As long as politicians hold the enormous power over the economy that voters have given them, they will always sell that power to the highest bidder in exchange for campaign contributions or just greater wealth. To paraphrase the great P.J. O’Rourke, when politicians are put in charge of the market, the first thing sold are the politicians. Christians must recognize that sinful people do not become saints simply by winning elections. Politicians are no more honest or altruistic than the people who vote for them. Voters who do not like the politicians in Washington, D.C. have only themselves to blame because people get the government they deserve. The only solution is to take power over the economy from politicians and free the market. Christians need to repent of the socialist fallacy that the state can improve human nature through laws, regulations and education. It cannot. The state cannot change society; it merely reflects the society of the majority of voters.
The only government God ever created, and which shows what a Christian government should be like, is the one in the Torah described in chapter 3.
Christian money
The Apostle Paul wrote that the love of money is the root of all kinds of evil, and certainly Christians must have a proper attitude toward accumulating it. But there is a moral aspect to money far more dangerous than mere greed and most mainstream economists have no knowledge of. It is the damage the manipulation of money supply can cause: it transfers wealth from wage earners to the wealthiest, impoverishes retirees on fixed incomes, bankrupts pension funds and increases income inequality by rewarding the wealthiest for gaming the system. To understand the danger, we need to review the history of money.
There never seems to have been a time when people did not use money. Grains of barley and cattle were among the earliest forms. Barley grains were used for purchasing everyday goods, such as eggs and milk, while cattle served well for buying land and wives. But why did people invent money? Barley and cattle fulfilled the three uses of money: a store of value, a medium of exchange and measuring tool to compare the market values of different goods, or a common denominator. Barley and cattle served those purposes because they retained their value over time relatively well, so people could use them as savings; they were in high demand so almost everyone would accept them in exchange; and people could use them to compare the exchange value, or prices, of other goods. For example, if a large jar would sell for a quart of barley and an axe for a gallon, consumers could see that most people valued the axe about four times as much as the jar in terms of barley.
Keep in mind the foundation of economic thought from prehistory and until recently that wealth is limited and one man can profit only at the expense of another. So if a businessman sells a clay jar to a farmer, neither the businessman nor the farmer can increase his wealth, or profit from the exchange, otherwise the exchange becomes unjust. That is why Aristotle wrote that the items exchanged in trade must be of equal value. And how do we know that the items exchanged had equal value? Aristotle wrote that objects have an intrinsic value, much of which depended on the honor attached to each item. A related theory was that something manufactured should sell for a price close to its cost of production. But the general thought was that the exchange was unjust if one person made a profit from it. The ancient ideas about limited wealth and objective value lead logically to the condemnation of commerce because it was clear that businessmen earned profits from their exchanges, making commerce appear extremely immoral since the businessmen impoverished their customers according to pagan economics.
People continued to think in those ways about business until the theologians of Salamanca discovered the subjective theory of value that says nothing has an intrinsic value; each person values things according to the usefulness for them. Related to it is the quantity theory of how people change their valuation of something: the value of an item in the market will change in proportion to the volume of that item offered for sale. For example, suppose farmers are in the habit of exchanging a bushel of barley for a lamb, but one year the barley farmers discover that irrigating and fertilizing their fields will double their harvest. The farmers might discover that as they bid for the lambs the exchange value of their barley will decline until the price of a lamb becomes two bushels, if the number of lambs for sale has not changed.
The opposite would happen if the barley harvest produced half as many bushels, due to a drought during the growing season, for example. As a result, farmers could buy a lamb for half a bushel. Changing values based on changes in supply and demand are important for coordinating market activity because higher prices signal that a shortage exists and for producers to increase production. Lower prices tell producers to cut back.
Salamancan scholars discovered that the quantity theory of value applies to money as well, because money functions like any commodity in the market. Originally, money was just another commodity. So if the quantity of money increases, the value of that money in exchange for other goods will lose value proportionally, all other things remaining equal. Barley worked well as money because, within a small geographic area, the volume of barley probably remained relatively constant and its value in exchange did not change much. The same applied to cattle.
But barley and cattle had problems as money. Barley can rot and rats can eat it while disease can ruin entire crops. Lions and wolves can eat cattle and illnesses can kill herds. People gradually abandoned those forms of money for silver as mining technology improved, but they measured silver by its weight in barley grains so that the transition to the new money went smoothly. The shekel in the Bible, one of the oldest forms of silver money, equaled the weight of 180 barley grains. For many years people carried silver in bags and used scales to weigh the appropriate amount of silver for a purchase, just as they had with barley. For example, Abraham paid for a cave to bury Sarah in by weighing so many shekels of silver. Eventually, Egyptians began to cast silver into large rings with consistent weights and purity of silver, which made payment easier. Finally in about the eighth century B.C. the Lydians made coins of silver with the weight stamped on them.
