Well-known scholars thus far have understood that the private banking system is the root cause of the perpetuating debt and unsustainable growth that many countries have been experiencing.
These problems have forced many leaders to propose solutions to the current monetary system.
This movement is known as Monetary Reform, and within the movement there are quite a few different camps. These include;
Fiat Debt-Free Money Reformers (FDF)
Modern Money Theorists (MMT)
Post Keynesian Reformers (PKR)
Islamic Banking Advocates (IBA)
Social Credit Reformers (SCR)
Land Reformers (LR)
Hard Money Reformers (HM)
Competing Currency Reformers (CCR)
This article presents the case of hard money advocates and their proposals to reform the current monetary system.
Hard money advocates hold the view that Government’s should back the value of their currency with hard, tangible, and lasting material.
Gold, silver or platinum are often used since these metals retain their value over extended periods of time.
The concept of hard money and the gold standard originally stems from the principles brought forth by the Austrian Economic School of thought.
The Austrian School is a school of economic thought that derives its name from its Austrian founders and early supporters, most notably Ludwig Von Mises.
Austrian School of Economics
Austrians differ significantly from other schools of economic thought, in their methodology.
Mainstream schools, such as Keynesian and Monetarists, adopt empirical, mathematical, and statistical methods in studying economics.
Austrians reject empirical statistical methods, natural experiments, and constructed experiments as tools applicable to economics, arguing that the actions of humans are too complex for such a treatment because humans are dynamic and adaptive.
Austrian economist’s views on inflation, the business cycle, and monetary reform have also widely differed from those of other schools.
Each of these views is covered in more detail below.
Many Austrian economists maintain that inflation is simply an increase in the money supply that leads to a higher nominal price level for goods and services in demand (i.e. bonds).
Nominal Price refers to the price of goods without factoring in inflation.
For example, a bond worth $1000 in 2010 earning 10% at simple interest would be worth $1100 in 2011.
Real Price refers to the Nominal price minus inflation.
From the previous example, if inflation rose by 5% during 2010, then the real price of the bond would be $1100 (Nominal Price) – $50 (5% Inflation) = $1050 real price of bond.
Thus one can see that inflation eroded $50 dollars of the value of the bond which means the real price of the bond is now $1050.
Austrian School economists regard the private bankers and the central banks as the main cause of inflation in an economy because all major economies have a central bank supporting the private banking system.
This regard holds true in Canada, where the Bank of Canada deliberately sets inflation at 2% in order to preserve confidence in the value (purchasing power) of money.
Austrian economists also state that the private and central banks also contribute to the various booms and busts of the Business cycle.
According to Austrian School economist Joseph Salerno, what most distinctly sets the Austrian school apart from other theories is the Austrian Business Cycle Theory.
According to their theory, the business cycle unfolds in the following way,
Fractional reserve banking continually causes inflation through the “artificial” lowering of interest rates compared to what they would be in a stable money environment.
This can occur indefinitely with the aid and assistance of the central bank. Central banks can offer low interest rates to encourage fresh borrowing and new credit creation, thereby increasing the short term profitability of the banking system.
However, the expansion of credit created by the fractional reserve system also causes an expansion in the money supply.
This artificial increase in money and credit inevitably leads to the misallocation of capital resources.
The extra credit allows borrowers to speculate and pursue diminishing investment opportunities that they would not have pursued had the money supply remained stable.
This inevitably leads to a correction (recession) because credit creation cannot be sustained.
Eventually the markets clear and the money supply contracts, which cause resources to be reallocated back toward more efficient uses.
To prevent this recurring cycle of booms and busts, Austrian economists propose two solutions to reform the current monetary system.
Full Reserve Banking
These are discussed in greater detail below.
Free Banking (FB)
In the first solution, Austrian scholars propose the Free Banking System, where banks are permitted to engage in fractional-reserve banking activities provided they comply with the laws against fraud.
Under the Free Banking System, banks are not supported in any way against the possibility of bank runs and are forced into bankruptcy if they are not being able to pay their debts.
The advantage of this system is that it protects taxpayers from having to bailout over-leveraged banks.
Full-Reserve Banking (FRB)
In the second solution, Austrian scholars advocate the Full-Reserve Banking system, because they consider fractional-reserve banking to be inherently unethical and disruptive.
Full-Reserve banking requires banks to retain all deposits for immediate withdrawal. Banks may be permitted to lend from long-term deposits with the depositor’s permission.
In essence, the FRB system imposes a 100% reserve requirement on the private banks.
This would greatly reduce the financial risks associated with bank runs, as banks would have all the money in reserve needed to pay depositors – regardless of whether they actually claimed their money.
This also eliminate the need for a central bank, which is normally needed to support the banking system in times of systemic risk, as these financial risks would not exist in a FRB environment.
In either solution, Austrian scholars argue that the abolition of legal tender laws and the spontaneous return to a gold or silver monetary system would effectively constrain unsustainable fractional-reserve banking practices, ensuring that inflation would never spiral out of control.
Many of the principles put forth by the Austrian school of economics originated from a handful of prominent academics.
A few of the most notable academics throughout the decades have been Ludwig Von Mises, Murray Rothbard, and Friedrich Hayek.
