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The Daily Capitalist: What Is Money? Part II — A Fable

Out of a simple desire, the hero of this story created a gold standard. What happened?

A long, long time ago there was a wheat farmer named Jeff, and after harvest he had 100 sacks of grain left over after he figured what he would need to live on until the next harvest. Jeff wanted to get one of those newfangled plowshares with a bronze tip. So he went to his good buddy, Red, the blacksmith, and asked how many sacks of wheat he wanted for the bronze thingie. Red said, “Jeff, I don’t need any wheat; I’ve got wheat up the wazoo from you damned farmers. What I need is more ore to make bronze. Go get me some ore and I’ll make the plowshare.” It took Jeff a while to find someone who would take a few sacks of wheat for some copper ore and even longer to get some tin ore. Finally, he got his bronze plowshare.

Sitting down that night with his snappy new bronze plowshare set on the kitchen table to show it off to his family, Jeff said to himself, “What a hassle that was to get this thing. What if there was a way to hold my excess grain (which he called ‘capital’ for some reason) in another form until I choose to spend it on something I need? That way I could get rid of my grain before it spoiled or the rats got it. What other good or commodity could I hold?” He thought about it all night. Shoes? (Too many foot sizes to order.) Copper ore? (Too big and messy to carry around and exchange.) Copper or bronze? (They were making so much of it now that it would take too much to buy things like a donkey or a cart.) Spears? (A sack a dozen.) What is the something that everyone wants?

Then it occurred to him that gold would be perfect: it’s hard to mine and refine; there’s enough around but not too much; everyone wants it; it can be divided up into smaller and smaller pieces; you can test its weight and standardize it into units; it’s durable, malleable and easy to maintain. He shouted out, “I will call it ‘money,’ which is a much cleverer word than ‘medium of exchange’.” It was as if the words just popped into his head.

Ancestors with foresight coined the phrase,
Ancestors with foresight coined the phrase, “In Gold We Trust.”

So Jeff went to back Red the blacksmith and Red’s clever son and told them his idea. They thought Jeff was brilliant and they pooled their resources, bought some gold, refined it, stamped it into little round disks of equal size and weight, and put “1/10 Ounce Fine Gold” on one side and “Bank of Jeff, Red and Red’s Kid” on the other side. It was beautiful to see. Soon everyone in the village accepted them in exchange for goods, so they made more, and pretty soon the whole county was using them. They earned a little bit off each disk for making it and they guaranteed it as to weight and purity. Trade exploded. Later, Red’s son bought out Jeff and Red, and Jeff went back to farming. The son changed the name of the enterprise to “Bank of Red’schild” and became very successful.

Red’schild was brilliant in his own right. He invented banking as well and lent out money and charged a small fee for doing it. Red’schild thought a lot about gold and trade. He thought it would be much easier to carry around pieces of paper rather than a lot of heavy gold coins. So, his bank issued what he called “gold receipts.” Each receipt said the holder owned gold in a specified amount (one-tenth ounce, one ounce, 10 ounces, etc.) held in the vault of the bank. Traders thought this was a great idea and exchanged their gold coins, got gold receipts for the coins, tucked these pieces of paper into their purses, and traded the paper for goods far and wide. Pretty clever. It worked great because Red’schild was trusted. Red’schild got a little fee for each receipt he issued. Trade grew even more. He grew rich, retired and turned the business to over to his son, Red’schild Jr.

Red’schild Jr. had a great banking idea. He noticed that people rarely cashed in the receipts to take possession of their own gold on deposit in their vault. Hmm. What if, he thought, I start lending out the gold that’s just sitting there? He knew that people only demanded about 10 percent of the physical gold held at any one time. He realized he could lend more money than he actually had. “Eureka! I’ve figured out a new paradigm in banking. I’m going to call it ‘fractional reserve banking.’ This can’t fail! I’ll surpass my father. And I’m going to change my name to ‘Rothschild’ because it sounds fancier.”

