost sell us all good things at the price of labor.
Leonardo da Vinci

The bottom line is that money has value not because of any commodity, faith or law alone but because it is backed by labor and that which labor produces.

If I give my neighbor my word that I will mow his lawn tomorrow then that is as good as giving him the $20 (or more) he would have to pay a mowing service. It is also as good as $20 in gold, silver or wheat. I created this value seemingly out of thin air by the fiat of my word alone; but was the value created from nothing?

Not exactly. My word in this matter only has value because my labor has value. Labor does not come out of thin air but is energy guided by constructive intelligence.

Conclusion: Fiat money and commodity money both trace back their value to one source: human labor.

Read This entire series. Here are the links.