History of Money

The history of money doesn’t need to be confined to one specific country or time period. It is rather expedient to outline the role money has played and the changes it has gone through in virtually all countries over time. Some events might have occurred earlier or later in one nation or another. However, the general trend to date has been the same. Understanding this trend is of major importance when it comes to understanding money today. This article describes the imaginary story of a country that went from no money at all to a fiat money, paper money. It is conceptually applicable to any country on earth.

The demand for money arose with the appearance of division of labor, when individuals began producing for others rather than for themselves. This was of course a direct outcome of the law of comparative advantage and the corresponding specialization of labor. If individual A transforms land and produces a good that individual B demands, but B has nothing to offer that A demands for consumption, A might still consider receiving a product M in exchange that he can then give to individual C. C happens to demand B’s product for consumption AND offers something that A also demands for consumption. In this case, from A’s point of view M is a medium of exchange, a money.

With division of labor spreading, different goods would be used as money, such as tea, coffee, beans, salt, or cattle. There are numerous accounts of the usage of these goods as money in history. However, there are goods that are better and goods that are worse than others for usage as a medium of exchange. A medium of exchange needs to fulfill criteria such as durability, divisibility, homogeneity, measurability, sufficient but limited availability and broad acceptance. The metals gold and silver emerged as goods that best fulfilled these criteria when used on the market.

Consumers, entrepreneurs, capitalists, landowners, and workers dug up and/or used gold and silver as money in exchange and credit transactions on the market. Decentralized, competing gold mines would channel gold into the market, part of which was used as money. For a fee, some entrepreneurs began offering the service of depositing money in warehouses, also known as deposit banks, so the owners of the money wouldn’t have to carry it with them. They would issue receipts for the money deposited. Soon the receipts themselves, rather than the deposited gold, would be used as money, hence gaining value as media of exchange.

Some of the gold would not be redeemed but rather stay in the warehouses. Thus the entrepreneurs issuing the receipts started offering their own receipts in exchange and credit transactions which were not backed by their own gold. However, they had to be careful not to issue too many uncovered receipts. Because as the price of their additional receipts would drop, their customers would begin redeeming them in exchange for gold again. If there were too many uncovered receipts issued, the warehouse would ultimately lose all its deposits and hence go out of business.

Thus in the long run those deposit banks who managed their deposits most prudently would be the most successful and profitable ones.

But some of the depositors had loaned receipts to the government and hence accumulated public debt. When they faced the threat of going out of business, due to a massive drain upon their gold reserves they sought help with the government.

The government used its police force in order to prevent the deposit banks from having to redeem their customers’ receipts for gold. It declared the receipts of the banks a legal tender, which means that they became a fiat money, a money that people are forced to accept or face government force if they don’t. The operations of different banks were consolidated within one central bank and numerous fractional reserve banks with the exclusive authority to produce fiat money. In addition, the government forcefully confiscated private gold holdings and declared private ownership of gold illegal.

This central bank was no longer under the constraints that the deposit banks used to face. It didn’t depend upon gold deposits and it could inflate the money supply at will. Without voluntary competition within the country, the result was that the quality of the money produced was low. Inflation became a common phenomenon.

Just as seen in the example of the production of cars in the Soviet Union, the more monopolized and centralized the production of a good, the less competition exists, and the less the consumer is given a choice, the lower the quality of the good produced will be from the point of view of those consuming the good.

Roughly, this has been the History of Money and Banking in the United States and the course of events that led to the establishment of the Federal Reserve Bank.

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Government Constraints

A government operates under constraints that are different from that of an entrepreneur.

The entrepreneur has no choice but to satisfy his consumers by withdrawing from the market factors of production whose output, directly or indirectly, currently satisfies fewer consumers than they are looking to satisfy or currently satisfies less urgent needs than they are looking to satisfy. The profit they reap is a result of the improved allocation of these factors of production.

A government obtains goods in a different fashion. It needs to obtain them via taxation, which is in last resort an act of theft against the individuals within its territory. But individuals in general resent acts of aggression. In the long run a government can’t just send its police to collect taxes under no pretense whatever. Violent upheavals by the governed and subversion would inevitably ensue after some time. This holds true for a dictatorship as it does for a democracy. In order to justify its acts of aggression a government needs the consent of the majority of the governed, it needs public opinion on its side.

Which means it employs in order to attain this objective cannot categorically be determined. Throughout history, governments have employed different justifications for its existence:

Throughout history governments across the globe have always appealed to fear of foreign enemies to justify its necessity. But in addition there have been subtleties in other areas: In ancient days government leaders would be anointed by the clerical class which had the greatest influence on public opinion. During the age of enlightenment, with the appearance of capitalism, the idea of using government to protect private property and individual liberties became popular. When in the 20th century the concepts of socialism conquered the hearts and minds of the broad majority, the idea of complete government control of the factors of production had become unstoppable and was swiftly put into practice virtually everywhere in the world. When the attempts of socialism had proven impracticable and lead to the collapse of the Soviet Union, the ideas of interventionism convinced the peoples of the world of the necessity of government bureaucracy. Minimum wage, centrally planned welfare programs, fiat money and subsidies for special industries became the norm.

