This post is the kick-off "meeting" of our book club. A book club, unlike a book review, means that everybody participates in the discussion on an equal footing. Like many meat-space book clubs it will be moderated (hopefully lightly - just to prevent abuse.)
As previously announced we are reading A History of Money and Banking in the United States: The Colonial Era to World War II by Murray N. Rothbard (HOMIUS, for short.)
After I started writing this first installment I realized that it would be hard to have a meaningful discussion without first clarifying some concepts. That is the meaning of 0.1 in the title - it is mostly not about the book itself, so strictly speaking not the first post on the main subject.
I also realized how difficult it is for me to find time and focus on writing. Approximately 1/3 of this post was written in August while I was on vacation spending a few days away from my family. The rest was written on a train commuting to and from work.
What is Money?
Money is defined by its functions, of which there are famously three: it is a medium of exchange (aka currency), a store of value, and a unit of account. The more something meets those criteria the more it is money-like. It's the first function, however, that is the most indicative. Land and real estate have been used in many societies as the store of wealth, but I know of no examples when it was used as a medium of exchange on a regular basis or directly as a unit of account (do you?). Also, something is usually used as a unit of account when it is used as currency at least somewhere.
If you search for the definition of money on the interwebs you'd find many that that require it to be a commodity. We all know, however, that it does not have to be a commodity, or even something physical. For most westerners nowadays money is just some information stored digitally by their financial institution.
One of the most fascinating examples of money is Rai stones from Yap islands. They are the proof that money is an abstract concept and does not have to have an intrinsic value.
Time Preference
People have different time preferences. Folks with low time preference value the future compared to the present relatively more than those with high time preference (think YOLO.) The former prefer hard money so that they can use it to transfer value to the future. Also, as a rule low time preference folks among private people (not banks or merchants) are creditors. After all, they have money to lend and are more willing to lend it to get a future payoff. And lenders don't like inflation.
Those with high time preference prefer soft inflationary money, so that they can borrow now and repay less in real terms later.
Governments tend to have high time preference. It's not their own money that they spend, so why not spend it now? In addition, low time preference assumes that I see my future self or my heirs strongly connected to my present self. That does not work with impersonal governments - a future government is not the future self of the present government. [Note that that argument works well for large-scale democracies and oligarchies, it somewhat breaks down for monarchies and aristocracies, as well as for smaller-scale governments - e.g. town and community governments as long as they are sufficiently independent.]
War is a major driver of inflation. It is easier administratively to finance wars with debt rather than with ramping up taxes. The domestic debt comes in two main flavors: bond and fiat issuance. Fiat is more expropriatory than bonds as it is forced on people by the direct power of the government. You are legally required to quote the same price regardless of if paid in fiat or in hard money. And there are consequences if you don't.
Bonds are a more honest type of debt as people are not directly forced to buy them. There are always indirect ways, though, such as propaganda to induce people to buy government bonds - we'll see it later in HOMIUS. In addition the question with bonds is how they are redeemable. Specie? Fiat? In lieu of paying taxes? Even if initially the obligation was to pay in specie the government might "change its mind" and decide to pay in fiat instead.
Banks and Fractional Reserve Banking
Time and again Rothbard uses the concept of banks pyramiding bank notes and deposits on top of their reserves. "Pyramiding" means that the sum total of the notes and deposits is greater than the reserves of specie (or specie and fiat - we'll come to that later) in the bank's vaults. Think of the tip of an inverted pyramid representing the reserves, while its base represents the notes and deposits. Why notes and deposits? Because those are the bank's on-demand liabilities. They must be exchanged more or less immediately for specie from the reserves when demanded by note holders or depositors.
That pyramid is created when banks originate loans. When a bank originates (buys a new) loan (a stream of future payments) it pays for it in one of three ways or their combination: with reserves, by issuing notes, or by creating deposits. Which means decreasing the ratio of reserves to on-demand liabilities. That ratio is called the reserve ratio. The important point to grasp here is that loans are *future* payments. A bank cannot legally demand loan repayment from or sell the collateral of a borrower who is not in default. So in case of a bank run the reserve ratio is what matters. The higher it is the better the bank can weather the bank run. Which in turn means that the bank run is less likely to happen.
Pyramiding increases the amount of money in an economy. Consider a simple example. Alice deposits 100 gold coins with Bob's bank. The bank now loans 50 of those gold coins to Charlie to be repaid in a year (with interest, but that's not relevant for this example.) Now Charlie can spend those 50 gold coins, but Alice also behaves on the assumption that she has the full amount of her 100 coins deposited in the bank. She might decide to buy a more expensive new car, rather than a cheaper used car, which she would not do if she knew that she had only 50 coins and not 100. So we see that de facto the amount of money in the system increased by 50 coins.
