Mosaic Economics

Mosaic Economics

Thomas Allen

In Moses the Economist (1947, Editor Ben Williams, Reprinted 2009, American Christian Ministries), C.F. Parker gives his understanding of Mosaic economics as described in the Pentateuch. Some of his descriptions and my comments follow.

– Value. Parker believes that the value of the labor used to provide a product or service determines its value. (Both Adam Smith and Karl Marx held this view.) The opinion of the consumer is irrelevant. Thus, if the labor value of a product is $100 and the consumer values it at $50, the product cannot be sold for $50. To sell it for $50 would cheat the workers of their due wages and would be an ill-gotten gain for the consumer, who has cheated the workers out of part of their wages. For the product to sit on the shelf and deteriorate is better than selling it for less than $100. How the workers are better off losing $100 by the product deteriorating to worthlessness than losing $50, Parker does not explain.

Like most people, he has the cost of labor and materials determining the selling price of the product backward. The cost of labor and other inputs to produce a product does not determine the selling price of the product. The marginal consumer does. What the consumer is willing to pay for a product determines the cost of the labor and other inputs in the production of the product.

– Taxes. Farmers bear the primary burden of funding the government. They pay 10 percent of their crops and increase in herds to the government. (If their herds decrease, does this the government reimburses them for 10 percent of their loss — probably not.) However, they pay their taxes in products and livestock instead of money.

To provide additional revenue (taxes) for the government, Parker extends this principle to manufacturers. Through some convoluted reasoning, he concludes that the use of tools powered by steam or electricity produced by coal, petroleum, natural gas, uranium, water, and now wind and solar makes their products equivalent to agriculture. Consequently, manufacturers would pay the government 10 percent of what they produce. Thus, applying the agricultural equivalency, an automobile manufacturer would give the government 10 percent of the cars and trucks that he produces. A spark plug manufacturer would give the government 10 percent of the spark plugs produced. In like manner, a toy manufacturer would pay the government 10 percent of the toys that he produces. And, likewise, for other manufacturers.

However, if furniture manufacturers or seamstresses used no power tools in producing their furniture or apparel, they pay no taxes. Yet, if they use power tools, such as electric saws and drills and electric sowing machines, they pay 10 percent of their products to the government.

Providers of services are exempted from taxation. For some strange reason, Parker puts miners, who extract God-given ore from the ground, in the nontaxpaying category. Although he is unclear whether extractors of petroleum, natural gas, and coal pay taxes or not, he seems to place them in the nontaxpaying category.

Parker does not address solar and wind energy because when he wrote his book, they were not used to produce electricity, although the wind was used to grind grain, pump water, and move ships. However, based on his agricultural principle, since God provides the wind and sun, people who use them to produce electricity should give the government 10 percent of the electricity that they produce.

– Land. Parker is a proponent of the jubilee where all land returns to the original owner every 50 years. For the Western Hemisphere, this means that all land return to the Indians (who gets the land of the extinct Indian tribes?). Or, it returns to the monarchs of Spain, Portugal, Great Britain, France, the Netherlands, Denmark, and Russia. If the principle of the right of conquest, the land belongs to whoever conquers it, is applied as it is applied to the Israelite’s conquest of Canaan, then the aforementioned monarchs are the original owners since the land was conquered for them and in their name. Consequently, the Indians have no claim. (See “Jubilee” by Thomas Allen.)

– Usury, Loans, and Debt. Of course, charging interest including fees, which is interest by another name, on loans is prohibited. Moreover, all debts are canceled after seven years —not seven years from when the loan is made but a fixed calendar seven years for all loans. Thus, a loan may be canceled a year after it is made. (See “Questions for Anti-Usurers” by Thomas Allen.)

If all debt is canceled every seven years, then all paper money and its electronic equivalent including checkbook money become void every seven years. These types of money are obligations, i.e., debts. Parker seems not to recognize this cancellation of credit or representative money, which he believes is real money like full-weight gold and silver coins. His confusion about money derives from his belief that money is a mere token. (See “What Is Money?”,  "What Are the Functions of Money,” and “What Is the Difference Between Commodity and Fiat Money” by Thomas Allen)

Although Parker does not realize it, his anti-usury stance if carried to its logical conclusion forbids farmers from saving part of their crop as seed for the next season. Deciding how much to consume now and how much to save for future consumption involves interest, usury.

Furthermore, even the holdings of Social Security, of which Parker approves, would cease to exist every seven years because they are obligations (debts) owed to the participants.

– Money. Further, Parker has little understanding of commodity money, e.g., gold and silver, and a commodity monetary system, e.g., the gold standard. He believes that the monetary commodity has a different value, usually, a lower value, from the commodity stamped as a coin. Under a true commodity standard, the commodity has approximately the same value as an equivalent weight of the commodity when stamped as a coin. Money has value in and of itself that is independent of any image, words, or numbers stamped on it. The weight of the commodity in the coin is what gives it value and not what is stamped on it. (If the monetary value of a currency exceeds the commodity of which it is made, as with paper money, it represents real commodity money and is, therefore, an obligation to pay real commodity money, i.e., it is a debt payable in real commodity money.)

If he had looked in Genesis, he would have found the attributes of real money, which are quantity, a measure of weight, and substance. According to Genesis 23:16, Abraham bought a burial plot. He paid 400 (quantity) shekels (measurement of weight) of silver (substance). All commodity money has these three attributes, which makes money more than a mere token.

Therefore, a token even if used as a medium of exchange is not Biblical money. When used as a medium of exchange, token money represents money and passes the obligation to pay real money from one person to another. When the seven-year debt cancellation comes, token money becomes a canceled debt, and the person holding it is cheated out of whatever value it had as a medium of exchange.

Nevertheless, Parker is correct about money itself not being wealth. However, the gold in a gold coin is wealth as gold bullion. (See “What is the Gold Standard?” by Thomas Allen.)

– Banks. Banking as known today would cease to exist. People who wanted to save their money in a secured vault would have to pay someone to protect their money in a vault.

As for checking accounts, people would have to pay a depositary to hold their money against which they could write checks. They may also have to pay when a check is cashed or money is transferred from one account to another account. A return to yesteryear where bill collectors visited people’s houses or businesses to collect payment may return. Most likely, people may have to visit centralized offices to pay their bills as that would be the cheapest way of making payments.

– Wages. According to Parker, people should be paid according to their effective endeavors. Also, he seems to argue for a wage system that is akin to what progressives promote from time to time. Some governmental bureaucrats establish a relative pay scale for each type of job based on their opinion of its importance and on the labor required for that job. 

Nevertheless, he maintains that workers who work more efficiently acquire more wealth than less efficient workers. The incompetent and slackers become impoverished. He is a proponent of meritocracy in the workplace, which the free market generally provides when the government does not interfere with employment.

According to Parker’s understanding of Mosaic economics, wealth is fixed and is the aggregate of the rivers, lakes, oceans, soil, plants, animals, atmosphere, and the like. Wealth has nothing to do with human intelligence in organizing and using these resources. Thus, African countries rich in resources should be wealthier than Singapore, which is extremely poor in natural resources, but most are not.

