Let’s follow the thinking of the goldsmith on Silver Island, who sees things just a little different from the goldsmith on Gold Island.
Like the goldsmith on Gold Island, the goldsmith on Silver Island creates paper notes (IOUs) to represent the actual money (gold and silver) that people deposit with him.
The amount of the notes exactly equals the amount of gold and silver coins he has on deposit. If there are 100,000 oz. of gold and silver on deposit, there are notes equaling 100,000 oz. of gold and silver in circulation.
How much money is there in total?
If you answered 200,000...
No! No! No!
The total is still only 100,000 in money.
Only the gold and silver coins on deposit are money. The paper notes are symbols of that money.
Paper notes are NOT money.
They are currency.
But the goldsmith on Silver Island notices that almost everyone who uses the paper notes thinks of them as money. Some people almost never come to redeem their notes for actual money.
They are happy to use the paper notes for trade and payment.
Workers begin asking employers to pay them in paper notes rather than gold and silver coins. The workers know they can trade them in at any time, but why bother?
Paper notes are so much more convenient to carry.
The Silver Island goldsmith then has a crafty idea.
What if he printed up extra notes?
And spent them?
Who would notice?
You can see how tempting it would be to the goldsmith who is normally honest, but who suddenly has a medical expense.
Remember, this is Silver Island. The people here are a mix of good and bad. Sometimes they know it, and sometimes they don’t.
On Silver Island, some otherwise good people can rationalize something bad as being good.
The goldsmith’s child needs help and he is short on money.
Why not just “borrow the money” now by printing up a few extra paper notes to pay the doctor?
Then just pay it back later by destroying the other paper notes when he collects his storage fees?
No one would know. And besides, it’s good for the child.
So the goldsmith does print up the extra notes. And nobody notices. And the child gets better. And the goldsmith pays back the “money.”
What he does is a good thing, right?
As time goes by, the goldsmith rationalizes other bad actions as being good.
Why not print extra paper notes to buy better food, pay someone to rebuild the fence, and get his wife a nice gift?
He figures that since nobody notices, why should he even pay it back?
He works hard for a living. So what if he has a few extra nice things. Nobody notices. Nobody cares.
Soon for every 100 oz. of gold stored, there are notes circulating for 110 oz. of gold.
And prices around town
begin to mysteriously rise.
What the goldsmith on Silver Island does not realize, and almost everyone else as well, is this:
When more paper notes are “spent” and put into circulation, merchants notice that more goods are in demand.
When demand rises, the value of what people buy rises, and therefore merchants naturally charge more.
More paper notes = Rising demand = Rising prices
Supply and demand. Cause and effect. Choice being exercised in a free society.
A year later, the goldsmith on Silver Island decides to support another islander for election to the local council.
Together they hatch a scheme to outspend their opponent. The goldsmith prints up a lot of extra paper notes and donates it to the candidate’s campaign.
Because, you know, his opponent has bad ideas, so the extra paper notes are really a good thing, you know, for the good of everybody.
More notes begin to circulate as the candidate spends the extra notes for political influence.
And prices mysteriously rise.
The candidate is elected and begins putting pressure on the goldsmith. Print up more notes so that the government can hire extra people. And spend money on community projects.
The goldsmith does.
And prices mysteriously continue to rise.
Who is to blame for the higher cost of living?
The politician blames the greedy merchants. And the merchants don’t know what to say. They do not understand the real cause of the rising prices.
But the merchants, and actual creators of wealth, continue to be called greedy and uncaring.
They do not realize that the rising prices are a natural result of the inflation.
What is meant by inflation?
You know what happens when you inflate a balloon. As more air is pushed into the balloon, the amount of air increases.
What increases when you have economic inflation?
The supply of paper notes (currency).
Government, and people who make a living off of debt, will tell you that inflation is rising prices, just a natural force of nature, without anyone causing it.
Right?
Wrong!
Inflation is NOT rising prices.
Inflation CAUSES prices to rise.
As the currency supply increases, prices are forced to rise.
If you think the definition of something makes no difference, then you are a good target for con artists.
What if I can plant the idea in your mind that inflation is merely the rising of prices?
I can keep you from seeing the cause-and-effect relationship between printing paper notes and rising prices.
And if I can plant the idea in your mind that government debt is a good idea, then government can continue creating money out of thin air.
To do what?
To finance projects, wars, entitlements, and many other government “goods.”
Who pays?
Workers who create wealth and become taxpayers are the ones who pay. Not the ones whose income is paid out of tax money.
The bankers and politicians on Silver Island soon tell the public that they have to withdraw gold and silver from circulation.
Why?
Because there’s not enough to go around, and besides, the paper notes work well as money.
And almost everyone believes them, except a few kooks who talk about some kind of conspiracy between bankers and politicians.
