Satoshi Revolution- Chapter 2: Currency Creates Freedom and Civilization…Or Oppression (Part 4)

October 21, 2017

The Satoshi Revolution: A Revolution of Rising Expectations.
Section 1: The Trusted Third Party Problem
Chapter 2: Monetary Theory
by Wendy McElroy

Currency Creates Freedom and Civilization…Or Oppression (part 4)

“Historically, money was one of the first things controlled by government, and the free-market ‘revolution’ of the eighteenth and nineteenth centuries made very little dent in the monetary sphere. So it is high time that we turn fundamental attention to the life-blood of our economy—money.”
–Murray Rothbard, What Has Government Done to Our Money?

Currency Creates Freedom and Civilization…Or Oppression

I was seven years old when I realized my parents did not understand some of the most important dynamics of life. I was riding in the back seat of the car with a bag of candy purchased from a roadside store which was supposed to keep me quiet. It didn’t work. A thought tumbled out of my mouth. “Why do we pay for anything?” I asked. “Why don’t people just go into stores and take what they need?”

My mother replied, “It is wrong to steal.”

I explained, “I don’t mean stealing. I mean why do we give people money instead of sharing everything?” My parents fell silent.

When I asked again, my mother shot back over her shoulder, “Don’t ask stupid questions!”

They didn’t know the answer; I recognized this immediately. And their inability to explain why we needed money disturbed me because they discussed money constantly. How to make more, was there enough to repair the car, could they afford to replace the roof, someone needed dental work, what was the spending cap on Christmas? Concern about money ran through every aspect of their lives and, yet, my parents didn’t know how to answer the basic question of why we need it.

“Money is simply how the world works,” they finally explained, “because it lets people buy the things they need to live.” This was a non-answer because it returned me to the question of why we buy the things in the first place instead of sharing. Why do we trade paper for stuff, and why do people give us stuff for paper? At a childish level, I was trying to understand monetary theory and I’ve been struggling with it ever since.

Nothing has been more valuable in that quest than the short book “What Has Government Done to Our Money?” by Murray Rothbard. He does not use the term “trusted third party” or its equivalent in the book nor did he use such a term elsewhere in writing or conversation, as far as I know. Murray was a friend and mentor; I suspect he would have viewed the need to trust a financial intermediary as not being a problem at all, because private banks could offer guarantees such as reputation, redemption in gold and audits. To him, the dilemma of modern money began with government and ended with the free-market that allowed individuals to issue money; Murray named his own hypothetical currency “the Rothbard.”

These were the pre-Bitcoin decades. Money radicals solved the trusted-third-party problem by demanding free-market money and banking; they did this because the only third party on which they focused was government. The solution did not go far enough because free-market alternatives also rested on trust and, any time trust is required, betrayals will occur. But privatization was the best solution possible at the time; the blockchain had not surfaced to allow people to become self-bankers.

“What Has Government Done to Our Money?” belongs to the pre-Bitcoin years but it has significant contributions to offer the cryptocurrency world. There, Rothbard explains the origins of money as well as its pivotal importance to freedom and civilization. Free-market money is rooted deep within the needs of human nature, which makes a lie of the argument that regulating bitcoin is no big deal or even beneficial. If freedom and civilization depend on a free-market money, then unregulated cryptocurrency is essential to human welfare. Rothbard next sketches the catastrophic impact of government on money; namely, it destroys freedom and reverses the progress of civilization. These are the stakes of the game. Rothbard provides a context in which to appreciate the immense liberation that is the blockchain and the immense oppression that is modern monetary policy.

The book is a deceptively simple exposition of the world’s greatest swindle: inflation. The scam was possible because people needed a trusted third party in currency and government legally usurped that role, especially through central banking systems. The scam is no longer inevitable, however, because an intermediary is no longer necessary.

To understand the devastation of inflation, it is necessary to grasp the nature and power of money. Monetary theory needs to be laid out in simplistic terms because an intentional haze of complexity has ensured that people like my parents are left speechless and puzzled when confronted by easy questions. The confusion is intentional because it could be easily avoided. Schools could teach commonsense economics; government and financial institutions could be transparent rather than presenting a brick wall, as the Federal Reserve does about being audited; fiscal policy could be presented in English rather than bureaucratized with impenetrable statistics. It won’t happen. The lack of public awareness benefits government in tightening its grip on money.

A Brief Tour of the Basics

(Note: “money” here is used as a synonym for “currency” because that is money’s most important function. The other functions — acting as a store of value or a unit of account — are consequences of its primary role as currency.)