– Stocks. Corporations with publicly traded stock would cease to exist under Parker’s Mosaic economics. Paying dividends on stock is outlawed because the owner of the stock did not earn the money. Moreover, one could never sell a stock for more than he paid for it because that is ill-gotten gain. Likewise, apparently, one could never sell a stock for less than what he paid for it because that would be an ill-gotten gain for the buyer. 

– Abundances and Scarcities. Buying items such as generators and food in a region of plenty and selling them in a region of want because of a natural disaster, war, or otherwise at a price above what existed before the disaster is forbidden. One must sell the item at the predisaster market price. (Higher prices mean stronger demand relative to the supply and are a signal for more supply. By fixing prices, Parker denies this signal. He appears to have a great deal of confidence in the integrity and the subjective opinions of governmental bureaucrats to move products from a region of abundance to a region of scarcity. He seems to want to eliminate the free market.)

Moreover, in a region that has an abundance of agricultural products, he would prohibit selling the products below the pre-abundant price. To do so would cheat the farmer. Apparently, the farmer and presumably the consumer benefit more from the excess crops rotting away than from selling them at a lower price.

– Selling Used Items. Selling a used product, including antiques and old masterpiece paintings, for a profit is forbidden. One cannot sell a used product for more than what he paid for it (or the original price if the original price is lower). Consequently, if a person inherits a painting, jewelry, furniture, or anything else whose original price is unknown, he cannot sell it.

Moreover, stamp and coin collecting as an investment would cease to exist. One can never sell a stamp or coin for more than its face value.

– Insurance. Private insurance is verboten. Nevertheless, Parker accepts governmentally run Ponzi schemes like social security, which is often called insurance.

– Conclusions. If implemented, Mosaic economics, as Parker explains it, would be detrimental to today’s economy. A small minority of the country, the farmers and manufacturers, bear the tax burden; the remainder remains untaxed. This dearth of taxes does keep the government small and, therefore, limited. The government could not make up for the shortfall by deficient spending as the cancellation of debt every seven years and the illegality of charging interest would prevent most people from lending to the government.

Further, his explanation of money is flawed. Also, his requirement for governmental price fixing is highly destructive and would create continuous surplus and shortages. He asserts that the value or price of labor in producing and distributing products fixes their value or price; the subjective opinion of the consumer, i.e., what the consumer is willing to pay for the product is irrelevant in fixing its value or price. His demand to abolish interest would cause the consumption of capital until society reverts to the hunter-gatherer stage. (See “Usury” by Thomas Allen.) 

Moreover, Mosaic economics, as Parker explains it, relies heavily on the wisdom, integrity, altruism, and near omniscience of governmental bureaucrats. Although historically and biblically, governments have been much more doers of evil than doers of good, Parker displays a childlike trust and confidence in governments always being doers of good.

Parker is convinced that Mosaic economics as he understands it will eliminate poverty. However, instead of making the country prosperous as he claims, his proposals would impoverish the country.

Copyright © 2022 by Thomas Coley Allen.

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Extinguishing Debt

Extinguishing Debt

Thomas Allen

    Commodity money, such as gold and silver, is real money. Real money is a medium of exchange that extinguishes debt and other financial obligations. Credit money, such bank notes, government notes, gold certificates, checks, and bills of exchange, is not real money. Credit money does not extinguish debt or other financial obligations. It merely discharges the debt or obligation by passing it to another person or entity.
    Although checks, bank notes, government notes, and certificates, are used as mediums of exchange, they are not real money themselves. Only real money can extinguish debt. They are promises to pay money. Under today’s monetary system, the issuer has no intentions of keeping that promise. Therefore, under today’s monetary system only national bankruptcy via hyperinflation or repudiation can extinguish debts.
    When a person buys groceries, he can pay with full-weight gold coins (assuming the gold standard) or with a check or bank note. If he pays with gold coins, no further obligation exists. The grocer has received something that is no one else’s obligation, gold coins. If the buyer pays with a check or bank notes, the buyer’s obligation to the grocer has been discharged. However, it has not been extinguished. The grocer has received a promise to transfer gold to the grocer. The obligation is not extinguished until the grocer presents the bank notes or check to the bank that issued them, and the bank converts the check or bank notes to gold coins.
    Likewise, with debt, a borrower extinguishes the debt when he pays with gold coins. He has paid the lender with money that is no one else’s obligation. If he pays with bank notes or check, he has merely discharged the debt. It has not been extinguished. It has been transferred to the bank. The debt is not extinguished until the lender presents the check or bank notes to the issuing bank, and the bank converts them to gold coins.
    If the buyer or borrower uses governmentally issued notes, like U.S. notes or gold certificates, he has discharged his financial obligation to the grocer or debt to the lender. However, the financial obligation or debt has not been extinguished. It has been passed to the government. The obligation or debt is not extinguished until the government redeems its notes and certificates in gold, that is, commodity money.
    In the United States between 1879 and 1933, gold certificates (first issued in 1882), bank notes, and government notes, which were called U.S. notes and nicknamed greenbacks, were redeemable in gold on demand. (U.S. notes were legal-tender; the other two were not.) If a debtor used one of these forms of credit money to pay his debt, he discharged his debt, but he did not extinguish it. If he paid with bank notes, the obligation was transferred to the issuing bank. If he paid with gold certificates or U.S. notes, he transferred the obligation to the U.S. government. The debt was not extinguished until the bank note, certificate, or greenback was converted to gold. (This conversion permanently retired the bank note and gold certificate. However, it did not permanently retire U.S. notes. The Secretary of the Treasury had a statutory obligation to reissue U.S. notes after they were redeemed.)
    Under today’s paper monetary system, debts and other financial obligations are never extinguished. They are merely passed from one person to another and eventually become an obligation of the government or its central bank. (In the U.S. all debts become obligations of the U.S. government as federal reserve notes are by law obligations of the U.S. government. Since the Bank of England is a department of the British government, its bank notes are obligations of the British government.) Nevertheless, these debts will eventually be extinguished.
    Under a fiat monetary system, debts may be extinguished in several ways. First and most likely, is to inflate the debt away by destroying the value of the money and pushing it to zero. (The Continental, assignat, the Hungarian inflation of 1945-46, and, more recently, the Zimbabwe dollar are examples of this phenomenon.) However, this approached is often forestalled by replacing one fiat paper money with another fiat paper money. (This has occurred often in Latin American countries.) Even countries that have destroyed their paper money with hyperinflation usually choose to replace the old paper money with new paper money. Another way debt can be extinguished under a fiat paper money system is for the issuing country to die as the result of war. (That is what happened to debts denominated in Confederate dollars. When the Confederate States of America died as the result of the War for Southern Independents, their money, which was not legal tender, also died. Along with the death of the money was the extinction of debts denominated in Confederate dollars.) Countries may also extinguish debt by repudiating them as monarchs of the Middle Ages occasionally did. Another approach is to return to a commodity monetary system, such as the gold standard, where paper money is convertible in the monetary commodity. (Great Britain took this approach some years after the Napoleonic Wars when it returned to the gold standard. The United States returned to the gold standard in 1879 after leaving it in 1861.)
    Thus, debt can be extinguished in several ways. One is by reputation. Another is by the death of the currency from inflation or war. The best and least painful way to extinguish debts is with commodity money, such as gold. That is, by paying debt with money that is no one else’s obligations.
    Commodity money, such as gold and silver, extinguishes debts and other financial obligations. Credit money, such as checks, bank notes, government notes, and bills of exchanges, cannot extinguish debts and other financial obligations. They discharge debts and financial obligation by transferring them to another.
    (Bills of exchange were another form of credit money used under the gold standard. A retailer accepted a bill of exchange from a wholesaler. The wholesaler could use the bill to discharge his debt to the manufacturer. When the wholesaler paid with the bill, he was no longer in debt to the manufacturer. He had discharged his debt to the manufacturer with a debt, the bill, which promised to pay gold by a specific date. The wholesaler paid his debt by passing it to the retailer. The debt still existed. Now the retailer had the obligation to extinguish the debt by paying gold to the manufacturer instead of to the wholesaler. When the retailer paid the bill in gold to the manufacturer, he extinguished the debt. The financial obligations represented by the bill, and the bill itself, ceased to exist.)

