The total stock of money in a society is the total number of ounces of the money commodity available. Throughout this volume we have deliberately used “gold ounces” instead of “dollars” or any other name for money, precisely because on the free market the latter would only be a confusing term for units of weight of gold or silver.

The total stock, from one period to another, will increase from new production and decrease from being used up—either in industrial production as a nonmonetary factor or from the wear and tear of coins. Since one of the qualities of the money commodity is its durability, the usual tendency is a long-run increase in the money supply and a resulting gradual long-run decline in the PPM. This furthers social utility only in so far as more gold or silver is made available for nonmonetary purposes.

We saw in chapter 3 that the physical form of the monetary commodity makes no difference. It can be in nonmonetary use as jewelry, in the form of bars of bullion, or in the form of coins. On the free market, transforming gold from one shape to another would be a business like any other business, charging a market price for its service and earning a pure interest return in the ERE. Since gold begins as bullion and ends as coin, it would seem that the latter would command a small premium over the equivalent weight of the former, the bullion often being a capital good for coin. Sometimes, however, coins are remelted back into bullion for larger transactions, so that a premium for coin over bullion is not a certainty. If, as generally happens, minting coins costs more than melting, coins will command the equivalent premium over bullion. This premium is called brassage.

It is impossible for economics to predict the details of the structure of any market. The market for privately issued gold bars or coins might develop as homogeneous, like the market for wheat, or the coins might be stamped and branded by the coin-makers to certify to the quality of their product. Probably the public would buy only branded coins to ensure accurate quality.

One argument against permitting free private coinage is that compulsory standardization of the denominations of coins is more convenient than the diversity of coins that would ensue under a free system. But if the market finds it more convenient, private mints will be led by consumer demand to mint certain standard denominations. On the other hand, if greater variety is preferred, consumers will demand and obtain a more varied number of coins.29

• 29For an exposition of the feasibility of private coinage, see Spencer, Social Statics, pp. 438–39; Charles A. Conant, The Principles of Money and Banking (New York: Harper & Bros., 1905), I, 127–32; Lysander Spooner, A Letter to Grover Cleveland (Boston: B.R. Tucker, 1886), p. 79; B.W. Barnard, “The Use of Private Tokens for Money in the United States,” The Quarterly Journal of Economics, 1916–17, pp. 617–26.
       Recent writers favorable to private coinage include: Everett Ridley Taylor, Progress Report on a New Bill of Rights (Diablo, Calif.: the author, 1954); Oscar B. Johannsen, “Advocates Unrestricted Private Control over Money and Banking,” The Commercial and Financial Chronicle, June 12, 1958, pp. 2622f.; and Leonard E. Read, Government—An Ideal Concept (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1954), pp. 82ff. An economist hostile to market-controlled commodity money has recently conceded the feasibility of private coinage under a commodity standard. Milton Friedman, A Program for Monetary Stability (New York: Fordham University Press, 1960), p. 5.

Chapter 2 described the difference between “claims to present goods” and “claims to future goods.” The same analysis applies to money as to barter. A claim to future money is a bill of exchange—an evidence of a credit transaction. The holder of the bill—the creditor—redeems it at the date of redemption in exchange for money paid by the debtor. A claim to present money, however, is a completely different good. It is not the evidence of an uncompleted transaction, an exchange of a present for a future good, as is the bill; it is a simple evidence of ownership of a present good. It is not uncompleted, or an exchange on the time market. Therefore, to present this evidence for redemption is not the completion of a transaction or equivalent to a creditor’s calling his loan; it is a simple repossessing of a man’s own good. In chapter 2 we gave as examples of a claim to present goods warehouse receipts and shares of stock. Shares of stock, however, cannot be redeemed in parts of a company’s fixed assets because of the rules of ownership that the companies themselves set up in their co-operative venture. Furthermore, there is no guarantee that such assets will have a fixed money value. We shall therefore confine ourselves to warehouse receipts, which are also more relevant to the supply of money.

