Tuesday, May 26, 2015

Separation Between Money and State

We will skip chapters 4 and 5 of Thomas E. Woods Jr.'s "Meltdown: A Free Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse" for these chapters describe about the business cycle and the Great Depression in the 1930s. The business cycle chapter in particular is a discussion of F. A. Hayek's concept, which I think is better considered using the book of Hayek's intellectual mentor himself, Ludwig von Mises. I am referring to the "Human Action" specifically Chapter 20 Sections 8 and 9. I summarized this topic in three articles:

Our primary concern in the present article is about money. In particular we want to talk about the separation between money and State. We have been told that in the past, the separation between church and state was a great accomplishment that prevented numerous abuses. Likewise, living in an interventionist age, the blogger agrees that a new kind of separation is needed in our time for citizens of nations to live in freedom, peace and prosperity. This is the separation of money and state.

For most people, this idea is next to impossible. Governments and central banks will not allow this to happen not unless citizens become economically informed. This ideal can only be achieved if an intellectual revolution would occur as a result of people's search for an answer once the existing interventionist crisis reached its ultimate end.

I think Chapter 6 of Thomas Woods' book will help us understand how to achieve the identified separation. Woods explains this by exposing two popular myths and by introducing fundamental economic and monetary concepts. 

Two Popular Myths

The first myth is economic. It has something to do with the role of the Federal Reserve. It is difficult to break the spell of this myth for almost everybody is asking for it. This is how Woods describes this myth: "We need the Fed to push down rates so there can be more borrowing and lending. Then we'll be prosperous" (p. 126). 

The problem with this superstition is that the Fed itself has no resources of its own to lend, except the USD coming from the printing press. This kind of credit does not come from people's saving. It is just being created out of paper and ink.

The second myth is monetary. The focus of this fallacy is hostility towards commodity money such as silver and gold. It has at least five different versions. Woods enumerates them as follows:

1. "Gold and silver aren't flexible enough. We need money that is more flexible." The key in understanding this fallacy is to know how the term "flexibility" is used by those who are hostile to commodity money. Once you understand this term, you will also see that being "inflexible" is in fact a virtue of gold and silver.

2. "Precious metals are too bulky." This can be easily dismissed for debit cards can be "used with a precious metal money" (p. 131). 

3. "A gold standard is too costly; paper money is les expensive to produce." The mistake in using this line of reasoning is the failure to see the real cost of paper money, which is the enrichment of the political and bureaucratic class at the expense of the taxpayers. 

4. "There isn't enough gold or silver to facilitate all the transactions of a modern economy." Woods disagrees with this for he believes that sufficient quantity of gold or silver exists to facilitate market transactions. Furthermore, he does not believe that increasing the money supply will benefit the economy apart from the growth in the quantity of products and services. In fact, he cited the experience of the Americans during the 19th century that a relative "constant money supply" was matched with the increase in goods and services. This resulted to lower prices and growth in the purchasing power of people's money, and thereby also increased the American's standard of living. 

5. "The supply of gold cannot keep up with the growth in business activity." This is just an extension of the previous myth. For Woods, there is no need to increase the money supply just to offset the fall in prices. Doing so, is the primary cause of the business cycle.

Fundamental Economic and Monetary Concepts

In beginning chapter 6, Woods complains about the exclusion of critical monetary issues from mainstream discussion. He identified five of them:

1. The existing monetary system has depreciated 95% of the value of the USD.

2. The existing monetary system is an indirect way of expropriating the people.

3. The existing monetary system with the power of the Federal Reserve to control interest rates is the cause of the business cycle.

4. That there is a need for a new monetary system and policy

5. That the kind of monetary policy we need is the one that will discourage "reckless leveraging and risk-taking."

The central concept that Woods argued throughout the book is that the current banking system and its monetary policy is the source of economic instability and miscalculation. After exposing the above two myths, we will now identify the fundamental economic and monetary concepts that Woods wants to introduce.

The first concept is about the source of money. Money is not a government creation. It originated from the market. And since at present, we are all used to paper money, Woods argues that for it to have value, it must have a connection to commodity money.

The second concept is about the process how governments arrived to its present monopoly of money. Woods explains this process in three stages:

1. It all starts with the market's use of commodity money.

2. The circulation of paper notes started as a substitude of commodity money.

3. The government confiscates the commodity money.

For Woods, such act of confiscation is a "violation of private property rights" and "it always involves the threat of violence" (p. 113). 

Roman Catholic scholasticism championed the third concept. Two examples of popular thinkers from this school include Nicholas Oresme (1323-82) and Juan de Mariana (1536-1624). They condemned the act of monetary debasement as a violation of the 8th commandment. 

The fourth concept is about the qualities possessed by gold and silver that qualified them as money: durability, divisibility, and relatively valuable. Other Austrian economists add scarcity and transportability.

The fifth concept is about the connection of commodity to liberty. Woods echoed the argument of Joseph Schumpeter that "a commodity standard was the only monetary system compatible with freedom." The other face of this argument is that under the existing fiat monetary system, tyranny is winning the day. 

The sixth concept is about the Federal Reserve. Woods does not believe that the Fed was established for the good of the American public. Instead, it was a "special interest" institution disguising as working for public good. 

The seventh concept is about the confusion regarding the meaning of inflation. I don't want to elaborate on this further for I already wrote about this topic. You can find it here:

The final concept is about deflation. This is what most economists are afraid of today. Contrary to popular belief, Austrian economists like Thomas E. Woods Jr. does not believe that falling prices result to economic difficulties. Instead, he affirms that falling prices is either "the natural outcome of a progressing market economy" (p. 135) or an indication of depressed economic condition after a series of inflationary measures has been stopped.

The blogger agrees with Thomas E. Woods Jr. that unless people will understand the identified fallacies and the basic concepts discussed in chapter 6 of his book, American economy as well as the global economy will continually sink deeper into economic abyss. The journey to freedom, peace and prosperity will only start once the tie between money and state is disconnected. 

Guide Questions:

1. How did Thomas Woods explain the concept of separation between money and state?

2. What are the two popular myths? Briefly explain each.

3. Enumerate the five versions of monetary myth.

4. What are the five critical monetary issues excluded from mainstream discussion?

5. What is the central argument of the book?

6. Enumerate the 8 fundamental economic and monetary concepts introduced in this chapter. Briefly explain each.

Source: Wood, T. E. Jr. (2009). Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Washington, DC: Regnery Publishing, Inc.