Copyright © 2016 by Thomas Coley Allen.

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A Review of Rudy Fritsch’s Beyond Mises — Part 1

A Review of Rudy Fritsch’s Beyond Mises — Part 1

Thomas Allen

The following article is a review of Beyond Mises: Based on the Work of Antal Fekete by Rudy J. Fritsch and published by Hypnonaissance, Canada, 2010. This book may be bought at http://www.beyondmises.com/about-Rudy-Fritsch.html.

Mr. Fritsch has written an excellent book. I enjoyed reading it and learned from it. I especially like his examples and analogies. This is a book that I highly recommend for anyone who is interested in monetary theories in general and Prof. Fekete’s theory in particular, which is the true gold-coin standard accompanied by the real bills doctrine. It is an excellent introduction to Prof. Fekete’s theory. For anyone who is new to his theory, this is a good book to read before reading his writings. For anyone familiar with his work, it is also a good book to read as a refresher and to bring certain aspects of his theory into a better focus.

Also, this book is an excellent book for anyone who wants to learn about real money. It provides an overview of the real bills doctrine, the quality theory of money, and other aspects of money not often found in other monetary writings.

Any comments about fiat money reformers are solely mine. Mr. Fritsch does not mention them in his book. He only refers to the Keynesians and Friedmanites. I have used remarks that he makes to expose the irrationalities, absurdities, and frauds of fiat money reformers. Unless I specifically mention Mr. Fritsch making the comment, the reader should assume that the comment is mine.

Mr. Fritsch contrasts Prof. Mises’ concept of gold certificates and bank notes with that of Prof. Fekete. Prof. Mises claims that gold certificates and bank notes have present value like a gold coin. Prof. Fekete rebuts this claim. He argues that they were obligations, a future good, and not a present good like a gold coin. Prof. Fekete is correct. Gold certificates and bank notes are like checks, and if I understand Prof. Mises correctly, Prof. Mises considers a check to be a future good, a continuing obligation. Gold certificates, bank notes, and checks are all forms of credit money, which makes them obligations and future goods. The transaction is not completed until the gold is transferred, which extinguishes the credit.

Mr. Fritsch gives a good overview of subjective valuation and individual value scales.

In some of my critiques of the fiat monetary reformers (money cranks as others call them), I use the individual’s value scale to show that their reforms are doomed to fail just as the current Keynesian system is. Under a fiat monetary system, a small group or an individual decides how much money should be created and placed in circulation. To know how much is really needed, they have to know the value scale of every individual on the planet, which is about six billion value scales. The only thing constant about these value scales is that they are constantly changing as Mr. Fritsch illustrates. For any small group to know how much money is needed, when it is needed, and where it is needed — and getting that amount there at the right time — is impossible. The markets will always do a better job. And the freer the markets, the better the job it will do.

To deviate from his book for a few paragraphs, the reason that I have exposed fiat monetary reformers like Mr. Dale, Mr. Cook, Mr. Norburn, and the American Monetary Institute is that they are misleading many people. (For my critiques of their proposals, see “Analysis of Byron Dale’s Monetary Reforms as Presented in Bashed by the Bankers,” “Analysis of Richard Cook’s Monetary Reforms as Presented in We Hold These Truths,” “Analysis of Charles Norburn’s Monetary Reforms as Presented in Honest Money,” and “Analysis of the American Monetary Institute’s American Monetary Act.”) After listening to talk radio shows, especially on shortwave where these reformers get a forum, I find many otherwise intelligent people following for their poison.

They deceive people by accurately describing the current monetary system and its destructive effects on the economy and society. They usually focus on the Federal Reserve or the banking system in general. According to them, a major part of the problem is the private ownership structure of the Federal Reserve. Now comes their false solution. The government should acquire ownership of the Fed or abolish it and transfer its monetary authorities to another governmental agency. For them, the problem is not centralized banking itself, it is the ownership structure (I have never heard a good rationale explaining away the Bank of England, which is a governmental agency.) Furthermore, if the government would just issue the money directly, our economic problems would go away. They differ on the criteria for issuing the new money. None seem to have a mechanism for removing excess money from the economy other than the government having a budget surplus, which is highly unlikely. To them, the problem is who issues the fiat money and how it is issued. The problem is never fiat money itself. They also agree that gold should not be money.

Fiat money reformers are the Jannes and Jambres (2 Timothy 3:8) of the reconstruction of America’s monetary system. They are like Pharaoh’s wise men who confronted Moses with their magic (Exodus 7:11).

Besides the fiat money reformers, another barrier that adherents of the true gold standard, the gold-coin standard, face comes from “hard money” folks. Nearly all advocate a fiat monetary system that incorporates gold. Most support using gold to back the money in some fashion. Under the true gold standard, gold does not back the money: Gold is the money. Many of these folks seem to support some kind of gold-exchange standard. (Gold-exchanged standards are political contrivances and are not market creations like real bills or the gold-coin standard. For an explanation of the gold exchange standard, see my article “Gold-Exchange Standard.”) Some seem to want a system similar to the euro where gold backs a fraction of the money. Only a few seem to want to require the paper money to be redeemed in gold on the demand of citizens of the issuing country.

Many of these hard-money folks appear to oppose returning to the true gold standard because they believe that there is not enough gold. Without the real bills doctrine, their concern has some validity. However, as I show in “There Is Enough Gold” with further explanation in “Response to Dale’s Analysis of ‘There Is Enough Gold’” when the real bills doctrine accompanies the gold-coin standard, enough gold is available to accommodate world trade many times over. Even under the silver standard, enough silver is available to accommodate world trade several times over.

Now back to Mr. Fritsch’s book, his description of Keynesian economics reminds me of allopathic medicine. Keynesians attempt to cure chronic economic problems by attacking the symptoms while ignoring the underlying cause. Allopathic medicine attempts to cure chronic diseases by attacking (suppressing) the symptoms while ignoring the underlying cause.

One thing is missing from his discussion of real bills. He does not discuss selling a bill (commercial money) to a bank and having the bank convert the bill into bank notes and checkbook money (bank money). In my “Response to Dale’s Analysis of ‘There Is Enough Gold,’” I give a brief discussion of this action. I also mention it in some of my other articles.