When a man deposits goods at a warehouse, he is given a receipt and pays the owner of the warehouse a certain sum for the service of storage. He still retains ownership of the property; the owner of the warehouse is simply guarding it for him. When the warehouse receipt is presented, the owner is obligated to restore the good deposited. A warehouse specializing in money is known as a “bank.”

Claims to goods are often treated on the market as equivalent to the goods themselves. If no fraud or theft is suspected, then evidence of ownership of a good in a warehouse is considered as equivalent to the good itself. In many cases, individuals will find it advantageous to exchange the claims or evidences—the goods-substitutes—rather than the goods themselves. Paper is more convenient to transfer from person to person, and the expense of moving the goods is eliminated. When Jones sells Smith his wheat, therefore, instead of moving the wheat from one place to another, they may well agree simply to transfer the warehouse receipt itself from Jones to Smith. The goods remain in the same warehouse until Smith needs them or until the receipt is transferred to someone else. Of course, Smith may prefer, for one reason or another, to keep the goods in his own warehouse, in which case they are moved from one to the other.

Let us take the case of a warehouse owned by the Trustee Warehouse Company. It holds various goods in its vaults for safekeeping. Suppose that this company has developed a reputation for being very reliable and theft-free. Consequently, people tend to leave their goods in the Trustee Warehouse for a considerable length of time and, in the case of goods that they do not use frequently, will even tend to transfer the goods-certificates (the warehouse receipts, or evidences of ownership of the goods) and not redeem the goods themselves. Thus, the goods-certificates act as goods-substitutes in exchange. Suppose that the Trustee Company sees this happening. It realizes that a good opportunity for fraud presents itself. It can take the depositors’ goods, the goods that it holds for safekeeping, and lend them out to people on the market. It can earn interest on these loans, and as long as only a small percentage of depositors ask to redeem their certificates at any one time, no one is the wiser. Or, alternatively, it can issue pseudo warehouse receipts for goods that are not there and lend these on the market. This is the more subtle practice. The pseudo receipts will be exchanged on the market on the same basis as the true receipts, since there is no indication on their face whether they are legitimate or not.

It should be clear that this practice is outright fraud. Someone else’s property is taken by the warehouse and used for its own money-making purposes. It is not borrowed, since no interest is paid for the use of the money. Or, if spurious warehouse receipts are printed, evidences of goods are issued and sold or loaned without any such goods being in existence.

Money is the good most susceptible to these practices. For money, as we have seen, is generally not used directly at all, but only for exchanges. It is, furthermore, a widely homogeneous good, and therefore one ounce of gold is interchangeable with any other. Since it is convenient to transfer paper in exchange rather than carry gold, money warehouses (or banks) that build up public confidence will find that few people redeem their certificates. The banks will be particularly subject to the temptation to commit fraud and issue pseudo money certificates to circulate side by side with genuine money certificates as acceptable money-substitutes. The fact that money is a homogeneous good means that people do not care whether the money they redeem is the original money they deposited. This makes bank frauds easier to accomplish.

“Fraud” is a harsh term, but an accurate one to describe this practice, even if not recognized as such in the law, or by those committing it. It is, in fact, difficult to see the economic or moral difference between the issuance of pseudo receipts and the appropriation of someone else’s property or outright embezzlement or, more directly, counterfeiting. Most present legal systems do not outlaw this practice; in fact, it is considered basic banking procedure. Yet the libertarian law of the free market would have to prohibit it. The purely free market is, by definition, one where theft and fraud (implicit theft) are illegal and do not exist.

To part with goods or money held in trust or to issue spurious warehouse receipts is, of course, a dangerous business, even when the law permits it. If the warehouse once failed to meet its contractual obligations, its fraud would be discovered, and a general panic “run” on the warehouse or bank would ensue. It would then be quickly plunged into bankruptcy. Such a bankruptcy, however, would not be similar to the failure of an ordinary speculative business enterprise. It is rather similar to the absconder who gets caught before he has returned the funds he has “borrowed.”

