Why we can’t have nice things – The Fiat Money System
What is the world’s most pressing issue? Many might think of climate change, global poverty or factory farming, whereas I’d like to discuss an issue that is much more fundamental: Our monetary system.
Nation-states all over the world have introduced a fully free-floating legal tender, and it took the powers that be many decades to abolish the redemption in specie, but finally in 1971 US president Richard Nixon unilaterally cancelled the direct convertibility of the United States dollar to gold and ever since a system of national fiat monies has been used globally, with freely floating exchange rates between the major currencies. The adoption of fiat currency by most countries, from the 18th century onwards, made much larger variations in the supply of money possible. Clearly, without fiat (= money created out of thin air) all major wars since WWII would not have been possible, as central banks had to greatly increase the supply of money to give the necessary loans to their governments to finance their war machinery.
Our monetary system enslaves billions of people all over the world and prevents humanity from evolving further.
Delving deeper into the interwoven web of modern finance, through the fractional reserve system banks are empowered to lend money they don’t have and make a profit from the interest; and thanks to government bailouts they can socialize their losses – meaning taxpayers have to pay for it.
Fractional reserve banking means that a bank accepts deposits, makes loans or investments, and holds reserves that are equivalent to a fraction of its deposit liabilities. Hence, if the central bank sets a minimum reserve requirement of only 10%, banks can multiply the deposits they hold tenfold and lend ten times as much as they actually have control over. The ECB currently sets a minimum reserve requirement of 2.75%, meaning banks in the EU can lend 36€ for every euro we hold in our bank accounts. If a larger number of bank customers would try to withdraw their money at the same time, a bank run would occur as only a fraction of all savings are available and the banks would go bankrupt. Ultimately, the fractional reserve banking is only a symptom of a bigger disease: the central banking system.
The Mises Institute sums up the case for abolishing the US central bank like this:
“Abolishing the Fed would put a huge brake on the planning state. Without the ability to expand the money supply at will, the federal government would become about as threatening as state or local government. That is to say, the federal government would still be an intolerable imposition on life, liberty, and property; but we wouldn’t be worrying about hyperinflation, large-scale bubbles in specific sectors, crazy business cycles, trillion-dollar bailouts, controls that reach into every nook and cranny of our lives, a cradle-to-grave welfare state, or a global empire that invades any and every country at will, and makes America the enemy to whole regions of the world. […] It would dramatically change the political culture in this country. Bureaucracies would tumble. Trade would stabilize. The investment-risk calculus would accord with the free market. The Left could no longer live out its pipe dreams of socialist utopia at our expense. The Right would have to give up its wacky notion of a world police state. The power ambitions of whole sectors of society would be scaled back.“
Moreover, when a central bank decides to increase the money supply, the new money enters the economy through the same markets that people borrow and lend. The new money increases the supply of present money available for lending, which, as we all know, will decrease the price, or the interest rate in this case. To be clear, this lower interest rate does not reflect people’s willingness to save or invest, but only reflects the central bankers’ intervention. This artificially low interest rate sends all of the same signals to entrepreneurs and lenders that a normal interest rate does, but is not based on people’s real preferences. The lower interest rates induce more borrowing and less saving. Entrepreneurs are eager to take out loans at the lower interest rate and they take their funds and purchase factors of production. At the new, lower interest rate, the lines of production they undertake are the ones that weren’t as profitable as before. Everybody is happy as they consume, invest, earn higher wages, start new projects, and enjoy the ride to the top.
Unfortunately, this high cannot last forever. no new resources have been created, only new money out of thin air – fiat money. The signals entrepreneurs rely on were falsified and based on the whims of a few powerful people, not the collective, voluntary interactions of individuals on the market place everywhere. The boom peaks and falls into a bust when the increasingly scarce factors of production become too expensive and people start to realize the damage that has been done. In the past and up to today, the necessary correction – the bust – hasn’t been allowed to run its course before central banks reinflate and restart the cycle; therefore we know it as the boom-bust cycle.
In a nutshell, the malinvestment of money created out of thin air leads to boom and bust cycles, which in turn cause huge economic damage.
Lastly, our monetary system keeps the majority of workers in artificial poverty even though we have made enormous technological developments and should have greatly reduced human hardship everywhere.
Expansionary monetary policy constitutes a transfer of purchasing power away from those who hold old money to whoever gets new money. The so called Cantillon effects are the real fundamental changes in resource allocation that result from changing relative prices between the time of the creation of new money and the full adjustment to the increase in supply. This way, all major banks and corporations close to the central bank chain of money supply will benefit from cheaper prices until the laws of supply and demand adjust the price ratios again. The downside of this is that eventually everyone else in the market will be expropriated through this hidden inflation tax and suffer from less purchasing power. The improvements in technology and industrial efficiency are mostly eaten away by these Cantillon effects, so that we still experience poverty and crime in 2016, even though this could have been a thing of the past if it wasn’t for central banks and their fiat money system.
Essentially, our monetary system is based on central banking, the fractional reserve system and valueless legal tender, which allows governments and their cronies to manipulate the market economy in their favor. Everyone else living in this fiat money world has to suffer from this, as they have to work much more and harder than they would actually have to. Much of the world’s adversities would be prevented if we had a sound monetary system.
 End the Central Bank, 11/10/2008, Llewellyn H. Rockwell Jr.
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