Mr. Fritsch remarks that labor is a poor selection for money, resulting in poor quality money because it lacks the ability to store value. This inability to store value is one of the several reasons that Mr. Dale’s fiat monetary reform would result in poor quality and inferior money. He claims that his money would be based on labor associated with building roads. (An irony is that Mr. Dale has a better understanding of the true gold-coin standard than many hard money folks. Like most people, he is convinced that there is not enough gold for it to function as money today.)

In his discussion on credit, Mr. Fritsch gives two examples: John borrowing $200 and Ricardo selling a TV today for payment 60 days later. These types of transactions could not occur under Mr. Cook’s monetary system. At least they could not occur without governmental approval. Mr. Cook asserts that all credit should be the property of the government. Only the government should be allowed to create credit.

I have a minor correction to make about Mr. Fritsch’s comment on the Federal Reserve’s assets and liabilities. He states that U.S. government bonds are assets of the Federal Reserve and liabilities of the U.S. Treasury and that federal reserve notes are liabilities of the Federal Reserve. In the bookkeeping sense, he is correct. Bonds are on the asset side of the ledger, and federal reserve notes are on the liability side.

If I understand the U.S. monetary laws correctly, federal reserve notes are not liabilities of the Federal Reserve. They are the liabilities of the U.S. government. To enhance their acceptability, Congress made them obligations of the U.S. government. Thus, it appears that the law gives the Federal Reserve “its cake and lets it eat it too” by making the Federal Reserve’s liabilities the U.S. government’s liabilities.

Mr. Fritsch asks if the U.S. Treasury tried to buy back its bonds, where would it get the money. The U.S. government can buy back a little less than $347 million by printing U.S. notes. As far as I know, the law that allows the Department of the Treasury to print that many U.S. notes still exists. Congress could always increase that amount to cover the entire debt. That would make the fiat money reformers happy. It would also quickly expose the fraud and bankruptcy concealed by the current system.

As Mr. Fritsch so well illustrates, fiat paper money does not survive the military might of the issuing government that forces it on the people. (Fiat money made of a commodity, such as the silver dollar from 1878 to 1900, can survive its issuing government to the extent of the value of the commodity.) Some fiat monetary reformers believe that money should die with its issuing government. Such a belief reveals their lack of concern for the people.

Mr. Fritsch provides a good discussion of interest. For most fiat money reformers, interest is the arch enemy to be slain. Most disguise interest by calling it a fee (generally, a one-time fixed fee or a percentage fee charged up-front, which presumably would be much less than the standard interest rate), share-the-wealth or income, or something similar. Nearly all would definitely outlaw compound interest, which would do away with conventional savings accounts. Few go as far as prohibiting any kind of payment for a loan above the amount lent, which really does get rid of interest. Most do not seem to realize the chaos and poverty that they would create by outlawing interest. They need to answer my questions for anti-usurers in my article “Questions for Anti-Usurers.”

As Mr. Fritsch notes, the dual benefit of interest for lender and borrower can occur only with commodity money. It does not occur with fiat money. As fiat money reformers want to keep fiat money, they must deal with the one-sided effects of interest under fiat monetary regimes. Thus, most seek to suppress it, if not outright outlaw it. Instead of freeing the people and the economy from the heavy hand of government by returning to the true gold-coin standard, they seek to extend it in their attempt to control or eliminate interest. Thus, instead of eliminating the governmental intervention that caused the problem, they want more governmental intervention to solve the problem. How much simpler and freer the gold standard makes life.

Mr. Fritsch discusses the leather strap that used to be used in schools to maintain order and discipline. It was seldom applied. Students knowing that the leather strap was there and would be applied was usually enough to maintain order and discipline. (Much of the unruliness in schools today comes from the removal of the leather strap.)

He uses the leather strap as an analogy for the gold standard, which he calls the “Golden Strap.” It was highly efficient and effective at maintaining economic order and restraining politicians. With the outbreak of World War I, politicians the world over saw a chance to discard the Golden Strap. Discard it they did.

The world is surely in need of it today. It has been needed since World War I. To avoid the strap, countries adopted the gold exchange standard after World War I instead of returning to the gold-coin-standard-real-bills system as existed before the war. They then abandoned the gold exchange standard in the 1930s to avoid the strap. The same thing happened following World War II. A gold exchange standard was established and then abandoned when the strap appeared.

I may have a disagreement with Mr. Fritsch’s concept of the demand for money or it may be my misunderstanding of his argument or it may be semantics. To me, a person’s demand for money is how much money he wants to hold, hoard. It is not how much he would accept if someone gave him all he wanted. In this case, his acceptance demand is only limited by the space that he has to store the money. If the money were electronic, it would exceed a googolplex. When a person spends money, his demand for what he buys exceeds his demand for the money that he spends; otherwise, he would not make the purchase.

Mr. Fritsch writes that the discovery and exploitation of new gold and silver supplies never led to inflation. Did not the massive hoards of gold and silver that the Spaniards plundered from the Indians of Central and South America and sent to Spain cause an inflation in Spain that eventually brought Spain down? Didn’t this inflation spread across Europe?

Most economists attribute the rise in prices between 1896 and 1914 as caused by the large quantity of gold entering the markets from the new mines in South Africa. Thus, an increase in the world supply of gold led to a decline in its purchasing power. (Others contribute gold’s decline in purchasing power to natural market forces and not to the South African gold entering the markets.)

I am convinced that the primary cause of the decline in prices during the nineteenth century, especially the latter part, was the increase in productivity. New goods were being offered at a faster rate than the money supply was growing — hence, the downward trend in prices. This is what one would expect under the gold standard.

Moreover, if national bank notes had been tied to real bills instead of U.S. government bonds, the deflation in the United States between 1870 and 1896 would have been reduced. Under the real bills doctrine, money to buy new goods entering the markets would have been injected into the economy along with the new goods. Backing bank notes by government bonds instead of real bills greatly interfered with this process.

Copyright © 2010 by Thomas Coley Allen.

Part 2 

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What Is the Difference Between Commodity and Fiat Money

What Is the Difference Between Commodity and Fiat Money
Thomas Allen

Monetary systems can be divided into two major categories. One category is fiat money, which is sometimes called managed money, debt money, forced paper money, or irredeemable paper money. The other is commodity money, which is sometimes called full-bodied money, metallic money, specie, hard money, or precious metal money.

Commodity money is “that sort of money that is at the same time a commercial commodity.”[1] Gold and silver are the premier commodities used as money.

Fiat money “is a legal claim, since it derives all its properties from the law.”[2] It is simply a purchase voucher, whose purchasing power varies, that can be exchanged for goods and services. The settlement of debts is its only fixed right.

Webster’s New International Dictionary (second edition, unabridged) defines fiat money as “paper currency of government issue which is made legal tender by fiat or law, does not represent, or is not based upon, specie, and contains no promise of redemption.” The government or its central bank issues fiat money, and the government declares it to be legal tender. Currently, in the United States fiat money occurs as federal reserve notes.

Commodity money differs from fiat money in two important ways. First, under a commodity monetary system, the money supply adjusts automatically to monetary needs. “[T]he demand for, and supply of, money react simultaneously, through market prices for all goods and services and the monetary metal, to determine a given quantity of money.”[3] The markets decide how much money to create and issue. Under a fiat monetary system, the money supply is regulated artificially. The government or its central bank regulates the money supply. The government decides how much money to create and issue. Second, the value of commodity money is directly related to the material of which it is made. For fiat money, value is independent of its material and depends solely on the demand for and supply of money. Of these two differences, the most important lies in the method used to regulate the supply of money.

