Wednesday, October 21, 2009

Tales from the History of Money and Banking, Part II

In Part I, I stated the following:
There are many books on the history of money and banking, philosophy and economics but very few if any that integrate these concepts together to show how essential the concept of money is to civilization. The lack of integration directly follows from the disastrous state of the economics profession and of modern philosophy. The result is that most people are left without any understanding of the fundamental economic or philosophical ideas needed to combat the government's assault on money.
Consequently, I said that the purpose of these posts is to "to integrate the history, economics and philosophy of money and banking but in a way that makes the basic concepts intelligible to the non-economist and non-philosopher."

With that in mind, recall that in another post,
The Barometer of the End, I discussed the relationship of hyperinflation to the collapse of civilization, and I referred to a book titled Fiat Money Inflation in France: How It Came, What It Brought, and How It Ended, by Andrew Dickson White (the full paper is available at the previous link or in book form). White wrote this paper in 1912 to chronicle the hyperinflationary chaos of the French Revolution. What is fascinating about this history is that the process by which France went from dabbling with irredeemable paper money to all out hyperinflation, economic collapse, and the imprisonment and guillotining of businessmen all took place in only a five year span. Not surprisingly, this period mirrors the exact process by which virtually every hyperinflation manifests and is completely applicable to what is occurring in the United States today. In the foreword at the above link, Michael Kosares writes:

In 2012, the famous Andrew Dickson White essay you are about to read will celebrate its 100th anniversary. How can something written over 90 years ago describing monetary events occurring almost 215 years ago in France carry relevance for investors in the United States (and the rest of the industrialized world) today? The short answer is that the United States increasingly appears to be travelling a path similar to that of France in 1789 when the debasement of the currency, as Dickson White so matter of factly tells us, left the bulk of the population penniless.
Of course, the United States has actually been on this path for almost 100 years, albeit, at a slower pace. The Federal Reserve established in 1913 still maintained dollar convertibility to gold. In 1933, Roosevelt legally prohibited the private ownership of gold but maintained gold convertibility for foreign transactions. The last vestige of any tie to gold was ended in 1971 when Nixon closed the gold window by refusing to redeem dollars from foreign central banks. What this means is that as of 1971, the United States has been able to print as many dollars as it likes, whereas, on a precious metals standard, an increase would have been limited by the practical difficulty of actually producing the metal.

Without any tie to precious metals, the United States government, via the Federal Reserve system, has been constrained only by the willingness of those in power at any given time to limit the increase. Of course, just as in France during the revolution, politicians today find the power to create money out of thin air, rather than tax or borrow, to be virtually irresistible. Today, the Fed has created over 1 trillion in reserves in just the last year alone! What is fascinating is that, just as now, the politicians of revolutionary France knew full well the dangers of fiat currency. France had been the victim of the boom and bust fraud perpetrated by the notorious
John Law in the 1720's. As White states:

It would be a great mistake to suppose that the statesmen of France, or the French people, were ignorant of the dangers in issuing irredeemable paper money. No matter how skillfully the bright side of such a currency was exhibited, all thoughtful men in France remembered its dark side. They knew too well, from that ruinous experience, seventy years before, in John Law's time, the difficulties and dangers of a currency not well based and controlled. They had then learned how easy it is to issue it; how difficult it is to check its overissue; how seductively it leads to the absorption of the means of the workingmen and men of small fortunes; how heavily it falls on all those living on fixed incomes, salaries or wages; how securely it creates on the ruins of the prosperity of all men of meagre means a class of debauched speculators, the most injurious class that a nation can harbor,--more injurious, indeed, than professional criminals whom the law recognizes and can throttle; how it stimulates overproduction at first and leaves every industry flaccid afterward; how it breaks down thrift and develops political and social immorality.
Even Mirabeau, the French statesmen and "great orator of the Assembly", famously characterized fiat money as "A nursery of tyranny, corruption and delusion; a veritable debauch of authority in delirium."

Notice that here we have White's paper, written 100 years ago about an event, the French Revolution, which had taken place 120 years before its publication, discussing intellectuals who knew better from experience endured 70 years before the revolution! Yet, the French rationalized the issuance of fiat money in the same way Ben Bernanke and his ilk do today.

To give you a brief overview of the story, the French government of 1789, under heavy debt, issued notes called assignats that bore interest and that were secured by confiscated clergy land. This issue was meant to relieve some of the French government's debt and thought to be valid as it was secured by real property, originally worth more than the issue. Essentially, the issue of assignats was really just a convoluted way to sell or redistribute land confiscated by the government.