But nobody really believes them.
Let’s look at how governments change the definitions of money in order to take wealth away from you without you realizing they are doing it:
Through currency inflation and changing definitions.
Chapter 10
A History of U.S. Money
That paper money has some advantages is admitted. But that its abuses also are inevitable, and, by breaking up the measure of value, makes a lottery of all private property, cannot be denied. Shall we ever be able to put a constitutional veto on it?
Thomas Jefferson,
letter to Dr. Josephus B. Stuart, May 10, 1817
As you read this chapter, please:
Don’t freak out!
Ripping away the pretty mask of government financial actions often causes people to act rashly: protesting taxes, going on anti-government campaigns, making emotional investments.
The history of U.S. money reflects practices
that governments have engaged in
for thousands of years.
All governments today have done what the U.S. government has done.
You’ve heard that power corrupts, and absolute power corrupts absolutely. Manipulating the definitions of money is standard practice for power brokers, both in government and in financial institutions.
I propose that, by going through this history, you will be better informed to make financial decisions. If you freak out instead, you take on unnecessary risks.
Okay. Let’s begin...
Here is an example of legitimate paper money, a U.S. Gold
Certificate, issued 1863-1934. Pay attention to its exact legal language:
THIS CERTIFIES THAT THERE HAVE
BEEN DEPOSITED IN THE TREASURY OF
THE UNITED STATES OF AMERICA
TEN DOLLARS
IN GOLD PAYABLE TO THE BEARER ON DEMAND
Notice that on the left between the words “Gold” and “Certificate” is the statement: “This certificate is a legal tender in the amount thereof in payment of all debts and dues public and private.”
This note is an IOU, just like those issued by the goldsmith on Gold Island.
It is not money.
It is a symbolic representation of real money, gold, on deposit in the U.S. treasury.
The bearer of this note can, ON DEMAND, trade it in for gold.
The same is true of Silver Certificates, issued 1886-1963.
THIS CERTIFIES THAT THERE HAVE
BEEN DEPOSITED IN THE TREASURY OF
THE UNITED STATES OF AMERICA
ONE DOLLAR
IN SILVER PAYABLE TO THE BEARER ON DEMAND
Notice how the language has been simplified to the left of the president:
THIS CERTIFICATE IS LEGAL TENDER
FOR ALL DEBTS PUBLIC AND PRIVATE
One thing should be obvious about both of these certificates: Neither is gold or silver.
But a couple of things are not so obvious:
Notice that the gold certificate will pay ten dollars in gold. And the silver certificate will pay one dollar in silver. These certificates are not dollars.
Remember from previous chapters when we talked about measuring gold in ounces. Well gold and silver were also measured in dollars.
Think about it this way: Suppose someone came up to you and said, “Do you want to buy a gallon?”
You would be confused.
Why?
Because that question makes no sense.
You would rightly ask, “A gallon of what? A gallon of milk? A gallon of gas?”
A unit of measurement has no meaning
except when it measures something.
Notice that the gold and certificates measure something: ten dollars in gold coin, one dollar in silver.
In earlier days, if one person asked another, “Would you like a dollar?” the person asked would answer, “A dollar of what? Gold? Silver?”
Definitions of words are important. When you change the definition, you change the picture people hold in their minds.
Therefore, manipulating definitions
is one method of a kind of mind control.
In 1913 the U.S. Congress passed the Federal Reserve Act. Soon after, the Federal Reserve began issuing Federal Reserve Notes (FRN).
And the language began a subtle transformation. The first FRNs stated that they were redeemable in gold on demand (see the text to the left of the president).
But do you notice a subtle change in the language of the note?
First, in the text to the left, there is a new phrase. The note is redeemable “in gold or lawful money at any Federal Reserve Bank.”
So the Federal Reserve can have something other than gold as lawful money?
Perhaps they mean silver, or something else. But there is another subtle shift in the language.
Can you see it?
Look at the text above and below the president.
FEDERAL RESERVE NOTE
WILL PAY TO THE BEARER ON DEMAND
FIVE DOLLARS
See the shift? Even though the note elsewhere states the note is redeemable in gold or lawful money, the note now states the unit of measurement (five dollars) disconnected from gold or lawful money.
Isn’t that interesting?
The Federal Reserve issued the FRN pictured above in 1928. Six years later it issued the FRN pictured below.
See something missing?
The statement to the left of the president says, “This note is legal tender for all debts public and private and is redeemable in lawful money at the United States Treasury or at any Federal Reserve Bank.”
The note has been completely
disconnected from gold.
You may recall that President Franklin Delano Roosevelt made the ownership of gold illegal and withdrew it from circulation. (Much like the bankers and politicians on Silver Island.)
Now people were expected to redeem these notes for silver or whatever the government deemed as lawful money.
Not a problem, right?
