The Greatest Con in the History of Money

“It is only in periods of decadence that truth becomes complicated.”
 — Henry Miller, American writer

The history of money and banking is a history of thieves, scoundrels, and scumbags. Today, I want to tell you about their greatest con. 

Money was once a very different thing than it is today. Money grew out of the free, spontaneous, and evolutionary process of the market, like language or common law. Governments did not create it. That came later. Later, governments seized and monopolized the creation of money — just as they too came to monopolize the creation of law. These were long, torturous processes.

But to get back to money… In man’s early history, all kinds of things acted essentially as money. But over time, gold evolved to dominate. The market — that is to say, the people — chose gold for a variety of reasons. It was durable, portable, divisible — and rare. 

Banking, too, was once a very different thing than it is today. Banks began as simple safekeeping houses for customers to hold their money (i.e., gold). The banks paid no interest on these deposits. They did not loan them out. They kept the gold in a vault, and that was that. The bank offered other services, such as simple cashier services and facilitating payments involving third parties. 

Customers paid banks for these services. It was all a pretty simple and straightforward business. This was the case in ancient Greece. Athenians did not look at banks as sources of credit.

How Bankers Screw You out of Your Savings

Nevertheless, unscrupulous bankers sometimes couldn’t help it. Cheating was so easy — and so profitable. So they sometimes took deposits and loaned them out. 

Cheating? Yes. See, if I placed my gold with you to store, it was against the law for you to take my gold and lend it out. This was a basic violation of property rights. In fact, we have records of an early trial featuring a depositor suing a banker because the depositor was unable to get his gold — since the banker had lent it out and could not collect it. 

We have a word for this today. We call it embezzlement. But for many sad reasons, we do not apply the term to bankers. We call it “fractional reserve banking.” This, dear reader, is the greatest con ever foisted upon a money-using public.

The long history of banking is one of a fight between that depositor and his unscrupulous bankers and thieving governments. For over 2,000 years, the depositor has fought a losing rear-guard action, as the bankers, in cahoots with their governments, found new ways to prop up their dubious legal claims — and slip their fingers into savers’ pockets. 

Today, the bankers prevail. Few would challenge the legality of fractional reserve banking. 

The Solution: The 100% Pure Gold Standard  

As a result, our money is a wasting asset. Our savers lose their savings to inflation — the constant increase in the supply of money, always chipping away at the buying power of our money. It is an insidious tax. 

Our economy endures recurrent booms and busts. (More on this below…) Our government pursues wars and spends money at a level that a pure gold standard would never sustain or permit.

But it’s important to start with the history of money, because it asserts two things:

1. Money is not a creation of the state. It grew out of the free market.
2. Long legal tradition supports the idea of a 100% reserve system.

Therefore, the cure for our monetary ills has a definite atavistic flavor. That is part of its charm and part of its strength. We are not hoeing new ground here. 

As the great economist Murray Rothbard wrote: “The only coherent long-term solution: a free banking system with a 100% reserve requirement, the abolition of the central bank, and the establishment of a pure gold standard.”

Basically, restore the creation of money to the market. 

Some people believe in the return to a gold standard. But what they support is, unfortunately, “a spurious gold standard rooted in fractional reserve banking” (in the words of Rothbard). 

The Proud Tradition of the Pure Gold Standard  

Distrust of fractional reserve banking has a long history, as I’ve alluded to. The Salamancans warned against it at least as far back as the 16th and 17th centuries. David Hume, the Scottish philosopher of the 18th century, was another prominent witness to the implicit theft and the dangers of it. Even American presidents, such as Thomas Jefferson and Andrew Jackson, distrusted it. 

And there is a long line of great thinkers who tried to impart the public with the knowledge that fractional reserve banking was a terrible mistake. The great Austrian economists Ludwig von Mises and Murray Rothbard are among the more recent. But there is a line that goes way back. (The great American economist Amasa Walker was a particularly outstanding advocate in the 19th century.)

A great new book that deals with all of this is Jesus Huerta de Soto’s Money, Bank Credit, and Economic Cycles. It’s a doorstopper of a book — you have to hold it with two hands. Printed in large, readable text, the book is handsomely produced under the Mises Institute’s imprint.

This book supplants all monetary treatises before it. I used to say Ludwig von Mises’ The Theory of Money and Credit was the best book on money I’ve ever read. Now I say it is Huerta de Soto’s tome. It is the new standard in monetary thought. In it are fascinating bits of history and lots of theoretical material dealing with all facets of money and banking. 

Avoid Widespread Economic Crisis

De Soto also gives full treatment to the idea of a 100% gold standard — with no fractional reserve banking and no central bank. The final 100-page chapter alone, titled “A Proposal for Banking Reform: The Theory of a 100 % Reserve Requirement,” is worth the price of the book. The advantages of such a system are numerous, and Huerta de Soto’s exposition is brilliant.

A 100% standard prevents the cyclical economic crises that arise from credit creation. Malinvestments, those widespread economic errors that cause cyclical crises, occur when there are distortions in the economic fabric. An economy has only so much real savings; credit makes it appear as if there were more. That’s why we see economy-wide busts. The house of cards built by fractional reserve banking reaches its natural end.

Importantly, in the words of Huerta de Soto, a 100% gold standard “would not avert all economic crises and recessions. It would only avert the recurrent cycles of boom and recession which we now suffer.”

Years of credit expansion inured people to the damages of credit. So they think credit expansion is needed for economic development. If you’re not booming, you’re stagnant — and there is some stigma to that, as if we must always be hitting some growth targets.

As Huerta de Soto writes: “People fail to see that rapid, exaggerated economic expansion is always likely to have an artificial cause and must be reverse in the form of a recession.” A 100% standard prevents the contractions and inflations of money supply that wreak havoc.

Make Bankers and Governments Honest — And Poorer

Banks would not disappear. A 100% standard merely ensures that only voluntary savings back loans. Banks could still lend money, but it would have to be via explicit contracts with savers. Banks could still take deposits for a fee, intermediaries, ancillary services (cashier, records), safe deposits boxes, etc., etc. 

Credit availability would decrease. Again, a 100% system guarantees that only “that which has been saved would be lent.” Increased difficulties would be the logical outcome of a market-based system. The current housing bubble, with its ridiculous price increases, would be impossible under such a system. Housing would be more affordable, and our reliance on credit severely lessened.

Beyond fitting squarely in the tradition of property rights and providing immeasurable economic benefits, there are other considerations, too. 

War is much harder to wage, for example. This alone makes it worth it. The First World War, the Second World War, and countless others would have simply been impossible while maintaining a 100% gold standard. These disasters needed bucketfuls of credit, and they consumed their nation’s currencies.

Who loses? A 100% gold standard penalizes those who benefit from fractional reserve banking — banks and the government, chiefly. It protects savers — usually older people and those living on fixed incomes.

For all these reasons, a 100% gold standard is the only gold standard worth pursuing. Will it happen? As with most revolutions, things have to get really bad before people consider radical change. The American poet Charles Bukowski said it best: “True revolution comes from true revulsion; when things get bad enough the kitten will kill the lion.”

Until next time,
Chris Mayer
July 5, 2006

The Daily Reckoning