Originally, 400 million assignats were issued. Despite initial concerns, the new currency was a success. It temporarily relieved some of the government's debt and acted to stimulate the economy as the new notes found their way into circulation. But, the government was still broke. So, violating its initial promise, it issued 400 million more, this time setting a legal limit of 1200 million.

As prices began to rise and the assignats began to devalue, everything and everyone was blamed except the arbitrary creation of this currency. Ultimately, a law called the Maximum was passed which set strict price controls. Anyone caught violating the price controls was subject to fines, imprisonment, or death. Naturally, shortages developed, just as they would if the government forced a BMW dealer to sell his cars for $20, leading to rationing and bread lines. Yet, the government kept printing more assignats. Quoting White:

First, the Assembly had inflated the currency and raised prices enormously. Next, it had been forced to establish an arbitrary maximum price for produce. But this price, large as it seemed, soon fell below the real value of produce; many of the farmers, therefore, raised less produce or refrained from bringing what they had to market. But, as is usual in such cases, the trouble was ascribed to everything rather than the real cause, and the most severe measures were established in all parts of the country to force farmers to bring produce to market, millers to grind and shopkeepers to sell it. The issues of paper money continued. Toward the end of 1794 seven thousand millions in assignats were in circulation. By the end of May, 1795, the circulation was increased to ten thousand millions, at the end of July, to fourteen thousand millions.
You would think at this point they would have stopped, recognized their folly, and reversed course. But, you would be wrong. In 1794, a new government was formed - the Directory - and they drew precisely the wrong conclusion.

[The Directory] found the country utterly impoverished and its only resource at first was to print more paper and to issue even while wet from the press...Complaints were made that the array of engravers and printers at the mint could not meet the demand for assignats--that they could produce only from sixty to seventy millions per day and that the government was spending daily from eighty to ninety millions.
According to a later report "the entire amount of paper money issued in less than six years by the Revolutionary Government of France had been over forty-five thousand millions of francs--that over six thousand millions had been annulled and burned and that at the final catastrophe there were in circulation close upon forty thousand millions."

White aptly concludes:
Such were the results of allowing dreamers, schemers, phrase-mongers, declaimers and strong men subservient to these to control a government.
Unfortunately, it wasn't over.

The new government discontinued the assignat and "decreed" that a new paper money "fully secured and as good as gold" be issued under a new name - "mandats." If you think decreeing a paper money to be "as good as gold" to be the height of absurdity consider what they did next. Not only was it made illegal to refuse this currency as legal tender, it became illegal to even think that the "mandat" was not legitimate.
The old plan of penal measures was again pressed. Monot led off by proposing penalties against those who shall speak publicly against the mandats; Talot thought the penalties ought to be made especially severe; and finally it was enacted that any persons "who by their discourse or writing shall decry the mandats shall be condemned to a fine of not less than one thousand francs or more than ten thousand; and in case of a repetition of the offence, to four years in irons."
In addition to all of the usual effects of inflation, there is another interesting subplot. Inflation induces illiquidity as individuals tend to save very little as they anticipate the continued devaluation of the currency and cash is readily available. The wild fluctuations provide incentives for speculation and investment schemes designed to profit from continual nominal price appreciation. For example, those who obtain the new money early in the cycle can purchase physical goods which retain their value or participate early in booms in particular types of investments. Rather than thrift, hard work, and productivity leading to wealth, inflation rewards those simply clever enough to profit from the price inflation. Consequently, while "the vast majority of the wealthy classes suffered from impoverishment, the laboring classes, salaried employees of all sorts, and people of fixed income and of small means, especially in the cities, underwent yet greater distress" subsisting "mainly on daily government rations of bread", a certain class had accumulated extraordinary wealth by profiting from the inflation which led to wide disparities in wealth.
A few years before this the leading women in French society showed a nobility of character and a simplicity in dress worthy of Roman matrons. Of these were Madame Boland and Madame Desmoulins; but now all was changed. At the head of society stood Madame Tallien and others like her, wild in extravagance, daily seeking new refinements in luxury, and demanding of their husbands and lovers vast sums to array them and to feed their whims. If such sums could not be obtained honestly they must be had dishonestly.
This aspect interested me, because I recall a post by Dr. George Reisman detailing how credit expansion is actually responsible for increasing income disparity. Quoting Reisman:
The truth is that credit expansion is responsible not only for the boom-bust cycle but also for another major negative phenomenon for which public opinion mistakenly blames capitalism. Namely, sharply increased economic inequality, in which the wealthier strata of the population appear to increase their wealth dramatically relative to the rest of the population and for no good reason.
White provides a great summary of the entire process of inflation:

New issues of paper were then clamored for as more drams are demanded by a drunkard. New issues only increased the evil; capitalists were all the more reluctant to embark their money on such a sea of doubt. Workmen of all sorts were more and more thrown out of employment. Issue after issue of currency came; but no relief resulted save a momentary stimulus, which aggravated the disease. The most ingenious evasions of natural laws in finance which the most subtle theorists could contrive were tried--all in vain; the most brilliant substitutes for those laws were tried; "self-regulating" schemes, "interconverting" schemes--all equally vain. All thoughtful men had lost confidence. All men were waiting; stagnation became worse and worse. At last came the collapse and then a return, by a fearful shock, to a state of things which presented something like certainty of remuneration to capital and labor. Then, and not till then, came the beginning of a new era of prosperity.
And how did this end? Partially, through a phenomena discussed in Reisman's Capitalism - the "spontaneous remonetization of the precious metals." Quoting White:
but when all was over with paper money, specie began to reappear--first in sufficient sums to do the small amount of business which remained after the collapse. Then as the business demand increased, the amount of specie flowed in from the world at large to meet it and the nation gradually recovered from that long paper-money debauch.
And how long did it take?
But though there soon came a degree of prosperity--as compared with the distress during the paper-money orgy, convalescence was slow. The acute suffering from the wreck and rain brought by assignats, mandats and other paper currency in process of repudiation lasted nearly ten years, but the period of recovery lasted longer than the generation which followed. It required fully forty years to bring capital, industry, commerce and credit up to their condition when the Revolution began, and demanded a "man on horseback," who established monarchy on the ruins of the Republic and thew away millions of lives for the Empire, to be added to the millions which had been sacrificed by the Revolution.
Of course, the "man on horseback" was Napoleon Bonaparte. This period ended in dictatorship and world war just as the hyperinflation of Weimar Germany ended with Adolph Hitler and world war. Today, as we hear every reason given for the financial crisis except the correct one, as Nobel Prize winning economists and panels of the most educated statesmen clamor for more currency debasement, I point to White's 1912 paper about the 1789 French Revolution in which French intellectuals evaded the lessons of the 1720's. Will the intellectuals ever learn the lesson?

What this episode shows is that if politicians have the power to print money - they will. All that can constrain them is a legal prohibition of this power, i.e., a fully free and private banking system as would occur under a system of full laissez-faire capitalism. And the only thing that can bring about laissez-faire and a government dedicated to protecting individual rights is a
philosophy of reason, egoism, and capitalism.


John P. said...

we just need to stop all of this and live as nomads so that we can live free with nature and live with no economic classes. Once we stop living as creatures of stuff we will be free to live as we were intended.

Doug Reich said...

John P.,

Uh, not exactly the take-away I was hoping for...

Galileo Blogs said...


Great post (and prior posts).

Notice the names of the fiat currencies: "assignat" and later "mandat". The French revolutionaries at first thought they could simply "assign" the value to the currency. When that did not work, they had to "mandate" the value. That is fiat currency, the attempt to put mind over money. Or you could say that it is the primacy of consciousness applied to finance.

Doug Reich said...


Yes, absolutely. I laughed at those names. The next one would have been the "ok-you-better-accept-this-or-we-will-kill-you-at"

I agree completely that the whole premise underlying the fiat currency is based on a primacy of consciousness orientation. It is the attempt to confer value to something, well, by fiat, or by a wish that reality is something it is not.

I made this exact point in my post: Production and the Primacy of Existence:

Fiat currency represents the logical extrapolation of the "consumptionist" view of economics that upholds the absurd notion that "all we need is consumer demand and people spending money" to create prosperity. Of course, this is an inversion. Production comes first and that creates demand (Say's Law).

The fiat currency-consumptionist-Keynesian framework wsa properly characterized by Dr. Reisman as "anti-economics" as it represents a complete inversion of reality.

People produce things and then they go out and use those things to trade for other things. No one goes out and says "here I am, I want to consume...give me something" - yet, that is literally the premise of fiat currency and inflation - it's the attempt to implement the latter and in the process, destroys the former