Money: Sound and Unsound

0:00My friend and colleague at the Mises Institute, Joseph Salerno, published a book this year entitled Money, Sound and Unsound. The book consists of 26 chapters which were based on articles that were published over the previous 30 years in publications around the globe. And the common theme of that book is explaining the principles of sound money to an audience of non-specialists. And this principle of sound money consists of two things. The first of which is the positive affirmation of the market's ability to discover and maintain money and provide all the benefits that it confers upon society. The second is the negative view of government meddling in money and all the negative consequences it has for society.

0:51And Salerno is a leading light in contemporary Austrian economics. The book really does a marvelous job of presenting all the important theoretical debates to the general reader. There are, of course, important historical stories that are beautifully disentangled, particularly regarding the Great Depression. The book is chock-filled with analysis of policy, including some of the very best discussions of inflation and deflation. Finally, in terms of moving forward, the book contains several important industries, excuse gives me essays on the gold standard and how to re-implement it. So I highly enthusiastically recommend this book to you. The book is a great accomplishment and contains the very information we need to move the world in the right direction.

1:41Therefore I'm dedicating my lecture today to Joe and his accomplishments and to his goal of restoring the principle of sound money. And so what is sound and unsound money? Well the principle of sound money acknowledges what the market has provided society in the form of money. Money began as a commodity that started to be used as an intermediary in exchange. For example, I accept tobacco in payment for a service even though I have no desire to consume tobacco, but I do know that I can use the tobacco to buy some tomatoes down at the Vegetable Stand. Initially such goods back in history, such as tobacco, may serve the purpose as an exchange intermediary. However, there is a natural tendency for particular goods to emerge as the best intermediaries for exchange across the entire economy. Eventually only a small number of goods emerge as the very best commodities to serve as intermediaries.

2:50These goods will naturally have qualities that allow them to best serve the economy. These qualities include being durable because you don't want an intermediary good that might spoil or degenerate between the time you accept it and the time you want to reuse it in exchange. Another important quality is that the good be divisible in order that you can measure To measure the amount of a commodity you might be willing to offer in exchange, therefore a cow would not be a very good intermediary because you couldn't just cut off one leg and then sell it bit by bit.

3:35Tobacco on the other hand, for example, can be measured by weight to a precise amount. Tomatoes on the other hand are less divisible and less durable than tobacco. The very best intermediaries will also be easy to transport and store, and also represent a large value relative to weight and size, and they also must be difficult to forge or to imitate. The commodities that emerged on the market process as the very best intermediaries are what we call money, or the medium of exchange, because they are the very best in terms of of Salability in the Marketplace. Now, it is important to note that this is not some mysterious process unguided by human choice.

4:23But rather, it is an entrepreneurial process whereby certain individuals discover those particular commodities that have these properties and that they can benefit from them, that they can profit from them. The best entrepreneurial discoveries are eventually imitated and the market is driven in the direction of these certain commodities and away from others. Now long ago, metals emerged as some of the very best intermediaries for exchange, specifically things like bronze, tin, copper and silver and gold. These commodities are extremely durable, highly divisible, easily transportable and stored and very difficult to counterfeit. And to enhance the divisibility of these metal commodities, metalsmiths would cut the metals into equal-sized pieces and add their marks to indicate the weight and who produced them, and in this manner the business of minting coins came into being. In order to enhance the ability to store and transport money, banks and banknotes came into being.

5:37Initially goldsmiths and silversmiths, who already had a safe place to store their own metal, served as the repository for storing other people's money. In order to enhance the transportability of money, paper bank notes emerged as a way of reducing the cost of transportation and the problem of theft during transport. So instead of transporting 100 pounds of silver for a trip from London to Paris, I would simply have my London banker write me out a bank note for 100 ounces of silver, which I would carry with me and then redeposit or cash at the corresponding bank in the city of Paris. This is the good form of paper money.

6:23Now, yeah, this might all seem rather simple and obvious, but it's very far from that. This process whereby money and banking developed could never have been imagined prior to it actually happening. There is an example of cigarettes becoming money very quickly in World War II prisoner of war camps in Germany, but that's only because the prisoners already knew about money Money and what money was and how it could be used. No one would have been capable of discovering money in its modern form back in prehistoric times. Likewise, governments could never have been capable of creating such a system by themselves.

7:08Governments merely monopolized existing forms of money. Now of course, everybody thinks money is important and most of us would like to have more of and that's why Ben Bernanke is popular in some circles. But few people realize how important it really is. Without money, the ability to exchange would be extremely limited. Bartering goods is a costly and cumbersome process where you have to find somebody that wants something that you have and they have something that you want and you can come to terms on how much each of you are going to be willing to without money people would have to supply most of the goods for themselves and their families by their own production and as a result you would have much less to consume we would basically all be on a subsistence level of existence the specialization and division of labor would be extremely limited because we wouldn't have the ability to pay our workers other than in the production of whatever we're doing.

