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Why Sound Money Does Not Need a Central Bank, Only the Rule of Law

Why Sound Money Does Not Need a Central Bank, Only the Rule of Law
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The money that all nations use today is composed either of reserves created by a central bank and/or credit money created by banks via fractional reserve banking. In the first case, a central bank can create reserve money via open market operations, whereby the central bank buys an asset–any asset–with reserves that it creates out of thin air. These reserves land in a bank and allow the banking system to create credit money in multiples of the new reserves via the fractional reserve lending process. Both methods of money creation are fraudulent, if done by any entity other than a central bank, in the case of open market operations, or a bank member of that central bank system, in the case of fractional reserve lending. All nations have thrown the rule of law out the window for these monetary counterfeiters.

 

A sound money system does not sanction counterfeiting money, either via creating reserves out of thin air or via creating credit money via fractional reserve lending. In a sound money system there is only commodity money; i.e., gold, silver, bails of tobacco, etc. Commodity money may be spent, as in using gold or silver coins in everyday transactions, or other receipts may be exchanged which represent commodity money that is stored in a safe and trusted facility. Issuing a coin that does not contain exactly the weight and purity as represented is fraud in a society governed by the rule of law. Issuing certificates or bank receipts in excess of the stored commodity also is fraud in a society governed by the rule of law.

 

A society governed by the rule of law does NOT exempt any entity, including the government itself, from the law. Thus, a central bank that creates reserves out of thin air is committing a crime, as recognized by Sir Robert Peel in his famous Bank Charter Act of 1844. A member bank that pyramids these reserves into multiples of credit money via the lending process is committing a crime, as cogently explained by Jesus Huerta de Soto in his Hayek Memorial Lecture at the London School of Economic in 2010.

 

In a free society governed by the rule of law any entity can create money and offer its use to the public. I can offer the public the use of my wife’s delicious quart jars of homemade pickles as money, either in direct exchange (for example, a jar of pickles for a box of nails at our local hardware store) or as indirect exchange (a certificate that may be redeemed for a jar of pickles upon demand). However, I have violated the law if I hand over a jar that I claim contains my wife’s pickles but instead contains something else. Likewise, I have violated the law if I issue more certificates for my wife’s pickles than jars of pickles in her larder, which fraud would be revealed should too many people try to redeem their certificates at my house.

 

Of course, for transactions among people who do not know one another personally, unlike the local recipients of my wife’s pickles, a more generally accepted commodity would be used and certificates and/or book entry receipts would have to be issued by more widely known entities. For example, Citibank or Bank of America might issue gold certificates and maintain book entry gold accounts that would be generally accepted by a wide group of strangers as long as these strangers had confidence that Citibank or Bank of America had not engaged in fraud. Gold in their vaults equaled the certificates plus book entry accounts to the gram.

 

All that is required to convert to the rule of law is the repeal of legal tender laws granting special exemptions from normal commercial law to the central bank and its system of member banks. The reverse of Gresham’s Law would prevail. i.e., sound money would drive out bad.

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Profile photo of Patrick Barron

Patrick Barron is a consultant to the banking industry. He teaches Austrian school economics at the University of Iowa and Bank Managemant Simulation for the Graduate School of Banking, University of Wisconsin. Visit his blog. Send him mail.

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