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Source link: http://archive.mises.org/10082/murray-rothbards-case-against-the-fed/

Murray Rothbard’s Case Against the Fed

June 5, 2009 by

The Federal Reserve System is accountable to no one; it has no budget; it is subject to no audit; and no Congressional committee knows of, or can truly supervise, its operations. The Federal Reserve, virtually in total control of the nation’s vital monetary system, is accountable to nobody — and this strange situation, if acknowledged at all, is invariably trumpeted as a virtue. FULL ARTICLE


Ken June 5, 2009 at 10:44 am

I read The Case Against the Fed shortly after I read Hazlitt’s Economics in One Lesson. They stand near the top of the pile of the most important books I’ve ever read.

Cynicus Economicus June 5, 2009 at 8:16 pm

There are many points in this article with which it is only possible to agree. However, I still do not see the point in a gold (or similar) standard.

As is identified, money only has value in exchange, and the value in exchange is just a matter of perception. As such, what is wrong with a fiat currency, provided that the quantity of issue is absolutely fixed?

There is a full explanation of the principles here:


The argument commences about half way down the post. Essentially, if the number of units is fixed, they can only be subdivided through commensurate destruction of the larger unit, then the money becomes an exact mirror of the output of the economy in question. If for example, 1000 units were issued at the outset, 1 unity will always represent 1/1000th of total output.

If the currency becomes unwieldy, 1 unit might be divided into a hundred units, but this would mean the removal of the 1 larger unit. To continue the butter analogy in the article, there would still only be one pound of butter, but it would be divided into smaller slices.

Thoughts are welcomed on this.

Kris June 5, 2009 at 11:51 pm

@ Cynicus:

“As is identified, money only has value in exchange, and the value in exchange is just a matter of perception. As such, what is wrong with a fiat currency, provided that the quantity of issue is absolutely fixed?”

Your scope of what is “money” is unnecessarily limited. Money is identified as ONLY an agent of exchange precisely BECAUSE fiat money has no other relevant economic uses for which it is readily substituted. Not so with commodity-based money.

The difference between commodity-based money and fiat money is that the commodity that backs whatever currency is in circulation is governed by the same economic laws and principles as are all other goods and services. That is, real resources must be expended in finding, mining, minting, and distributing gold, silver, or whatever other commodity ostensibly backs money. This is unequivocally not so with fiat money, which derives its value from nothing more than the seal of the particular government on its chosen paper. Far fewer real resources are expended in the production of additional fiat money than in the production of an additional quantity of the commodity that would back a given currency. Because mining entrepreneurs, and the firms they run, employ the same cost-benefit analyses in determining whether to increase or decrease production of their mines as oil firms do for oil production, the expansion or contraction of the money supply is governed by economic laws, as opposed to the political laws that govern the expansion or contraction of government controlled fiat money supplies.

In short, the opportunity cost of monetary expansion in a fiat regime is infinitesimal compared to that in a commodity-based regime. One would naturally expect, then, the rate of monetary expansion to be exponentially higher in fiat regimes.

newson June 5, 2009 at 11:57 pm

to cynicus:

why would you need the force of law (fiat) if the object was not to inflate? are politicians worthy of blind trust?

Gil June 6, 2009 at 1:03 am

Don’t forget the historical tidbit when Kublai Khan confiscated gold and silver money and replace it with paper money.

Anonymous June 6, 2009 at 1:33 am

Cynicus Economicus,

How would the money you describe come into existence? In other words, how would the money you describe originate on the market?

Money can only originate on the market. A barter economy is characterized by direct exchange. Indirect exchange then occurs to overcome the double coincidence of wants. Individuals will chose the most marketable commodity to conduct indirect exchange. The use of that especially marketable commodity will feed upon itself until that one commodity becomes the general medium of exchange (money).

There are characteristics that make certain commodities especially suitable to serve as money. These characteristics include durability, scarcity, divisibility, and high value per unit of weight. Paper possesses none of these qualities. That is why paper has never been chosen by the market to serve as money.

The system you suggest wouldn’t work, even if government imposed it using coercion. Money can only originate through the market process summarized above. Paper money exists today only because governments made previous claims to gold irredeemable and then made those irredeemable money substitutes legal tender.

P.M.Lawrence June 6, 2009 at 3:12 am

Newson, there is a realistic motive for governments to use fiat money that isn’t because they are intending inflation. It’s the same one that was active in the US “gold window” period: to drain bullion from domestic uses and have more available for foreign trade. Of course, it doesn’t stay that way, but the inflationary temptation is a different motive.

Beta Hater June 6, 2009 at 3:46 am

Cynicus Economicus,

The system you suggest would require government involvement or some sort of social contract. Your system could not arise spontaneously through the market process:

“Money does not and cannot originate by order of the state or some sort of social contract agreed upon by all citizens; it must always originate in the processes of the free market” (pg. 3, The Mystery of Banking).