8:23Economies of scale would be very difficult, would be very limited as a result. Complex goods simply could not be produced without the existence of money. We wouldn't have prices, we wouldn't have wages, we wouldn't have the ability to create complex production processes. And so barter is a very, very difficult form of an economy, and you can't just go to Craigslist and, you know, put what you have up there and try to find somebody that you can make an exchange with. There would be no Craigslist. There would be no computers. There would be no internet. There would be no cell phones. There wouldn't even be phones.

9:14In other words, the long-term development of our standard of living is based on and coincides with the development of money. There are still societies in Africa and Asia and the Americas that are non-monetized, but they're very primitive. People live in primitive structures, have primitive clothing, and have a very unsure supply of food. They have none of the things that we take for granted, like indoor plumbing, refrigeration, Soap, Clean Underwear. Their lives could be healthy and satisfying, but the point is, is that their lives are very different, and if we didn't have money, our lives would be incredibly different. So the principle of sound money is based on commodity monies that emerged from the market guided by the principles of property, commerce, and entrepreneurship.

10:13As the system of money developed and spread across cultures, it did cause shocks to various culture-specific economies as they became integrated into the system, and such integration is always a messy process, but ultimately the monetary integration itself was a wholly beneficial process to both societies. Now on the other hand, any step away from the principles of sound money can cause the And here I am speaking about the unsound money and specifically about government interference and intervention into money and banking. The first type of intervention is the monopolization of money and banking, basically the government taking control over the minting of coins.

11:09Now this may have an initial appearance of benefit as the coins become homogenous, the government has the power to stamp out counterfeiters and the like. However, government monopoly ultimately leads to a second type of interference which is debasement of money or what we call monetary inflation. Government and counterfeiters will shave, they'll clip, they'll reduce the size of coins over time in order to have more money to spend for themselves. And of course now we have simply electronic monetary inflation where they press a button and the money supply starts to grow. And even if the state did not use the monopoly to inflate, it would have destroyed the market process.

12:02Only with competing money suppliers would it be possible to have certain types of innovation and product development that improves money and thereby enhances economic development throughout the economy. And another book that I'd like to plug is by George Selgin, it's called Good Money, And basically, it's a wonderful historical study which shows that when the government stepped away from the minting of small change, that the private sector move in, took over and provided a better product than what the government had done previously. The types of innovation that have occurred with state monopoly of money have all been negative.

12:47They include fractional reserve banking, bi-metalism, the gold exchange standard, central banking, fiat paper money, the Brentwood system, the World Bank, the International Monetary Fund, the current dollar hegemony, and of course, QE2. Now time limits me from actually going into the problems of all these developments, but Rest assured that they are all handled in great detail within the Austrian Economics literature and on Mises.org. Needless to say, we have drifted far, far away from the principles of sound money. We now have a system of fiat paper money with no commodity backing whatsoever.

13:32We have fractional reserve banking that until recently there were basically no reserves backing up our demand deposits. and finally we have a central bank that is embarked on a series of extreme and unconventional policies. Our national debt is exploding and we have a futures funded unfunded liabilities or what they call now a fiscal gap that has been estimated to be as high as 200 trillion dollars and of course debt is the sort are the fuel that fires inflation. The more debt a nation has, the more inflation it tends to undertake. And now we have quantitative easing too.

14:17We have the price of gold shooting up over $1,400 an ounce. And so finally, the gold standard is back in the news. On the one hand, you have Robert Zolik, who is the head of the World Bank, has suggested said that we go back to some type of gold price targeting as a guide for monetary policy. Sort of a positive statement about gold. On the other hand, you have New York economist, Nouriel Roubini, who has recently attacked gold for several reasons. First, he says it would limit the Fed's policy flexibility. Second, it would prevent the Fed from stimulating growth. Third, it would prevent the Fed from managing the price level.

15:07Fourth, it would prevent the Fed from being a lender of last resort. And fifth, it would prevent the Fed from bailing out the banks. Now, of course, these are precisely the reasons that Austrian economists oppose the central bank can support the gold standard itself.

15:30The economics profession was long composed of various schools of economic thought, with the Austrians consisting of a small but highly innovative number of economists who worked within many of the leading institutions of higher learning. More recently, the Austrian School has been growing rapidly and significantly, both inside and outside academia. However, instead of there being sort of a mixture and a continuum of economic thought, there's basically two camps, the Austrians and various types of Keynesian economist. The Austrian camp, what I've labeled and discussed as supporting the positive principles of sound money, support commodity money, competitive currencies, The Keynesian Camp supports what I have labeled the negative principles of sound money that involve various forms of government intervention.

16:35My view is that the Keynesian Camp does not really understand how the economy works. as a social system of entrepreneurial actions on the part of millions of people. Instead, they seem to view the economy as some kind of machine or some kind of single being that they can stimulate with fiscal and monetary stimulus to obtain various results. You can sort of think of Frankenstein or something along those lines. So now I would like to discuss some examples of the Differences Between Austrians and Keynesians. And these are going to include the Great Depression, the problem of deflation, and how to get out of this economic mess that we're in.

