The consequences of this short-lived paradise [inflation] are malinvestment, waste, a wanton redistribution of wealth and income, the growth of speculation and gambling, immorality and corruption, disillusionment, social resentment, discontent, upheaval and riots, bankruptcy, increased governmental controls, and eventual collapse. — Hazlitt, Henry. Man vs. The Welfare State (LvMI) (p. 136). Ludwig von Mises Institute. Kindle Edition.
“A few months, at most.”
This was the prevailing view of how long the fighting would last when Austria-Hungary declared war on Serbia on July 28, 1914. As Dr. Robert P. Murphy tells us in his incisive Understanding Money Mechanics, quoting Melchior Palyi:
All involved would go “bankrupt” shortly and be forced to come to terms, perhaps without a decision on the battle fields. The belligerents would simply cease to be credit-worthy. Such was the frame of the European mind in 1914; the idea that credit and the printing press might be substituted for genuine savings was “unthinkable.” “Sound money” ruled supreme, supported by the logic of the free market. (RPM’s emphasis)
And the ultimate irony, sound money — in this case the classical gold coin standard — was scorned by John Maynard Keynes in his 1923 “Tract for Monetary Reform” as a barbarous relic, though as Tyler Cowen reports “many other people had written similar terms (‘gold is a relic of barbarism’) well before 1923.”
Credit and the printing press financed one of the most destructive wars in human history, while the belligerents relegated gold to the sidelines. Yet economists affix the label “barbarous” to gold, instead of the deliberate, man-made inflation that funded the savagery.
The degree of barbarism that the war produced could not have been accomplished had a gold standard been in force. The public would have stripped the banks of the public’s gold. The governments would have had to come to terms with the enemy.
It was the abandonment of the gold standard that made modern barbarism affordable.
Governments had pledged to uphold the promise on the monetary receipts the public held —- immediate delivery of the commodity (gold) in weight and fineness as spelled out on the receipts. They readily broke that promise.
Clearly, a government-guaranteed gold coin standard is a fool’s gold coin standard. As North wrote, “There is no long-run limit on the State when the State controls the coinage. The traditional gold standard is a paper standard, revocable at will by politicians.”
Yet there was something special about life in the gold coin era, even under the corrupt eye of the State. Murphy tells us, quoting economist Oskar Morgenstern:
[T]here was freedom of travel without passports, freedom of migration, and freedom from exchange control and other monetary restrictions. Citizenship was freely granted to immigrants…capital would move unsupervised in any direction…. There were hardly any quantitative restrictions on international trade…[I]t was a world of which recently many…would have been inclined to assert that it could not be created because it could never work. (emphasis added)
Keynes made similar observations in The Economic Consequences of the Peace, Chapter 2, “Europe Before the War,” though he curiously fails to mention the role of gold:
What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914! . . . The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep . . . He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality . . .
But, most important of all, he regarded this as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable. The projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion, which were to play the serpent to this paradise, were little more than the amusements of his daily newspaper, and appeared to exercise almost no influence at all on the ordinary course of social and economic life, the internationalization of which was nearly complete in practice. (emphasis added)
The most devastating part of Keynes commentary above is bolded. The “state of affairs” would last forever, subject only to improvement, and any derailment was avoidable. It wasn’t avoided, the derailment was branded progressive and sold to the global public as new and improved.
The “amusements” of the media have become state policies and the media itself a mouthpiece of government. The wrecking ball of monetary inflation has taken its toll. As governments were able to extend the war with inflation, they thereafter increased their footprint into every area of our lives with inflation.
In the same book Keynes also wrote that not one man in a million could fathom the mechanism of monetary debauchery (inflation), and consequently the public is now faced with the prospect of global impoverishment in which they would live on bugs and own nothing.
And with the exception of the Austrian School economists, economic commentators have done their part by defining inflation as price increases (see here, here, here for starters) and overlooking the role of the central bank in creating it.
Murphy’s antidote
In this seeming pit of despair comes Murphy’s 2021 book, Understanding Money Mechanics.
He says the ultimate purpose of his book “is to give the reader a solid grasp of how money works in today’s world” — an understatement if there ever was one.
He begins by explaining how money arises as a solution to the limits of direct exchange and concludes by defining money as a “universally accepted medium of exchange.” Very importantly, money would necessarily be a commodity valued for its own qualities — meaning something that could also be consumed — which historically has been “livestock, shells, tobacco, and of course the precious metals gold and silver.”
Money allows for the creation of prices (ratios) in terms of a standard unit, since it is on one side of every transaction, allowing for profit/loss calculations. When a metal serves as money coining it into a uniform size and purity (fineness) provides a great convenience even though it is the raw form, not the coins, that is the actual money.
From here, Murphy explains the role of banks. Why are banks in a book about money? “To put it bluntly—banks enjoy the legal ability to create money.” In this section he explains the fundamentals of fractional reserve banking, on which he elaborates in greater detail in a later chapter.
He next presents a brief history of the US gold standard, beginning with the Coinage Act of 1792, the suspension of specie (gold or silver) payments during the Civil War, the resumption of redemption for gold only in 1879, the fight between the advocates of silver monetization and gold supporters during the election of 1896, and finally with the abandonment of gold for unlimited bloodshed in World War I. “The First World War . . . dealt a mortal blow to the gold standard from which it never recovered.”
Next, he discusses FDR, the Great Depression, Bretton Woods, and Nixon Shock, in which the latter put the whole world on a fiat standard — from which we have yet to recover.
He then goes into great detail about the history and structure of the Federal Reserve and how it changed from its original charter in 1913. He explains how the Fed and commercial banks create money, including details of the various monetary aggregates (M0, M1, etc.).
Perhaps the biggest surprise (and reward) of a book on mechanics are the remaining chapters. Did you know about the $92 trillion phenomenon called shadow banking? Maybe you’re rusty on LIBOR or the Fed’s Repo market, and how about the BIS and Basel Accords? And let’s not forget the Fed’s role in the 2008 financial crisis in which it invented QE and the paying of interest on commercial bank reserve balances. Murphy even presents a detailed timeline of the “tools” the Fed acquired.
Did you know “that the Austrian theory of the business cycle isn’t based on fiat money”? The housing bubble, the coronavirus, hyperinflation, detailed discussion of price inflation versus monetary inflation — followed by Keynes’ explanation of the Great Depression, Milton Friedman’s criticism of Keynes, Bitcoin, and the Austrian take on Modern Monetary Theory (MMT), focusing on Stephanie Kelton’s 2020 book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy round out his mechanics presentation.
And as if all this weren’t enough, Murphy includes a detailed list of references with links after each chapter that engaged me almost as much as his book.
For those who ever generated a thought about money and its corruption that Hazlitt so ably describes at the beginning of this article, Dr. Murphy’s Understanding Money Mechanics could, if enough people read it, become a world-saver. Don’t let the $3.99 Kindle price stop you.