“Business usage alone can transform a commodity into a common medium of exchange. It is not the state, but the common practice of all those who have dealings in the market, that creates money … If the State creates credit money – and this is naturally true in a still greater degree of fiat money – it can do so only by taking things that are already in circulation as money substitutes (that is, as perfectly secure and immediately convertible claims to money) and isolating them for purposes of valuation by depriving them of their essential characteristic of permanent convertibility” (pg. 93, The Theory of Money and Credit).

Econ Guy June 6, 2009 at 5:39 am

Rothbard shows that fractional reserve banking is unethical and should be illegal. How can one argue otherwise after reading this book? Rothbard demonstrates that fractional reserve banking redistributes wealth.

Selgin, White, and Horwitz argue that fractional reserve banking is ethical and legally justifiable: “No fudging, no hedging, no hesitation. FRB is neither legally nor ethically problematic. Period. End of sentence” (Horwitz). They’re all great thinkers, but they miss the point entirely about wealth redistribution.

Money is not a consumer or capital good. Thus, an increase in the money supply does not confer a social benefit. Here’s the question: if fractional reserve banking is ethically/legally justifiable, how come counterfeiting is not?

newson June 6, 2009 at 6:28 am

to pm lawrence:
fdr’s infamous executive order # 6102 was a deliberate inflationary policy move.

Cynicus Economicus June 6, 2009 at 9:30 am

Many thanks for the replies, which offer some interesting thoughts.

I will admit that I have been a little simplistic on the use of money, but did not want to go into more detail in a brief comment. However, regarding the origin of money, I do not believe this is an issue. What is at issue is that money should not be subjected to arbitrary inflation by government. I am guessing that we can all agree that inflation of the money supply is not a positive process, and might even be described as theft/or stealth taxation or redistribution.

However, the point about money is that it is just a perception in the mind of each individual. Perhaps someone more scholarly than me can reference this, but I believe that sea shells and other items have been used for money.

One of the points I should have mentioned in my discussion of money was that it must also serve as a contract. I discuss this in a post, during which I was starting to form a broader view of economics:


You will note that, in the article, I was at that time of the view that a gold standard made sense. However, I have shifted the view to a fixed supply, as there have been cases where commodity money has not worked. e.g. Spain’s opening of the New World and the surge in silver coinage.

On the other hand a fixed (eternally) supply of money with a process of substitution (cutting the pound of butter into smaller pieces) appears to do everything that money should do. It stores value – in this case the value of the money is fixed to x% of total output. As such it serves as a contract to, in the future, buy x% of total output of an economy. That appears to be an honest form of money.

In the case of a gold standard, the value is tied to output of gold, which is uncertain (e.g. if there was civil unrest in South Africa), and the value of gold for use in ornament and in industry. These are possibly unstable. It is also possible for speculation, and other manipulations to be used in the gold market (e.g. at the moment oil is sitting in tankers outside of ports around the world in the hope of price rises). As such, gold does not offer much surety of future value, which might fluctuate in a dramatic way.

On the other hand, a fixed currency has many positives. If a currency is tied to total output, it might also fluctuate in value, but it is less likely to have a serious decline in value. Furthermore, as many wiser people than I have recognised, wealth and poverty are relative to those around us, and therefore relative wealth will not be greatly changed in the event of devaluation (e.g. output contracts and the value of the currency will decline in line with the decline in output). Crucially, it is nigh on impossible to manipulate the entire output of an economy (excepting in totalitarian states).

(Note to Anonymous: Electronic money is the obvious answer, not paper money).

Beta Hater: You quote a passage that appears to suggest that something has to be taken for a fiat money to come into being. The whole point about a fixed fiat currency is that it can be issued purely as an accounting tool, with no commodity backing, and no debt obligations. The point is that it is a representational token of x% of the output of the issuing economy, and therefore is simply a means of exchange and a contract to repay x% of output now with exactly the same % at any future date.

There is considerable discussion that a currency can only naturally emerge from the market in the replies to my initial comment. However, once the problem of the expansion of money supply is removed, what is wrong with paper or electronic money. Whilst the belief in such money is about to be tested by QE and other such lunacy, up to now we (meaning people in general outside perhaps of Austrian economists) have believed in bits of paper as money, and they have functioned perfectly well in this role (albeit that people have been persuaded to allow the evils of perpetual inflation).

I see no reason why, bearing in mind the purpose/s of money, why there is any reason why it might need to ‘emerge’.

I also note talk of coercion in the replies. What is coercive about a legal system of exchange, where governments have no method of expropriating the value of money through expansion. Under this system, there is no reason to make it the exclusive legal tender, because I do not think any other issuance would start to match it as a store of value. Once the ability to expand money is removed, there is no reason to challenge the belief. It will be every bit as real as a lump of gold, and will work perfectly well in that role.

