Banking and the Stateby Thorsten Polleit
Mises Daily, February 1, 2013
“It had come to be accepted that the pigs, who were manifestly cleverer than the other animals, should decide all questions of farm policy, though their decisions had to be ratified by a majority vote.”
Orwell, G. (1989 [1945]), Animal Farm, S. 34.
The Starting Point: Civilization BeginsThe founder of the Medici banking dynasty, Giovanni di Bicci de' Medici (1360–1429), said to his children on his death bed: “Stay out of the public eye.”[1] His words raise the question, "How much do bankers know about the truth of modern money and banking?"
To develop a meaningful answer to this question in the tradition of the Austrian School of economics, one has to start right at the beginning, and that is with the process of civilization.
Civilization denotes the development through which man substitutes the state of the division of labor and specialization (that is, peaceful and productive cooperation) for the state of subsistence (that is, a violent hand-to-mouth existence).
In his magnum opus Human Action (1949), Ludwig von Mises (1881–1973) put forward a praxeological explanation of the process of civilization, which helps us understand the course of its evolution.[2]
To Mises, two factors are at the heart of the process of civilization: (1) There must be an inequality of wants and skills among people. This is a necessary condition for people to want to seek cooperation.
(2) Man must recognize that higher productivity is possible through a division of labor. Mises thus assumes – as a necessary condition – a minimum intelligence among human beings and a willingness to use this intelligence in practical life.
Money Emerges – Carl Menger's Theory of the Origin of MoneyThe inequality of skills and wants, accompanied with the assumption of a minimum intelligence, leads people to engage in the division of labor and specialization. This, in turn, brings about the need for interpersonal exchange.
The primitive form of an exchange economy is barter. Barter has limitations, however. For instance, under barter, exchange opportunities depend on a double coincidence of wants.
Sooner or later, people (assuming a minimum of intelligence) will realize that using an indirect means of exchange is economically beneficial.
Using an indirect means of exchange increases the opportunities for exchange, as the double coincidence of wants is no longer a requisite for making trading possible.
The indirect means of exchange that becomes universally accepted is called "money."
In Principles of Economics (1871), Carl Menger (1840–1921) theorizes that money emerges spontaneously from market activities, and that free market money emerges out of a commodity (such as precious metals).[3]
Mises later showed with his regression theorem that this must indeed be so, for praxeological reasons: Money must have emerged out of a market; and it must have started out as a commodity.[4]
Money WarehousingMoney is an economic good like any other. As such, it will be economized, like any other good.
People will demand convenient ways of holding and exchanging their money proper.
With people differing in individual time preference, there will be savers (those who hold excess balances of money proper) and investors (those who demand money proper in excess of their actual holdings).[5]
It is against this backdrop that two kinds of money businesses would emerge in the free market: deposit banking (or money warehousing) and loan, or credit, banking.[6]
Deposit banking offers custodian, safeguarding and settlement services to holders of money proper. For instance, holders of money proper can deposit their commodity money with a deposit bank against receiving a money certificate (in the form of a banknote or a sight deposit).
Credit banks would refinance themselves by obtaining genuine savings, that is by issuing interest-bearing bonds. Savers will willingly exchange their money proper against such return-yielding bonds.
The market interest rate will be determined by the supply of and demand for money proper, and so the equilibrium market interest rate will reflect the societal time preference rate. In other words, In a free market, there will quite naturally be a profession which we may call “bankers”: some bankers will work in the money warehousing business (or deposit banking), some in credit banking.
To be sure: In a free market deposit banking and credit institutions will represent legally separate entities, and so we would have the deposit banker, and we would have the credit banker.
The Incentive for AggressionIn a free market, there are only three ways of acquiring property (that is, in a non-aggressive way): homesteading (which actually denotes the “first-user-first-owner principle”), production, and voluntary contracting.
In reality, however, things may be somewhat different.
Franz Oppenheimer pointed out that “There are two fundamentally opposed means whereby man, requiring sustenance, is impelled to obtain the necessary means for satisfying his desires. These are work and robbery, one's own labor and the forcible appropriation of the labor of others.” [7]
The logic of human action tells us that there is – in fact, there must be – for the individual an economic incentive to aggress against other peoples’ property. Two interrelated praxeological insights explain this.
