All money is a tool for market efficiency and specialization. As efficiency and specialization occur, more production is possible. As a result, the amount of labor it takes per unit of production decreases; hence, its price, naturally decreases. A single unit of a commodity based currency with intrinsic as well as utilitarian value tends towards deflation because it purchases more and more goods and services.
Likewise, given an ethical populace, with ethical laws and standards, all economies with a healthy currency, tend toward full employment. This too is self-interest. Why should any member of the economy want to work more than is necessary? If goods and services become less and less expensive, then the incentives to invest or hire others to do work you once did increases. Moreover, a deflationary economy increases demand as the purchasing power of the monetary units increase. An efficient market is an inclusive market.
By definition, a fiat currency implies a very powerful centralized government. Since bigger, more centralized governments are less responsible, they tend toward debt. This in turn breeds inflation-ridden fiat currencies. “When governments fear the people, there is liberty. When the people fear the government, there is tyranny” (Jefferson). A less responsive government is less responsible. Hence, governments with the power to issue fiat currencies tend to be less responsive and in greater debt. Debasing the currency allows governments to extend their debt by repaying loans or by paying contracts in less valuable currency than they borrowed. This is a hidden tax.
Whether or not tyrannies have lost their fear of the people is an open question, but a strong currency is a still in every government’s self-interest. Run away inflation doesn’t benefit even the most powerfully centralized government. The power to tax and to exert authority, even over the military, is based on a steady currency. Hence, every government with a fiat currency must have a monetary policy to combat hyper inflation and to avoid deflation. It should surprise no one that today’s Federal Reserve Chairmen try to produce a “low-inflation environment,” for this is monetary policy most in the interest of every centralized government. As the economy specializes and becomes more and more efficient, the government’s fiat policy will allow it to extort a hidden tax by scraping the first fruits of those efficiencies into its own coffers (on some of these increased efficiencies see Horwitz’s PowerPoint Table 1). This slows demand and the inclusive quality of healthy free-market economies. An inflationary fiat currency limits money’s ability allow a society to self-organize and optimize.
A centralized government will contract with Contractor Dave for X dollars of fiat currency. By the time Dave is paid, he will be paid in X minus Y where Y is the amount of inflation the government thinks the economy can bear. Not only does Dave suffer loss of Y (which he may have been able to calculate and include in his bid), but he also loses what he can’t calculate: the natural deflationary benefits he should be reaping from the greater and greater efficiency of the market of which he is a part. There is a science to keeping a fiat currency in a low-inflation environment. It is a far from perfect or complete science, but it is a study of “money supply.” Such studies endeavor to use the illusions debt produces to generate specific results. “Money” no longer includes only what is produced (Says Law) but is a measurement of the promise of production.
Debt generates illusions because of the human sense of time. Almost every debtor receives a momentary euphoria when a loan is granted because he receives current benefits while responsibilities for production are in the hazy future. The greater the benefits, the greater the euphoria, and, of course the greater future responsibilities the debtor incurs. Should a debtor incur more responsibilities than he should, he will be forced into dire consequences such as bankruptcy. This is a microcosm of the boom and bust “cycle” of capitalism. A loan confers the ability to demand services in the present for a future of contracted demand. These illusions are the fundamental source of the complexity involved in evaluating economic processes and developing monetary policy.
When a laborer is paid with a fiat currency he is, essentially, a creditor. The laborer is not made whole until he makes a second transaction. In an inflationary environment he has made a bad loan. He had little say in the matter, but the government instituting the fiat currency and debasing it experiences the sense of invulnerability that generally accompanies receiving a new loan. This is a bad thing for the government of a free people to experience.
The sparkling allures of fractional banking are another branch of the illusions of debt. Monetary theorists often speak of fractional banking as expanding the money supply by “creating” money out of nothing. Of course fractional banking does no such thing; instead, fractional banking generates a bubble of demand by putting everyone in debt. Joe Farmer deposits $100.00 into Jim Fisher’s legally permitted fractional bank. Mr. Fisher then loans $90.00 of Farmer’s money to everyone else. Mr. Fisher is now in debt for $90. Not only is Fisher in debt, but others in the economy are now also $90 in debt. The economic system has $180 of debt where there was once $100 of savings. Theoretically, if Fisher’s $90 was loaned to a second, smaller bank run, by, let’s say, Mr. Angler, Mr. Angler could then loan out another $81. Hence, the increase in debt would be $180 + $171, or $251.00. A period of suddenly high demand results from this process, but its increase is with the promise of a future time of decreased demand. More importantly, every time Fisher receives $1 dollar of Farmer’s money back he can lend out almost nine more.
