Tomorrow we join the Coalition for Capital Homesteading at
their annual demonstration at the Federal Reserve Board of Governors building
in Washington, DC. If you’re in the
neighborhood, you might consider showing up to see the fun . . . and hear a few
speeches, including a very brief one by me that might sound suspiciously like
this posting (assuming I can condense it into five minutes or less).
The demand to “End the Fed” is a graphic illustration of the
fact that we fear that which we do not understand. And of all the things people don’t understand
in this world, money, credit, banking and finance are right up there near the
top of the list.
Ironically, it’s not that hard to understand — as long as
you first realize that a lot of what you’ve been told is just plain wrong. It’s actually very simple once you get the
very first principle down pat.
The first principle of money is its definition. Money is anything that can be accepted in
settlement of a debt.
Money is not just coin or banknotes, or checks. Money is a symbol, a means of exchanging what
we produce, for what others produce.
That is why money is called the medium of exchange.
As Adam Smith pointed out in The Wealth of Nations, “Consumption is the sole end and purpose of
all production.” If we cannot produce,
we cannot consume. If others produce
something we want, we have to offer them something we have produced in
exchange.
As Jean-Baptiste Say explained, we don’t really purchase
what others produce with money, but
with what we produce. Money is, again,
only a symbol of what we produce by means of our labor and capital. Thus, if we wish to consume, we must first
produce.
We obviously cannot consume more than we produce, and
because the purpose of production is consumption, we shouldn’t consume
less. If everyone is producing and
consuming, then, and if everything else is equal, supply will equal demand, or,
as some have a little oversimplified matters, supply generates its own demand,
and demand its own supply. This is
“Say’s Law of Markets.”
All money is a contract.
In fact, in a sense we can say that all contracts are money because all
contracts involve exchanging what we produce or supply, for what others produce
or supply — the quid pro quo, or
“consideration,” the inducement to enter into a contract. Anybody who is competent to enter into a
contract can therefore create money.
If you don’t know me or trust me, however, you won’t enter
into a contract with me.
That’s where banks come in.
For a small fee, a bank will accept my contract, and issue its own
contract called a promissory note. Assuming
that people in the community trust the bank, I can either take the bank’s
promissory note and use it as money, or the bank holds on to the promissory
note and creates a demand deposit on which I can draw checks.
If other people don’t know or trust the bank, however, they
won’t accept the bank’s promissory notes or checks drawn on the bank.
That’s where central banks come in. Just as an ordinary commercial or mercantile
bank ensures that an individual’s or business’s promises are good, a central
bank ensures that a commercial or mercantile bank’s promises are good. This makes certain not only that there is
always exactly enough money in the economy, but that all the units of currency
have the same value because they are all, ultimately, backed up by the central
bank.
Thus, if used properly, a central bank is the “lender of
last resort” for the private sector, making certain that every good promise somebody
makes can be turned into money as needed.
This is, in fact, what it says in the first paragraph of the
original Federal Reserve Act of 1913:
“An Act To provide
for the establishment of Federal reserve banks, to furnish an elastic currency,
to afford means of rediscounting commercial paper, to establish a more
effective supervision of banking in the United States, and for other purposes.”
