No one takes the time to shave base metals like pennies or nickels.
You may remember seeing old coins from Roman Empire that have a hole punched in the middle of them. When one of the corrupt Caesars, like Caligula, had too many parties and his treasury was nearly empty, he would order that holes be punched through gold and silver coins.
The corrupt Caesar would have the punched-out gold and silver melted down, coined, and then spent for more parties.
Then Caesar would order citizens to trade the punched coins as if they still held the full value. He would declare the counterfeit coins legitimate.
Of course, prices then would mysteriously begin to rise to make up for the reduced value in the coins. And workers would demand higher wages for the same work.
And then the government would institute wage and price controls to restrain the greedy business owners, and then...
But that’s a story for another book.
Now you may be thinking...
What about the dimes and quarters and so-called silver dollars in my pocket right now that are all made out of the base metals of nickel, copper, and zinc?
They have mill marks.
But why should they, since they no longer contain gold or silver? Could someone be trying to make us think the value is the same? That the coins declared legitimate? Like Caesar declared his counterfeit coins to be?
And what about the paper euros and paper dollars and paper yen that I have in my purse or wallet right now?
That’s money, right?
Well, it used to be...
Deep Dive: Government’s Economic Role
If you believe that government should be a major player in influencing a country’s economy, then you are likely a believer in government experts knowing better than the average person what is good for them.
Think about how elitist this idea is: People are fallible. People are not experts. People don’t know what’s good for them. People must be led by experts who know better.
But oddly, when people get government jobs, they seem to know better than the rest.
How is that idea working out? Especially once you recall that these “experts” are also fallible people, people subject like everyone else to vanity, greed, lust, anger, and other vices.
Government expertise fails to take into account the history of how power corrupts.
An example: If you take all the federal money allocated to helping the poor, you can calculate that it is over $200,000 per poor person each year.
Clearly, poor people are not getting all that money. Who’s getting it?
Many people like to say that government handouts create dependency. And that is true. For example, when a person in need manages to increase their income by $10,000 annually, they then lose over $15,000 in medical benefits.
What becomes the incentive to get a job?
The truth is that the dependency goes more the other way. Government is dependent on the poor. Why? Because it supports the livelihood of a lot of government workers.
Make no mistake—the intentions of these workers may be honorable. But they have no incentive to achieve the honorable goal of eliminating poverty.
This fact explains why the Great Society programs that started in the 1960s to help the poor have actually had the unintended consequence of increasing poverty.
Thomas Sowell tells the story of his experience of being a committed Marxist who got a job with the Federal Bureau of Labor Statistics. A Marxist believes in socialism, a socioeconomic system based on social ownership of the means of production, distribution based on one’s contribution and production organized directly for use.
In layman’s terms, from each according to his ability, to each according to his needs. In other words, the moral goal of equal distribution is set without regard for incentives.
Imagine that among a dozen workers, you work twice as many hours as the others, and some of the others are not working at all, yet the fruits of your labor are equally distributed. At what point do you decide that working harder than others makes no sense?
Thomas Sowell wanted the job because he believed in statistics. He believed in getting the facts to prove that government economic intervention helped people. That socialism worked.
At that time, the government had mandated a federal minimum wage. Sowell had accumulated data, the facts, that demonstrated without ambiguity, that the federal minimum wage was hurting the people it was designed to help.
And nobody in the agency cared. Nobody was interested in changing the policy. Why? Because if government is seen to have an adverse economic effect with its programs, the result would be a lesser need for government. That is, fewer government workers.
Chapter 7
Paper Currency
The trifling economy of paper, as a cheaper medium, or its convenience of transmission, weighs nothing in opposition to the advantages of the precious metals; that it is liable to be abused, has been, is, and forever will be abused, in every country in which it is permitted.
Thomas Jefferson,
letter to John W. Eppes, Nov. 6, 1813
People don’t like carrying heavy coins everywhere they go.
Today the word currency is used mainly to mean money. To avoid confusion, we will use the word money for coins (gold and silver) and currency for paper notes.
Let’s talk about a new innovation that happens resulting from trade between the people of Gold Island and Silver Island.
The people of Gold Island and Silver Island begin trading. Both have created the same system of money, using gold and silver coins of similar value.
The main difference is that Gold Island money is stamped with the words “Gold Island” and Silver Island money is stamped with the words “Silver Island.”
Iron Island bandits don’t care about trade and coins, except for those that they can steal.
Both Gold Island and Silver Island accept the other island’s money because the weight is the same for the same kind of coin.
Both islands benefit from trade. The people of Gold Island make the best fishing poles and slingshots. They have skill sets that the people of Silver Island don’t have.
