The Demise of Money and Credit

Central banks worldwide, led by the U.S. Federal Reserve, mint new money ceaselessly to bail out insolvent governments, banks, and politically powerful corporations and labor unions. Currency convertibility to gold, enforced by law, established a finite limit to the money supply. Inflation would lead citizens to promptly cash out for gold, thus reducing the money supply and ending the rise in prices.

By Lewis E. Lehrman
May 2013 Issue
The American Spectator

LATELY WE HAVE BEEN engulfed by headlines reporting financial turmoil on every continent, in almost every nation, large and small. The commissars of central planning who so marred the history of the 20th century have been replaced by central banks in the 21st. In Cyprus, the new leadership now dares to confiscate citizens’ wealth with a one-time tax of up to 60 percent on bank deposits above 100,000 euros. Self-interested prime ministers blame continental monetary policies for instigating the currency wars that they themselves surreptitiously carry on.

Central banks worldwide, led by the U.S. Federal Reserve, mint new money ceaselessly to bail out insolvent governments, insolvent banks, and insolvent but politically powerful corporations and labor unions. This new money goes first to insiders in the financial sector, who exchange the cheap credit for commodities, stocks, and real estate at ever-rising prices. This is the so-called carry-trade, monopolized by a financial class that uses free money from the Fed to front-run the authorities for insider profits.

From the beginning of the American republic until not long ago, dollars could be exchanged for gold at a parity established by congressional statute (1792–1971, but from 1934–1973 convertible by foreigners alone). Currency convertibility to gold, enforced by law, established a finite limit to the money supply. Inflation—caused by the issue of excess money and credit—would lead citizens to promptly cash out for gold, thus reducing the money supply and ending the rise in prices. In a sense, the system was self-regulating.

With an unlimited money supply, the insolvency of national banking institutions has become an endemic global problem. Depositors are at risk of loss or arbitrary confiscation by panicked political authorities, as in Cyprus. Taxpayers are involuntarily dragooned in to bail out the banking system, as at the start of America’s recession. And if the central bank credit bubble collapses, systemic deflation will be the profound and destructive consequence.

The expropriation in Cyprus, the problems in the eurozone, the unrest in Iceland, and the crisis of the American banking system are but a few examples of legions of insolvencies engendered by the unrestrained and unlimited issue of inconvertible money and credit balances by central banks that are not restrained by effective institutional limits—except that of collapse itself.

This has not always been the case. The institutions of money and credit evolved over a period of three millennia, and the story of their origin suggests that stability and trustworthiness were once paramount goals.

In the Beginning, There Was Barter
FORERUNNERS OF MAN LIVED on the planet several million years ago, but unique social order emerged only 4,000 to 5,000 years ago. Historical and archeological evidence suggests that the institution of money evolved coterminously with civilization. From the standpoint of the 100,000-year history of Homo sapiens, civilization and money are but young and fragile reeds.

In the beginning, there was barter: the moneyless exchange of one man’s goods for those of another. Each family stored varied supplies—wheat, wood, or venison—to exchange directly for others—cows, tools, or coal. But barter cannot always work. For example, the meat one man produces might not be desired by the person with whom he tries to trade.

Thus other, more indirect forms of commerce developed. Under a system called potlatching, practiced by natives in northwestern North America, one party gives a gift with the hope but not the certainty of a return. There is no guarantee of an immediately satisfying exchange, but in a tight-knit community, reciprocal faith acts as a sort of invisible currency—the “money” of a moneyless community. Gifts are given in exchange for unwritten promissory notes, implied liabilities that the grateful debtors repay in the future with gifts in return.

Potlatching amplifies barter and indirectly tends to encourage growth. All members of a community freely make goods for one another, which are often repaid in kind and more. As George Gilder puts it, this productive circle of givers increases the sympathy of its members for the special needs of one another.

Money evolved through a historical process not unlike that of trial and error or natural selection. But standardized and certified coins originated with an act of human creativity around 650 b.c.

The first such coins appeared in Lydia, Asia Minor, at a time when the original Sumerian civilization was in its fourth millennium of development. The Lydians minted coins using a natural mixture of gold and silver called electrum. Lydian coins exhibited specific properties that made them uniquely suitable as a medium of exchange: They were small, portable, and enduring. Made of scarce precious metals, they were beautiful and cherished. Men had exerted great effort and intelligence to produce them, giving them intrinsic value.

The test of time proved the lasting worth of Lydian coins. Merchants came freely to select these coins for their intrinsic monetary properties, and they became increasingly accepted in ever-widening trade by people of many tongues in the Levant and Near East.

Coins became a useful yardstick by which to measure the value of the other products of human intelligence available on the market. Their high value, relative to their small size and low weight, made them easy to transport and store. History taught the ancients that the value of these precious metals endured, and that their purchasing power remained reasonably stable from year to year, even generation to generation.

Money enhanced the options of all those who toiled, augmenting their freedom to provide for themselves as they pleased. Workers could defer purchases because they held concrete tokens encompassing an irrevocable right to demand future goods. They could even leave a surplus for their children. Real money lasted. It could be inherited and passed on.

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