From Commodity Money to Representative Money to Fiat Money

Posted by PITHOCRATES - April 8th, 2014

History 101

(Originally published November 8th, 2011)

The Drawbacks to Using Pigs as Money Include they’re not Portable, Divisible, Durable or Uniform

They say we use every part of the pig but the oink.  So pigs are pretty valuable animals.  And we have used them as money.  Because they’re valuable.  People were willing to accept a pig in trade for something of value of theirs.  Because they knew they could always trade that pig to someone else later.  Because we use every part of the pig but the oink.  Which makes them pretty valuable.

Of course, there are drawbacks to using pigs as money.  For one they’re not that portable.  They’re not that easy to take to the market.  And they’re big.  Hold a lot of value.  So what do you do when something is worth more than one pig but not quite worth two?  Well, pigs aren’t readily divisible.  Unless you slaughter them.  But then you’d have to hurry up and trade the parts before they spoil because they’re not going to stay fresh long.  For pig parts aren’t very durable.

Suppose you have two pigs.  And someone has something you want and they will trade two pigs for it.  But there’s only one problem.  One pig is big and healthy.  The other is old and sickly.  And half the weight of the healthy one.  This trader was willing to take two pigs in trade.  But clearly the two pigs you have are unequal in value.  They’re not uniform.  And not quite what this trader had in mind when he said he’d take two pigs in trade.

Our Paper Currency Evolved from the Certificates we Carried for our Gold and Silver we Kept Locked Up

Rats are more uniform.  They’re more portable.  And they’re smaller.  It would be easier to price things in units of rats rather than pigs.  They would solve all the problems of using pigs as money.  Except one.  Rats are germ-infested parasites that no one wants.  And they breed like rabbits.  You never have only one rat.  Man has spent most of history trying to get rid of these vile disease carriers.  So no one would trade anything of value for rats.  Because these little plague generators were overrunning cities everywhere.  So rats were many things.  But one thing they weren’t was scarce.

Eventually we settled on a commodity that addresses all the shortcomings of pigs and rats.  As well as other commodities.  Gold and silver.  These precious metals were portable.  Durable.  They didn’t spoil and held their value for a long time.  You could make coins in different denominations.  So they were easily divisible.  Unlike a pig.  They were uniform.  Unlike pigs.  Finally, you had to dig gold and silver out of the ground.  After digging a lot of holes trying to find gold and silver deposits.  Which made it costly to bring new gold and silver to market.  Keeping gold and silver scarce.  And valuable.  Unlike rats.

But gold and silver were heavy metals.  Carrying large amounts was exhausting.  And dangerous.  A chest of gold and silver was tempting to thieves.  As you couldn’t hide it easily.  Soon we left our gold and silver locked up somewhere.  And carried certificates instead that were exchangeable for that gold and silver.  And these became our paper currency.

Governments Everywhere left the Gold Standard in the 20th Century so they could Print Fiat Money

The use of certificates like this is typically what people mean by gold standard.  Money in circulation represents the value of the underlying gold or silver.  And can be exchanged for that gold or silver.  Which meant that governments couldn’t just print money.  Like they do today.  Because the value was in the gold and silver.  Not the paper that represented the gold and silver.  And the only way to create money was to dig it out of the ground, process it and bring it to market.  Which is a lot harder to do than printing paper money.  So governments everywhere left the gold standard in the 20th century in favor of fiat money.  So they could print money.  Create it out of nothing.  And spend it.  With no restraints of responsible governing whatsoever.

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Hard Money versus Paper Money

Posted by PITHOCRATES - March 17th, 2014

Economics 101

(Originally published April 1st, 2013)

Money would have No Value if People with Talent didn’t Create things of Value

Money is a temporary storage of wealth.  We created it because of the high search costs of the barter system.  It took a lot of time for two people to find each other who each had what the other wanted.  And we started trading things to have things we couldn’t make efficiently for ourselves.  Someone may have been a superb potter but was a horrible farmer.  So, instead, the potter did what he did best.  And traded the pottery he made for the things he wanted that he was not good at making.  Or growing.  Before that we were self-sufficient.  Whatever you wanted you had to provide it yourself.

As we go back in time we learn why money is a temporary storage of wealth.  For it was the final piece in a growing and prosperous economy.  And at the beginning it was people with talent, each creating something of value.  Something of value that they could trade for something else of value.  It’s the creative talent of people that has value.  And we see that value in the goods and/or services they make or provide.  Money temporarily held that value.  So we could carry it with us easier to go to market to trade with other talented and creative people.  Who may not have wanted what we made or did.  But would gladly take our money.

So we took our goods to market.  People that wanted them traded for them.  They traded money for our goods.  Then we took that money and traded for what we wanted elsewhere in the market.  Trade grew.  With some people becoming professional traders.  By trading money for goods from distant lands.  Then trading these goods for money at the local market.  People who didn’t spend time creating anything.  But bought and sold the creative talent of others.  Who were able to do that because of money.  The creative talent came first.  Then the goods.  And then the money.  For money is a temporary storage of wealth.  Which has no value if no one is making anything of value.  Because if you can’t buy anything what good is having money?

There were no more Gold Certificates in Circulation than there was Gold in the Vault to Exchange them For

These early traders used a variety of things for money.  Pigs, tobacco, grain, oil, etc.  What we call commodity money.  Which was valuable by itself.  As people consumed these commodities.  Which is what gave them the ability to store value.  But because we could consume these they did not make the best money.  Also, they weren’t that portable.  And not easy to make change with.  Which is why we turned to specie.  Such as gold and silver.  Hard money.  It was durable.  Portable.  Divisible.  Fungible.  For example, all Spanish dollars were the same while all pigs weren’t.  One pig could weigh 30 pounds more than another.  So pigs weren’t fungible.  Or durable.  Portable.  And, though divisible, making change wasn’t easy.

So in time traders big and small turned to specie as the medium of exchange.  For all the reasons noted above.  If you worked hard to produce fine pottery you trusted in specie.  You would accept specie for your pottery goods.  Because you knew this hard money would hold its value.  And you could use it in the future to buy what you wanted.  No matter how long that may be.  Why?  Because the money supply remained relatively constant.  As it took a lot of work and great expense to mine and refine ore to make specie out of it.  So there was little inflation when using hard money.  Which meant if you saved for a rainy day that hard money would be there for you.

Gold and silver could be heavy to carry around.  Anyone struggling under the weight of their specie were targets for thieves.  Who wanted that money.  Without creating anything of value to bring to market.  So we found a way to improve a little on using gold and silver.  By locking our gold and silver in a vault.  And carrying around receipts for our gold and silver to use as money.  These gold certificates were promises to pay in gold.  People could continue to use them as money.  Or they could take these receipts back to the vault and exchange them for the gold inside.  These gold certificates were as good as gold.  And there were no more gold certificates in circulation than there was gold in the vault to exchange them for.

