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This article, published in NOMOS in the Spring of 1984, has become even more relevant today as people turn more and more to "e-cash" and "digital currency" systems. I've included in italics a few comments based on some later developments. I include at the end some relevant links. I sent a copy to Friedrich Hayek wjho sent me a congratualtory note; Milton Friedman, however, wrote me a nasty one. Obviously, both were impressed in one say or another! See my other relevant article on local economics called Finding Freedom in Your Own Backyard.
Today’s money system is in crisis. The Nixon inflation, Ford recession,
Carter hyper-inflation, and Reagan near-depression have taught the
general
public more about the money supply and the workings of the Federal
Reserve
System than they ever wanted to know. Yet most are still confused - and
so are economists.
“Economics,” according to the A.A. Alchian and W.R. Allen university
textbook,
“lacks a fully satisfactory theory of the supply of money for the
modern
money system.”(1) Free market advocates insist that government
intervention
in monetary systems makes such “satisfactory” theories impossible. They
believe that only through trial and error experimentation in a free
market
will traders be able to discover what is the correct supply of money.
My interest in theories of money has led me to investigate modern trade
exchanges, the spontaneously created alternative money systems
currently
working outside the government controlled money system. From only a few
exchanges in the early seventies, the industry has blossomed to several
hundred exchanges serving over 50,000 members. My research and
experience
(including working for an exchange) suggest to me that we now have
enough
experience with money to describe both what it is and what should
determine
its proper supply.
Money cannot somehow exist apart from trade, or be created to stimulate
trade. Libertarian credit analyst E.C. Riegel wrote, “When men form a
compact
to trade with each other by means of accounting, in terms of a value
unit,
then a monetary system is formed.”(2) The concept “trade creates
money” helps us recognize that it is the volume of trade and the demand
for money that determines a proper money supply. It discredits the
belief
that either government or the gold standard should restrict the
legitimate,
trade-created growth in the money supply.
In order to support this dissident viewpoint, I will describe three
kinds
of money -- commodity, fiat, and credit -- and then describe how
the last of these works in spontaneously generated trade exchanges.
Finally,
I will summarize what this shows about the nature of money.
COMMODITY MONEY
In the beginning was barter; yams traded for chickens, nails for cloth.
With the specialization of labor and the growth of cities, traders
found
it more convenient to use easily transported items with widely
recognized
value. These commodities included salt, tobacco, beads, and fishhooks.
But the most popular commodities, because of their relative scarcity,
imperishability
and malleability, were gold and silver minted into coins.
Ancient rulers quickly saw the advantage of monopolizing the minting of
coins. By debasing the coins with non-precious metals they could
stretch
the private gold brought for minting and pocket the surplus. This
subterfuge
was easier than sending soldiers out to collect taxes from sullen
peasantry.
When the people noticed the coins were worth less, they didn’t storm
the
palace but simply raised prices or attacked the local merchants who did!
In more recent times, individuals found it more convenient to leave
their
gold in warehouses and circulate their receipts for gold as money.
Because
most traders remained satisfied to exchange receipts, warehouses began
printing up extra receipts and loaning them to eager borrowers to earn
interest. However, occasionally one of these “warehouse banks” created
too many receipts or made more bad loans than it could cover. Nervous
depositors
would make a “run” on the bank, demanding to be paid fully in gold. If
there was not enough gold to cover the receipts, the bank folded and
the
depositors were ruined. Since kings, governments and their cronies so
often
received these extra receipts and defaulted on their loans, it isn’t
surprising
that governments began to create central banks that would shift gold
from
bank to bank and even suspend payments when depositors became nervous.
Today’s hard money advocates want to return to gold, either the 100%
gold
dollar or fractional reserve banking based on gold. But in government
and
private hands worldwide there are approximately two billion ounces of
gold
and eight billion ounces of silver.(3) That works out to just one
half ounce of gold and two ounces of silver for each of earth’s four
billion
inhabitants. (circa 1984) This is obviously not sufficient to
make
widespread trade with gold or silver coins possible; even with
fractional
reserve banking there would be a strong deflationary pressure because
of
inadequate reserves.
FIAT MONEY
Fiat money is any coin or receipt simply declared to be money, usually
by government, occasionally by private issuers. Once a government
announces
that it will no longer redeem its notes in gold or silver, it becomes
free
to increase the supply of its fiat currency without real restraint, at
least until inflation destroys government credibility and traders
refuse
to deal in the currency. While today some governments increase their
money
supplies by just printing bills and paying their debts with them,
others
like the U.S. use more sophisticated methods.