Thus the main constraint for a government is the approval for its actions by the majority of the people. It will always do its best to mold public opinion to the extent possible. So long as it confines its activity to the protection of individuals against aggression and theft no major harm is caused. As soon as it begins to embark upon broader expansions of its bureaucracy, those who are governed by it need to be ever more vigilant and doubtful.

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Human Action and Economics

It is important to understand the context and the scope of the science of economics. It is a common misconception that economics is a science that primarily deals with maths, numbers, statistics, averages, medians, and charts. Myriad university professors all across the globe teach students about supply and demand curves and how to calculate market equilibrium through the derivative of those, and perform many other numbers games.

All this accomplishes nothing but to obfuscate the true essence of economics. Little attention is paid to important concepts, such value and time preference, the formation of prices, the importance of consumption goods vs. factors of production, the concepts of money and monetary policy.

All market data is nothing but the outcome of actions performed by individuals, cooperating, producing, consuming, and competing on the market. Economics is first and foremost a science of human action, so before embarking upon an analysis of statistical data and mathematical concepts it is indispensable to understand the motivating forces behind actions performed by humans. Those have been fully explained by Praxeology.

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Government Growth in the United States

(Check here for much better and updated charts regarding government growth.)

If there has been one consistent trend in economic developments in the United States over the past 60 years it would be the growth of the size of federal, state, and local governments in relation to the private sector.

The extent to which federal, state, and local governments in the US spend on the one hand and tax and borrow on the other hand has grown consistently. The best way to measure this is to take a look at the development of government receipts and spending as compared to total spending in the United Stated which is measured by GDP ( = Total Consumer Spending + Total Investment Spending + Total Government Spending + Exports – Imports):

US Government Expenses as % of GDP 1948 - 2007

As can be seen in the first chart above, government expenses as % of GDP in the US increased from 17.2% in 1948 to 31.5% in 2007. The second chart shows that taxes rose from 21.7% to 29.2% in the same period.

What is noteworthy that there was a brief period (1992 – 2000) where federal, state and local governments as a whole managed to cut its expenses as compared to the private sector from 33.4% to 29.2%. From 2001 through 2007, however, total government expenditures have once again grown consistently.

The fact that government expenses have grown throughout US history is hardly ever acknowledged or even mentioned in media outlets or by the responsible authorities. This is not surprising. For once one acknowledges it, the age-old myths about neo-liberalism, free markets on steroids, anarchy, merciless capitalism, or insufficient government funding would immediately be debunked and could no longer be utilized as convenient excuses by those in power.

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Government

In order to elaborate on the essence of government, nothing more is needed than the explanations by the two economists Ludwig von Mises and Murray Rothbard. Regardless of how unpopular and unconventional, every single word of their definitions is true, and nothing viable has ever been raised in objection or refutation against them:

Ludwig von Mises:

“Government is in the last resort the employment of armed men, of policemen, gendarmes, soldiers, prison guards, and hangmen. The essential feature of government is the enforcement of its decrees by beating, killing, and imprisoning. Those who are asking for more government interference are asking ultimately for more compulsion and less freedom.” (Mises, Human Action, Chapter XXVII, Part 2)

Murray Rothbard:

“The State is a group of people who have managed to acquire a virtual monopoly of the use of violence throughout a given territorial area. In particular, it has acquired a monopoly of aggressive violence, for States generally recognize the right of individuals to use violence (though not against States, of course) in self-defense. The State then uses this monopoly to wield power over the inhabitants of the area and to enjoy the material fruits of that power. The State, then, is the only organization in society that regularly and openly obtains its monetary revenues by the use of aggressive violence; all other individuals and organizations (except if delegated that right by the State) can obtain wealth only by peaceful production and by voluntary exchange of their respective products. This use of violence to obtain its revenue (called “taxation“) is the keystone of State power. Upon this base the State erects a further structure of power over the individuals in its territory, regulating them, penalizing critics, subsidizing favorites, etc. The State also takes care to arrogate to itself the compulsory monopoly of various critical services needed by society, thus keeping the people in dependence upon the State for key services, keeping control of the vital command posts in society and also fostering among the public the myth that only the State can supply these goods and services. Thus the State is careful to monopolize police and judicial service, the ownership of roads and streets, the supply of money, and the postal service, and effectively to monopolize or control education, public utilities, transportation, and radio and television.” (Rothbard, War, Peace, and the State)

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