Governments Today use nothing but Paper Money because it gives them Privilege, Wealth and Power

Some saw advantages of expanding the money supply with paper currency.  Money that isn’t backed by gold or any other asset.  Money easy to print.  And easy to borrow.  Allowing rich people to borrow large sums of money to buy more assets.  And get richer.  Giving them more power.  And if you were the one printing and loaning that money it gave you great wealth and power.  So having a bank charter was a way to wealth and power.  You could make it easy for those who can help you to borrow money.  While making it difficult for those who oppose you to borrow money.  So there were those in business and in government that liked un-backed paper money.  Because a select few could borrow it cheaply and get rich and powerful.

While some liked these banks and that paper money there were others who bitterly opposed them.  Some who didn’t like to see so much power in so few hands.  And the hard money people.  Who wanted a money that held its value.  The common people.  People who couldn’t borrow large sums of cheap money.  But people who had to get by on less as the inflation from printing all those paper dollars raised prices.  Leaving them with less purchasing power.  Making it harder for them to get by.  Often having to turn to the hated banks to borrow money.  Again and again.  Such that the interest on their loans consumed even more of their limited funds.  Making life more tenuous.  And more bitter between the classes.  The rich who benefited from the cheap paper money.  And the common people who paid the price of all that inflation.

Rich people, on the other hand, loved that inflation.  It helped them make money.  When they bought something at a lower price and sold it at a higher price they made a lot of money.  The greater the inflation the greater the selling price.  And the more profit.  Also, the money they owed was easier to pay off with money that was worth less than when they borrowed it.  Allowing rich people to get even richer.  While the common people saw only higher prices.  And the value of their meager savings lose value.  So this cheap paper money fostered great class warfare.  The hard money people hated the paper money people.  Debtors hated creditors.  The middling classes hated the large landowners, merchants, manufacturers and, of course, the bankers.  And those who had talent to create things hated those who just made money with money.  The greater the inflation the greater the divide between the people.  And the greater wealth and power that select few acquired.  This is what paper money gave you.  Privilege.  Which is why most governments today use nothing but paper money.

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North Korea Manufactures and Sells Meth to Chinese addicts to bring Hard Currency into the Country

Posted by PITHOCRATES - August 25th, 2013

Week in Review

Keynesian economists, and those on the left, think there is nothing wrong with printing money.  Because they don’t understand money.  What it truly is.  So what is money?  It’s a temporary storage of wealth.  It is not wealth.  Doctors make a lot of money because they have learned great skills.  Skills few people have.  And doctors are willing to exchange these skills for money.  The wealth is a doctor’s skills.  The money temporarily holds this wealth until the doctor finds something to trade that money for.  From someone else that has wealth.  Who created something of value the doctor is willing to trade for.

All money did was make this trading of valuable things easier.  So we could trade with anyone even if they don’t want anything we can make or do.  A doctor doesn’t have to find someone who wants their gallbladder removed who has a television set if the doctor wants a television set.  The doctor can just go to a store and buy one.  Because of money.  Making the exchange of goods and services far easier than in a barter system.

Those who think money is wealth and that we should just print it and hand it out to the people are missing one very important point.  If you did this no one would have to work.  Those on the left would applaud that.  But if no one worked there would be no valuable things to trade.  And if there are no valuable things to trade then your money is worthless.  For if there is nothing to buy what good is having money?

North Korea has a lot of money.  But their money is worthless.  Because they just print it.  While their economy contains no valuable things to trade.  Not a big problem in a closed economy.  And you make your people slaves.  But it’s a problem if you want to trade with the outside world for the luxury items the lucky few in the ruling elite enjoy.  For if you have no valuable things in your economy then you must trade for valuable things with hard currency.  Money that isn’t worthless paper.  So North Korea came up with a way to get hard currency (see How North Korea got itself hooked on meth by Max Fisher published 8/21/2013 on The Washington Post).

A new study published in the journal North Korea Review says that parts of North Korea are experiencing a crystal meth “epidemic,” with an “upsurge” of recreational meth use and accompanying addiction in the country’s northern provinces…

So how do people in North Korea, a country where markets are so tightly regulated that even video CDs can be considered dangerous contraband and where social controls are often beyond Orwellian, manage to get hold of meth..?

The problem actually goes back to the 1990s, when North Korea experienced a famine so devastating that virtually the entire world believed the country would collapse at any moment. But it didn’t, in part because Pyongyang finally decided to open up the world’s most closed economy just a small crack, by allowing a degree of black market trade across North Korea’s border with China. The idea was that the black market would bring in food, which it did, preventing North Korea’s implosion.

The black market trade into China has remained that little bit open ever since, either because Pyongyang authorities can’t close it now or because they see some trade as beneficial, probably both. Some provinces along the border have seen their economies liberalize a tiny, tiny bit — most notably North Hamgyung, which is named in the North Korea Review report as particularly blighted by meth addiction.

In the years after the border with China opened that little crack, two other things have happened that led to the current meth crisis. First, medicine ran out and the once-not-terrible health system collapsed — more on this later. Second, North Korea started manufacturing meth in big state-run labs. The country badly needs hard currency and has almost no legitimate international trade. But it was able to exploit the black market trade across the Chinese border by sending state-made meth into China and bringing back the money of Chinese addicts.

This is where things started to spin out of control for North Korea. The state-run meth factories and the cross-border black market trade started to mingle. And some of that meth ended up migrating back across the border and into North Korea, through the black market trade that brings in Chinese rice and DVDs and the like.

This is where the collapse of the North Korean health system becomes relevant. As Isaac Stone Fish reported in a great 2011 Newsweek story, many regular North Koreans started using meth to treat health problems. Real medicine is extremely scarce in the country. But meth is much more common, which means that the prices of medical drugs are artificially inflated, while the price of meth is artificially low. In a culture without much health education and lots of emphasis on traditional remedies, people were ready to believe that meth would do the trick for their medical problems, and many got addicted.

Poor Chinese.  First the British got them addicted to opium.  Then North Korea got them addicted to meth.  It appears the Chinese people are nothing but pawns in the game of international trade.

Back in the days of mercantile Britain trade was all about who collected the most hard currency.  Basically gold and silver in those days.  The British loved Chinese tea.  And were filling ships full of the stuff to bring it back to Britain.  The problem was that the Chinese didn’t want anything the British were selling.  So Chinese goods were flowing to Britain.  But no British goods were flowing to China.  And without having exports to offset imports Britain was forced to trade the only thing they had that China wanted.  Their hard currency.  Their silver.  So Chinese goods flowed out of china.  And Britain’s hard currency flowed out of Britain.  So China was accumulating piles of hard currency while Britain saw their piles diminish.  Which was the exact opposite mercantile Britain wanted.  So they did something about it.  Thanks to India.