The U.S. Federal Reserve System manipulates the money supply by
requiring
banks to hold a certain ratio of reserves to loans; only by increasing
reserves can banks increase their loans and thereby increase the money
supply. When the Federal Reserve lowers either the reserve ratio or the
interest rate it charges banks to borrow reserves from it, it increases
the amount of money banks can loan out to businesses - to government
itself.
More often, however, the Federal Reserve just increases the reserves.
In
accordance with U.S. law it buys U.S. Bonds on the open market. The
money,
of course, goes straight to the government. The Federal Reserve, with
the
“backing” of these bonds, can print an equivalent amount of currency as
reserves. This is often called monetizing the federal debt.
Federal Reserve apologists generally fall into two categories:
Keynesians
and Monetarists. Economists of both types support monetization of the
debt
but disagree about how fast the money supply should be allowed to grow.
Keynesians prefer to rapidly expand the money supply through government
spending projects. Although they deny that such spending need primarily
go into armaments, it is historically true that voters are more willing
to support defense than public works “boondoggles” usually funded by
raising
local taxes. Most Keynesians deny that their policies lead to
inflation,
blaming it variously on OPEC, greedy businessmen, and irresponsible
consumers.
Monetarists tend to advocate balanced budgets, deregulation of the
economy
and a growth in money supply of no more than two to three percent per
year.
Despite the efforts of influential monetarists in many national
governments
at the present time, voters, special interests, and politicians all
continue
to refuse to control their appetites for more guns and butter, insuring
continuing massive budget deficits. (Still true today!)
Eliminating government deficits without reducing spending can only be
done
through (politically unpopular) tax increases, heavy borrowing from
banks
(which crowds out the private sector), or monetarization of the debt
(which
leads to inflation). Pessimists predict that, as hyperinflation and
international
monetary collapse approach, governments will enforce strict wage and
price
controls, confiscate private pensions and other financial assets, print
metallic stripped money to prevent cash from leaving the country and
even
abolish cash all together and institute electronic money so that every
dollar can be traced and taxed. Some predict great “patriotic
wars”
to quash protest, and even nuclear catastrophe. (Variations
on
all of these, of course, have happened in various countries over the
last
18 years. The United States' boom of the 1990s based on decrease
in the growth of military spending, technological advances, increased
free
trade and a favorable investment environment is not likely to continue.)
CREDIT MONEY
Credit is a claim on goods or services, or, alternately, the promise to
pay cash, goods or services. Verbal promises, bills of exchange, credit
notes, etc. have been around as long as humans have traded and often
are
passed from hand to hand much like commodity or fiat monies. The bulk
of
savings and bank loans today are not cash but claims to cash. As
Alchian
and Allen write, “Debt is money - provided that the debt is the
particular
kind owed by commercial banks, payable on demand, and transferable by
checks...the
world relies heavily on credit and confidence in fulfilling one’s debt
obligations."(4)
Despite this realization, economists remain uncomfortable with the
concept
of credit as money. One reason is that credit is not easily quantified.
As Milton Friedman writes, “It has so far proved impossible to find a
satisfactory
quantitative measure of credit conditions.”(5) Recognizing this,
Ludwig von Mises “on grounds of convenience” preferred to use a
narrower
formulation of the concept of money” which excludes some kinds of
credit
money.(6) Hard money advocate Murray Rothbard denies that credit
even is money, but Hayek’s broad definition would include it.
Recently, economist Ludwig M. Lachman urged Austrians to begin applying
their “subjectivism,” their concern with individual choice and
subjective
value, to the theory of money. He also pointed out that economists like
Pigou, Keynes and Friedman have shown that the creation and maintenance
of credit depends on the individual demand for money.(7) Leftist
economist Graham Thomson has noted that “the financial system has gone
on creating credit largely independently of Treasury and Bank of
England
policy.“(8)
A SUBJECTIVE THEORY OF MONEY
Libertarian E.C. Riegel (1879-1953) offered a coherent explanation for
the mysterious creation and fluctuating supply of money. In his last
work,
Flight
From Inflation: The Money Alternative, Riegel advanced the
“subjective”
view that “trade creates money. He wrote, “When men form a compact to
trade
with each other by means of accounting, in terms of a value unit, them
a monetary system is formed, and actual money springs into existence
when
any of them, by means of the act of paying for a purchase, incurs a
debit
in the accounting system.” Debits create and credits destroy money.
There
is no “proper supply,” only records of how much was traded and what
volume
of units remains.
In effect, Riegel redefines money as a unit of account. He believed
that
both government reserve requirements and gold standards restrict
commercial
banks’ ability to create the amount of credit traders need to conduct
all
the trade they are actually capable of doing. Riegel contrasted this
legitimate
commercial bank money with government money which does not represent
real
trade and just adds valueless units to the money system, thereby
creating
inflation. Riegel considered his system to be a true “economic
democracy”
because individuals would no longer be constrained from trading and
competing
by governments and their banker cronies.