17:22These examples are just three of the many things you're going to find discussed in Joseph Salerno's book, which in my opinion is the single best source of information and knowledge about these and many other economic issues Related to Money. The Great Depression, which began in 1929 and lasted throughout the 1930s, has been thoroughly studied by economists. And the Keynesian camp has come up with various explanations or theories. They all basically say that there was a lack or insufficient aggregate demand. But insufficient aggregate demand is really what recessions and depressions are all about.

18:11It's really not true that we have insufficient aggregate demand. I mean, if you could just demand things at will, well, you'd want a new car, you'd want a better house, you'd want to buy a whole new set of clothing, there would be tremendous stimulation in the economy. But insufficient aggregate demand is merely a description of a phenomenon. It is not an explanation of the phenomenon. Milton Friedman said that the Great Depression was caused by a fall in the money supply in the early 1930s. Ben Bernanke, who's the chairman of the Fed and wrote his dissertation on the subject, said that it was bank failures in the early 1930s that caused the Great Depression. And I always thought it was funny that, you know, the guy who literally wrote the book as far as big banks failing in the early part of the Great Depression and that if the Fed had only prevented them from failing, if they only bailed them out, that we wouldn't have

19:14had the Great Depression. I always thought it was funny that he somehow got the job as chairman of the Federal Reserve right at this point in time in history. But again, falling money supply, failing banks are simply what recessions and depressions are all about. They're not explanations for why things happened in the first place. Other economists have even blamed the gold standard for the Great Depression because it prevented authorities from expanding the money supply rapidly. Now let's contrast what Salerno writes in his book. He demonstrates in his book that the Federal Reserve was a highly inflationary central bank during the 1920s, which helped set off a bubble in the stock market and malinvestments throughout the economy, investments that could not be sustained.

20:18Rather than being deflationary, Salerno finds that the Federal Reserve tried and generally succeeded in being inflationary, increasing the money supply during the 1930s. Salerno also points out the simple fact that we effectively left the traditional gold standard in 1914 and was not on the real gold standard during the 1920s, 30s and forward. He shows that they basically substituted a Federal Reserve bureaucracy and the gold exchange standard for the real one. And the reason why the Great Depression was so great, why did it last so long, was basically is really a continuing series of policies on the part of the Hoover administration and on the part of the Roosevelt administration to enact policies that prevented the market from working and specifically prevented wages and prices from falling.

21:23And that takes us to the second example, which is deflation. Deflation defined as falling prices. Mainstream economists have a fear of deflation. One whiff of the word of deflation and Paul Krugman would faint. Ben Bernanke also has a tremendous fear of deflation, which is why he's engineered such a massive inflation. Salerno and Austrians think that deflation or falling prices is a good and natural thing, as do most of us in this room. We like falling prices. That's why cash for clunkers worked. That's why the first time home tax credit worked.

22:11Falling prices led to increased sales. But Keynesians associate deflation with depression, which, as Salerno explains, that association does not hold up statistically over U.S. history. So being fearful of deflation is wrong and the reality is quite the opposite. When economy goes into a recession, there is a tendency for prices to fall. No doubt. However, if we look at the types of falling prices, and this is very important, the price of capital goods falls dramatically. That's why you see stock market prices go down dramatically. The price of land goes down dramatically during a recession or a depression.

22:59The price of labor goes down. But the price of consumer goods, especially necessities and non-discretionary goods, they don't fall so much. So prices are falling, but as the Austrians are pointing out, they're falling at different rates. So how would entrepreneurs look at that? How would future or present entrepreneurs look at that? Capital's falling, land's falling, labor's falling, but the price of goods is not falling so much. Well it means that there's a profit opportunity there. It means you can combine capital, you can combine commodities, you can combine labor with lower prices and sell them to consumers at relatively higher prices, rather than causing the economy to cycle out of control in a downward deflationary spiral which Krugman and Bernanke believe deflation is actually a natural shock absorber that stabilizes the economy.

24:08The final example is the differences between the two schools in restoring prosperity. The Keynesians believe that you need to increase the money supply, and now appears that there's no limit to that increase. They also believe that you need to have stimulus spending, and there seems to be no end to that anymore as well in their minds. As part of that stimulus, they recommend that the government borrow the money, increase Increase the Deficit and Increase the National Debt, and again, there seems to be no limit to all of that. Whatever is necessary to get the job done, basically those are the policy prescriptions which led to the hyperinflations, which Professor Terrell explained to us just prior to lunch.

25:01The Austrians view all these so-called remedies to be harmful and to impede the process of of Economic Readjustment that corrects for the very malinvestments that occurred during the boom, the Great Depression of the 1930s, the stagflation of the 1970s, the Japanese economy of the 1990s, and the current economic crisis stand as testimony to our point of view. The correct view is that government should simply get out of the way, cut taxes, cut to cut the size of government, restore a good environment for entrepreneurs, and allow markets to work. Most importantly, government should adopt the principle of sound money.

25:46We need to restore the gold standard, which Salerno has written about at great length in his book, close down the Federal Reserve, and return the operation of money and banking back to the marketplace. Thank you very much.