Silver worked well as money for centuries because it met all of the requirements for money mentioned above, but was easier to transport and was more durable than barley and cattle. It only became a problem when governments gave themselves a monopoly in the production of coins. As mentioned in chapter 4, Solon, a leader of Athens in the sixth century B.C., discovered that he could cheat people by mixing a base metal, like copper, with the silver. The coins contained less silver but were stamped with the original weight, which is unadulterated fraud. Philosophers considered him a genius instead of a criminal because the new dishonest money allowed Solon to pay off his debts. But when people tried to spend the new money, it did not impress merchants. They ignored the weight stamped on the coins and raised the prices of goods to match the true amount of silver in the devalued coins. Historians call the merchants greedy. Solon had violated the Biblical command to keep honest weights and measures. "You shall not have in your bag differing weights, a large and a small. You shall not have in your house differing measures, a large and a small. You shall have a full and just weight; you shall have a full and just measure, that your days may be prolonged in the land which the LORD your God gives you,” Deuteronomy 25:13-16. Using false weights is as much theft as burglary, but governments usually receive praise for it.
Money began to cause the most trouble with the invention of a practice known as fractional reserve banking. The Spanish economist Jesus Huerta de Soto tells the history in his incredible book, Money, Bank Credit and Economic Cycles. The original fractional bankers may have been goldsmiths who warehoused for a fee the gold and silver people had saved. Since all of the gold coins looked alike, people did not require that the goldsmith give them the exact coins they had deposited when they asked for them as long as he gave them coins with the same weight and purity.
Goldsmiths noticed that people rarely asked for their savings. Staring at a warehouse full of gold coins for years gave some golds
mith the idea of loaning the gold to merchants who wanted to invest it, say to ship a load of Greek wine to Egypt. The owners of the gold would never know and the borrower would repay the loan with interest, which the goldsmith would keep as his profit. Greed lured the goldsmith into loaning out all of the warehoused gold except for around 10 percent, which he kept on hand to meet the daily withdrawals of the owners.
The process worked well until some of the borrowers defaulted on loans because their business ventures had failed. Then the 10 percent reserves began to run out and the goldsmith had to deny some customers their savings. Word spread quickly; people panicked, and all of his customers showed up to demand their money at once. Of course, he could not pay, but usually he had skipped town before that happened. If not, he often paid with his life. Their life savings gone, the people quit spending in order to rebuild their savings and the economy collapsed as poverty spread.
Similar crises happened enough that Rome outlawed the practice of fractional reserve banking, but did not eliminate it. They merely drove it underground. Fractional banking revived in the middle ages with the growth of banks in Italy. Church theologians debated the practice but split on the issue of its morality. Some considered it immoral, since the bankers were loaning out money that belonged to depositors without their knowledge. Others decided that the practice was permissible because people understood when they deposited their money that the bank might lend it. Governments settled the issue by selling the right to establish a bank and making fractional banking legal in exchange for the banks making large loans to the kings.
The economic problems caused by loaning out depositors’ money did not end because it was legal. Banking crises and recessions became common features of life. Theologians who approved of the practice urged bankers to keep more reserves and to take fewer risks, but the crises continued. The Bank of Amsterdam in the Dutch Republic operated on the 100 percent reserve principle, meaning it did not loan depositors’ money, in the seventeenth century as was mentioned in chapter 5. But the economy still experienced booms and busts, as the tulip mania episode illustrates. That happened for the most part because of a financial instrument known as bills of exchange, which were nothing more than IOU’s. A merchant who had been paid by such a bill could present it at the seller’s bank and get his money in gold or silver. Bills made hauling loads of gold and silver coins around the country unnecessary and the holder received interest on his loan.
Businessmen used the bills as an early form of paper money by paying off their debts with bills they had received from customers. The system worked well until businessmen began to abuse it by issuing more notes than they could redeem. They could do that because a bill might pass through a dozen hands before someone presented it to the bank for redemption, so the float between issuance and redemption could be long. The value of bills of exchange in circulation could reach as high as twenty times the amount of gold in banks. As happened with fractional banking, a few defaults would cause the whole stack of bills to come tumbling down and plunge the local economy into a depression.
By the middle of the nineteenth century, economists had begun to understand the connection between the expansion of the money supply through fractional reserve banking and the recurring cycle of expansions followed by depressions. Ludwig von Mises was the first to develop a comprehensive theory in his 1912 book, The Theory of Money and Credit. Friedrich Hayek followed in 1933 with his Monetary Theory and the Trade Cycle. The theory became known as the Austrian business-cycle theory (ABCT) because both economists were from Vienna.