First, we know for sure that an earlier satisfaction is preferred over a later satisfaction of wants; we also know for sure that a satisfaction of wants associated with low costs is preferred over a satisfaction of wants associated with high costs. In other words, individuals try to achieve their ends with as little input as possible and in the shortest period of time.
Second, the process to civilization does not extirpate man’s inclination to aggression. Individual A can be expected to aggress against B (that is against B’s property) if and when he gets away with it—that is, if the (expected) benefits for A from aggressing against B will be higher than the (expected) costs he has to bear by doing so.
It is the individual’s economic incentive to aggress against other peoples’ property that is at the heart of the emergence of what is typically called "government."
A government can be understood as a territorial monopolist of compulsion: an agency that engages in institutionalized property rights violations and the exploitation – in the form of expropriation, taxation, and regulation – of private property owners.[8]
To answer the question, "What do bankers know about the truth about money and banking?", it is necessary to take a closer look at the various forms of government.
To start with, one can make a distinction between governments with a low time preference and governments with high time preference.
At one end of the spectrum is, to borrow a criminal metaphor from Mancur L. Olson (1932–1998), the roving bandit.[9] The roving bandit represents a form of government that has a limited interest in the welfare of society and, as a result, his theft typically approaches 100 percent of society’s income.
The roving bandit does not have to share in the damage his aggression causes to society (in terms of lost income). The time preference of the roving bandit is therefore relatively high. He takes as much from his victims as possible, and there is next to no economic incentive to restrain his stealing.
At other end of the spectrum is the stationary bandit. Like the roving bandit, he also holds the monopoly of coercion over his victims.
However, the stationary bandit has an encompassing interest in society’s welfare. He wishes to keep his victims producing: the more his victims produce, the more there is to take for the stationary bandit.
Sharing in society’s losses, the stationary bandit will make sure that his thievery is limited. The higher the losses in production from thievery are, the lower will be the level of aggression at which the stationary bandit’s take is maximized. The stationary bandit’s time preference will therefore be lower than the time preference of the roving bandit.
Taking a closer look at the stationary bandit, one can make a distinction between private ownership of government (feudalism/monarchy) and public ownership of government (democratic-republicanism).[10]
The caretaker of a privately held government maximizes the present value of the total income which results from expropriating the property of the ruled.
A monarch, for instance, holds the monopoly of expropriation over his victims, and his time preference will be, due to his encompassing interest, relatively low.
In contrast, the caretaker of a publicly owned government will maximize his current income. His time preference will therefore be relatively high.
Public ownership of government means majority voting. The majority of the people decides about who will serve as the temporary caretaker of public ownership of government.
The average voter will support those politicians who are expected (rightly or wrongly) to improve the voter’s economic situation. A voter has every economic incentive to act in this way – irrespective of the fact that the income he may obtain in this way results from expropriating fellow citizens.
The caretaker of public ownership of government, in turn, has an incentive to secure the majority of the voters. He will favor policies of expropriating the (typically few) high income producers to the benefits of the (typically large group) of less productive or nonproductive people.
The important insight here is as follows: public ownership of government will lead to an ongoing erosion of the encompassing interest of the majority of the people in the market income of society, or in other words, society’s time preference will increase.
Government Brings Fraudulent BankingThe rise in society’s time preference is the central explanatory factor for explaining the emergence of fraudulent banking, which is epitomized by a pure fiat money regime.
We know that the caretakers of publicly owned government wish to expropriate resources from the public at large. This can be done most conveniently by (1) obtaining control over money production, (2) replacing commodity money with fiat money, and (3) producing money through credit expansion.
The banking industry and the bankers are therefore the natural ally for government’s planned thievery. In fact, those in government and the bankers will, and logically so, collude for establishing a pure fiat money system.
Bankers realize that they would earn additional revenue if and when they are allowed to issue new money balances through credit expansion (or ex nihilo): making loans beyond the amount of money proper available to them.
They understand that such fractional reserve banking is a fairly profitable undertaking to them, and so the deposit as well as the loan banker will be in favor of merging deposit banking with loan banking.
