Thursday, June 2, 2016

A Reaction to Resilience, I: Can the State Create Money?

We got the following comment to our posting on “financial resilience” the other day.  It is valuable in that it states fairly concisely the errors that many people have about money, credit, banking, and finance, most of which are rooted in some variation of Georg Friedrich Knapp’s “chartalism,” i.e., the idea that “money” is peculiarly (Keynes’s word) a creation of the State, and the absolutist State has the power to “re-edit the dictionary” to make contracts conform to its needs, regardless of the intent of the original parties to the contract.
And how many bankers have you really seen doing this?
Many economists teach that banks create money but they do not; they create credit which can be used temporarily but when repaid the temporary money is destroyed. All sustainable money comes from the US Treasury, all of it. There is no other legal source of US money. The government must supply money to the economy and does. The process is simple and very old. The government spends into the economy and then, after spending, extracts and destroys a portion of the money that was spent before spending more. The destructive extraction is called taxes and it prevents inflation, maintains price stability and moves money around in the economy by taxing “A” and spending to “B”. The notion that money is created in the economy as stated here in this article, is an old and thoroughly discredited idea. The only economic recourse if the government does not establish and support a currency is a barter economy which has a very significant problem in creating its own currency.
There are a number of misconceptions here.  First and foremost, the commentator takes the “Currency Principle” as a given, where the posting was from the “Banking Principle” perspective.  The Currency Principle and the Banking Principle are based on assumptions 180 degrees from each other, viz., the Currency Principle assumes that production derives from money, while the Banking Principle assumes that money derives from production.  One principle cannot be critiqued on the grounds that it is not the other; you cannot compare apples and oranges.
Henry Dunning Macleod
Then, money and credit are artificially separated.  Under the banking Principle, however, money and credit are simply different forms of the same thing: the medium of exchange.  As Henry Dunning Macleod put it, “Money and Credit are essentially of the same nature; Money being only the highest and most general form of Credit.” (Henry Dunning Macleod, The Theory of Credit. Longmans, Green and Co., 1894, 82.)
Our understanding develops naturally from the definition of money we use: “anything that can be used to satisfy a debt,” or (as the legal definition has it), “all things transferred in commerce.”  (“Money,” Black’s Law Dictionary.)  All money is therefore a contract (a promise to deliver something of value), just as, in a sense, all contracts are money.
A contract consists of three essential elements.  These are offer, acceptance, and consideration.  “Offer” and “acceptance” are pretty straightforward.  You make me an offer, and I accept it.  “Consideration” is defined as “the inducement to enter into a contract.”  That is, consideration is the thing or things of value being exchanged, e.g., “I will give you ten chickens for that pig.”  The ten chickens are my consideration, the pig is your consideration.
Without these three elements, offer, acceptance, and consideration, there is no contract, and no money is created.  Further, the parties to the contract must have a private property right in the consideration.  Obviously, my offer to you to give you someone else’s chickens for a pig that you intend to steal is not a valid contract as neither of us has the right to convey a private property right that we don’t have.  It is a fundamental legal principle (as well as common sense) that you cannot give someone something that you don’t own or that you have no right of disposal in.
Make like an Egyptian: record every contract.
All legitimate or valid money creation therefore consists of contracts.  People created money in this way long before coined money or banknotes — or State debt — were a gleam in a politician’s eye.  The vast bulk of documents from the ancient world are not great works of literature, but financial instruments, contracts . . . money.  Mortgages, bills of exchange, promissory notes, letters of credit, and so on, are all different forms of money, the media of exchange.
Governments only got into the money business because there was a need to set standards (regulate) and enforce contracts — and keep in mind that all money is a contract, just as all contracts are money.  Regulation and enforcement, however, are not creative processes, but certification and implementation processes.  A government does not create money.  It only sets the standard for the currency (“current money”), and makes certain that parties to contracts fulfill their respective sides of the bargain.
In theory, anyway.  What happened very early on, however, was that governments realized that they could say one thing, and do another.  According to Plutarch, Solon the Lawgiver set the standard of the Athenian Drachma as 6,000 to a talent of silver.  He then reduced the weight of the coined Drachma slightly to cover the costs of minting, making the silver in a coin less than the face value.
Archaic period Athenian Drachma: less than face value of silver.
This would have been acceptable except for one thing: the government treated this “agio” or “seniorage” as a profit instead of a liability.  It considered the difference between the face value and the actual silver weight as revenue instead of an obligation that had to be redeemed.  Thus, government-induced inflation became standard monetary policy almost from the very beginning of what most people today erroneously think of as the first “money” . . . even though, strictly speaking, this was a hidden tax on users of the currency, who were cheated as people realized that a coined silver Drachma didn’t contain a full drachma of silver, and raised prices accordingly.
Subsequent governments did the same thing, thinking it was an easy and painless way to raise revenue.  Henry VIII Tudor (among his other crimes) carried this to extremes, earning the nickname (after his death, of course) of “Old Coppernose” for having more base metal in his coins than silver; .333 for England, .250 for Ireland.
In essence, by inflating the currency — “creating money” backed by its own debt that it refused to acknowledge or redeem — a government in this fashion unilaterally interfered in all contracts valued or denominated in the official currency, transferring wealth from the private sector into its own coffers without the necessity of levying taxes or being accountable to the taxpayers.  In a brilliant bit of spin-doctoring, however, governments almost always managed to put the blame for the resultant chaos on “the Jews,” “the banks,” “the capitalists,” or whatever individual or group came onto the radar as a handy scapegoat.
Are “the Jews,” “the banks,” or “the capitalists,” however, really the villains here?  We’ll take that up on Monday.

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