India was part of the British Empire.  And she grew opium poppies.  Something some Chinese did want.  So the British used this opium demand to stop the flow of hard currency out of the empire.  And traded Indian opium for Chinese tea.  This solved the trade deficit problem.  But it created a lot of addicts in China.  The addiction problem got so bad that it spawned two wars.  The Opium Wars.  Which did not end well for China.  And things did not get better in the century or so that followed.  And now here is North Korea.  Turning Chinese into addicts to get hard currency out of China (and into North Korea).  Just like the British did.  Of course, North Korea is nothing like the mighty British Empire.  So one would believe that China is allowing this addiction problem to happen.  As it is probably a smaller price to pay than the refugee problem should North Korea collapse.  And they may like that North Korean buffer between them and South Korea.  Japan.  And the United States.

North Korea is everything the left would like to have in the United States.  Tightly regulated markets.  National health care.  No rich people accumulating private property.  Where they frown on profits.  The even put people before profits.  Just like liberals want to do.  There’s no talk radio.  No Rush Limbaugh.  No Fox News.  No free trade.  No low-cost imports to undermine union manufacturing.  No obesity.  Because there is no junk food.  And no 32 ounce sugary beverages.  And a government that can do what is right for the people without having to worry about a Tea Party challenger in the next primary election.  North Korea is liberal nirvana.  Yet life there is horrible and wretched.  Because it’s everything liberals want.  But nothing the people want.

Liberals want to keep expanding government.  To have more government intervention into the free market.  But where does it end?  How far do they want to take things towards North Korea before they say they have enough?  And why anyone should worry about this is because as horrible and wretched life is in North Korea, those in the ruling elite have it pretty darn good.  Because the people in charge of these regimes never suffer like the people outside of the ruling elite.  So the farther they move towards North Korea the less they have to worry about an election taking away their comfy life.  This is why we should worry about a government growing larger.  For throughout world history life like that in North Korea has been the norm.  While life like that in the United States has been the exception.  And the United States has only been around for 225 years (counting from the ratification of the U.S. Constitution).  A crazy new fad the entitled ruling elite (i.e., liberals) would like to do away with.  So they can rule like they did in the good old days.  Much like they do today in North Korea.  Where the supreme ruler, Kim Jong-un, has an obesity problem.  One of the few in North Korea that isn’t gripped with a gnawing hunger every minute of every day.  This is life in a country where the ruling elite hates capitalism.  And puts people before profits.  This liberal nirvana.  Those in power live well.  While everyone else suffers.

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Roman Denarius, New World Gold and Silver, American Continental and German Mark

Posted by PITHOCRATES - June 25th, 2013

History 101

Money that is not Scarce is a Poor Temporary Storage of Wealth

They say money doesn’t grow on trees.  And it’s a good thing it doesn’t.  For money is a temporary storage of wealth.  It temporarily stores value.  And one if its attributes is that it has to be scarce.  For example, let’s say you are a highly skilled tomato grower.  And you work in your garden 12 hours each day weeding, fertilizing, watering, tying, pruning, etc., your many fields of tomato plants.  Producing beautiful tomatoes that everyone just loves.  You love your tomatoes so much that you actually gave up your day job to grow them full time.  And support your family with the proceeds from selling your tomatoes.  Which you will exchange with others for money.  Provided that money is scarce.  And will hold the value of your tomatoes.  Until you can exchange that money for something you want.

Now let’s assume money grows on trees.  Anyone can plant one in their backyard.  And it grows like a weed.  That is, you don’t have to fertilize it or water it or do anything else for it.  And anytime you want something you just walk to your money tree and pick the bills you need.  We would never have to work again if we all had money trees in our backyard.  Wouldn’t that be great?  Or would it?  What would happen if everyone quit working because they, too, had a money tree in their backyard?  If no one worked then there would be nothing to buy with the money from your money tree.

But there is another problem.  If everyone had a money tree there would be such much money in circulation that it would no longer be scarce.  And if it’s not scarce it isn’t money.  It isn’t a temporary storage of wealth.  It won’t temporarily store value.  Because someone that has something of value, say delicious tomatoes, won’t want to trade them for something that he or she can just pick off of his own money tree.  Instead, he or she would rather trade those tomatoes for something that does have value.  Like, say, mozzarella cheese.  So a skilled cheese-maker and the skilled tomato-grower can meet to trade things of value with each other.  Tomatoes and mozzarella cheese.  And then each can make a delicious Caprese salad.  Which also has value.  Unlike money that grows on trees that anybody can pick whenever they want to.  Filling the world with people with lots of money but nothing to buy.  Because no one works to grow or make anything.

When Spain brought back New World Gold and Silver it unleashed Inflation in the Old World

For anything to be money it must be scarce.  Just think of the laws of supply and demand.  If there are droughts all summer long farmers have smaller harvests.  Which raises the price of what they bring to market.  Because demand is greater than the supply.  If there was a great growing season they have bumper crops.  Which lowers the price of what they bring to market.  Because supply is greater than demand.  So the scarcer something is the more valuable it is.  And so it is with money.

The main Roman coin was the silver denarius.  As the Roman Empire reached its zenith her borders stopped moving out.  The Roman legions stopped conquering new lands.  And without new conquest there were no spoils to send back to Rome.  So the Romans had to raise taxes to pay for the cost of empire.  The administration of it.  The protection of it.  And a growing welfare state to keep the people content.  To help with these great expenditures they began to debase the denarius.  Mixing more and more lead into the coin.  Reducing the silver content.  So they could make more coins with the available silver.  Thus making these coins less scarce.  And less valuable.  Unleashing an inflation so bad that it devalued the denarius so much that no amount of them could buy anything.   Eventually even the Roman government would refuse to accept it in payment of taxes.  Demanding gold instead.  Or payment in kind.

When Spain arrived in the New World they found a lot of gold and silver.  Which Europeans used as money in the Old World.  The Spanish brought so much gold and silver back to the Old World that it greatly expanded the money supply.  Making gold and silver less scarce.  And less valuable.  Requiring more of it to buy the things it once bought.  So prices rose.  Because of the inflation of the money supply.

The War Reparations the Versailles Treaty imposed on Germany led to their Hyperinflation

During the American Revolution there was little specie (i.e., gold and silver coin) in the colonies.  As wars are expensive this made it difficult to finance the war.  The Continental Congress asked for contributions from the states.  And could only hope the states would give them some money.  For they had no taxing powers.  But they never were able to raise enough money.  So they borrowed what they could.  And then started printing paper money.  The continental.  But they printed so many of them that they were far from scarce.  The massive inflation devalued the continental so much that it created the expression “not worth a continental.”  Which meant something was absolutely worthless.  The people would refuse to accept them as legal tender from the Continental Army because they were worthless pieces of paper.  So the army took what they needed from the people.  And gave them IOUs that Congress would settle at some later date.