The temporary caretakers of publicly owned governments are very much in favor of fractional reserve banking, too. Being a first receiver of the new money, government can expropriate resources from the natural owners of things.
Having monopolized the law, it will be relatively easy for government to declare fractional reserve banking legal.
Engaging in fractional reserve banking, however, is risky for the banker. He knows that if and when his counterfeiting is detected, a bank run may ensue, and he would be forced out of business, or worse.
For government, bank failures are fairly undesirable, too. It would bring severe political and economic problems. Most important, defaulting banks endanger access to credit and money on easy terms.
Government will therefore, greatly supported by the bankers, set up a central bank, which will enable and greatly encourage all banks to inflate the quantity of money in a combined effort.
Even with a central bank in place, however, the risk of a bank run is not entirely eliminated. What is needed is for the central bank to have a monopoly over money production.
This is why sooner or later commodity money will be replaced by irredeemable paper, or fiat, money; and fiat money will be granted legal privileges (such as, for instance, legal tender status). To this end, government will make it legal for bankers to suspend the redeemability of outstanding money certificates into money proper.
Collective CorruptionOne may wonder: How do government and bankers get away with this – that is fraudulently extracting resources from producers and contractors via issuing inflationary money?
Is it a lack of knowledge on the part of those who are on the losing end of the counterfeiting money regime? Or are the costs of revolting against a pure fiat money regime prohibitively high from the viewpoint of the individual?
An economically reasonable, that is praxeological, answer to this question can be found with (what I call) “collective corruption.” [11]
Once government intervenes in society’s (monetary) affairs, individuals will increasingly develop a disposition for violating other peoples’ property.
By taking advantage of governmental coercive action, an individual can reap the benefits from aggressing against the property of others, while he has to bear only a fraction of the damage his action does to society as a whole.
He has every incentive to act in this way; he would have to bear the losses of whatever opportunity for violating other’s private property he passes up.
A pure fiat money system, once it has set into motion, will lead to collective corruption on the presumably grandest scale.
As is well known, government can secure its support by letting the public at large (actually parts of it) share in the enjoyment of the receipts fraudulently extracted from natural owners of things.
For instance, government will offer reasonably-paid jobs (in particular for the intellectuals and second-hand dealer of ideas). It will also provide firms with public contracts (such as, for instance, for construction and building projects).
With growing government handouts, a growing number of people and businesses will become economically and socially dependent on the continuation (or even further expansion) of government activity.
Quite naturally, resistance against a further expansion of government and the fiat money regime – which necessarily means further violation of individuals’ property rights – will decline.
Clearly, bankers play an important role in spreading collective corruption. It may suffice here to say that a growing number of people will start investing their lifetime savings into fiat-denominated bank deposits and bonds.
Sooner or later people will develop a great interest in supporting government and upholding the fiat money regime – by whatever means deemed necessary.
It Will End in HyperinflationCollective corruption, once it has become sufficiently widespread, will lead to hyperinflation – meaning an accelerating increase in the quantity of money, leading to an erosion, or even a total destruction, of the purchasing power of fiat money.
Of course, those in government and bankers have a common interest in avoiding hyperinflation. They prefer a kind of inflation that goes on basically unnoticed, a form of inflation that won't spin out of control.
However, once collective corruption has become widespread and the banking and financial industry has become highly important in terms of financing government and serving as an important hoard for individuals' lifetime savings, the pendulum has already been swung toward hyperinflation.
From praxeology, we know for sure that a fiat money boom will ultimately end in depression. We also know that efforts to escape depression by increasing the quantity of fiat money even further will only postpone the day of reckoning, and that it will raise the costs of the depression in the future.
How will the majority of the people respond to an approaching depression? If and when people can expect to rank among the first receivers of the newly created money (which is actually the case once collective corruption has become sufficiently widespread), the answer appears to be obvious.
The majority of the people may expect to benefit from running the electronic printing press, and they will prefer the running of the electronic printing press over letting government and banks default. Under such an incentive structure the fiat money system would end up in hyperinflation.
In view of what has been said above we can conclude: (1) If and when public ownership of government takes hold, commodity money will be replaced by fiat money. (2) Fiat money leads to collective corruption on a grand scale. And (3), once collective corruption has become sufficiently widespread, the fiat money regime will be destroyed by hyperinflation.
