Saturday, November 8, 2008

A bit of review on "The Mystery of Banking"

I recently finished Murray Rothbard's, "The Mystery of Banking."
That was such an eye-opening and exciting book (if you are the type of person who _can_ derive feelings of excitement from a book on economics)!

The overall aim of the book is to discredit the worth of the US Federal Reserve System, and fractional-reserve banking as facilitated by central banking in general.

In this, Rothbard puts forward some very well-reasoned and common sense practical arguments. I came away from the read with a new appreciation for economics as a field, and recognized now that the subject is perhaps overthought by most modern scholars. Economics isn't any sort of system so much as it's what results when groups of people act when influenced by just a few rather simple rules.

Anyway, Rothbard sets up his critique of the Fed and central banking by offering an easy-to-follow primer on some basic economics and history of money: how it developed, how people use it, how it is both supplied and demanded just like other products in an economy, and how those forces influence prices.

This first section of the book is crucial for non-economist folks to at least review. It assumes zero starting knowledge, and in short order will have you up to speed with a working knowledge of the mechanics of money. It also gives thorough treatment to the concepts it introduces. Once they become clear to you, it may start to feel redundant. I was able to skim over the final pages of this section. It begins historically, and you'll understand how a society gradually comes to the use of a modern coin-commodity money as its culture and technology and sheer size develop.

After the concepts primer, the following sections deal with how an evolved commodity money system is gradually influenced and ultimately usurped by government to transform into a fiat currency. This can only be done in complex societies where trust in institutions has been built up with the people for eons, or the culture will not ascribe value to the currency and merely recognize it for what it intrinsically is: valueless slips of paper (albeit with fun and artful printing).

A scholarly worth with detailed footnotes and citations, the book wonderfully fuses history with the theory to demonstrate and support concepts. The reader learns about the development of paper currency; its backing by hard money in gold and silver coin; and its use in banking to make hard money more convenient and secure.

The reader then is shown how the backing on paper currency, which makes it acceptable as money stand-in, is gradually removed via various mechanisms and interests until one is ultimately left with a money which a value "declared" by government, or fiat, rather than a thing with some intrinsic worth all on its own, the mere stand-in for hard money is declared to itself be the money, by fiat.

We then are shown how, after the conversion over to a fiat currency is complete, how now there exists possibilities for its value to be manipulated, and how these manipulative effects generally tend to harm society by subjecting it to booms of credit expansion, followed by busts as worthless credit is exposed and recessions and depressions result.

We by this point get to a crucial and cynical rub. Who benefits from a fiat currency? No one but government. Its unique properties offer levers of control which power-brokers may use to influence people and business. It also enables government to more readily pay for its operation. If all else fails, it may simply print more paper money and spend it. So long as the population continues to accept it. In this way fiat currency is the true source of inflation (along with fractional-reserve banking) and represents a hidden tax on populations as the purchasing power of their fiat paper slips is eroded.

The book does not necessarily advocate movement away from paper money or checkable deposit accounts, these do provide great security and flexibility benefits. Rothbard's concluding section does, however, advocate replacing the fiat nature of our currency with its former commodity backing in gold, re-imbueing true intrinsic worth to our dollar.

To this end, the book lays out a surprisingly straightforward plan to return our money to a gold-coin and bullion standard (note: not a gold exchange standard, which is very different). If implemented, we would wake up with the ability to go to our bank and redeem our paper dollars and checkable deposit amounts for a share of the real gold held in our treasury. This gold would be distributed to banks to back our deposits and to be offered in exchange for our paper notes.

Once done, our current paper money (in its current Federal Reserve Note form) would be redeemed for the gold and retired. The Federal Reserve System would then be liquidated and done away with. Our money would be gold on deposit with our local banks. Paper money could and probably would still exist, but as a type of gold certificate (like it had been before the Great Depression). Gold would be the real money, on deposit at a bank of our choosing (a competitive process) and used to back any contrived paper or card or electronic system we might develop to serve our desired for flexibility and convenience.

The point is that the heavy hand of government would once more be divorced from the value of money. We would be free to redeem our gold deposits and transfer them to another bank at any time and for any reason. Loan and deposit banking would again be separated. Fractional-reserve banking might not be outlawed (it would be difficult to enforce even if it was), but market competitive forces and depositor faith would keep banks honest about the redeemability of their gold reserves, lest customer fear of the irredeemability of their gold start a run and force a bank to reveal their insolvent standing.

The first section of the book shows you why such a state would be a good thing, if you don't see now the advantage. Among the claims by Rothbard is the notion that the business cycle is a side-effect of fiat money and fractional-reserve banking's ability to create new money out of thin air. Without this, all money has real worth, so business cannot be puffed up by "Monopoly" money for the relatively short boom periods when we ascribe this "thin-air" money the same temporary worth as money backed by real reserves. The waking up we do to the true valuelessness of this thin-air credit expansion is what drives the bust which follows.

After reading the book, my cynical nature cannot believe a time where we might ever return to hard money from government fiat money. Nothing short of a revolution and formation of a new nation could achieve this, in my view. Once government aquires the power to print a fiat money from its people, the vast new power this confers makes it a practical impossibility for government to then be asked to give up. It's like the "One Ring to Rule Them All".

To the government it is, "the precious." Even the honest reformers within government would come under grave pressure to keep the scope of their ideal reform strictly limited. What government voluntarily gives up its own power? The best we could hope for would be some sort of "custodial" relationship where government merely pledges not to use the power it will still have. That'd be like letting the alcoholic keep their Scotch bottle if he agrees never to take the cap off again. At some point he'd have himself a three-fingers of the delicious liquid, and he'd have a great excuse why.

"The Mystery of Banking," makes a great, entertaining, and enlightening introductory book to the Austrian School of Economics.

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