Even if the receipt does not say on its face that the warehouse guarantees to keep it in its vaults, such an agreement is implicit in the very issuance of the receipt. For it is obvious that if any pseudo receipts are issued, it immediately becomes impossible for the bank to redeem all of them, and therefore fraud is immediately being committed. If a bank has 20 pounds of gold in its vaults, owned by depositors, and gold certificates redeemable on demand for 30 pounds, then notes to the value of 10 pounds are fraudulent. Which particular receipts are fraudulent can be determined only after a run on the bank has occurred and the later claimants are left unsatisfied.

In a purely free market where fraud cannot, by definition, occur, all bank receipts will be genuine, i.e., will represent only actual gold or silver in the vaults. In that case, all the bank’s money-substitutes (warehouse receipts) will also be money certificates, i.e., each receipt genuinely certifies the actual existence of the money in its vaults. The amount of gold kept in bank vaults for redemption purposes is called its “reserves,” and the policy of issuing only genuine receipts is therefore a policy of “100-percent reserves” of cash to demand liabilities (liabilities that must be paid on demand).30 However, the term “reserve” is a misleading one, because it assumes that the bank owns the gold and independently decides how much of it to keep on hand. Actually, it is not the bank that owns the gold, but its depositors.31

An enormous literature has developed dealing with the physical form of the money receipts, and yet the physical form is of no economic importance. It may be in the form of a paper note, a token coin (essentially a note stamped on coin instead of paper), or a book credit (demand deposit) in the bank. The demand deposit is not tangibly held by the owner, but can be transferred to anyone he desires by written order to the bank. This order is called a check. The depositor has a choice of which form of receipt to take, according to his convenience. Which form he chooses makes no economic difference.

• 30Time deposits are, legally, future claims, since banks have a legal right to delay payment 30 days. Moreover, they do not pass as final media of exchange. The latter fact is not determining, however, since a secure claim to a money-substitute is itself part of the money supply. “Idle” cash balances are kept as “time deposits,” just as gold bullion is a more “idle” form of money than coins. The deciding factor, perhaps, is that the 30-day limit is virtually a dead letter, for if a “savings” bank should impose it, a bankrupting “run” on the bank would ensue. Furthermore, actual payments are sometimes made by “cashiers’ checks” on time deposits. Thus, “time” deposits now function as demand deposits and should be treated as part of the money supply. If banks wished to act as genuine savings banks, borrowing and lending credit, they could issue I.O.U’s for specified lengths of time, due at definite future dates. Then no confusion or possible “counterfeiting” could arise.
• 31Such items as bills of lading, pawn tickets, and dock warrants have been warehouse receipts rooted in the specific objects deposited, in contrast to the loose “general deposits” where a homogeneous good can be returned. See W. Stanley Jevons, Money and the Mechanism of Exchange (16th ed.; London: Kegan Paul, Trench, Trübner & Co., 1907), pp. 201–11.

Since money-substitutes exchange as money on the market, we must consider them as part of the supply of money. It then becomes necessary to distinguish between money (in the broader sense)—the common medium of exchange—and money proper. Money proper is the ultimate medium of exchange or standard money—here the money commodity—while the supply of money (in a broader sense) includes all the standard money plus the money-substitutes that are held in individuals’ cash balances. In the cases cited above, gold was the money proper or standard money, while the receipts—the demand claims to gold—were the money-substitutes.

The relation between these elements may be illustrated as follows: Assume a community of three persons, A, B, C, and three money warehouses, X, Y, Z. Suppose that each person has 100 ounces of gold in his possession and none on deposit at a warehouse. For the community, then:

The total supply of money is here identical with the total supply of money proper.

Now assume that A and B each deposits his 100 ounces of gold at warehouses X and Y respectively, while C keeps his gold on hand. The total supply of money is always equal to the total of individual cash balances. Its composition now is:

A—100 ounces of X-Money-Substitute
B—100 ounces of Y-Money-Substitute
C—100 ounces of Gold Money Proper

Total supply of money (in the broader sense) = Total cash balances = 200 ounces of money-substitutes + 100 ounces of money proper.