Goods and services are exchanged within every society because exchange is a human need. It is the engine of economic life. It is a wellspring of prosperity because exchange is not a zero-sum game, as some economists argue. That is to say, if a person trades a fish for a loaf of bread, it is not because the value of a fish is one loaf of bread with each trader’s gain and loss equaly balancing the other’s. The exchange occurs because one person values the bread more than the fish and vice versa; each profits from the exchange or it would not occur. As a by-product of trading, the parties also establish cooperation and perhaps a level of good will, which means exchange may be the basis of civil society as well.

Human beings are so diverse that the skills within even a small set of individuals can vary dramatically; trading these skills, and the resulting goods, increases the odds of survival both for the group and for each member. But direct exchange or barter is severely flawed, as Rothbard explains. “The two basic problems are ‘indivisibility’ and ‘lack of coincidence of wants’.” Indivisibility means it is difficult or impossible to divide many barter items, like a plow, in order to trade for several different things with multiple people. So no trade occurs. A lack of coincidence of wants means Smith has eggs and Jones has shoes but Smith wants to trade for butter. So no trade occurs.

Indirect exchange solves the barter problem…to a degree. Smith trades with Jones for a marketable good he doesn’t want but which can be traded to a third person for something he does want. A remarkable by-product spontaneously emerges: money. Indirect trading naturally encourages a medium of exchange to appear. Why? Those who buy a good to trade it will favor a highly marketable one that exchanges widely, easily and well. Highly marketable goods tend to share characteristics such as divisibility, durability, fungibility and transportability; it is no coincidence that these same characteristics are often used to describe good money.

In the beginning, the marketable good is generally desired due to its use value. Rothbard lists some goods that went on to become currencies: “tobacco in colonial Virginia, sugar in the West Indies, salt in Abyssinia, cattle in ancient Greece, nails in Scotland, copper in ancient Egypt, and grain, beads, tea, cowrie shells, and fishhooks.” The demand for the good soon generates a “reinforcing spiral: more marketability causes wider use as a medium which causes more marketability, etc. Eventually, one or two commodities are used as general media–in almost all exchanges—and these are called money.” (On this basis, Rothbard would have rejected bitcoin as currency, insisting it did not originate in or constitute a “useful commodity.” A rebuttal of this position occurs earlier in this chapter.

Commonly-accepted currencies eliminate the need for indirect exchanges that can be clumsy, time consuming and geographically limited. Eventually, currency created a complex free-market that allowed millions of people to consume products from around the world. Prosperity ensued. In short, money catapulted human beings from survival and into circumstances with time to think, to be artistic, to pursue relationships, to invent, to waste time. In other words, money permitted civilization. Mark Twain was correct in revising the old expression to read, “the lack of money is the root of all evil.”

Enter government. Currency had played a defining role in freeing and civilizing human beings but now it would be used to enslave and debase them.

Inflation, the Greatest Theft of All

Unlike individuals, government does not trade goods and services for money in a voluntary exchange. Instead, government expropriates wealth from productive people by forcing them to pay for its ‘goods’ and ‘services’ whether or not they want to or benefit from them. Taxation is the most visible form of theft but a myriad of others exist, from monopolizing goods like postage stamps to licensing cars.

The most powerful tool of expropriation is the government’s monopoly on issuing money or fiat. Rothbard explains, “The emergence of money, while a boon to the human race, also opened a more subtle route for governmental expropriation of resources….[I]f government can find ways to engage in counterfeiting—the creation of new money out of thin air—it can quickly produce its own money without taking the trouble to sell services or mine gold. It can then appropriate resources slyly and almost unnoticed, without rousing the hostility touched off by taxation.”

Everyone understands taxation because it comes with forms to fill out, a need to write checks or to pay a visible premium at the checkout. No wonder tax resistance and rebellions have been common themes through U.S. history since the American Revolution. But inflation is too subtle and complex to create enraged mobs…that is, until it goes badly out of control and then it is too late. If taxation is a gun, then inflation is like a cat burglar. This makes it all the more important to understand.

Inflation is an increase in the supply of money and credit. It is usually associated with government, and with good cause, but it can occur with free-market money as well. For example, the supply of gold could increase for various reasons. But a crucial difference exists between government and free-market inflation. Gold fulfills many non-monetary uses and those employments would increase as the cost of gold fell. This means an inflation in gold is a social good for the other uses even if the inflation temporarily reduces its monetary value. The increased demand for non-monetary uses both absorbs the “excess” supply and drives the monetary value back up. In short, the inflation tends to be self-adjusting, temporary and is accompanied by a social benefit. Moreover, a fall in gold will drive up the value of competing currencies, such as silver.