The people of Silver Island also create all kinds of different tools, silks, crafts, and other goods that the people of Gold Island can’t produce.
Since both economies have grown strong, a lot of gold and silver coins get used. Some people are getting very rich. And gold and silver coins are heavy to carry.
So one of the good persons on Silver Island comes up with a new idea.
Why not become a goldsmith?
A goldsmith is someone who stores gold for travelers and merchants and charges a small storage fee.
The idea catches on and someone on Gold Island starts a goldsmithing business as well. Goldsmiths store gold and silver coins, have hired security to prevent the Iron Island bandits from stealing it, and charge people a small storage fee.
In place of the coins, the goldsmith gives the traveler or merchant an official slip of paper that reads something like this:
“Tor has on deposit with the Silver Island Goldsmith 20 ounces in gold and 65 ounces in silver. Payable on demand.”
Each note is signed both by the goldsmith and by the traveler. The goldsmith keeps a record of all transactions.
The paper is an IOU note for the gold and silver coins that are stored.
The traveler can now go to market and wander around town without carrying all that weight in coins.
And the traveler does not have to worry that a bandit from Iron Island (or one of the less honest people from Silver Island) will rob him or her of those coins.
After a while, the goldsmith on Gold Island has an idea. Each paper IOU note is specifically created for each person.
What if the IOU notes had a more general design that is not specific to the person?
The IOU note might read something like this:
“Will pay to the bearer 20 ounces in gold, payable on demand at the S
ilver Island Goldsmith.”
What if the goldsmith created different values for different notes?
There would be a whole set of IOU notes. And the people could trade IOU notes with each other.
In other words, the traveler can get a set of IOUs from the goldsmith:
Four notes would be for 5 ounces in gold, three notes would be for 10 ounces in silver, five notes would be for 5 ounces in silver, and ten notes would be for 1 ounce in silver.
The traveler can go to local merchants and trade the paper notes for goods and services. The merchants know that they can always go to the goldsmith and receive the gold and silver coins.
The goldsmith charges a small fee for each storage transaction. And everyone is happy.
Now here is where everyone’s understanding of money begins to break down. Pay close attention:
The paper notes are not money.
Paper notes are IOUs.
Paper notes are symbols of money.
Paper notes are NOT money.
We will be exploring what less-than-honest people on Silver Island can do with paper notes in the chapter on Inflation.
For now, let’s see what other good things can come from the honest people on Gold Island.
Deep Dive: The Founder’s Economics
When George Washington, James Madison, Alexander Hamilton and many others convened the Constitutional Convention in Philadelphia in 1787. One of their major goals was to correct the deficits of the Articles
of Confederation and put the federal government on a sound financial footing.
They knew from direct experience what economic havoc speculators could wreck, especially when paper currency was involved.
You may have heard of the phrase, Not worth a continental? They know what could happen to currency not backed by real money.
So in the U.S. Constitution, they ensured that the new federal government would close the door to such economic havoc. They did it in two ways.
1) In Article I. Section 8, they wrote, “The Congress shall have Power… To coin Money, regulate the Value thereof....
2) Section. 10. No State shall… make any Thing but gold and silver Coin a Tender in Payment of Debts….
Look more closely at Section 8. Notice that the founders said the Congress shall have the power to coin money, not to print money. They did not want Congress to have the power to print paper money.
Some would argue, Wait. Sure, they wanted Congress to make coins, but that doesn’t mean they were closing the door to paper money.
Yes, it does. Remember, the purpose of the U.S. Constitution is to define explicitly the power of the new federal government. That government could not exercise any power not clearly defined.
If there were any doubt, Section 10 should clear it. In that section, Congress said that no state shall make anything but gold and silver legal tender in payment of debts. In other words, states could not make paper currency a legal tender as well. All taxes must be paid in gold or silver.
And the curious thing is, these two articles regarding money have never been amended. They are still the law of the land.
So how did Congress get around those constitutional provisions?
Chapters 9 and 10 on Inflation and A History of U.S. Money will give you a glimmer of what maneuvers were needed to circumvent the law of the land.
Chapter 8
Banking
“...banking establishments are more dangerous
than standing armies...”
Thomas Jefferson,
letter to John Taylor, May 28, 1816
Thomas Jefferson obviously makes a strong statement about banking.
In later chapters, we will see the nature of his concern. For now, let’s talk about what can be good about banks run by people with a moral conscience and who believe in free choice.
When real money is saved, when wealth is saved, it can be used to do good work.
How?
By making money available for capital investments.
