Wednesday, December 22, 2010

Central Banking for Dumbos, Part I: The Magical Money Machine

First, of course, we'd like you to note the title of this brief series with which we intend to close out the year — more or less. It's "Central Banking for Dumbos," not "for Dummies," or "for Idiots." We don't want to get involved in any multi-million dollar lawsuits with the publishers of the two popular series books that, in general, do an excellent job of helping people get a reasonably good grasp of difficult subjects. Not in-depth, mind you, but good and certainly useful. Given the state of "higher education" today and its devolution into job training, the "Dummies" and "Idiots" books might possibly give a better basic education in many subjects more quickly and certainly more cost-efficiently than most colleges and universities. For example, the material in Business Plans for Dummies duplicated the material I took in a class on business planning almost verbatim.

No, we might get into trouble with Disney, but not the Dummies or Idiots people — and our defense with Disney is that we're not using "dumbo" as a proper name, but as a description of our readers, and then only as a way of describing their excusable ignorance and failure to speak up, not any inexcusable stupidity. (St. Thomas Aquinas, after all, one of the most brilliant thinkers who ever lived, was described as "the dumb ox." Maybe the title should be, "Central Banking for Dumbox" . . . "Dumbeaux"?) The fact that our readers tend to have large and inquisitive, if metaphorical, ears is a coincidence. To the best of our knowledge, none of them are elephants, although many of them fly — with the aid of airplanes, gliders, and balloons, not by means of their ears, so there.

We've covered basic commercial and deposit banking in the previous postings this week, so let's cut straight to the chase (even if, like me, you have no idea what that means), and start looking at central banking.

As the financial systems in Europe began to regain lost ground in the 17th century in response to the demands of a rapidly expanding economy, there was a return to the deeper and more sophisticated understanding of money and credit that had prevailed before the introduction of coined money, cir. 700 BC. Frankly, money in the form of certified and regulated lumps of gold and silver is much more convenient for daily transactions than bills of exchange and their derivatives (e.g., promissory notes, drafts, etc. — any form of negotiable contract that circulates as a medium of exchange). Coined money was so convenient, however, that many people became convinced that only coined money and its substitutes are "real" money.

That's bad enough — but it gets much worse. We won't make the argument here, because it is extremely complex. The fact is, however, that many people became confused about sovereignty and human dignity, and thus private property and other natural rights. They began to believe that natural rights are a grant from the State, not inherent in each human being. Yes — the State has the duty to define and enforce the exercise of natural rights, but the State does not grant these rights. Each human being has them by nature.

Cutting to the chase (and what does that mean, exactly?), people began to think that the State has the power actually to create money! Not so. Money, being anything that can be used in settlement of a debt, is an exercise of two natural rights: private property and liberty (freedom of association/contract). Anybody who has ownership of the present value of something for which somebody else is willing to trade, and the freedom to carry out a transaction has the power to create money.

If either of those two rights is absent (ownership/private property or liberty/freedom to associate and enter into a contract), then whoever it is we're talking about cannot legitimately create money. To issue money, you have to 1) own something of value, and 2) have the freedom to enter into contracts. Money, after all, is simply a contract (promise) to deliver an ownership interest in the present value of some marketable good or service on demand or maturity of the promise. Thus, every free man, woman, and child has the inherent power to create money. (There are some restrictions on minors, criminals, and incompetents, imposed for the sake of expedience — e.g., a contract with an unemancipated minor is voidable, not void — but we don't need to get into that.)

States soon discovered, however, that they could abuse their certification and regulatory authority to their own advantage. This started out innocently enough. Even Solon the Lawgiver fell into the trap. In order to cover the cost of minting the coins, the amount of metal in the coin was reduced below the face value. In effect, the State certified that there was exactly one drachm's worth of silver in a coin that actually had less than one drachm's worth of silver. Instant profit, right? The money machine was open for business; free goodies for everybody.

Wrong — as we'll see in the next posting in this series.


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