All of this is the illusion of debt. Each borrower is betting on harvesting the benefits of an increasingly efficient economy. Of course, as increased borrowing hypes demand, the returns on investment seem too good to ignore. The illusion of mass debt masks the reality that the economies efficiencies are not as great as everyone thinks. This tends toward a mass irresponsibility. Almost inevitably, like a game of musical chairs, the music stops and the bill suddenly comes due. Historically, banks go belly up. Fisher skips town. Farmer loses his savings. The money supply “contracts” because everyone is broke. In America deposits up to a $100,000 insured. If the banks that were allowed to fail in 2008 and in 2009, the FDIC would have owed the trillions our government loaned to the banks. The taxpayers would have been picking up the tab either way.
It would be ironic indeed if future historians found that Federal Reserve officers were far more responsible than the corrupt officials elected and appointed by the people. Federal Reserve banks do have an interest in a stable currency, and they have reason to continue to use their authority responsibly. However, any cursory study of the Federal Reserve Bank’s sweeping economic powers, coupled with its utter lack of accountability, reveals the tremendous potential for abuse in the current system.
Since all fiat money is debt (see Part II), the power and the dangers of debt must be factored into any monetary policy.
Fractional banking tends towards inflation. At first this seems counter-intuitive. If Mr. Fisher lends out $100, wouldn’t he want to be repaid in dollars of equal value? Well, yes, on the one hand, that’s the plan, but as long as Jim can charge an interest rate above the rate of inflation, he is more than happy with inflation. Why? Jim needs collateral on his loans. These appear on the bank’s balance sheets. If Jim lends $100,000 to Tony, Tony’s house must be worth at least $110,000, or Jim has made a bad loan. If Tony loses his job and can’t repay the bank, the bank can sell Tony’s house and get its $100,000 back plus the $10,000 Tony originally invested as a down payment (not to mention any payments of principal and interest Tony has made in the interim). That’s fair right? Well it gets even fairer with a little inflation. With a little inflation the home Tony purchased for $110,000 might be worth $135,000 by the time Tony loses his job. Mr. Fisher’s asset balance always looks great. On the other hand, if there is deflation Tony is in a strong position to ask for a restructuring of his loan. After all, if Tony defaults and the bank can only get $80,000 for Tony’s home, ol’ Jim Fisher is in a bit of a tangle. This is why the deflationary policies can cause bank runs and bank failures. That’s why when gas prices popped the housing bubble by substantially reducing demand for more expensive homes in suburban areas, the world’s banks shuttered. If the inflationary pressure on homes had continued, the bad Fannie Loans wouldn’t have mattered because the bank portfolios would have increased, not decreased in asset value.
Because all genuine demand is based on production, the illusions debt generates create bubbles in markets. The actual values exchanged are warped by the euphoria the borrower gets. The borrower typically overpays for goods or services because the actual value of the money he is exchanging is lost in the fuzzy future.
The notion of Keynesian deficit spending adds a second level to the illusion. When the government of a free people sells itself into debt, it sells its people into debt. Because of debt’s powerful illusions, the fate of the people is all but completely obscured.
The Federal Reserve Bank has the power to confer all sorts of loans. It is especially dangerous in so far as it makes loans that postpone the payment of government debt. Because the Federal Reserve Bank’s powers to confer debt are far greater than little Jim Fisher’s, its power to produce bubbles is vast. The Federal Reserve Banking System was formed to provide solutions to the boom and bust cycle caused by fractional banking. Theoretically, as centralized units of cavalry could be rushed quell violence on distant points of the frontier so also could gold be rushed to banks at which there was a run. Instead of ending the practice of fractional lending, the United States doubled down on the powerful illusions generated by debt.
The essence of all property rights is the right to the fruits of one’s labor. The fundamental fight in much political, all economic, and some literal war is over the power to separate a person from his property rights. The age old method of economic warfare is the careful crafting and wielding of debt.