Johnson makes the following comparison between commodity money and fiat money: “(1) commodity money, or money made out of material of which the free use is permitted as money, so that its value is the product of two sets of utilities, namely its utility as money and its utilities as an ordinary commodity; (2) fiat money, or money the value of which has no relation to the value of the material out of which it is made, being the product solely of its utility as money.”[4]

Many people often confuse commodity money with fiat money when the fiat monetary system incorporates gold or silver. A money backed by gold is not necessarily commodity money. (Under the true gold standard, gold does not back the money. Gold is the money.) For example, legal tender federal reserve notes between 1933 and 1968 were legally required to be backed by gold. Yet it was not commodity money. No American citizen could redeem federal reserve notes for gold. The Federal Reserve decided how many federal reserve notes to issue instead of the markets. The value of gold backing them was much less than the monetary value of the notes. Hoppe makes this error.

Hoppe compares fiat money with commodity money as follows: “Fiat money is the term for a medium of exchange which is neither a commercial commodity, a consumer, or a producer good, nor title to any such commodity: i.e., irredeemable paper money. In contrast, commodity money refers to a medium of exchange which is either a commercial commodity or a title thereto.”[5] Hoppe’s description overlooks an important feature of fiat money, and, that is the issuance of fiat money is arbitrary. Under Hoppe’s description, silver dollars issued in the 1880s and 1890s were commodity money as they contained a commercial commodity. They were money in their own right and were not directly redeemable in gold on demand. However, as Congress and the Secretary of the Treasury arbitrarily fixed the amount issued, they were fiat money. Moreover, the coin’s face or monetary value was greater than the value of its metal content.

Rist explains the difference between commodity money and fiat money as follows:

[I]t must be recognised that the belief in gold arises not from age old superstitions of a more or less magical character, but from age old experience. A claim on gold—a cheque or a banknote—is something clear and precise that everybody understands, just as everybody understands a mortgage on a piece of land or a house that he knows. Paper [fiat] money is a claim on something unknown, on a country or a government, whose political, social or financial escapades and arbitrary decisions nobody can be sure of beforehand.[6]

Vieira compares commodity money with fiat money as follows:

With commodity money, the actual commodity, the silver or the gold, is both the medium of exchange and the standard of value. The supply of commodity money is self-limited because of the costs of minting, refining, and coining the silver and gold. New supplies of commodity money will be coined only to the extent that coinage is economically profitable. The market will simply not produce more gold and silver coin than is necessary compared to all the other uses of that capital. . . . [F]iat money is composed of some intrinsically valueless substance which the issuer does not promise to redeem in a commodity or in a fiduciary money. Because fiat money has no legal connection to a commodity money, and, therefore, has no real economic cost in terms of production, the supply of fiat money is never self-limiting and is always largely a matter of public confidence in the economic or political stability of the issuer.[7]

Vieira's description of commodity money and fiat money fails to account for silver dollars of the 1880s and 1890s. They contained a valuable substance, silver, which seemed to make them commodity money. However, the government decided the quantity to issue instead of the markets, which makes them fiat money.

It also fails to account for U.S. notes between 1879 and 1933. U.S. notes were redeemable in gold on demand during those years. However, Congress decided the quantity to issue. Also, the gold backing them varied between about one-third and one-half. Thus, they were not genuine warehouse receipts as were gold certificates, which were required to be fully backed by gold.

Mises describes the difference between commodity money and fiat money as follows:

. . . it is the commodity in question that constitutes the money, and that the money is merely this commodity. The case of fiat money is quite different. Here the deciding factor is the stamp, and it is not the material bearing the stamp that constitutes the money, but the stamp itself. The nature of the material that bears the stamp is a matter of quite minor importance.[8]

Mises’ description accounts for silver dollars of the 1880s and 1890s The stamp instead of the metal content gave these silver dollars their value. His description also accounts for U.S. notes between 1879 and 1933. The stamp and not the metal backing gave them their value as they were not fully backed by gold.

With commodity money, the commodity makes the money. “The value of a coin has always been determined, not by the image and superscription it bears nor by the proclamation of the mint and market authorities, but by its metal content.”[9] With fiat money, the stamp and force of government make the money. Fiat money derives its power to make purchases and to pay debt solely from words printed on the currency, i.e., it derives its power from governmental fiat.

Fekete notes that commodity money is “tied to a positive value: the value of a well-defined quantity of a good of well-defined quality.”[10] Fiat money is “tied not to positive but to negative value—the value of debt instruments.”[11]

Commodity money is the only form of money that is a present good. All paper money, including certificates and fiat money, is a promise to pay; it is a future obligation. With fiat money the payment is never made; it is only discharged. Payment with commodity money completes the transactions; payment with fiat money is an extension of credit. (In this respect a gold certificate is like fiat currency. The gold certificate is credit, a promise to pay in gold, and the transaction is not completed and the debt retired until the certificate is redeemed in gold.) With irredeemable fiat currency, the transaction can never be completed because the currency is irredeemable. The transaction is discharged by a transfer of credit.

Under a fiat monetary system, debt, promise, or obligation is used as money and as final payment. Fiat money is basically paper money and its electronic equivalent representing nothing but a promise or an obligation. Under a fiat monetary system, a final payment can never really occur as one is always paid with debt, promise, or obligation, a representation that something else is owed. Thus, fiat money can only discharge debt; it can never retire debt.

Under a pure commodity monetary system, the final payment is always in the commodity being used as money in the transaction. The commodity can function as final payment because it is no one’s obligation. Receipt of the commodity in payment ends all further obligations. Thus, it retires debt.

In fiat monetary systems, the monetary unit is a nebulous abstraction, a legal fiction. Fiat money is not tangible, lacks definition, and has no defined unit of measure. It is an illusion with no connection to reality.

In commodity money systems, the monetary unit is tangible and measurable. It is a specific and definable weight of a particular commodity, usually gold or silver. Unlike fiat money, commodity money has value in and of itself independent of its monetary use.

Under a commodity monetary system like the gold or silver standard, the quantity of money is not subject to governmental manipulation. With fiat money, the government maintains control of the money and can change the money supply to suit political considerations.

With a commodity monetary system like the gold standard, market forces determine the quantity of gold coined. The people decide how many gold coins that they need by the quantity of gold brought to the mint for coinage and by the quantity of gold coins melted for other usages. Thus, a commodity monetary system uses the knowledge and wisdom of all the people to regulate the money supply.

With a fiat monetary system, a definite governmental monetary policy is needed to regulate the quantity of the fiat money. Development of this policy requires the opinions of “experts” on the desirable goals. Thus, this policy is nothing more than the personal value judgment of these experts. Once they have selected a policy, the force of government is needed to carry it out. Neither the experts who develop the policy nor the governmental agents who impose it can accurately foresee the long-term effects of the policy. Adolph Miller, a member of the Federal Reserve Board, in his testimony before Congress, summed up this major problem with fiat money: “Up to this day it has never yet been demonstrated that any agency can be invented to which power to govern the currency could be entrusted without ultimately disastrous consequences.”[12]

Commodity money is an economic currency. The needs of the economy determine its quantity. It is directly connected with the production of real goods and services.

