The Buzz

The Central Bank Dilemma

Referring to gold and all physical money as a “barbarous relic” (a phrase “coined” … please excuse the misuse of the term … by Lord Keynes, see Monetary Reform (1924), p. 172) is the favorite pastime of gold-bashers and fiat currency worshippers everywhere. In attempting to convince the public that real, hard money should be an object of derision, fiat fanatics, some wittingly and some unwittingly, are advancing the cause of “statism” (socialism and fascism) and its American analogue “cronyism”.

There is, indeed, a barbarous relic, but it is NOT gold.  The real barbarous relic is central banking, and it is central banking, especially as practiced by the U.S. Federal Reserve (“Fed”), the European Central Bank (“ECB”), the Bank of Japan (“BOJ”) and the Peoples Bank of China (“PBOC”), that deserves the public’s derision. Sooner rather than later, the practices of central bankers are sure to incur the public’s wrath.

Money (gold and silver used as currency) was conceived to be both a “battery” and a “time machine”.  As a battery, real money stored an individual’s labor and allowed that individual to trade that stored labor for a good or service provided by an individual who neither needed nor desired the laborer’s specific output.  A man who built barrels and who wanted fish did not have to seek out a fisherman who wanted a barrel.  As a time machine, money preserved the value of the individual’s labor over his lifetime, so that it could be “spent” when that laborer was no longer able to produce (either efficiently or at all). Because of its function as both a short term and long term labor storage device, real money was a fundamental building block of a free society.  (This is not to suggest that real money was a sufficient condition for a free society, but real money is necessary to preserve the freedom of a society.)

Real money performed its dual function perfectly for thousands of years, whenever governments and central banks did not control it. Now, under the complete control of central banks, money, i.e., its modern analogue, fiat money, no longer is an efficient battery. Given the loss of fiat currency’s purchasing power (96% loss since 1913 - see this) since the advent of the Fed, money no longer is a time machine.

Money has been transformed from an object with no counterparty risk, the value of which was determined by the market process of free exchange, into a tool of central economic (and thereby societal) command.  Worse, that command is implemented with neither democratic check nor balance, but by autocratic force and decree. The force employed by, and on behalf of, central banks (by governments), and the decrees of central banks are disruptive to the market process, and, ultimately, are ruinous to the freedom of society.

Before central banking, physical gold or physical silver was exchanged for goods and services.  The Bank of England altered this exchange process in 1694 by creating a money substitute called the “banknote”.

But banknotes were merely paper representations of gold or silver; they were not tangible assets. They were not “money” itself.

Why is a banknote not “money”?  Because a banknote is merely the liability of the bank issuing that paper currency. It is an “account receivable” in the hands of its holder and an “account payable” by the bank.  Sure, if there is gold or silver backing up each and every banknote issued (i.e., a “100% reserve”), then the risk of non-payment, i.e., the risk of non-conversion to “real money”, is nearly zero.  But there’s the rub.  Banks issuing banknotes began employing “fractional reserve banking”.  They issued more banknotes than the gold or silver they held in their vaults. That introduced payment risk, the risk that there might be no “real money” when the recipient of the banknote attempted to exchange the banknote for real money (the gold or silver “backing” the banknote). This “money failure risk” did not exist when tangible assets (e.g., gold and silver coins) were used as currency. Of course, since August 15, 1971, with the closure of the “gold convertibility window”, forced on President Nixon by LBJ’s abandoning all reserve requirements for gold backing of the U.S. Dollar in March of 1968, the “money failure risk” became substantial, and even likely over time.

Central banks’ control over the fiat money supply has transformed market economies into top down, command economies. It is laughable when TV commentators, media columnists and “Occupy Wall Street” protesters blame free market capitalism for the serial economic “busts” experienced in 1987 (“Black Monday” market crash by 22.6%), 1999-2000 (the “dot-com” bubble) and 2008 (the “housing bubble”). In fact, there has been no free market in the United States since 1913, when the Fed was established. Indeed, the Fed’s power of command over the economy increased exponentially with the enshrinement of 100% fiat money in August of 1971.