The Germans paid for World War I by borrowing money.  The increased debt of the nation during the war devalued the currency.  The German mark.  It took more and more of them to exchange for stronger currencies.  Like the U.S. dollar.  The Versailles Treaty that ended the war saddled Germany with the responsibility for the war.  And made them pay enormous amounts of war reparations.  In gold.  Or foreign currency.  So the Germans turned up the printing presses.  And printed marks like there was no tomorrow.  Making them less scarce.  And worth less.  It took more and more of them to exchange for foreign currency to make their reparation payments.  But they didn’t care what the exchange rate was.  For whatever amount of devalued marks they needed to exchange they just turned to their printing presses.  And printed whatever they needed.  This rapid inflation devalued the mark more.  Requiring them to print more.  Which just fed into the inflation.  Eventually bringing on a hyperinflation where it took enormous amounts of marks to buy anything.  For example, it was cheaper and easier to burn marks than it was to buy firewood to burn.

Anytime you make money less scarce you make it worth less.  The inflation of the money supply devalues the currency.  Which raises prices.  Because it takes more of the devalued currency to buy what it once did before the inflation.  So expanding the money supply leads to price inflation.  Good if you’re a rich investor.  But if you’re someone just trying to buy firewood to keep from freezing to death during the winter?  Not so good.  The Romans, the Europeans, the Americans and the Germans all suffered from bad inflation.  Some worse than others.  If the inflation is so bad, such as in the case of hyperinflation, people may lose all confidence in the currency.  And simply stop using it.  Going to a barter system instead.  Like when a tomato-grower trades his tomatoes for a cheese-maker’s mozzarella cheese.

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Coin Debasement, Currency Inflation and the Loss of Purchasing Power

Posted by PITHOCRATES - April 16th, 2013

History 101

The Roman Citizens welcomed the Barbarian Invaders as Liberators from the Oppressive Roman Regime

The Roman Empire pushed its borders out for centuries.  And when they did their legions conquered new territories.  And other civilizations.  Allowing them to send a lot of spoils back to Rome.  Providing the necessary funds for the empire.  With this lucrative stream of wealth flowing back to Rome they could leave the economy alone.  And did.  Economic activity was pretty much laissez-faire.  Then something happened.  The Romans had conquered pretty much all of the known civilized world.  And they stopped pushing their borders out.  Putting an end to that lucrative stream of wealth flowing back to Rome.

This created a problem.  For the empire was never larger.  With a greater border to protect than ever before.  And more territory to administer.  Which meant more soldiers.  And more civil servants.  Neither of which worked for free.  Which changed how the Romans handled the private sector economy.  They began to tax and regulate the hell out of it.  To raise the funds to pay the costs of empire.

Things got so bad that some people just started disappearing.  So the Romans introduced something that would evolve into European feudalism.  They forbade people from leaving their jobs.  Ever.  They even forbade the children from leaving their father’s profession.  While they were doing this they were debasing their coins.  The gold a little.  As it paid the soldiers and the civil servants.  And the silver a lot.  The money of the common people.  Who weren’t as important as the soldiers and the civil servants.  Until their silver was nothing but worthless slugs.  Causing prices to soar.  And the economy to collapse back into the barter system.  Hastening the fall of the Roman Empire.  As the Roman citizens welcomed the barbarian invaders as liberators from the oppressive Roman regime.

The Spanish brought back so much Gold and Silver from the New World that it actually Depreciated the Money Supply

Europe met Asia on the Bosporus.  The straits that connected the Black Sea and the Mediterranean Sea.  And it was where the Silk Road brought the exotic goods of the Far East into Europe.  Which the Europeans just couldn’t get enough of.  Making the Mediterranean powers the dominant powers.  For they controlled this lucrative trade.  Until, that is, the European nations made better ships.  Ships that could cross oceans.  And were bigger than the ships that plied the Mediterranean.  So they could bypass the Mediterranean powers.  And sail directly to the Far East.  Fill their large holds with those goods the Europeans couldn’t get enough of.  Getting rich and powerful.  And shifting the balance of power to these European nations.

But the Europeans just didn’t go east.  They also went west.  And bumped into the New World.  The Dutch, the French, the British, the Portuguese and the Spanish all had colonies in the New World.  It was the age of mercantilism.  Colonies sent raw materials to their mother country.  Who manufactured these raw materials into finished goods.  And shipped them from the mother country on the mother country’s ships through the mother country’s ports.  For the name of the game was balance of trade.  Which meant you imported lower-valued raw materials and you exported higher-valued finished goods.  And because the value of their exports was greater than the value of their imports there was also a net in-flow of gold and silver.  Which was what mercantilism was all about.  Trying to accumulate more gold and silver than your trading partners.

And the Spanish hit mercantile pay-dirt in the New World.  Gold and silver.  Lots of it.  So they loaded it up on their ships.  And sent it back to Spain.  Where it entered the European money supply.  And none too soon as the Europeans were cash-starved.  Because of all those exotic goods the Europeans couldn’t get enough of.  While those in the Far East had no interest whatsoever in European goods.  Which meant that European gold and silver went to the Far East to pay for those exotic goods.  Leaving the Europeans starving for gold and silver.  But thanks to the New World, they were able to reverse that net outflow of gold and silver.  In fact, so much gold and silver arrived from the New World that it actually inflated the money supply.  Which actually devalued the currency.  And because the currency lost purchasing power prices rose.  Making food more costly.  And life more difficult.

President Andrew Jackson joined the Hard-Money People and refused to renew the Charter of the BUS

Responsible nations have chosen gold and silver as their currency as it is difficult to increase the money supply and cause inflation.  Because mining these precious metals, refining them and minting coins is very costly.  Unless you discovered a New World with gold and silver paving the streets.  But that didn’t happen every day.  The irresponsible government, though, figured out a way to make that happen every day.  By just getting rid of the responsible gold and silver.  And replacing it with paper notes.  Fiat money.

Fiat money dates back to 11th century China.  To the Song Dynasty.  Which allowed the government to spend more money than their taxes raised.  Especially during war time.  But printing money devalued the currency.  And when you make the currency worth less it takes more of it to buy the things it once did.  Reducing purchasing power.  And unleashing price inflation.  Making food more costly.  And life more difficult.  During the American Revolutionary War there was so little gold and silver available that the Continental Congress turned to printing money.  And they printed so much that they unleashed a punishing inflation.  Causing prices to soar because the money became so worthless.  People wouldn’t accept it for payment.  So the Continental Army had to take the provisions they needed.  Leaving behind IOUs for the Continental Congress to make good on.  Later.