Fiat money is a political currency. The needs of politics determine its quantity. It is directly connected with government debt even if the government issues the currency directly and interest-free. (When the government issues a currency like U.S. notes, it is issuing interest-free government debt that is used as money. Often such debt is never paid.)

With fiat money, the government gains a monopoly over money. Using its monopolistic control of money, it can inflate until the money becomes completely worthless. With legal tender laws, it can force people to accept ever-depreciating money.

Under a commodity monetary system, the value of the monetary commodity comes from its production. Under a fiat monetary system, the value of money comes from its legal obligation.

With fiat money, people trust politicians, bureaucrats, and bankers. They trust paper and promises. With commodity money, people trust gold and silver. They trust that which is no one’s obligation or promise.

Fiat money is totally dependent on commodity money, at least initially, for its value. Greaves describes this dependency as follows:

The original value of any money was the use value that commodity had in its other uses before it was first used as a medium of exchange. It then had an objective exchange value based on some other use or uses. This historical link is absolutely necessary, not only for commodity money, but also for every legally sanctioned credit or fiat money. No fiat money ever came into use without first satisfying this requirement. It is absolutely impossible to start a new money without an historical use value, or without its being related to some previous money or commodity with a prior use value. Before an economic good or a “paper money” begins to function as money, it must possess, or be given, an exchange value based on some use or good other than its own monetary value.[13]

“Money cannot originate as a new fiat name, either by government edict or by some form of social compact.”[14] Fiat money grows out of commodity money. “Money must emerge as a commodity money because something can be demanded as a medium of exchange only if it has a pre-existing barter demand. . . .”[15]

Unlike commodity money, fiat money does not come into use spontaneously. Conversion from commodity money to fiat money requires coercion. People do not naturally and freely abandon commodity money for fiat money.

Fiat money rests upon the premise that the power of government is enough to give value to a piece of paper that has no intrinsic value. Fiat money adherents firmly believe that a government can create value by simply proclaiming that a piece of paper has value. Evidence of this is seen in the federal reserve note. Originally, the note promised to pay in gold. Now it just declares itself to be so many dollars. It went from being a legitimate substitute for real money, gold, to being fiat money.

Gold and silver protect the people. Fiat money enslaves them. Frederick von Hayek remarks:

With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people. What is dangerous and ought to be eliminated is not the government's right to issue money, but its exclusive right to do so and its power to force people to accept that money at a particular rate.[16]

Commodity money limits the power of the government.

Gold and silver money limits the size of the government by restraining its growth. Fiat money allows the government to expand almost without limits.

Endnotes
1. Ludwig von Mises,. The Theory of Money and Credit (New edition. Translator H.E. Batson. Irvington-on-Hudson, New York: The Foundation for Economic Education, Inc., 1971), p. 61.

2. Charles Rist, History of Monetary and Credit Theory from John Law to the Present Day (1940; reprint. Translator Jane Degras. New York, New York: Augustus M. Kelly, 1966), p. 337.

3. Richard H. Timberlake, “Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy,”Econ Journal Watch, II (August 2005), 199.

4. Joseph French Johnson, Money and Currency: In Relation to Industry, Prices, and the Rate of Interest (Revised edition. Boston, Massachusetts: Ginn and Company, 1905), p. 32.

5. Hans-Hermann Hoppe, “How is Fiat Money Possible?—or, The Devolution of Money and Credit,” The Review of Austrian Economics, VII (1994), 49.

6. Rist, p. 434.

7. Edwin Vieira, Jr., “Restoring the Dollar,” http://www.citizensforaconstitutionalrepublic.com? Vieira_Restoring_the_Dollar.html, Apr. 23, 2008.

8. Mises, p. 62.

9. Mises, p. 62.

10. Antal E. Fekete, “Whither Gold?”, Oct. 29, 1996, http://www.sagold.com/whithergold.html, Sept. 13, 2007.

11. Ibid.

12. Percy L. Greaves, Jr., Understanding the Dollar Crisis (Belmont, Massachusetts: Western Islands, 1973), p. 231.

13. Ibid., p. 157.

14. Murray N. Rothbard, The Case for a 100 Percent Gold Dollar (Washington, D.C.: Libertarian Press, 1974), p. 10.

15. Hoppe, p. 51.

16. Antony C. Sutton, War on Gold (Seal Beach, California: ‘76 Press, 1977), p. 65.

Copyright © 2010 by Thomas Coley Allen.

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What Are the Functions of Money

What Are the Functions of Money
Thomas Allen

Money has four basic functions. They are a medium of exchange, standard of exchange value, store of value, and payment of debt.

As a medium of exchange or purchasing medium, money is used to buy goods and services. It is immediately available in its existing form to the buyer and immediately acceptable by the seller. Not only is money a means of payment; it is also the thing used as final payment for purchases. After a purchase has been made, money involves no continuing or further obligation. As a medium of exchange, money can transport value through space.

Fiat money is a failure as a medium of exchange. When a person buys something with fiat money, he pays with credit (the fiat notes). Buying goods and services with fiat money is more like nothing-for-something than something-for-something that occurs when commodity money is used. Fiat money is a poor semblance as a medium of exchange.

When a person buys with commodity money, he exchanges a real asset whose material value equals its monetary value for assets. Even if he buys with a form of credit money, such as a bank note or check, instead of commodity money itself, he still buys with a real asset. The credit money that he uses quickly converts into the underlying commodity. Fiat money can only be converted into another obligation.

Besides being a medium of exchange, money also serves as the standard unit of exchange value, i.e., as a standard of prices and of account and debt. Money is the standard by which the value of various things is measured and compared. Thus, money is a measure of value. As a standard of value, money can transport value through time. It enables people to estimate the present value of future acts.

With commodity money, the standard of value is objective. It is the value of the commodity in its nonmonetary use. With fiat money, it is an arbitrary arithmetical abstraction.

Being the standard of value, money is the common denominator by which the value of things is compared. It is the measure. As a measure of value, money simplifies the comparison of contemporaneous values of goods and services. By comparing prices of various goods and services, a buyer can determine their relative value to each other. For example, if a haircut costs $15 and a hamburger costs $3, then a haircut has the value of five hamburgers. Money becomes the common denominator by which the values of things are reduced to their prices. Price is simply “the exchange value of an article in terms of the monetary unit.”[1] Price makes possible the keeping of general accounts. Thus, as the standard of value, money becomes the unit of accounts.

However, for money to function properly as the common denominator by which values are compared, the monetary unit itself must have value. The monetary unit must have a specific definition and made of something that has value.[2] To measure value, it must be a unit of concrete value. For example, a silver dollar, the dollar mentioned in the U.S. Constitution, is 371.25 grains of fine silver or 412.5 grains of standard silver (nine-tenths fine). Money should contain material that is in itself valuable. It ought not to be an abstraction. It must be able to move value from one place to another and from one time to another.

The value of paper fiat money becomes an abstraction. Initially, its value is based on the commodity money that it replaces. No paper fiat money spontaneously comes into existence without a relationship to a preexisting commodity or tangible asset.