The important features of Riegel’s monetary alternative are:
(a.) A credit and debit accounting system using value units or
“valuns”
issued only by private banks; governments would not be allowed to issue
money at all. While banks could establish credit limits, they would be
set in recognition that the individual or corporation is “entitled to
create
as much money by buying as he or it is able to redeem through selling.”
(b.) Banks would launch their value units on par with the dollar
as a way of keynoting it, just as the American dollar was initiated at
par with the Spanish dollar. Although banks could still decrease the
value
of their unit by making too many bad loans, Riegel felt that the fact
that
the units are so clearly tied to trade, plus free market competition,
would
discourage such abuse.
(c.) Banks would earn their profits by charging service fees on
all
transactions.
(d.) The system could be instituted by the worldwide efforts of
international
businessmen or by local traders as an alternative to hyperinflation and
monetary collapse.
(e.) Riegel believed that, as inflation increased and more and
more
individuals joined the superior valun system or some other private
system,
the state would be undermined.
TRADE EXCHANGES
Riegel’s
viewpoints have been largely supported by the development of trade
exchanges.
(And,
today, various forms of "e-cash" and "digital currency.") In
fact, trade exchanges vividly illustrate his contention that “money is
but a medium of evidencing barter balances.”
In 1960 former advertising executive and banker Marvin McConnell formed
Barter Systems, Inc., one of the first, and now the oldest, of modern
trade
exchanges. He pioneered the first system of credits and debits used by
an exchange. Trade exchanges began growing in popularity during the
1974
recession when businesses, faced with excess inventories, tight money
and
inflation, sought to increase sales and reduce overhead. In 1979 the
International
Association of Trade Exchanges was formed to help legitimize exchanges
and to suggest guidelines for exchange operations.
Exchanges use a credit and debit accounting system which uses the trade
credit as the unit of account. Exchanges usually allow members to
overdraft
up to a certain limit for, as McConnell says, “If you don’t have
somebody
overdrafting, you will not have your first barter
transaction.”(9)
As long as traders take up their debits promptly through credits from
sales,
exchanges allow them to debit as much as they like. Some exchanges
allow
traders to loan idle accumulated credits to others and charge interest
for them. Traders care that the credits are useful for trade, not that
they are solid commodities or emblazoned with the Great Seal of the
United
States. Says one typical trader, “It’s the bottom line that counts. Who
cares how you get there?”( 10)
Exchanges pay expenses and make profits through charging cash
membership
fees of $100 to $500 and service fees of 5—10% per transaction. While
some
exchanges issue script which can be used just like cash, the majority
of
exchanges utilize checkbooks or credit cards. Members are kept informed
of available services and new trading opportunities through directories
and newsletters.
While exchanges too often advertise their credits as being worth a
dollar,
in fact their value may vary from 5 cents to 80 cents depending on two
factors. First, trade exchange operators may just create credits
(called
deficit spending) to attract new members with “free credits” and to pay
business expenses and profits. Second, the value of the credit varies
according
to the number, variety and desirability of members of the exchange.
There
are trade credit brokers who take advantage of differences in values by
arranging exchanges between members of different exchanges and by
buying
low from cash-short members or exchange dropouts and selling high to
outsiders
who want to trade with members.
Internal and external problems currently limit the growth of trade
exchanges.
Internal problems include incompetent or dishonest exchange operators.
Members often drop out because there is not a good ratio of services to
hard goods, because they earn more credits than they can spend in the
exchange,
or because of obvious overcharging by members or inflation by
operators.
Often the exchange operator starts creating more credits to attract
members
and pay expenses. Soon the credits lose all value, trading stops, and
the
exchange folds.
The one big external problem is government interference. In 1980 the
IRS
announced that a trade credit in any barter club (regardless of the
health
of that club) would, for tax purposes, be considered equal in value to
one U.S. dollar. The decision led one observer to predict that “the
ruling
will undoubtedly have a crippling effect on the trade club industry..
.It
may even force a small number of businesses (trade club members) into
bankruptcy
as the IRS attempts to collect taxes they now believe are
due.”(11)
To add to trade exchange woes, the 1982 Tax Bill declared that third
party
organizations like trade exchanges must supply the IRS with a record of
all credits earned by members during the year. Another less widely
recognized
problem is state and federal labor laws which discourage paying
full-time
employees partially or fully in anything but dollars. A vigorous
campaign
to educate the public about the nature of exchanges and to remove legal
barriers might overcome public apathy and reverse some of these
decisions.