Of course, not everyone suffered during times of inflation.  Speculators did very well.  For their friends in the government’s central bank could print money and loan it to them on very favorable terms.  The speculators then used this cheap money and bought and sold assets.  Pocketing handsome profits in large part because of that inflation.  As the currency depreciation raised prices.  Including the prices of the assets they were selling.  So the rich got richer during periods of inflation.  While the working class just lost purchasing power.  Which is why President Andrew Jackson joined the hard-money people.  Those who favored gold and silver over paper currency.  And refused to renew the charter of the Second Bank of the United States (BUS).  Being one of the first world leaders not to choose destructive inflationary policies.  Instead choosing policies that favored the people.  Not the state.

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Hard Money versus Paper Money

Posted by PITHOCRATES - April 1st, 2013

Economics 101

Money would have No Value if People with Talent didn’t Create things of Value

Money is a temporary storage of wealth.  We created it because of the high search costs of the barter system.  It took a lot of time for two people to find each other who each had what the other wanted.  And we started trading things to have things we couldn’t make efficiently for ourselves.  Someone may have been a superb potter but was a horrible farmer.  So, instead, the potter did what he did best.  And traded the pottery he made for the things he wanted that he was not good at making.  Or growing.  Before that we were self-sufficient.  Whatever you wanted you had to provide it yourself.

As we go back in time we learn why money is a temporary storage of wealth.  For it was the final piece in a growing and prosperous economy.  And at the beginning it was people with talent, each creating something of value.  Something of value that they could trade for something else of value.  It’s the creative talent of people that has value.  And we see that value in the goods and/or services they make or provide.  Money temporarily held that value.  So we could carry it with us easier to go to market to trade with other talented and creative people.  Who may not have wanted what we made or did.  But would gladly take our money.

So we took our goods to market.  People that wanted them traded for them.  They traded money for our goods.  Then we took that money and traded for what we wanted elsewhere in the market.  Trade grew.  With some people becoming professional traders.  By trading money for goods from distant lands.  Then trading these goods for money at the local market.  People who didn’t spend time creating anything.  But bought and sold the creative talent of others.  Who were able to do that because of money.  The creative talent came first.  Then the goods.  And then the money.  For money is a temporary storage of wealth.  Which has no value if no one is making anything of value.  Because if you can’t buy anything what good is having money?

There were no more Gold Certificates in Circulation than there was Gold in the Vault to Exchange them For

These early traders used a variety of things for money.  Pigs, tobacco, grain, oil, etc.  What we call commodity money.  Which was valuable by itself.  As people consumed these commodities.  Which is what gave them the ability to store value.  But because we could consume these they did not make the best money.  Also, they weren’t that portable.  And not easy to make change with.  Which is why we turned to specie.  Such as gold and silver.  Hard money.  It was durable.  Portable.  Divisible.  Fungible.  For example, all Spanish dollars were the same while all pigs weren’t.  One pig could weigh 30 pounds more than another.  So pigs weren’t fungible.  Or durable.  Portable.  And, though divisible, making change wasn’t easy.

So in time traders big and small turned to specie as the medium of exchange.  For all the reasons noted above.  If you worked hard to produce fine pottery you trusted in specie.  You would accept specie for your pottery goods.  Because you knew this hard money would hold its value.  And you could use it in the future to buy what you wanted.  No matter how long that may be.  Why?  Because the money supply remained relatively constant.  As it took a lot of work and great expense to mine and refine ore to make specie out of it.  So there was little inflation when using hard money.  Which meant if you saved for a rainy day that hard money would be there for you.

Gold and silver could be heavy to carry around.  Anyone struggling under the weight of their specie were targets for thieves.  Who wanted that money.  Without creating anything of value to bring to market.  So we found a way to improve a little on using gold and silver.  By locking our gold and silver in a vault.  And carrying around receipts for our gold and silver to use as money.  These gold certificates were promises to pay in gold.  People could continue to use them as money.  Or they could take these receipts back to the vault and exchange them for the gold inside.  These gold certificates were as good as gold.  And there were no more gold certificates in circulation than there was gold in the vault to exchange them for.

Governments Today use nothing but Paper Money because it gives them Privilege, Wealth and Power

Some saw advantages of expanding the money supply with paper currency.  Money that isn’t backed by gold or any other asset.  Money easy to print.  And easy to borrow.  Allowing rich people to borrow large sums of money to buy more assets.  And get richer.  Giving them more power.  And if you were the one printing and loaning that money it gave you great wealth and power.  So having a bank charter was a way to wealth and power.  You could make it easy for those who can help you to borrow money.  While making it difficult for those who oppose you to borrow money.  So there were those in business and in government that liked un-backed paper money.  Because a select few could borrow it cheaply and get rich and powerful.

While some liked these banks and that paper money there were others who bitterly opposed them.  Some who didn’t like to see so much power in so few hands.  And the hard money people.  Who wanted a money that held its value.  The common people.  People who couldn’t borrow large sums of cheap money.  But people who had to get by on less as the inflation from printing all those paper dollars raised prices.  Leaving them with less purchasing power.  Making it harder for them to get by.  Often having to turn to the hated banks to borrow money.  Again and again.  Such that the interest on their loans consumed even more of their limited funds.  Making life more tenuous.  And more bitter between the classes.  The rich who benefited from the cheap paper money.  And the common people who paid the price of all that inflation.

Rich people, on the other hand, loved that inflation.  It helped them make money.  When they bought something at a lower price and sold it at a higher price they made a lot of money.  The greater the inflation the greater the selling price.  And the more profit.  Also, the money they owed was easier to pay off with money that was worth less than when they borrowed it.  Allowing rich people to get even richer.  While the common people saw only higher prices.  And the value of their meager savings lose value.  So this cheap paper money fostered great class warfare.  The hard money people hated the paper money people.  Debtors hated creditors.  The middling classes hated the large landowners, merchants, manufacturers and, of course, the bankers.  And those who had talent to create things hated those who just made money with money.  The greater the inflation the greater the divide between the people.  And the greater wealth and power that select few acquired.  This is what paper money gave you.  Privilege.  Which is why most governments today use nothing but paper money.

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Cyprus and the Eurozone Crisis shows why we’d be better off with a Gold Standard

Posted by PITHOCRATES - March 30th, 2013

Week in Review

Debtors love inflation.  They love to borrow cheap dollars.  And love even more to repay their loans with even cheaper dollars.  Creditors, on the other hand, hate inflation.  Because they are on the other side of that borrowing equation from the debtor.  And when a debtor repays a loan with depreciated dollars the creditor who loaned that money loses purchasing power.  Causing the creditor to lose money.  Just because they had the kindness to loan money to someone who needed it.  Which is a strong disincentive for making future loans.