As a standard of value, fiat money also fails. It is useless as a long-term accounting unit without adjustments. These adjustments are poor substitutes for sound money. Furthermore, “business profits are widely overstated because historically determined depreciation charges are inadequate in terms of current replacement costs. Likewise for inventory accounting and charges for goods sold.”[3]

Money is also a store of value, i.e., wealth can be held in the form of money. As a store of value, money must be able to retain its value when moved from one place to another and from one time to another. It transports value over time and space. Money serves “as a standard of deferred payments.”[4] It “stores up the value of future goods and services sold”[5] and bridges the present with the future. People expect today’s money to serve as payment ten to thirty years from now. Such expectations make long-term contracts practical. The expectation is that today’s money will retain its purchasing power over the long term. Also, as a store of value, money serves as insurance against the uncertainties of the future.

To serve as a store of value, money must be stable in value for an indefinite time. As a store of value, fiat money is a miserable failure. In the United States since 1933, the dollar had lost 93 percent of its purchasing power by 2005. Since its complete divorce from gold in 1971, it had lost 79 percent of its purchasing power by 2005.

On the other hand, gold has retained its value through the millennia. The ancient Babylonian and Hebrew gold shekel contained about 252 grains of gold or about as much gold as an American eagle (a $10 gold coin).[6] Those 252 grains of gold are still worth 252 grains today.

If a time traveler carried a $10 gold coin back two thousand years, he would have the buying power equivalent to about 58 days of wages of a common laborer. A common laborer’s wage at that time was about 17¢ per day.[7] Moreover, because a double eagle (a $20 gold coin) contains twice the gold of an eagle, it would have twice the buying power. If he carried a $100 and a $1 federal reserve note with him, he would get only what he could trade his bills for as a curiosity. He would find the $1 bill worth more than the $100 bill if the person with whom he is trading finds that the occult symbols on the back of a $1 bill have great value whereas a picture of Independence Hall on the back of a $100 bill has none. Unlike commodity money, fiat money fails to maintain its value over time.

Nevertheless, the purchasing power of gold and silver does fluctuate. At times their purchasing power rises; at other times it declines. Gold and silver’s value tends to rise for about 10 to 20 years and fall for about 10 to 20 years. However, compared to fiat money, whose purchasing power usually trends downward, gold and silver are stable.

Money is not the only store of value. Commodities, financial assets, land, and collectibles can serve as a store of value. However, there is a cost to converting money into other assets and these assets into money. Money is merely the most liquid asset for a store of value as no conversion is needed.

Finally, money must be able to pay debt. It provides a means to pay debt.

When a person pays a debt, he either retires it or discharges it. If he pays with commodity money, such as a full-weight gold coin, he retires the debt. He has paid the debt with something that is no one else’s obligation.

If a person pays with paper money (gold certificates, bank notes, or government notes), a check, or any other kind of money substitute (credit money or representative money), he merely discharges the debt. He has paid the debt with another obligation or debt. The debt is not retired until the paper money is converted into commodity money or the check transfers the commodity money to the creditor’s account.

Although the same substance can perform all four functions of money, it does not have to do so. Much convenience is often found in one substance performing all four functions. For example, a 10-pennyweight gold coin can be a medium of exchange, the standard by which value is measured, a store of value, and a payment for debt.

Under bimetallism, gold and silver were used as money with a legally fixed exchange rate or ratio between the two. In the United States, silver was the standard of value until 1862. In 1834 Congress changed the exchange rate or ratio between gold and silver. The new ratio reduced the value of gold in terms of silver. Thus, full-weight silver coins soon ceased circulating, and gold coins became the medium of exchange. Silver was the standard of value. Gold was the medium of exchange. Both were a store of value.

Endnotes
1. E.C. Harwood, Cause and Control of the Business Cycle (Great Barrington, Massachusetts: American Institute for Economic Research, 1974), p. 58.

2. J. Laurence Laughlin, The Elements of Political Economy (New York, New York: American Book Co., 1887), pp. 61, 68.

3. Ernest P. Welker, editor, Why Gold? (Great Barrington, Massachusetts: American Institute for Economic Research, 1978), p. 11.

4. Joseph French Johnson, Money and Currency: In Relation to Industry, Prices, and the Rate of Interest (Revised edition. Boston, Massachusetts: Ginn and Company, 1905), p. 15.

5. Charles Rist, History of Monetary and Credit Theory from John Law to the Present Day (1940; reprint. Translator Jane Degras. New York, New York: Augustus M. Kelly, 1966), p. 84.

6. Madeleine Miller and J. Lane Miller, Harper’s Bible Dictionary (New York, New York: Harper & Brothers Publishers, 1959), pp. 454-455.

7. John D. Davis, The Westminister Dictionary of the Bible (Revised by Henry Snyder Gehman. Philadelphia, Pennsylvania: The Westminster Press, 1944), p. 630.

Copyright © 2010 by Thomas Coley Allen.

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Gold and Silver as Fiat Money

Gold and Silver as Fiat Money

Thomas Allen

Gold and silver can be used as fiat money and in fiat monetary regimes. How can this be? To understand how gold and silver can be used as fait money, one needs to understand what distinguishes fiat money from commodity money.

With commodity money, the value of the money equals the value of the material of which it is made. This equality of value can only be maintained with unrestricted importation and exportation of the monetary commodity and free coinage. With the true gold and silver standard, gold and silver are commodity money.

The true gold or silver standard requires free coinage. Under free coinage, any person can bring any quantity of gold or silver bullion to the mint and get it coined. Once the bullion is coined, the mint returns the coins to the presenter. The government does not buy the gold or silver with a check, certificate, or other paper money. The gold and silver remains the property of the person presenting it for coinage. Likewise, the minted coins are the property of the person who presents the metal. Furthermore, the government does not coin gold or silver on its own account.

With the true gold and silver standard, the market automatically determines the quantity of gold and silver coins. The people with each person acting in his individual capacity according to his economic contribution decides how much gold and silver to coin and how many gold and silver coins to melt for other uses. Thus, economics determines the quantity of money as gold and silver coins. The government’s monetary activity is limited to minting gold and silver coins and to certifying the weight and fineness of the metal content.

As Mises notes:

. . . it is the commodity in question that constitutes the money, and that the money is merely this commodity. The case of fiat money is quite different. Here the deciding factor is the stamp, and it is not the material bearing the stamp that constitutes the money, but the stamp itself. The nature of the material that bears the stamp is a matter of quite minor importance.[1]

With commodity money, the value of the currency equals the value of the material of which it is made or into which it is redeemable. The commodity makes the money. "The value of a coin has always been determined, not by the image and superscription it bears nor by the proclamation of the mint and market authorities, but by its metal content."[2] It derives its power from the material of which it is made.

With fiat money, the value of the currency equals what the government declares it to be. (Here value means nominal value and not purchasing power.) The stamp and force of government makes the money. Fiat money derives its power to make purchases and to pay debt solely from words printed on the currency, i.e., it derives its power from governmental fiat, the weapons of government.

Commodity money differs from fiat money in two important ways. First, under a commodity monetary system, the money supply adjusts automatically to meet monetary needs. "[T]he demand for, and supply of, money react simultaneously, through market prices for all goods and services and the monetary metal, to determine a given quantity of money."[3] The markets decide how much money to create and issue. They regulate the money supply. Under a fiat monetary system, the money supply is regulated artificially. The government or its central bank regulates the money supply. The government decides how much money to create and issue. Second, the value of commodity money is directly related to the material of which it is made. For fiat money, value is independent of its material and depends solely on the demand for and supply of money. Of these two differences, the most important lies in the method used to regulate the supply of money.

