Suffering Under Improper Banking Practices and Government Monetary Laws
By Michael S. Rozeff, LewRockwell.com
Improper Means of Exchange
Throughout history, humanity has devised various methods of exchange—currencies, payment systems, and forms of money—that have proven effective over extended periods. As Menger illustrated, one such method is the discovery of a highly marketable commodity, leading to the prominence of precious metals. Additionally, banks have long acted as intermediaries for short-term (90-day) bills of exchange, issuing bank notes in the process. Another approach involves goldsmiths depositing gold at banks in exchange for circulating certificates. Furthermore, governments have created tax certificates that can be used to settle tax liabilities. Not to mention, numerous commodities have served as means of exchange.
This overview is not exhaustive. The point is that a private economy can generate various means of exchange to facilitate low-cost transactions without resorting to barter. It’s worth noting that legitimate means of exchange can be developed by a government without resorting to compulsory or illegitimate currencies, such as legal tender.
When properly employed, none of the aforementioned methods can disrupt an economy, nor cause unemployment. History has shown that disruptions occur only when banks or governments violate essential principles, transforming valid means of exchange into illegitimate or ineffective alternatives not suited to the economizing behavior of individuals.
Particularly, I am referring to acts such as:
- Governments taxing freely developed means of exchange, placing them at a disadvantage.
- Governments mandating the use of certain currencies through legal tender laws.
- Banks issuing notes backed by assets that lack liquidity or a short-term horizon, such as mortgages, stocks, and term loans.
- Banks leveraging excessive financial borrowing to acquire illiquid or long-term assets while simultaneously issuing notes against short-term, self-liquidating bills.
- Banks improperly rolling over short-term bills into longer-term obligations.
- Governments allowing their bonds to serve as a basis for issuing bank notes.
- Governments ensuring bank deposits while those banks invest in long-term or illiquid assets.
- Establishing central banks with special privileges, such as designating their notes as legal tender.
- Centrals banks possessing the authority to bail out illiquid banks that have purchased long-term assets and become insolvent.
- Governments and central banks favoring larger banking institutions.
- Centrals banks empowered to buy government bonds using government-mandated means of payment.
- Governments that confiscate gold, outlaw contracts in gold, and issue irredeemable currency.
- Governments issuing credit certificates that far exceed their ability to collect taxes.
- Governments restricting citizens from acquiring foreign currencies or assets.
- Centrals banks holding a monopoly on note issuance while phasing out notes from individual banks.
This list is also not exhaustive.
How Improper Means of Exchange Cause Large Scale Economic Problems
This situation paints a grim picture. Each of the improper and illegitimate practices mentioned has been historically utilized and has instigated significant economic issues.
Even before the Great Depression, numerous banks failed in America, not due to their structure but because they had invested in long-term, illiquid assets such as farmland and mortgages tied to farmland, which depreciated in value. This depreciation was attributed to price surges during World War I, driven by the central bank’s excessive creation of payment instruments. In the 1920s, the Fed’s funds contributed to stock purchases via loans that banks improperly issued, as stocks are inherently long-term assets. Repeatedly, history illustrates that banks cannot securely issue redeemable notes against long-term assets. Indeed, the stock market crash of 1929 led to widespread bank failures in America and globally.
The extensive bank failures of the 1930s resulted in a severe currency shortage, reminiscent of the situation in 1893. However, unlike that time, banks did not create a currency of clearinghouse certificates due to the Fed’s control over base money. The outcome was massive deflation and economic depression.
Had there been a private creation of currency through appropriate means and legal frameworks, this scenario could have been avoided.
Suffering Under Improper Banking Practices and Government Monetary Laws
When banks adhere to improper practices and governments enact flawed laws that influence the banking sector and the broader monetary system, the consequences are dire. This leads to inflation, deflation, stagflation, economic booms followed by crashes, rising unemployment, and, often, senseless wars. It causes international tensions, disrupted trade, and pronounced asset volatility. Resources become misallocated to shield against such a flawed system, resulting in accounting failures, widespread fraud, rampant speculation, and malinvestment—all contributing to unhealthy collusion between financial institutions and governments.
The ordinary populace bears the brunt of this unnecessary suffering.
Improper practices and regulations are prevalent, not rare. It is nonsensical to attribute the 2008 financial crisis and subsequent deep recession to free markets or capitalism. These elements are conspicuously absent in our current monetary system.
The financial issues that became apparent around 2007-2008 mirror past crises, as the origins remain unchanged: improper banking practices and misguided governmental laws shaping financial institutions and the monetary landscape.
Large banks and investment firms engaged in short-term borrowing to fund long-term loans, acquiring assets with deposits considered currency under the central banking system. They breached fundamental economic principles dictating that these deposits should only be properly invested in self-liquidating loans with a short-term maturity. Additionally, they violated other fundamental rules. The long-term assets involved were closely tied to the housing sector, which saw artificially inflated prices due to easy money policies from the Fed and government encouragement. When these asset prices declined, it initiated a chain reaction of failures. By propelling loan creation and increasing the base money supply, the Fed staved off large-scale failures of these fundamentally flawed institutions operating within an inherently flawed system of laws and regulations.
Yet, the Fed delayed addressing the root issues of the system. This inaction merely prolongs and intensifies the suffering. The core challenges have not been rectified over the past four years; they have merely been obscured, or more accurately, digitized. The system is now functioning in a state of “pretend.” In some European countries, this illusion is no longer sustainable.
Sincerely,
Michael S. Rozeff
for Economic Prism
[Editor’s Note: Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. He is the author of the free E-Book Essays on American Empire: Liberty vs. Domination and the free E-Book The U.S. Constitution and Money: Corruption and Decline.]