This has long been at the heart of all banking wars.  And banking crises.  The fight between paper money and hard money.  Printed dollars versus specie (gold and silver).  People who want to borrow money love paper.  Because banks could make a lot of it to lend.  Something they can’t do with gold and silver.  Because it takes a lot more effort and costs to bring new gold into the economy.  Those who want to borrow money argue that hard money hinders economic activity.  Because there is a shortage of money.  And because governments are always interested in boosting economic activity they are always in favor of expanding the paper money supply.  This generous expansion of credit is currently miring the Eurozone in a sovereign debt crisis.  And launched a confiscation of wealth in Cyprus.  Greatly threatening the banking system there.  As few depositors trust their money will be safe in their bank.  Causing people to return to specie (see Cypriot bank crisis boosts demand for gold by Ian Cowie posted 3/27/2013 on The Telegraph).

The Cypriot banking crisis reminds even the most trusting savers that not all banks or jurisdictions are safe – and is boosting demand for gold, bullion dealers claim.

As if to prove the old adage that it’s an ill wind that blows no good, enthusiasts for the precious metal argue that financial shocks in the eurozone are reminding savers of gold’s attractions…

[Daniel Marburger, a director of Jewellers Trade Services Partners (JTS)] said: “The situation in Cyprus has reignited the wider Eurozone sovereign-debt crisis. At a time like this, people are attracted to gold because it is the ultimate crisis commodity.

“The proposed levy on deposits of Cyprus’s savers has not only shaken confidence in the single-currency Eurozone, it illustrates the fragility of savings held within the banking system. In our experience, clients are attracted to gold because it offers insurance against extreme movements in the value of other assets. Unlike paper currency, it will never lose its intrinsic value…”

“The events in Cyprus prove once again that bank customers do face risks as creditors who are owed money…”

When you deposit your money into a bank you become a creditor.  You are loaning your money to the bank.  Who pays you interest to loan your money to others.  If the inflation rate is greater than the interest you earn your money actually shrinks in value.  And the more they print money the more it shrinks in value.  That’s why as a creditor you won’t like the harmful effects of inflation.  Even if it makes the people happy who borrow your money from the bank.  Because they get a real cheap loan at your expense.

Which is why people are drawn to gold.  Because they can’t print gold.  So it holds value better than paper.  And the government can’t just confiscate a percentage of your savings if it isn’t in the bank.  Another reason why people are drawn to gold.  If the banking system collapses, or if the government seizes people’s retirement savings to ward off a banking system collapse, people can take their gold and move somewhere else that isn’t having a financial meltdown.  And not lose any of their wealth.

Which is, of course, the last thing you want to happen in a country.  For a sound banking system is essential for a prospering middle class (if it weren’t for banks only rich people would own homes, cars, go to college, etc.).  Which is why a responsible monetary policy, and responsible people in government, is a prerequisite for a sound banking system.  Which few nations in the Eurozone have.  As few nations throughout the world have.  For they all want to buy votes by giving away free stuff.  And having the power to print money allows them to give away a lot of free stuff.  Pensions.  Health care.  College educations.  Lots and lots of government jobs.  Etc.  But there comes a point when you give away too much.  And you have sovereign debt crises.  As well as confiscations of wealth.

This was the advantage of a gold standard.  Like when we coupled the value of our world’s currencies to the price of gold.  It did not allow any nation to inflate their currency.  For if they did people would exchange that devalued currency for the fully-valued gold.  A strong incentive not to devalue your currency.  Which was nothing more than a promise to pay in gold.  The gold standard kept governments responsible.  But because it made it so difficult to buy votes everyone cheered when President Nixon decoupled the dollar from gold.  Putting an end to the last vestiges of a gold standard.  Allowing governments everywhere to be irresponsible.  Bringing on financial crises.  And the confiscation of wealth.  As we see happening in Cyprus.  And will no doubt see elsewhere.

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Laws banning Alcohol and Drugs didn’t stop Alcohol Violence or Drug Violence

Posted by PITHOCRATES - January 31st, 2013

Politics 101

Prohibition Violence spilled onto the Streets where Gangsters shot up each other with Thompson Submachine Guns

Men have always drunk in this country.  A lot.  After the working day was over they went to their corner saloon.  And drank away their pay.  Getting inebriated.  And making a lot of bad decisions.  Such as drinking away their pay.  Getting into fights.  Engaging the services of prostitutes hanging out at the saloons.  Catching a venereal disease or two.  Taking them home to the wife.  Worse, some of these drunken men were beating their wives.

Alcohol violence was taking a toll on the American family.  In particular on the women in those American families.  This alcohol violence was creating a war on women.  These drunken men were beating their wives.  And inflicting them with venereal diseases.  Causing great harm to their wives.  And destroying their families.  They needed to do something.  And that something led to the temperance movement.  Which ended in Prohibition.  An outright ban on alcoholic beverages.

And it worked.  Alcohol violence on women committed by their husbands decreased.  As did the rate of venereal disease infections on married women.  As Prohibition shut down the local saloons.  And all the problems they caused.  But it didn’t stop everyone from drinking.  There was such a large demand despite Prohibition that others stepped in to meet that demand.  Organized crime.  Prohibition violence spilled onto the streets where gangsters shot up each other, and innocent bystanders, with Thompson submachine guns.  As the profitability of the illicit alcohol trade erupted in violent gang wars.  Allowing crime bosses like Al Capone to take over cities.  And corrupting their police forces.  Causing even more trouble than the original alcohol violence on married women.  So they repealed Prohibition.  And the people could drink once again.  As they always wanted to.

The Illicit Drug Trade picked up where Prohibition left off in terms of Gun Violence

The British were addicted to Chinese tea.  They couldn’t get enough of it.  Or other Chinese luxuries like silk and porcelain.  The only problem was that the Chinese didn’t want anything from Britain.  So as the Chinese goods flowed to Britain silver flowed from Britain to China to pay for their goods.  Causing a huge trade imbalance.  Which the British corrected with the opium grown in India.  And being that opium was addictive more and more Chinese were using opium.  Which reversed the net silver flow.  Allowing the British to enjoy their tea, silk and porcelain.  Which they traded Indian opium for.  Causing an addiction problem in China.  And a destruction of Chinese society.  That the Chinese responded to with the Opium Wars.

Drug addiction has destroyed many families.  And societies.  Throughout the world.  Which is why hard drugs like heroin and cocaine are illegal in most countries.  For they are very addictive.  Drug addicts lose their jobs.  Their wives.  Girlfriends.  And families.  As they sink into addiction without a job they often turn to crime to pay for their habit.  Become thieves.  Or prostitutes.  Where they often suffer abuse.  End up in jail.  Or catch AIDS from sharing needles with other intravenous drug users.  Cocaine use spread in more affluent circles.  While crack cocaine devastated poorer circles.  Which is why most of the world has criminalized these drugs.  Despite this demand remains high.  Cocaine use has fallen in the West.  But only because some users have switched to methamphetamine.  Which is cheaper.  More powerful.  And longer lasting.