Let’s see...
In 1963 the Federal Reserve Bank took the next step in transforming (redefining) U.S. money. They began withdrawing silver from the economy that year. They also issued a new FRN.
To the left of the president is the statement, “This note is legal tender for all debts public and private.”
Above and below the president was this text:
FEDERAL RESERVE NOTE
THE UNITED STATES OF AMERICA
ONE DOLLAR
Notice anything missing?
No mention of gold, silver, lawful money, or anything making this note redeemable. Before 1963 all U.S. paper money measured gold, silver, and lawful money in dollars—a dollar in gold, a dollar in silver, a dollar in lawful money.
But in 1963 that all changed.
Citizens and foreign governments were expected to forget redeeming notes. Instead the note proclaims itself as one or more dollars.
In 1963 when the first FRNs were issued about the time of President Kennedy’s assassination, a mother could go into a bank with a pile of silver dollars and deposit them. Then, remembering, turn around and say, placing a FRN on the counter, “I forgot. It’s my daughter’s birthday, and I want to give her a silver dollar.”
And the bank teller would respond, “We’re sorry, but all silver dollars are being withdrawn and replaced with FRNs, because, you know, there is just not enough silver to go around, and it makes more economic sense to transition to a paper money, which are just as good as any dollar, you see.”
All the new coins were made, not with silver, but with nickel and copper.
By 1971, the U.S. government had printed up so much “money” that France and other countries began to distrust its value. They began trading in U.S. “dollars” for gold in the U.S. Treasury. To stop this run on gold, President Nixon ended the “Gold Standard.”
This action simply meant that FRNs were no longer redeemable. The government keeps the gold and silver, and everyone else gets paper.
That’s a fair exchange for a working economy, right?
Today’s currency is not money.
It has no intrinsic value.
And as the government via the Federal Reserve prints up more money (electronically these days), the value of that money decreases. But real gold and silver preserves value.
In 1971, gold was valued at $35 per ounce. As of this writing (summer 2013) gold is valued at $1,400 per ounce.
In the early 1960s, a gallon of gas could be purchased in some areas of the country for a silver quarter. Today that silver quarter can still buy you a gallon of gas in many areas of the country.
Gold and silver tend to preserve their value. Even though more dollars are needed to buy an ounce of gold, that ounce of gold or silver still buys the same value of things it used to buy.
In sum, governments that control money and currency will find ways to spend what they don’t have. Since citizens do not generally understand the nature of coin, currency, and circulation, nor do they like ever rising taxes, governments find ways of indirectly taxing them through inflation.
Money can’t be created out of thin air, but currency can. And the result of more paper chasing goods and services is a rise in the cost of goods and services.
We’ve discussed money and banking and inflation and currency. Next up: credit and debt.
Are there any traps in how we think about credit and debt?
You bet there is.
Side Notes
Note 1
By the way, have you ever wondered who got all
the gold and silver that was withdrawn from circulation?
Note 2
Remember the “mill marks” that were engraved on the edges of coins to stop people from shaving the coins and melting down the shavings?
Gold and silver coins had those mill marks, but nickel and copper coins did not. No one shaves base metal coins and melts down the shavings for their value.
But now that dimes, quarters, half-dollars, and dollars are made of nickel and copper, why keep the mill marks?
Perhaps to keep up the illusion that they are money?
Deep Dive: Minimum Wage Laws
Supply-and-demand says that above-market prices create unsaleable surpluses, but that has not stopped most of Europe from regulating labor markets into decades of depression-level unemployment.
Bryan Caplan,
Myth of the Rational Voter: Why Democracies Choose Bad Policies
The prime example of how a government with good intentions can distort an economy and harm the people it intends to help is minimum wage laws.
If you have understood all that has been discussed so far, you can likely predict what happens when employers are forced to pay employees more, due to an artificial law that makes it illegal to pay less than a certain amount.
A basic economic fact is this: Prices artificially raised tend to cause more to be supplied and less demanded.
In other words, if the price of labor (workers now needing to be paid a higher minimum wage) goes up, an employer can only afford to hire fewer workers. And employers will tend to look for those workers with greater skills, who embody a greater value for what they are being paid.
In other words, lesser-skilled workers, those the minimum wage is usually designed to help, end up with fewer jobs available for them to accept.
Demand for those workers goes down.
The data has long been presented to support this common economic fact. But few with good intentions seem to respond to the data. Instead, they talk about the greed of employers and businesses.
Greed there may be, though not in every case. But greed or a non-artificial increase in prices cause people real harm, people who are the targets of the well-intentioned.
Chapter 11
Credit and Debt
“He that sells upon Credit, expects to lose 5 per Cent. by bad Debts; therefore he charges, on all he sells upon Credit, an Advance that shall make up that Deficiency.”
Money and Wealth Page 6