By contrast, government fiat’s only use value is as currency which means there is no self-adjusting mechanism. World markets may react negatively and devalue the egregious fiat – that is, if their fiats are not as bad or worse. If so, the offending government can crank up the printing press and create a vicious circle of further increasing the money supply. The average person has little choice but to live with the inflation because legal-tender laws forbid competing currencies. In short, fiat inflation has no social benefit or escape route, only social devastation and entrapment.

The word “inflation” is often used as a synonym for “a rise in prices” but the rise is a consequence of inflation, not its cause. The cause is an increase in the supply of money and credit. The difference between these two usages is more than semantic. Viewing inflation as rising prices misses much of the great harm it inflicts. For example, inflation redistributes wealth from average people upward to the ruling classes. This happens because freshly-printed fiat is initially valued at the same rate as all other units of it in existence. Doubling the money supply overnight eventually collapses the buying power of each unit, but the first users enjoy the pre-inflation value because the increase has not trickled through the economy. The first users are typically government, banks, financial institutions or businesses that are offered favorable loans. The end user receives fiat that has gradually diluted in buying power as it has spread throughout the economy. This user is the average person who bears the full brunt of inflation by having the value of his income sink while prices around him soar.

With legal-tender laws and the elimination of the gold standard, there is little to check government from pumping up money and credit at will, using interest rates for fine tuning. The incentives are all on the side of inflation. It is hugely profitable to government and mostly invisible to the average person, especially in its early stages. The economic villain of free-market advocates, John Maynard Keynes, knew this well. His pivotal book “The Economic Consequences of Peace” (1919) states, “By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

The harms of inflation scroll on and on. Rothbard highlights a less-discussed one. “It distorts that keystone of our economy: business calculation. Since prices do not all change uniformly and at the same speed, it becomes very difficult for business to separate the lasting from the transitional, and gauge truly the demands of consumers or the cost of their operations. For example, accounting practice enters the ‘cost’ of an asset at the amount the business has paid for it. But if inflation intervenes, the cost of replacing the asset when it wears out will be far greater than that recorded on the books. As a result, business accounting will seriously overstate their profits during inflation—and may even consume capital while presumably increasing their investments.”

The Central Bank bears massive blame for the theft and market distortion of inflation. In the United States, the Federal Reserve System is sometimes called “private.” For one thing, the regional Reserve Banks are private corporations that are owned by their member banks. The label is illusory. The Federal Reserve was established by an act of Congress (1913) and derives its core power from a government-granted monopoly to issue money. The system may mimic a private agency in some ways but, as Rothbard explains, the system of banks are “always directed by government-appointed officials, and serve as arms of the government.”

The Federal Reserve consistently acts in a manner that enables inflation. It does so in two ways: removing checks on inflation and directing inflation itself. Rothbard offers an example of the first tactic. “[T]he Federal Reserve Act compels the banks to keep the minimum ratio of reserves to deposits and, since 1917, these reserves could only consist of deposits at the Federal Reserve Bank. Gold could no longer be part of a bank’s legal reserves; it had to be deposited in the Federal Reserve Bank.” He illustrates the second: “By controlling the banks’ ‘reserves’—their deposit accounts at the Central Bank. Banks tend to keep a certain ratio of reserves to their total deposit liabilities, and in the United States government control is made easier by imposing a legal minimum ratio on the bank. The Central Bank can stimulate inflation, then, by pouring reserves into the banking system, and also by lowering the reserve ratio, thus permitting a nationwide bank credit-expansion.”

Fiat inflation destroys the free-market which is its antithesis. The extent to which government tightens its grip on money is the extent to which the free exchange upon which liberty and civilization rests is weakened. Traditional private money confronts the government in an admirable David-Goliath fashion but it does not remove the statist loophole that allows inflation – the need for a trusted third party. Not until the blockchain side steps government and obviates trust does currency regain its status as a vehicle for freedom and civilization.

[To be continued next week.]

Thanks to editor/novelist Peri Dwyer Worrell for proofreading assistance.


Wendy McElroy has agreed to ”live-publish” her new book The Satoshi Revolution exclusively with Bitcoin.com. Every Saturday you’ll find another installment in a series of posts planned to conclude after about 18 months. Altogether they’ll make up her new book ”The Satoshi Revolution”. Read it here first.

The post Satoshi Revolution- Chapter 2: Currency Creates Freedom and Civilization…Or Oppression (Part 4) appeared first on Bitcoin News.

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