A post from our friend Rick, who will be a regular author here at Maggie's once we negotiate the compensation details (he won't take paper money):
"Give me control of a nation's money and I care not who makes its laws" — Mayer Amschel Bauer Rothschild
Many of us want to get rich. Some of us, anyway. What’s the fastest way to do it? Print your own money.
If it were only that easy. But what if it were? Ignoring counterfeiters, there have been several cases where privately printed money has fueled growth and provided value. Up to a point, that is, because as we all know, if it were that easy, everybody would do it. Yet the government does it because the government wants everyone to be rich, or the government wants to support declining prices, or the government wants to pay back money it borrowed. So the government creates money and backs it up with full faith and confidence and this should be enough for everyone to be rich and happy.
Why hasn't this goal ever been achieved? Let's take a look at one example where this theory was put to work.
In August 1717, somebody had a bright idea. The idea was based on the concept that the New World offered so much resource wealth and opportunity that anyone with a monopoly could sell portions of that untapped wealth to others, reduce his risk, and make himself and investors rich via joint stock ownership. Stock ownership was not a new idea, but this offer carried tremendous upside, particularly because the company offering the stock was owned and backed by a bank, and the company had been granted a government monopoly on all trade in the region.
John Law was the proprietor of the Banque Générale Privée (General Private Bank), which he funded by investing heavily in the debt of the French government. He literally invented paper money because he viewed money only as a medium of exchange, not a store of value or unit of account. It represented a claim on some value already in existence, and therefore could not have an impact on prices or overall valuations. He was brilliant and everyone, including himself, knew it. Law was so smart he was able to win card games by mentally calculating the odds. He also developed economic theories which are still the basis of some modern economic theory. One of his most persistent creations was the establishment of a central bank, which would oversee and manage the issuance of credit and paper money. Based on his theories, paper money had no relationship to the price of goods and services.
His theory was supported by the thought that if he printed and loaned money to someone, it had to be backed by collateral. All the money he loaned would be the manifestation of the value locked up in the collateral, and therefore did not impact overall prices since the money had to repurchase the good at some point. More importantly, by discounting present value for the credit (charging interest), any potential impact on prices would be muted and immaterial. According to his theory, he could issue as much paper money as he wanted as long as the collateral he received for the loans was valued properly.
This would work for collateral that was physical, such as gold or silver, or hypothetical, such as an IOU to cover future money made from the sale of a service or good. Up until this point, money was backed by specie: gold, silver, or some other precious metal. Law had taken an existing idea, the letter of credit, and turned it into what we all now recognize as Fiat Currency.
"Neither paper currency nor deposits have value as commodities, intrinsically, a 'dollar' bill is just a piece of paper. Deposits are merely book entries." — Modern Money Mechanics Workbook, Federal Reserve Bank of Chicago, 1975
Fiat Currencies were not new, but Law was about to do something astounding with it. He was about to introduce the world to the term 'millionaire'. His method of accomplishing this would be by issuing currency with nothing backing it except the speculative value of the stock. It was a sure thing. After all he had two things working in his advantage. The first was the grant of a royal monopoly on trade for the Mississippi Company. This allowed Law to buy several other monopolies and merged them to form the Company of the Indies. These monopolies represented tremendous value because it limited trade to only Law's companies. It was a sure fire money maker, and people couldn't get enough of the stock. Prices spiralled upward. Economic activity was picking up. The king's advisors was very pleased, and gave John his second advantage. Law's bank was granted the ability to print money in the name of the Crown, backed by the full faith and credit of King Louis XV. Things couldn't have been going better in the previously moribund economy, prices of stock continued to rise and business flourished. But something else was happening. Inflation. Law felt that this was a side effect of business activity, it couldn't have anything to do with his currency. But rising prices caused some bottlenecks.
There was not enough money to keep stock selling and business moving. So, John released more currency. Inflation raged, much to Law's chagrin. But economic activity was very high, and with the stock price rising, many people were getting rich. The term 'millionaire' was used to describe the newly wealthy of France. A number so large that it boggled the mind. But these rising prices were vexing. It had nothing to do with the currency, as far as he was concerned. What also wasn't concerning was how much of the activity was based on the illusion of wealth his policies were creating.
Then it happened. 'It' was a change in the price of the stock downward. Prices had gotten to the point that people needed to pay their bills, so selling the stock was the preferred means of maintaining their lifestyles. Law realized to allow people to buy stock and keep economic activity high, he had to release even more paper currency, which he did. It helped at first. Things seemed to stabilize. But then the truth came out. It was a harsh truth, and one the public was not prepared for. The government, which had allowed the bank to issue currency at will, did not have enough gold, silver, or anything of value to cover the bills in circulation. There was more paper money in circulation than the capital wealth of the nation. This was unexpected and there was only one natural outcome. The Company's stock was sold off rapidly as people tried to convert their gains into gold and silver, and the share price plummeted. But that wasn't the only price which fell. Every price fell. A general deflation occurred, and France was impoverished.
In a period of 3 years, John Law had created, then destroyed, vast amounts of wealth. The effect of his oversight would be felt for years, as France was less able to compete economically and militarily with Britain. Perhaps the longest lasting effect of this impoverishment is an event which would later benefit the United States. The great wealth promised by the Mississippi Company DID exist, but it would never be experienced by France. Law's mismanagement would eventually lead to the Louisiana Purchase, a business transaction which enabled Napoleon to keep France relevant on the world stage. Law, naturally, fled the nation, disguised as a woman.
John Law may have had good intentions, but turned out to be nothing but a master illusionist, and his exit was just one more illusion. It is somewhat ironic that the bubble financed by paper was driven by the desire to profit from the belief that vast sums of gold, silver and other prizes existed in the New World. What is more ironic is why the story of the Mississippi Bubble is so often overlooked by historians and economists. Today it is considered to be an event which is well understood and unlikely to ever occur in a well- managed economy.
The lessons may be understood, but are often blithely dismissed with a simple 'this time is different' hubris. Weimar Germany, Hungary 1922 and 1946, Zimbabwe in 2009, even the US during the Revolution (when something of little value was described as "not worth a Continental"), each was based on the the assumption that printing money can provide a floor to prices, can stimulate economic activity, or help pay down debts. All this while disregarding the corrosive effects of too much money chasing a limited quantity of goods and services. There has never been an example of a Fiat Currency surviving over the long term. Of course, there has never been an example of specie-backed currency surviving over the long term, either.
The difference, however, is that specie-backed currencies typically fail when a government decides to eliminate its backing, converting it into a fiat currency. This usually occurs when a government realizes its behavior has been inconsistent with sound fiscal policies. Fiat currency offers the ability to paper over these facts, however temporarily. Fiat Currencies have all failed because they lack value, allowing them to be treated in a manner that shows they have no value - a form of moral hazard. Lenin famously declared that the fastest way to undermine a democracy was to debase its currency.
History will have the final say on this comment, of course, and by putting the current situation faced by the world in an historical context, we can see that we have some very difficult choices to make.
"By this means government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft." — John Maynard Keynes "The Economic Consequences of The Peace" (1920)
Obama's 'solution' for what ails us is to utilize two common political treatments for recessions. First, the standard Monetarist 'Easy Money' solution by lowering interest rates. Second, the Keynesian 'Stimulus'. The unfortunate sit
Tracked: Oct 04, 12:05