(Since
then the government has become increasingly suspicious of digital
currencies
as a means of engaging in "money laundering" and tax avoidance and
subjected
such trade exchanges to even more regulation and oversight.)
THE MEANING OF MONEY REVEALED
Using various insights obtained from modern free market economics, E.C.
Riegel’s “monetary alternative” and the growth and operation of trade
exchanges,
I draw five conclusions regarding the nature and proper supply of money:
(1.) Money is whatever people are willing to use as a medium of
exchange,
unit of account, and store of value.
(2.) Modern trade exchanges show that it is possible to have a
medium
of exchange that emphasizes accounting features.
(3.) Bank and trade exchange creation of credit are really the
same
thing, since both represent real trade. But because of legal tender
laws,
banks must have available currency on hand which restrains them from
creating
as much money as legitimate trade demands.
(4.) Units of account can have stable and reliable value only if they
are
created to represent current or imminent exchanges. The supply of money
need only be limited by the individuals’ ability to trade. The
devaluation
of units is avoided when they are not created for the purpose of paying
bank expenses or profits, or to finance long-term or high-risk
ventures.
(Such ventures would be financed through loans of accumulated units
held
in time deposits on which a market rate of interest is charged.) In
this
way, general price rises are avoided, though temporary price rises in
booming
industries would remain a reality. Since there would be no false market
cues from public or private expansion of money supply leading to
over-investment,
there should be no boom/bust cycle.
(5.) We do not have to legislate a change of money systems, but
can
start educating and organizing around the trade exchange alternative
now.
In the event of incipient hyperinflation or monetary collapse, prepared
individuals could translate a large portion of their assets into trade
credits and avoid losing all they own.
(6.) Perhaps the greatest single cause of war, economic inequality, and
poverty is governments’ monopoly over the money supply. Government
control
of money results in the inability to get sufficient money into the
system
except through inflationary government spending (which is too often war
spending) and the inability of individuals or corporations without
substantial
assets or government connections to get the investment money they need.
A MORAL FRAMEWORK
Finally, this entire discussion should A be put within a moral
framework.
Any successful alternative to government money could be quickly crushed
or co-opted by government. It can only succeed in the context of a
movement
which emphasizes that the end does not justify the means, that fraud,
theft,
and violent coercion, private and public, are morally wrong. Also, no
financial
system can be a “fail-safe” system immune from human corruption and
incompetence.
In the end, it is not in gold or government or trade exchanges we
trust,
but in other human beings.
With this in mind, I urge readers with an interest in financial
alternatives
to investigate credit money and trade exchanges. I believe convincing
others
that government cannot create money or prosperity, that only our own
efforts
and our own trade creates money, is an important way of bringing them
over
to the true cause of peace and freedom.
Carol Moore, a
libertarian
activist in California, worked for a small trade exchange in Los
Angeles
in 1983.
1. Amen A. Alchian and William R. Allen, University Economics:
Elements
of Inquiry (CA: Wadsworth Publishing Co., Inc., 1972), p. 585.
2. E.C. Riegel, Flight From Inflation: The Monetary Alternative
(Los Angeles: The Heather Foundation, 1978), p. 21.
3. Douglas R. Casey, Crisis Investing (N.Y.: Stratfield Press,
1980),
p. 198.
4. A. Alchian & Allen, University Economies, p. 607.
5. Milton Friedman, Dollars and Deficits (N.J.: Prentice Hall
Inc.,
1968), page 144.
6. Ludwig von Mises, The Theory of Money and Credit (CT: Yale
University
Press, 1953), p. 53—54.
7. Ludwig M. Lachman, “An Austrian Stocktaking: Unsettled Questions and
Tentative Answers,” in New Directions in Austrian Economics, ed. Louis
Spadaro (Sheed, Andrew, & McNeil, 1978), p. 9—10.
8. George Thomson, “Monetarism and Economic Ideology,” Economy and
Society,
February, 1981.
9. Peg Long, “The Eight Percent Solution,” Inc. Magazine, August, 1982.
10. John Mamis, “Trade Secrets,” Inc. Magazine August, 1982.
11. John Stranger, What is a Barter Credit Worth?” Self—Reliant,
April/May,
1983.
Continental Trade Exchange http://www.ctebarter.com/
Trade Exchange of America http://www.tradefirst.com/
Private Enterprise Money by E.C. Riegel http://www.mind-trek.com/treatise/ecr-pem/index.htm
Money - Past, Present & Future: Sources of Information on Monetary History, Contemporary Developments, and the Prospects for Electronic Money http://www.ex.ac.uk/~RDavies/arian/money.html