So Rothschild began lending people new “certificates” that said the Bank of Rothschild would pay the bearer in gold in the named denomination. He wasn’t saying it was a deposit receipt for a specific sack of gold coins, but that he would pay in gold when asked. He had one ton of his own gold in the vault. He printed up certificates equal to five tons of gold — four more than he had — and proceeded to lend this new money to his customers. He increased the supply of money by 400 percent. People were pretty happy at first. Trade expanded rapidly with the new certificates floating around. The tanners, miners, builders and quarry owners who first borrowed most of the money bid up the price of wages and resources like hides, lumber, stone, iron, copper and wheat. People noticed that prices were creeping up rather dramatically. By the time the new money was spent by the borrowers, the farmers, cobblers and workers had to pay more for things like leather, bread, housing, cloth and shoes.

Now prices were really increasing with all the new certificates floating around and people were getting worried about the fact the certificates were buying less and less. Jeff’s grandson, Jeffson, noticed that gold coins would buy more than would the certificates. Jeffson brought his certificates into the bank and asked for gold coins. Rothschild tried to talk him out of it but Jeffson was stubborn and got the coins. Other people noticed the same thing and ran to the bank to exchange certificates for gold. Rothschild and the bank went bust because he issued certificates for five tons of gold but only had one ton. Jeffson thought about this phenomenon and called it “inflation,” and kept all of his money in gold from then on. Jeffson’s family motto became, “In Gold We Trust.” He decided to call himself Jefferson because it sounded nice.

Now leap forward in time. The village has become a big city in a large country. Jefferson10 is old money, rich because his family kept gold and invested wisely over the years. The Rothschild family went into banking and over the centuries blew up many times. Rothschild10 went into academia and studied a new kind of economics that said money was whatever the government said it was. He once told his mentor, Friedman, that “we’ll never have an economic collapse again because I control money!”

Jefferson10 became the city gadfly and Rothschild10 became the head of the government’s central bank. The first thing Rothschild did was to ban all forms of money as legal tender except the one that the central bank issued — “notes” called the dollar. The dollar was a piece of paper with numbers on it. The second thing he did was to sever the relationship of the dollar with gold or any other commodity. Rothschild had a big army to back up his edicts about money.

People everywhere in the country loved the dollar but had no clue what it represented. People seemed to want these pieces of paper a lot. They were pretty, green things, well made, and looked very official. People just stopped thinking about what money was.

Pretty soon the government embarked on great new projects like dams, bridges, roads, stadiums, government buildings and other things the leaders wanted to stimulate their sagging economy. These projects cost billions and billions of dollars. The people didn’t really like to be taxed so Rothschild said, “Leaders, you issue debt, I’ll buy it, and print dollars to pay you. Take the dollars and spend!” Which the government did. Pretty soon prices started going up and up and up and the central bank had to print more dollars to keep up with the demand.

Jefferson had a very nice business making farm implements. His workers were getting poorer because inflation caused prices to go up and up. He couldn’t raise his prices fast enough to keep up with wage demands. He said to his workers, look, I can pay you in dollars, but wouldn’t you like gold instead? He explained that the dollar was going down in value relative to gold and gold would buy more. It didn’t matter what the government did to the money as long as they held gold. The workers liked that so he issued gold certificates on the gold he held in a vault deep under his estate. Holders could come in and demand and receive gold in the amount of the certificate. The workers really liked this because the gold held its value and inflation didn’t bother them at all and they all prospered. People started using these certificates all around town.

Rothschild heard about this and had Jefferson arrested because he violated legal tender laws. Jefferson was convicted and thrown in jail and his gold was confiscated. Before he was hanged he gave a speech on the gallows:

“Fellow citizens, you work every day for what? A piece of paper? That piece of paper isn’t wealth or capital. Like the original Jeff 10 generations back, real wealth was the wheat he produced and saved. He exchanged it for something of value: gold. Gold is money because people value it as a medium of exchange. You’ve forgotten what money really is and now you trade your labor and goods for pieces of paper worth nothing! Now Rothschild and his cronies print paper at will to pay for what the government wants. Their legacy is inflation, just another tax on your labor. Gold, my friends, is the only thing that can prevent the government from inflating the money supply and stealing your wealth. They are destroying our economy. Rebel and demand we go back on a gold standard and have real money. Don’t let ...

There were murmurs of discontent in the crowd and Rothschild quickly pulled the trap door and Jefferson was left hanging in the wind. They forgot all about Jefferson in a few months because the government gave them some cash called a “rebate.”

Click here for Part I.

— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, The Daily Capitalist.

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