Thus, fiat money has two attributes that distinguishes it from commodity money. First and most important, the government or its agent, usually its central bank, arbitrarily determines the quantity of money. Second, the value of the material of which the money is made is usually less than its monetary value.

Commodity money is an economic currency. Needs of the economy determine its quantity. It is directly connected with the production of real goods and services.

Fiat money is a political currency. Needs of politics determine its quantity. It is directly connected with government debt even if the government issues the currency directly and interest free. (When the government issues a currency like U.S. notes, it is issuing interest free government debt that is used as money. Often such debt is never paid.) Politics and the fiscal needs of the government determines the quantity of fiat money. The quantity of money is independent of the market or economic needs or demand for money.

Three examples of gold and silver being used as fiat money or in connection with fiat money in the United States follow.

The first example involved the U.S. note or greenback. When President Lincoln first issued U.S. notes to finance his war to destroy the Constitution, they were pure paper fiat money.

U.S. notes were legal tender for public and private debts—except for the payment of tariffs. They could not be used to pay tariffs, which was a major source of revenue for the U.S. government.

The U.S. government did not fix the exchange rate between the U.S. note dollar and the gold dollar until 1879. In 1879, the U.S. government fixed the exchange rate of the U.S. note at 23.22 grains of pure gold per dollar. That is, a U.S. note dollar equaled a gold dollar. This exchange rate continued until President Roosevelt stole the people’s gold and ended the gold standard.

Obviously, U.S. notes were fiat money between 1862 and 1879 and after 1932. Congress arbitrarily fixed the quantity issued. Their monetary value far exceeded the material, paper, of which they were made.

Were they fiat money between 1879 and 1933 when Congress made them redeemable in gold at par? Yes. Congress decided the quantity issued. Also, as their gold backing was only about half or less[4] of the outstanding notes, they were not warehouse receipts like gold certificates. They represented at least twice as much gold as the gold backing them. Therefore, their monetary value was significantly more than their commodity value.

The second example is the silver dollar between 1873 and 1900. In 1873, Congress ended the silver standard, and by that action it ended the constitutional dollar. To appease the pro silver forces, Congress authorized the minting of silver dollars. However, it did not open the mint to the free coinage of silver. The U.S. government bought silver on its own account and coined it. Thus, Congress and the Secretary of the Treasury arbitrarily decided the quantity of silver dollars to mint and issue.

Furthermore, Congress declared the silver dollar to be money in its own right. It fixed the value of a silver dollar to equal the value of a gold dollar. Silver dollars could not be directly redeemed in gold on demand; therefore, it was not a subsidiary coin for gold as were silver halves, quarters, and dimes. Moreover, the value of silver in a silver dollar was worth less than a dollar. It varied between 40 cents and 97 cents in gold.[5] In 1900, Congress made the silver dollar a subsidiary coin for gold and by that ended its status as fiat money.

The third example is the federal reserve note after Roosevelt stole the people’s gold in 1933. Before his thief, federal reserve notes were not legal tender and were redeemable in gold on demand. They were not fiat money. They were merely a form of credit money.

After Roosevelt’s thief, American citizens could no longer redeem federal reserve notes in gold. Congress declared federal reserve notes to be legal tender for all public and private debts. Thus, federal reserve notes became fiat money. The Federal Reserve arbitrarily regulated the quantity of notes issued. The monetary value of a note far exceeded the value of the material of which it was made.

Nevertheless, Congress required a 40-percent-gold backing for federal reserve notes. It changed this requirement to 25 percent in 1945 and eliminated the backing entirely in 1968.

In summary, the United States has had fiat money redeemable in precious metal, fiat money made of precious metal, and fiat money backed by precious metal.

Another fiat monetary system using gold has been promoted by some economists. This system requires the Federal Reserve to expand and contract the money supply and credit to keep the price of gold within a specific range. It is a fiat monetary system where the price of gold becomes the index by which to adjust the money supply. This system has not been officially used in the United States.[6]

As shown above, fiat money is not necessarily paper money or its electronic equivalent although it usually is. Moreover, paper money is not necessarily fiat money. If the government, its central bank, or some other entity decides the quantity of paper money issued and regulates its supply, that money is fiat money. If the people with each person acting in his individual capacity decides how much

of their metallic money or commercial money[7] to convert to privately printed paper money, that paper money is not fiat money—especially if it can be converted back to gold or silver on demand.

The classical gold standard is an utter failure at accommodating the welfare-warfare state. It can accommodate world trade and commerce many times over, but it cannot support the welfare-warfare state. (One of the first casualties of war of any significant is the gold standard.) For this reason, governments hate the gold standard and seek ways to abandon it. They often replace it with a fiat monetary system that incorporates gold. Thus, they control the gold instead of the people or the markets. Whenever even this highly controlled gold begins to impede the welfare-warfare state, governments abandon it in favor of pure paper fiat money.

Because the quantity of gold and silver is limited, the quantity of fiat money using them is limited much more than fiat money using solely paper and electrons. For this reason, gold and silver seldom appear in fiat monetary regimes except as a ruse. The exception has been silver in subsidiary coins. However, even this silver must eventually be removed as the value of the silver in the coin approaches the value of the coin.

In summary, two types of monetary systems exists. One uses commodity money. The other uses fiat money. Using a commodity for the money does not make it commodity money. After all, paper is a commodity, and most fiat money is paper. What distinguish commodity money from fiat money is how the money is created and issued and how its quantity is regulated.

For a more detailed discussion of fiat money, commodity money, and the true gold and silver standard, see the author’s book Reconstruction of America’s Monetary and Banking System: A Return to Constitutional Money.
Endnotes

1. Ludwig von Mises, Theory of Money and Credit (new edition, 1971) p. 62.

2. Ibid., p. 65.

3. Richard H. Timberlake, "Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy," Econ Journal Watch, II (August 2005), 199.

4. In 1932, the U.S. Treasury held $156 million in gold to back $289 million in U.S. notes (Board of Governors of the Federal Reserve System, Banking and Monetary Statistics, 1914-1941, pp. 409, 506.) In 1879, it held $133 million in gold (H. White, Money and Banking, p. 196) to back $347 million in U.S. notes (J. Johnson, Money and Currency, p. 283).

5. Joseph F. Johnson, Money and Currency (revised edition, 1905), p. 251.

6. A variant of this system has been unofficially tried in recent years. Instead of adjusting the supply of dollars to maintain the price of gold within a specific range, the Federal Reserve and the U.S. government in collaboration with other central banks and governments have attempted to adjust the gold supply to maintain its price below a certain level.

7. Commercial money is a real bill of exchange. A real bill of exchange is created when a supplier or manufacturer enters into a agreement with a retailer to allow the retailer time, 90 days or less, to sell the merchandise to collect money from the final consumer to pay the bill. The supplier can use the bill of exchange to pay his creditors or sell it to a bank. When a bank buys a real bill of exchange, it converts it to bank money (bank notes or checkbook money).

Copyright © 2009 by Thomas Coley Allen.

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