Mises had been a prominent figure in the Austrian school and many of his arguments have called for the introduction of a gold standard, because it would be a check on inflation.
Mises presented the case for the gold standard in his book titled Economic Policy where he said,
The gold standard has one tremendous virtue: the quantity of the money supply, under the gold standard, is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against spendthrift governments.
Mises opposed coercive legal tender laws imposed by the government and believed that fiat currency (printed money) held no real value since it was backed by nothing.
Many of his ideas were later incorporated into the writings of Rothbard and Hayek.
Rothbard, a student of Mises, would go on to theorize a form of free-market anarchism, which he coined anarcho-capitalism.
All three of these individuals believed in similar economic and political arguments:
Politically, they believed the monopolistic power of government represented a great danger to liberty because the government would use its monopoly power to abuse the right to create money and defraud the people.
This is exemplified in Hayek’s Book New Studies in Philosophy, Politics, Economics and the History of Ideas, whren he wrote,
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.
For the economic side of the argument, these individuals believed in a laissez-faire (a.k.a. leave-it alone) approach to the economy.
This is the idea that transactions between private parties should be free from tariffs, government subsidies, and enforced monopolies, with only enough government regulations sufficiently necessary in order to protect property rights against theft and aggression.
The emphasis here is on “free”, for “freedom” or “liberty”. Liberty becomes a very central point to the principles of the Austrian school.
On this note, the Gold standard represents economic liberty, from the monopolistic tendencies of governments.
The case given for gold is that in contrast to gold’s properties, fiat money could be produced in massive quantities by central banks and governments which would inflate the money supply and erode the purchasing power of the monetary unit and rob the people.
All of this is explained in Rothbard’s book titled The Mystery of Banking, where he wrote,
Given this dismal monetary and banking situation…how can we possibly return to a sound noninflationary market money? The objectives, after the discussion in this work, should be clear: (a) to return to a gold standard, a commodity standard unhampered by government intervention; (b) to abolish the Federal Reserve System and return to a system of free and competitive banking; (c) to separate the government from money; and (d) either to enforce 100 percent reserve banking on the commercial banks, or at least to arrive at a system where any bank, at the slightest hint of nonpayment of its demand liabilities, is forced quickly into bankruptcy and liquidation.
The works of these intellectuals, and others in the Austrian school of thought, has greatly contributed to the political philosophy of Classical Libertarianism.
Libertarianism is a political philosophy that emphasizes freedom, liberty, and voluntary association.
Libertarians, like Austrian economists, generally advocate a society with less government intervention and they also discourage the use of force by the State, opposing the coercive legal tender laws imposed by the government.
Libertarianism has been increasingly more popular in recent years, due to the popularity of several individuals such as Lew Rockwell, and politician Ron Paul.
Ron Paul’s political campaign for presidency has placed much more awareness on the philosophies of Libertarianism.
Ron Paul, a career politician and general practitioner had been strongly influenced by the teachings of Hayek, Mises, Rothbard, and Ayn Rand.
Ron Paul has been an advocate for the return to the gold standard and has called for the abolishment of the U.S. Federal Reserve Bank.
His arguments for a gold standard were clearly expressed in his debate with Faiz Shakir on CNBC where he said,
Question: …you believe the Fed shouldn’t exist… make the case.
Ron Paul: First reason is, it’s not authorized in the Constitution, it’s an illegal institution. The second reason, it’s an immoral institution, because we have delivered to a secretive body the privilege of creating money out of thin air; if you or I did it, we’d be called counterfeiters, so why have we legalized counterfeiting? But the economic reasons are overwhelming: the Federal Reserve is the creature that destroys value. This station talks about free market capitalism, and you can’t have free market capitalism if you have a secret bank creating money and credit out of thin air. They become the central planners, they decide what interest rates should be, what the supply of money should be…
Question: How does the gold standard solves that?
Ron Paul: It maintains a stable currency and a stable value. If the Fed concentrated more on stable money rather than stable prices… They push up new money in stocks and in commodities and in houses, and then they have to come in to rescue the situation. They create the bubbles, then they come in and rescue it, and they do nothing more than try to do price fixing. Capitalism depends, and capital comes from savings, but there’s no savings in this country, so this is all artificial. It creates the misdirection and the malinvestment and all the excessive debt, and it always has to have a correction. Since the Fed has been in existence, the dollar has lost about 97% of its value. You’re supposed to encourage savings, but if something loses its value, why save dollars? There’s no encouragement whatsoever. […] Gold is 6000 years old, and it still maintains its purchasing power. Oil prices really are very stable in terms of Gold. […] Both conservatives and liberals want to enhance big government, and this is a seductive way to tax the middle class.
Paul strived to eliminate legal tender laws that mandate coercive power of the government to enforce fiat money as legal tender, and to remove the sales tax on gold and silver, so that the market may freely decide on what type of monetary standard(s) there should be.
In his earlier beliefs, Paul believed in a pure gold standard system however his stance has changed in recent years. The gold standard is a form of a monetary system, in which the standard economic unit of account is the fixed weight of gold.
Today, he would currently advocate that the U.S. dollar should be tied to competing currencies.
Pt 16 of this series analyzes the growing proposals for competing currencies.