By law banks are required to maintains a certain minimal reserve ratio (which, by the way, is currently zero in the US, but I digress.) Interestingly, here what Rothbard has to say about that legal requirement:
Reserve requirements are now considered a sound and precise way to limit bank credit expansion, but the precision can work two ways. Just as government safety codes can decrease safety by setting a lower limit for safety measures and inducing private firms to reduce safety downward to that common level, so reserve requirements can and ordinarily do serve as lowest common denominators for bank reserve ratios. Free competition can and generally will result in banks voluntarily keeping higher reserve ratios. But a uniform legal requirement will tend to push all the banks down to that minimum ratio. And indeed we can see this now in the universal propensity of all banks to be “fully loaned up,” that is, to expand as much as is legally possible up to the limits imposed by the legal reserve ratio. Reserve requirements of less than 100 percent are more an inflationary than a restrictive monetary device.
A related idea that Rothbard keeps repeating is that when there are a lot of independent banks they keep each other honest by requiring redemption of each other's notes in specie. Here is an example: Alice banks at bank A, while Bob at bank B. Alice pays Bob with a "one gold piece" note (or a check) from her bank. Bob goes to his bank which deposits that note or check in Bob's account. Which just means that it owes Bob one more gold piece. Now bank B collects all notes and checks it has from bank A and presents it to the latter for redemption in specie. When there are a lot of relatively small banks each one ends up facing frequent redemption demands for significant portions of its funds. So banks have to maintain relatively high reserve ratios.
Suppose now there is only one big bank FED. When Alice pays Bob with a note or a check from FED and Bob deposits it into his account at FED the bank just changes some numbers on its books. No gold needs to leave its vaults. The incentive to maintain higher reserve ratio is much lower in this case.
Gresham's Law
Understanding Gresham's law is a must for understanding money. It is sometimes confused with Gershwin's law (which is "it ain't necessarily so"). Gresham's law is usually stated as "bad money drives out good money". However, that formulation is incomplete. The important condition for Gresham's law is that people are forced (usually by governmental or some other authority) to accept at least two different kinds of moneys at a fixed exchange rate. The bad money is the money that is consistently overvalued by the enforced exchange rate. People then prefer to pay with the overvalued money while hoarding and exporting the good money. Hoarding comes in the hope of getting better value for the undervalued money later. "Exporting" means using the good money to buy imports, which become cheaper in nominal terms when paid for with good money. Since both hoarding and exporting have their costs there must be a sufficient arbitrage between the two kinds of money for Gresham's law to kick in. It seems that in America before WWI that arbitrage had to be at least 3%.
Bimetallism
At the time of this writing the gold price is approximately $60 per gram while silver is at $0.76 per gram.
A gold coin worth $1 would weigh approximately 17mg. For comparison, a dime weighs 2.3g. Considering that gold's specific gravity is approximately twice that of nickel and copper, a golden dollar that has the same thickness as a dime would be just 6% of the dime in diameter! That clearly would be very impractical. The minimal standard denomination of a golden coin that makes sense size-wise is $50, it would be slightly less than half in diameter than a dime at the same thickness.
On the other hand, a silver dollar would weigh 1.3g. Silver is just slightly heavier than copper and nickel, so a silver dollar would have the diameter of 70% of that of a dime at the same thickness. This is much more practical than a golden dollar coin. But even then making silver coins for smaller denominations than a dollar would be impractical. One approach would be to add copper and nickel to reduce silver content.
We conclude that silver is much more practical for minting coins of lower denomination. Why then not just use silver? That indeed was the case in many societies. Gold, however, is harder money than silver. Gold is less abundant than silver and harder to mine. The interwebs tell us that gold stock-to-flow ratio is 60-65 years, while for silver it's 20 years (although there are some opinions putting it higher.) In addition gold is better for minting coins of higher denomination and for stockpiling. Currently the richest person in the world (Elon Musk) is worth $250 billion. If he were to store 10% of his net worth in silver it would weigh almost 33,000 tonnes, and take at least 3,300 cubic meters of storage (a 6-story cube building.) In gold it would be 416 tonnes and take at least 22 cubic meters (a one-story cube building.)
[BTW, that example shows that all the calculations above have a serious deficiency: if we were to move to the gold standard, value of gold in terms of real goods would skyrocket. Because even according to the most liberal estimate the amount of gold in the world now is 200,000 tonnes; the combined net worth of the richest 200 individuals in the world is more than that given the current gold price.]
With both gold and silver having their pros and cons many societies, including the Ancient Rome, Britain, and America, ended up with the bi-metallic standard: the coins of higher denomination would be minted from gold, and the lower denomination coins would be silver, with some of the coins having copper admixture or even entirely made of copper.
The problem with bimetallism, of course, is that when the money's worth is assigned by law (e.g. coin face value), changes in relative worth of gold and silver would make one of them "good" and the other "bad" money with respect to Gresham's law. The good money would then disappear from circulation. Note that it's not necessarily gold that is always the "good" money in such a case.
> War is a major driver of inflation.
Or was until the 20th century. Then it became various social entitlements.