The effect of the deposit of money proper in the warehouses or banks is to change the composition of the total supply of money in cash balances; the total amount, however, remains unchanged at 300 ounces. Money-substitutes of various banks have replaced most of the standard money in individual cash holdings. Similarly, if A and B were to redeem their deposits, the total amount would remain unchanged, while the composition would revert to the original pattern.

What of the 200 ounces of gold deposited in the vaults of the banks? These are no longer part of the money supply; they are held in reserve against the outstanding money-substitutes. While in reserve, they form no part of any individual’s cash balance; the cash balances consist not of the gold, but of evidences of ownership of the gold. Only the money proper outside of bank reserves forms part of individuals’ cash balances and hence part of the community’s supply of money.

Thus, as long as all money-substitutes are full money certificates, an increase or decrease in the money-substitutes outstanding can have no effect on the total supply of money. Only the composition of that supply is affected, and such changes in composition are of no economic importance.

However, when banks are legally permitted to abandon a 100-percent reserve and to issue pseudo receipts, the economic effects are quite different. We may call the money-substitutes that are not genuine money certificates, uncovered money-substitutes, since they do not genuinely represent money. The issue of uncovered money-substitutes adds to individuals’ cash balances and hence to the total supply of money. Uncovered money-substitutes are not offset by new money deposits and so constitute net additions to the total supply. Any increase or decrease in the supply of uncovered money-substitutes increases or decreases to the same extent the total supply of money (in the broader sense).

Thus, the total supply of money is composed of the following elements: supply of money proper outside reserves + supply of money certificates + supply of uncovered money-substitutes. The supply of money certificates has no effect on the size of the supply of money; an increase in this factor only decreases the size of the first factor. The supply of money proper and the factors determining its size have already been discussed. It depends on annual production compared to annual wear and tear, and thus, on the unhampered market, the supply of money-proper changes only slowly. As for uncovered money-substitutes, since they are essentially a phenomenon of the hampered rather than the free market, factors governing their supply will be further discussed below, in chapter 12.

In the meanwhile, however, let us analyze a little further the difference between a 100-percent-reserve and a fractional-reserve bank. The Star Bank, let us suppose, is a 100-percent-reserve bank; it is established with 100 gold ounces of capital invested by its stockholders in building and equipment. In the familiar balance sheet, with assets on the left-hand side and liabilities and capital on the right-hand side, the condition of the bank now appears as follows:

The Star Bank is ready to begin operations. Several people now come and deposit gold in the bank, which in return issues warehouse receipts giving the depositors (the true owners of the gold) the right to redeem their property on demand at any time. Let us assume that after a few months 5,000 gold ounces have been deposited and stored in the bank’s vaults. Its balance sheet now appears as follows:

The warehouse receipts function and exchange as money-substitutes, replacing, not adding to, the gold stored in the bank. All the warehouse receipts are money certificates, 100-percent reserve has been maintained, and no invasion of the free market has occurred. The warehouse receipts may take the form of printed tickets (notes) or book credit (demand deposits) transferable by written order or “check.” The two are economically identical.

But now suppose that law enforcement is lax and the bank sees that it can make money easily by engaging in fraud, i.e., by lending some of the depositors’ gold (or, rather, issuing pseudo warehouse receipts for nonexistent gold and lending them) to people who wish to borrow it.32 Let us say that the Star Bank, chafing at the mere interest return earned on its fees for warehouse service, prints 1,000 ounces of pseudo warehouse receipts and lends them on the credit market to businesses and consumers who desire to borrow money. The balance sheet of the Star Bank is now as follows:

The warehouse receipts still function as money-substitutes on the market. And we see that new money has been created by the bank out of thin air, as if by magic. This process of money creation has also been called the “monetization of debt,” an apt term since it describes the only instance where a liability can be transformed into money—the supreme asset. It is obvious that the more money the bank creates, the more profits it will earn, for any income earned on newly created money is a pure unalloyed gain. The bank has been able to alter the conditions of the free market system, in which money can be obtained only by purchase, mining, or gift. In each of these routes, productive service—either one’s own or one’s ancestor’s or benefactor’s—was necessary in order to obtain money. The bank’s inflationary intervention has created another route to money: the creation of new money out of thin air, by issuing receipts for nonexistent gold.33 ,34

• 32We might ask why the owners of the bank do not really reap the spoils and lend the money to themselves. The answer is that they once did so profusely, as the history of early American banking shows. Legal regulations forced the banks to abandon this practice.
• 33This discussion is not meant to imply that bankers, particularly at the present time, are always knowingly engaged in fraudulent practices. So embedded, indeed, have these practices become, and always with the sanction of law as well as of sophisticated but fallacious economic doctrines, that it is undoubtedly a rare banker who regards his standard occupational procedure as fraudulent.
• 34For a brilliant discussion of fractional-reserve banking, see Amasa Walker, The Science of Wealth (3rd ed.; Boston: Little, Brown & Co., 1867), pp. 138–68, 184–232.

One popular criticism of 100-percent bank reserves charges that the bank could not then earn any income or cover costs of storage, printing, etc. On the contrary, a bank is perfectly capable of operating like any goods warehouse, i.e., by charging its customers for its services to them and reaping the usual interest return on its operations.

Another popular objection is that a 100-percent-reserve policy would eliminate all credit. How would businessmen be able to borrow funds for short-term investment? The answer is that businessmen can still borrow saved funds from any individual or institution. “Banks” may still lend their own saved funds (capital stock and accumulated surplus) or they may borrow funds from individuals and relend them to business firms, earning the interest differential.35 Borrowing money (e g., floating a bond) is a credit transaction; an individual exchanges his present money for a bond—a claim on future money. The borrowing bank pays him interest for this loan and in turn exchanges the money thus gathered for promises by business borrowers to pay money in the future. This is a further credit transaction, in this case the bank acting as the lender and businesses as the borrowers. The bank’s income is the interest differential between the two types of credit transactions; the payment is for the services of the bank as an intermediary, channeling the savings of the public into investment. There is, furthermore, no particular reason why the short-term, more than any other, credit market should be subsidized by money creation.

Finally, an important criticism of a governmentally enforced policy of 100-percent reserves is that this measure, though beneficial in itself, would establish a precedent for other governmental intervention in the monetary system, including a change in this very requirement by government edict. These critics advocate “free banking,” i.e., no governmental interference with banking apart from enforcing payment of obligations, the banks to be permitted to engage in any fictitious issues they desire. Yet the free market does not mean freedom to commit fraud or any other form of theft. Quite the contrary. The criticism may be obviated by imposing a 100-percent-reserve requirement, not as an arbitrary administrative fiat of the government, but as part of the general legal defense of property against fraud. As Jevons stated: “It used to be held as a general rule of law, that any present grant or assignment of goods not in existence is without operation,”36 and this general rule need only be revived and enforced to outlaw fictitious money-substitutes. Then banking could be left perfectly free and yet be without departure from 100-percent reserves.37

• 35Swiss banks have successfully and for a long time been issuing debentures to the public at varying maturities, and banks in Belgium and Holland have recently followed suit. On the purely free market, such practices would undoubtedly be greatly extended. Cf. Benjamin H. Beck-hart, “ To Finance Term Loans,” The New York Times, May 31, 1960.
• 36Jevons, Money and the Mechanism of Exchange, pp. 211–12.
• 37Jevons stated:
  If pecuniary promises were always of a special character, there could be no possible harm in allowing perfect freedom in the issue of promissory notes. The issuer would merely constitute himself a warehouse keeper and would be bound to hold each special lot of coin ready to pay each corresponding note. (Ibid., p. 208)