The goldsmith on Gold Island has a thriving business. Everyone trusts him. He stores people’s gold and silver, charges a reasonable fee for the service, and protects their money.
They have found the paper notes convenient to use for trade, and they can get their money from the goldsmith any time they want.
Time passes, and the goldsmith notices something. No matter how many transactions he has every day, the amount of gold and silver never falls below the equivalent of 100,000 ounces in gold.
The goldsmith has an idea. He could loan some of that gold to Tor, who wants to expand his fishing rod business.
Tor has all kinds of ideas about how to make fishing rods, nets, lures, and all other fishing equipment in faster and more efficient ways. He just needs some money.
So the goldsmith and Tor talk with some of the depositors who use the goldsmith’s service. They have an idea that will make everyone money.
Tor will borrow 10,000 oz. of gold for six months. He will pay it back with an interest rate of 1%. In other words, he will pay back 10,100 oz. of gold for the privilege of borrowing the gold.
Two depositors agree to allow the goldsmith to loan 5,000 oz. of gold from each of them. In return, each depositor will get 45 oz. of gold (a total 90 oz.), and the goldsmith will get 10 oz. of gold for making the arrangements.
Everyone understands they are taking a risk. Tor’s idea may not work. Something may happen that will make it impossible for him to pay back the gold.
But everyone thinks the risk is worth it.
Tor borrows the money, hires workers (creates jobs), creates new products (creates wealth in the form of capital goods), and his business takes off. After six months he is already making more than 100 gold oz. each month.
Tor easily pays back the loan, plus interest. Everyone makes money by making the saved money do extra work. The risk paid off.
Now the goldsmith has become a banker.
Honest bankers provide a service that makes money for everyone: depositors, borrowers, and bankers.
By using the saved money to make capital investments in people with good ideas, bankers and depositors create more wealth, not only for individual borrowers and depositors, but also for the community.
More and more people on Gold Island see the value of allowing the banker to lend their money and receiving part of the interest made on that money.
Soon even the local council sees an opportunity. People still travel the island by walking or using horses. But the paths traveled are bumpy and sometimes rough.
The local council has an idea and offers it to the community of taxpayers: If taxpayers are willing to pay the costs, the local council will borrow 20,000 oz. of gold to build some roads.
Some people in the community will have short-term jobs, and everyone will benefit from the roads. After six months, the local council will collect enough taxes to pay back to the banker 20,200 oz. in gold.
The tax could come in the form of tolls on people who use the roads. This then is an example of a good tax. The tax is a consumption tax, because only the people who use the roads pay the tax.
Yes, it is a risk. There could be a storm that wipes out materials and work partially done. But the local council chooses a time of year when the weather is not much of a problem.
The banker, depositors, and taxpayers agree.
They get new roads.
The banker and depositors make money.
Everyone is happy with a much higher standard of living for the community.
Life is good when people have the choice to save money, take thoughtful risks, and put wealth to work creating more wealth, thus raising the standard of living for everyone.
So what can possibly go wrong?
Deep Dive: Understanding Prices
The Wonder of markets is that they reconcile the choices of myriad individuals.
William Easterly, The White Man’s Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill and So Little Good
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People like to call the free market system a profit system. In fact, it is a profit-and-loss system.
Profits tell producers that people want more of something. Losses tell producers that people don’t want more of something. Therefore, losses force producers to stop producing.
This is another reason why governments can distort markets. Governments routinely force people to buy products and services they don’t want.
A market economy is so complex and varied that no expert can ever hope to get a handle on the true needs and desires of the millions of people engaged in markets. This is the wonder of prices.
Prices determine how much of a scarce resource gets used where, and how products get transferred to all those people. But prices are not just about transferring money. Prices provide financial incentives to affect behavior in the use of those scarce resources. They guide both consumers and producers, thus creating an effective and efficient profit-and-loss economic system.
As demand rises for a particular product, prices increase, signally the need for producers to produce more. As demand decreases, supply also decreases. In a free market economy, supply and demand affect production levels and pricing.
Remember, only when some instrument of force is introduced (or some natural limitation in nature) do we get constraints on production that keep prices artificially high. Although this can happen with corrupt businesses, it more often happens with corrupt or well-meaning government.
Chapter 9
Inflation
All the perplexities, confusion and distress in America arise, not from the defects in their constitution or confederation, not from want of honor or virtue, so much as from downright ignorance of the nature of coin, credit, and circulation.
John Adams,
letter to Thomas Jefferson, August 28, 1787
When everyone is honest, bankers, government workers, wealth creators, and taxpayers all benefit.
But what happens when people are less than honest?
Money and Wealth Page 5