Like with alcohol someone stepped in to meet this demand.  Organized crime.  And boy did they unleash drug violence onto the world.  From the street gangs shooting each other (and innocent bystanders) to control turf.  To the cartels higher up the distribution channels.  The illicit drug trade is big money.  Very big money.  Picking up where prohibition left off.  For it is the criminal element that truly benefits from banning anything.  The drug trade is so lucrative that it is now even funding al Qaeda.  Even though Islam strictly forbids the use of drugs.  But they have no problem taking a percent of the drug trade that flows from South America through Africa on its way to Europe.  Where it can destroy European societies.  Something al Qaeda has no problem with.

People already Breaking the Law will not be Stopped by another New Law

There is an epidemic of gun violence in the U.S.  Committed not by people who support and defend their Second Amendment right to own a gun.  For wanting to do that is not helped by shooting lots of innocent people.  In fact if one is prone to conspiracy theories one could say that the rise in gun violence is oddly coincidental to the Obama administration’s pursuit of gun control regulation.  Especially following Fast and Furious.  A program used by the Obama administration to try and stir up anti-gun sentiment.  Like that the current epidemic of gun violence is stirring up.  Which the conspiracy theorist could find a little too coincidental.   But I digress.

The people committing these acts of gun violence are some pretty disturbed people.  They have mental health issues.  Or are extremely angry about something.  Perhaps because they can’t get a job in the worst economic recovery in U.S. history.  Thanks to President Obama’s economic policies designed more for politics and social justice than actual job creation.  Who knows?  The only thing for certain is that this rise in gun violence corresponds with President Obama’s time in office.  For he didn’t campaign on the need for new gun control legislation.  But like his position on gay marriage he evolved to this position.  After witnessing a rise in gun violence during his time in office.

Whatever the cause is will new gun control legislation change anything?  Well, if we can learn anything from Prohibition and the War on Drugs, yes.  It will change things.  It will give organized crime another lucrative illicit trade.  But unlike alcohol and drugs their customers will not be people just trying to get a drink or a high.  It will be hardened criminals.  Who are shooting each other on the streets to defend their turf.  And at all levels of the illicit drug trade going right up to the cartels at the top.  So the criminals will have their guns.  And there will be new gang wars as criminal elements fight each other to control the gun trade.  Which may even increase the gun violence in places like Chicago.  Which is already one of the deadliest U.S. cities.  Despite having some of the most restrictive gun control laws in the nation.

So why do they have more gun deaths in Chicago than most cities?  Because there is a high demand for guns by the criminal element in Chicago.  Will a federal ban change that?  Will it put an end to gun violence?  Did it stop alcohol violence during Prohibition?  Does it stop drug violence now?  No.  A gun ban will not change what’s happening in Chicago.  For guns aren’t causing the gun deaths in Chicago.  It’s the people using the guns.  And people already breaking the law will not be stopped by another new law.

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Farming, Food Surplus, Artisans, Trade, Barter, Search Costs, Money, Precious Metals, Pound, Dollar and Gold Standard

Posted by PITHOCRATES - October 9th, 2012

History 101

Food Surpluses allowed Everything that followed in the Modern Age

Humans were hunters and gatherers first.  When the environment ruled supreme.  Then something happened.  Humans began to think more.  And started to push back against their environment.  First with tools.  Then with fire.  Bringing people closer together.  Eventually settling down in civilizations.  When the human race embarked on a new path.  A path that would eventually usher in the modern age we enjoy today.  We stopped hunting and gathering.  And began farming.

Throughout history life has been precarious.  Due to the uncertainty of the food supply.  Especially when the environment ruled our lives.  That changed with farming.  When we started taking control of our environment.  We domesticated animals.  And learned how to grow food.  Which lead to perhaps the most important human advancement.  The one thing that allowed everything that followed in the modern age.   Food surpluses.  Which made life less precarious.  And a whole lot more enjoyable.

Producing more food than we needed allowed us to store food to get us through long winters and seasons with poor harvests.  But more importantly it freed people.  Not everyone had to farm.  Some could do other things.  Think about other things.  And build other things.  Artisans arose.  They built things to make our lives easier.  More enjoyable.  And when these talented artisans and farmers met other talented artisans and farmers they traded the products of all their labors.  In markets.  That became cities.  Enriching each other’s lives.  By allowing them to trade for food.  For things that made life easier.  And for things that made life more enjoyable.

We settled on using Precious Metals (Gold and Silver) for Money for they were Everything Money Should Be

As civilizations advanced artisans made a wider variety of things.  Putting a lot of goods into the market place.  Unfortunately, it made trading more difficult.  Because while you saw what you wanted the person who had it may not want what you had to offer in trade.  So what do you do?  You look for someone else that has that same thing.  And will trade for what you have.  And when the second person doesn’t want to trade for what you have you look for a third person.  Then a fourth.  Then a fifth.  Until you find someone who wants to trade for what you have.

This is the barter system.  Trading goods for goods.  And as you can see it has high search costs to find someone to trade with.  Time that people could better spend making more things to trade.  What they needed was a temporary storage of value.  Something people could trade their things for.  And those people could then use that temporary storage they received in trade to later trade for something they wanted.   We call this ‘something’ money.

We have used many things for money.  Some things better than others.  In time we learned that the best things to use for money had to have a few characteristics.  It had to be scarce.  A rock didn’t make good money because why would anyone trade for it when you could just pick one up from the ground?  It had to be indestructible and hold its value.  A slab of bacon had value because bacon is delicious.  But if you held on to it too long it could grow rancid, losing all the value it once held.  Or you could eat it.  Which would also remove its value.  It had to be divisible.  A live pig removed the problem of bacon growing rancid.  However, it was hard making change with live pigs.  Which is why we settled on using precious metals (gold and silver) for money.  For they were everything money should be.

The Key to Economic Activity is People with Creative Talent to make Things to Trade

Money came first.  Then government monetary systems.  Traders were using gold and silver long before nations established their own money.  And when they did they based them on weights of these precious metals.  The British pound sterling represented one Saxon pound of silver.  The U.S. dollar came from the Spanish dollar.  Which traces back to 16th century Bohemia.  To the St. Joachim Valley.  Where they minted private silver coins.  The Joachimsthaler.  Where the ‘thaler’ (which translated to valley) in Joachimsthaler became dollar.  The German mark and the French franc came into being as weights of precious metals.  People either traded silver or gold coins.  Or paper notes that represented silver or gold.

We used silver first as the basis for national currencies.  Then with new gold discoveries in the United States, Australia and South Africa gold became the precious metal of choice.  Using precious metals simplified trade by providing sound money.  And it also made foreign exchange easy.  For when the British made their pound represent 1/4 of an ounce of gold and the Americans made their dollar represent 1/20 of an ounce of gold the exchange rate was easy to calculate.  The British pound had 5 times as much gold in it than the U.S. dollar.  So the exchange rate was simply 5 U.S. dollars for every British pound.  Which made international trade easy.  And fair.  Because everything was priced in weights of gold.