Introductory macroeconomics courses teach students the process that the banking system uses to expand the money supply through loans. The Federal Reserve controls that process by changing the interest rate banks can charge other banks for loans and by purchasing or selling bonds to banks, both of which change the market interest rates that banks charge customers. The higher the interest rate, the fewer loans banks will make and the slower the money supply will grow. Mainstream economists insist that such money creation has no bad effects on the economy, but the Austrian business-cycle theory (ABCT) disagrees. Essentially, the ABCT insists that credit expansion causes unsustainable expansions of the economy that end in recessions. Mainstream economists deny that the process causes boom and bust cycles, attributing cycles to supply or demand “shocks.” The evidence for the ABCT is extraordinarily good so the most likely reason for mainstream economists’ rejection is that it neutralizes their theories of market failures that they use to justify government intervention in the economy.
Mainstream economists will admit that in the long run increases in the money supply will cause price inflation, all other things being equal. But rising prices hurt retired people living on pensions and social security because it destroys the purchasing power of their savings. Even 2 percent inflation, the typical goal of central banks, will cut the value of money in half in thirty-five years. And safe government bonds earn almost no real return on investment.
Pension funds suffer as the purchasing power of their funds erode, but in addition, those funds grow at a much slower rate because of the low interest rates the Fed causes in order to boost the money supply. Wage earners suffer annual declines in the purchasing power of their wages because employers make cost of living wage adjustments the year following inflation, so wage increases never keep up. Finally, inflation damages capital intensive industries such as manufacturing because depreciation funds rarely consider future price inflation, so when the time comes to buy new equipment companies find they have saved too little.
The boom and bust cycles the Fed causes by its manipulation of money hurts the working poor the most because they lose their jobs in recessions. But the wealthy can take advantage of Fed policy by borrowing the new money first and buying assets, like stocks, bonds and real estate, before prices rise. Wage earners get the new money last, after prices have risen. That process is one of the major causes of rising income inequality in the United States as it transfers wealth from the poor and middle class to the rich.
The ideal money would be absolutely fixed. It could neither be increased nor shrunk. Under such a system, prices would accurately reflect supply and demand and coordinate economic activity as well as is humanly possible. Prices would rise as the population increased if production did not increase at the same rate. Prices would fall if productivity increased and production outpaced population growth. It would fulfill the Biblical command to use just weights and measures.
But such a system is impossible with humanity. The best system ever devised was the gold standard. Under it, prices in 1900 were roughly the same as those in 1800. The gold system worked because, as long as people could redeem paper money in gold at a fixed rate, banks soon reached a limit on how far they could expand credit. Still, countries under the gold standard suffered many recessions and banking crises because of state intervention into the business. The state’s demand for loans to conduct war destroyed the gold standard system, beginning with World War I and ending with President Nixon’s taking the United States off the gold standard in 1971.
Governments love price inflation because they survive on debt, and inflation reduces the real value of that debt, accomplishing the same fraud that Solon perpetrated on Athens, but in a subtler way that most people are unaware of. Mainstream economists enable the state’s addiction to debt because they have convinced themselves with their little math models that money printing, technically credit expansion, is the only way to save the country from a recession. They honestly believe that without credit expansion, the economy would spiral down into never ending depression and poverty.
But that elasticity of money causes severe problems internationally as well as domestically. When large economies like the U.S. expand credit, much of that new money flows out of the country and into emerging market nations for investment. The sudden flood of new money ignites an artificial boom followed by high rates of inflation. That forces the central banks of the flooded countries to
raise interest rates. Eventually, the same “hot” money rushes out of the country when recessions hit in the U.S. and causes economic devastation.
The closest we can come to Biblical money is a gold standard, but mainstream economics and worship of the state by the people will always prevent that. The next best thing would be a central bank that understood Austrian economics and the value of sound money. But that is unlikely to happen for decades because mainstream economists insist on the need for an elastic currency, which in plain English means they want to expand the money supply as much as possible whenever they want. Thriving financially in this world is difficult enough for the average person and the poor without the government making it harder for them through inflation and high taxes, but there are a few strategies that can help. The most important is to pay attention to the business cycle. My book, Financial Bull Riding, introduces readers to the Austrian business-cycle theory and gives advice on how to take advantage of that knowledge for business and investing.
Business owners have a slight advantage over wage earners because they can often raise the prices of their products and services and thereby neutralize the effects of Fed induced price inflation. But businessmen need to pay close attention to the business cycle. Too many entrepreneurs launch new businesses or expand with debt at the peak of the business-cycle expansion when prices and profits are high. But interest rates, the costs of inputs and labor are also at their highest levels, too, making new ventures expensive at that point of the cycle. Then the recession hits and the cost structure of the business is too high for the owner to make the debt payments let alone earn a profit at lower prices. Businessmen need to develop the discipline to pile up cash during the good years of the expansion and start new ventures or expand during recessions when others will not because of fear. Many wealthy people accumulated their wealth by using the cash they saved during the good times to buy businesses that had failed in recessions.
God is a Capitalist Page 44