It was John Maynard Keynes who observed:
A 'sound' banker, alas! is not one who foresees danger, and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can readi ly blame him. It is necessarily part of the business of a banker to maintain appearances, and to confess a conventional respectability, which is more than human. Life-long practices of this kind make them the most romantic and the least realistic of men.
CREATING MONEY OUT OF DEBT
Let us step back for a moment and analyze. In the beginning, banks served as warehouses for the safe keeping of their customers'
coins. When they issued paper receipts for those coins, they converted commodity money into receipt money. This was a great convenience, but it did not alter the money supply. People had a choice of using either coin or paper but they could not use both. If they used coin, the receipt was never issued. If they used the receipt, the coin remained in the vault and did not circulate.
When the banks abandoned this practice and began to issue receipts to
Obviously, it is easier for people to go into debt than to mine gold. Consequently, money no longer was limited by the natural forces of supply and demand. From that point in history forward, it was to be limited only by the degree to which bankers have been able to push down the gold-reserve fraction of their deposits.
From this perspective, we can now look back on fractional money and recognize that it really is a transitional form between receipt money and fiat money. It has some of the characteristics of both. As the fraction becomes smaller, the less it resembles receipt money and the more closely it comes to fiat money. When the fraction finally reaches zero, then it has made the complete 1. As quoted by Lever and Huhne,
,
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transition and becomes pure fiat. Furthermore, there is no example in history where men, once they had accepted the concept of fractional money, didn't reduce the fraction lower and lower until, eventually, it became zero.
No bank can stay in business for very long with a zero reserve.
The only way to make people accept such a worthless currency is by government force. That's what legal- tender laws are all about.
The transition from fractional-reserve money to fiat money, therefore, requires the participation of government through a mechanism which is called a central bank. Most of the balance of this book will be devoted to a study of that Creature, but, for now, suffice it to say that the euphoria of being able to create money without human effort is so great that, once such a narcotic is taken, there is no politician or banker who can kick the habit. As William Sumner observed: 'A man might as well jump off a precipice intending to stop half way down.'
NATURAL LAW NO. 4
And so, once again, we come to one of those natural laws that emerge from centuries of human experience. It can be stated as follows:
LESSON: Fractional money is paper money which is backed
by precious metals up to only a portion of the face amount. It is a hybrid, being part receipt money and part fiat money.
Generally, the public is unaware of this fact and believes that fractional money can be redeemed in full at any time. When the truth is discovered, as periodically happens, there are runs on the bank, and only the first few depositors in line can be paid.
Since fractional money earns just as much interest for the bankers as does gold or silver, the temptation is great for them to create as much of it as possible. As this happens, the fraction which represents the reserve becomes smaller and smaller until, eventually, it is reduced to zero. Therefore,
LAW: Fractional money will always degenerate into fiat
money. It is but fiat money in transition.
So much for the overview and generalities. In the next chapter we shall see what history has to say on this process. And what a history it is!
THE CREATURE FROM JEKYLL ISLAND
SUMMARY
Fiat money is paper money without precious-metal backing
which people are required by law to accept. The first recorded appearance of fiat money was in thirteenth century China, but its use on a major scale did not occur until colonial America. The experience was disastrous, leading to massive inflation, unemployment, loss of property, and political unrest. During one period when the Bank of England forced the colonies to abandon theii fiat money, general prosperity quickly returned. The Revolutionary War brought fiat money back to the colonies with a vengeance. The economic chaos that resulted led the colonial governments to impose price controls and harsh legal tender laws, neither of which were effective.
Fractional money is defined as paper money with precious-
metal backing for part, not all, of its stated value. It was introduced in Europe when goldsmiths began to issue receipts for gold which they did not have, thus only a fraction of their receipts was redeemable. Fractional money always degenerates into pure fiat money.
C h a p t e r Nine
THE SECRET SCIENCE