The pure gold standard, then, was part of the natural evolution of money.  The state did not create it.  It does not require an act of legislation.  Or political decree.  The pure gold standard existed before the state.  And states based their currencies on the monetary system that already existed.  Using weights of precious metals as money.  That is, a pure gold standard.  Central banks and fiat money are only recent inventions of the state.  And bad ones at that.  For the thousands of years that preceded the last hundred years or so there were only traders mutually agreeing to trade their goods for precious metals.  Using these precious metals as a temporary storage of wealth.  To temporarily hold the value of the things they made.  So the key to economic activity is people with creative talent to make things to trade.  And a sound money like gold and silver to facilitate that trade.  Not a central bank.  Or monetary policy.

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Goldsmiths, Specie, Bank Notes, Bank Reserves, Spanish Dollar, Continentals, Bank of the United States and the Panic of 1819

Posted by PITHOCRATES - June 26th, 2012

History 101

When Spain came to the New World they Brought Home a lot of Gold and Silver and Turned it into Coin

Our first banks were goldsmiths’ vaults.  They locked up people’s gold or other valuable metals (i.e., specie) in their vaults and issued these ‘depositors’ receipts for their specie.  When a depositor presented their receipt to the goldsmith he redeemed it for the amount of specie noted on the receipt.  These notes were as good as specie.  And a lot easier to carry around.  So these depositors used these notes as currency.  People accepted them in payment.  Because they could take them to the goldsmith and redeem them for the amount of specie noted on the receipt.

The amount of specie these first bankers kept in their vaults equaled the value of these outstanding notes.  Meaning their bank reserves were 100%.   If every depositor redeemed their notes at the same time there was no problem.  Because all specie that was ever deposited was still in the vault.  So there was no danger of any ‘bank runs’ or liquidity crises.

When Spain came to the New World they brought home a lot of gold and silver.  And turned it into coin.  Or specie.  The Spanish dollar entered the American colonies from trade with the West Indies.  As the British didn’t allow their colonies to coin any money of their own the Spanish dollar became the dominate money in circulation in commerce and trade in the cities.  (Which is why the American currency unit is the dollar).  While being largely commodity money in the rural parts of the country.  Tobacco in Virginia, rice in the south, etc.  Paper money didn’t enter into the picture until Massachusetts funded some military expeditions to Quebec.  Normally the soldiers in this expedition took a portion of the spoils they brought back for payment.  But when the French repulsed them and they came back empty handed the government printed paper money backed by no specie.  For there was nothing more dangerous than disgruntled and unpaid soldiers.  The idea was to redeem them with future taxation.  But they never did. 

Thomas Jefferson believed that the Combination of Money and Politics was the Source of all Evil in Government 

During the American Revolutionary War the Americans were starving for specie.  They were getting some from the French but it was never enough.  So they turned to printing paper money.  Backed by no specie.  They printed so much that it became worthless.  The more they printed the more they devalued it.  And the fewer people would take it in payment.  Anyone paying in these paper Continentals just saw higher and higher prices (while people paying in specie saw lower prices).  Until some just refused to accept them.  Giving rise to the expression “not worth a Continental.”  And when they did the army had to take what they needed from the people.  Basically giving them an IOU and telling the people good luck in redeeming them.

Skip ahead to the War of 1812 and the Americans had the same problem.  They needed money.  So they turned to the printing presses.  With the aid of the Second Bank of the United States (BUS).  America’s second central bank.  Just as politically contentious as the First Bank of the United States.  America’s first central bank.  The BUS was not quite like those early bankers.  The goldsmiths.  Whose deposits were backed by a 100% specie reserve.  The BUS specie reserve was closer to 10%.  Which proved to be a problem because their bank notes were redeemable for specie.  Which people did.  And because they did and the BUS was losing so much of its specie the government legislated the suspension of the redemption of bank notes for specie.  Which just ignited inflation.  With the BUS.  And the state banks.  Who were no longer bound by the requirement to redeem bank notes for specie either.  Enter America’s first economic boom created by monetary policy.  A huge credit expansion that created a frenzy of borrowing.  And speculation.

When more dollars are put into circulation without a corresponding amount of specie backing them this only depreciated the dollar.  Making them worth less, requiring more of them to buy the same stuff they did before the massive inflation.  This is why prices rise with inflation.  And they rose a lot from 1815 to 1818.  Real estate prices went up.  Fueling that speculation.  Allowing the rich to get richer by buying land that soared in value.  While ordinary people saw the value of their currency decline making their lives more difficult.  Thanks to those higher prices.  The government spent a lot of this new money on infrastructure.  And there was a lot of fraud.  The very reason that Thomas Jefferson opposed Alexander Hamilton’s first Bank of the United States.  The combination of money and politics was the source of all evil in government.  And fraud.  According to Jefferson, at least.  Everyone was borrowing.  Everyone was spending.  Which left the banks exposed to a lot of speculative loans.  While putting so much money into circulation that they could never redeem their notes for specie.  Not that they were doing that anyway.  Bank finances were growing so bad that the banks were in danger of failing.

Most Bad Recessions are caused by Easy Credit by a Central Bank trying to Stimulate Economic Activity 

By 1818 things were worrying the government.  And the BUS.  Inflation was out of control.  The credit expansion was creating asset bubbles.  And fraud.  It was a house of cards that was close to collapsing.  So the BUS took action.  And reversed their ruinous policies.  They contracted monetary policy.  Stopped the easy credit.  And pulled a lot of those paper dollars out of circulation.  It was the responsible thing to do to save the bank.  But because they did it after so much inflation that drove prices into the stratosphere the correction was painful.  As those prices had a long way to fall.

The Panic of 1819 was the first bust of America’s first boom-bust cycle.  The first depression brought on by the easy credit of a central bank.  When the money supply contracted interest rates rose.  A lot of those speculative loans became unserviceable.  With no easy credit available anymore the loan defaults began.  And the bank failures followed.  Money and credit of the BUS contracted by about 50%.  Businesses couldn’t borrow to meet their cash needs and went bankrupt.  A lot of them.  And those inflated real estate prices fell back to earth.  As prices fell everywhere from their artificial heights.

It was America’s first depression.  But it wouldn’t be the last.  Thanks to central banking.  And boom-bust cycles.  We stopped calling these central banking train wrecks depressions after the Great Depression.  After that we just called them recessions.  And real bad recessions.  Most of them caused by the same thing.  Easy credit by a central bank to stimulate economic activity.  Causing an asset bubble.  That eventually pops causing a painful correction.  The most recent being the Great Recession.  Caused by the popping of a great real estate bubble caused by the central bank’s artificially low interest rates.  That gave us the subprime mortgage crisis.  Which gave us the greatest recession since the Great Depression.  Just another in a long line of ‘real bad’ recessions since the advent of central banking.

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