From what has been said above it follows that we know that once a fiat money system has been put in place, banks and bankers have joined – some of them willingly and knowingly, some of them unknowingly – the vast criminal enterprise that is the state.
Being self-interested human beings, bankers can, and must, be expected to know a lot about money and banking. In view of a rather dismal monetary history, such a conclusion would also do much to explain Giovanni di Bicci de' Medici’s dying words to his children: “Stay out of the public eye.”
Thorsten Polleit is chief economist of the precious-metals firm Degussa Goldhandel GmbH. He is also an honorary professor at the Frankfurt School of Finance & Management. He is an adjunct scholar of the Ludwig von Mises Institute and was awarded the 2012 O.P. Alford III Prize in Libertarian Scholarship. His website is www.Thorsten-Polleit.com. Send him mail. See Thorsten Polleit's article archives.You can subscribe to future articles by Thorsten Polleit via this RSS feed.
Copyright © 2012 by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.
Notes* A similar version of this paper was held at the 7th annual meeting of the Property and Freedom Society on 29 September 2012 in Bodrum, Turkey.
[1] Parks, T. (2006), Medici Money, Banking, Metaphysics and Art in Fifteenth-Century Florence, Profile Books Ltd, London, p. 3.
[2] "If and as far as labor under the division of labor is more productive than isolated labor, and if and as far as man is able to realize this fact, human action itself tends toward cooperation and association; man becomes a social being not in sacrificing his own concerns for the sake of a mythical Moloch, society, but in aiming at an improvement in his own welfare. Experience teaches that this condition—higher productivity achieved under the division of labor—is present because its cause—the inborn inequality of men and the inequality in the geographical distribution of the natural factors of production—is real. Thus we are in a position to comprehend the course of social evolution.“ Mises, L. v. (1996), Human Action, 4th ed., p. 160-1.
[3] See Menger, C. (2007 [1871]), Principles of Economics, Chapter 8, pp. 257 – 285, esp. 261 – 262: “The origin of money … is, as we have seen, entirely natural and thus displays legislative influence only in the rarest instances. Money is not an invention of the state. It is not the product of a legislative act. Even the sanction of political authority is not necessary for its existence. Certain commodities came to be money quite naturally, as the result of economic relationships that were independent of the power of the state.”
[4] See Mises, L. v. (1996), Human Action, p. 408 – 410; Mises, L. v. (1953), The Theory of Money and Credit, pp. 97 – 123.
[5] On the issue of time preference see Mises, L. v. (1996), Human Action, 4th ed., pp. 483 –
490; also Hoppe, H.-H. (2006), "On Time Preference, Government, and the Process of Decivilization", in: Democracy, The God That Failed, pp. 1 – 43.
[6] In this context see, for instance, Hoppe, H.-H. (2006), "How is Fiat Money Possible? – or, The Devolution of Money and Credit", in: The Economics and Ethics of Private Property, Studies in Political Economy and Philosophy, 2nd ed., pp. 175 – 204.
[7] Oppenheimer, F. (1922), The State, p. 24.
[8] See, for instance, Hoppe, H.-H. (2006), "On Monarchy, Democracy, and the Idea of Natural Order", in : Democracy, The God That Failed, p. 45; also Rothbard, M. N. (2002 [1973]), For a New Liberty, Chapter 3, "The State", pp. 45.
[9] See Olson, M. (2000), Power and Prosperity, Outgrowing Communist and Capitalist Dictatorships, Basic Books, esp. pp. 1 – 24.
[10] In this context see Hoppe, H.-H. (2006), "On Monarchy, Democracy, and the Idea of Natural Order", in: Democracy, The Gold That Failed, pp. 45 – 76, esp. 46 – 48. On democracy see Rothbard, M. N. (2004 [1970]), Power and Markets, Government and the Economy, 4th ed., Chapter 2, 2.B., pp. 19 – 21, and pp. 233 – 245.
[11] See Polleit, T. (2011), Fiat Money and Collective Corruption, in: The Quarterly Journal of Austrian Economics, Vol. 14, No. 4, pp. 397 – 415.