However, there would need to be legal protection such that only the one ‘official’ form of currency might be called a $ or a £. Alongside this, I would not see any reason for individuals to use lumps of gold as a method of exchange, or to store value, or bits of tissue paper with ‘IOU 3 hours of labour’ written on them.

I just think that people would opt for the fixed supply fiat currency, given a choice. What better store of value is there??

Kris Says:

“In short, the opportunity cost of monetary expansion in a fiat regime is infinitesimal compared to that in a commodity-based regime. One would naturally expect, then, the rate of monetary expansion to be exponentially higher in fiat regimes.”

The only role the state might have in such a fixed fiat currency is the replacement of physical bank notes (which in any case will not be necessary for too much longer) and coins, and the introduction of names for the sub-divisions (or smaller slices of the butter) and introduction of appropriate notes/coins.

The key to any such system is how to enforce the prohibition on increasing the money supply. However, as has been seen with gold (clipping, and various means of government interference), this is a problem that is not unique to a fiat currency. In a way, it is easier to enforce the fixed money system, as any change is very visible, and there is less wriggle room for justification (e.g. moving from gold, to gold backed paper, to less gold per paper etc.) As Adam Smith recognised, governments will always try to corrupt money, and discussed the corruption of commodity money as part of his historical review (sorry, no page reference to hand, but I guess most readers are more scholarly than I, and will know the discussion).

I hope this addresses Newson’s point as well, and hope that I have covered most of the points that were made.

I am new to economics, and have only relatively recently read anything on economic theory and have been relying upon my own best intuitions/thoughts.

As such, forgive me if I am missing any underlying reason why a fixed currency is not better than a commodity currency. The answers appear to be a response to the existing fiat system, rather than the fixed fiat system I propose. I am still not sure that any reason has been given for not having a fixed fiat system, although I would agree with many of the arguments were they directed at the current fiat system.

Note: For fiat, I am using the term slightly inaccurately in my ‘fixed fiat’ system, and just mean a government backed official money, required to be used for transactions with the government.

Also, apologies for the random order of my responses. It is 2 in the morning here, but I thought I should at least do my best to respond to your interesting and thought provoking answers.

Kris June 6, 2009 at 1:32 pm

@ Cynicus:

First of all, embrace brevity. I’m surprised I made it through all of that. Now, on to the response.

“As such, forgive me if I am missing any underlying reason why a fixed currency is not better than a commodity currency. The answers appear to be a response to the existing fiat system, rather than the fixed fiat system I propose. I am still not sure that any reason has been given for not having a fixed fiat system, although I would agree with many of the arguments were they directed at the current fiat system.”

Several points:
1.) I’m assuming that the sole manager of this “fixed fiat system” would be the government. All governments, regardless of their stated intentions, succumb to political pressures and respond to political, rather than economic, incentives. Your system would only remain “fixed” to the extent that “fixed” money supplies are politically popular. It’s naive, and contrary to the conclusions found within the robust public choice literature, to assume that any politician would constrain themselves to doing what is “right” instead of what is politically expeditious. Competition (a feature notably absent in the type of monopolistic fiat system you propose), not government edict, ensures sound money.
2.) It’s curious that you acknowledge, via your Adam Smith reference, that all governments inevitably try to corrupt and debase currency, yet still advocate for a system in which the government alone monitors the money supply. What makes you so sure a “fixed fiat system” would be different? It’s a common folly: “THIS policy will be different…We just have to get the right technocrats employing the right policies…” This is at best naive and at worst cognitively dissonant. Hayek said it best: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

Sorry friend, but any proposed monetary regime that rejects the introduction of competition and fails to realign incentives from the political to economic realm can’t be taken seriously.

an anarchist June 6, 2009 at 1:41 pm

“As such, what is wrong with a fiat currency, provided that the quantity of issue is absolutely fixed?”

Maybe others have already said this, so let me apologise in advance if I’m just repeating the sentiments of others.

My answer to your question: Nothing, if it were possible to “absolutely fix” a fiat currency. But you can’t. Only in a utopia where men are ruled by angels could a fiat currence be “absolutely fixed”; but utopias cannot exist and statist solutions cannot work.

Thinker June 6, 2009 at 5:33 pm

Actually, there is a downside to fiat currency beyond the potential for inflation.

Under free market conditions, a commodity becomes used as money because it is the most valuable and most universally valued commodity. However, such a commodity (usually gold, silver, or something else fairly heavy) is hard to carry around and difficult to exchange all at once, especially in large transactions, so paper substitutes become used to represent the money. All this is basic Misesian theory.

Using the paper as currency is less efficient for exchanging value because of the paper itself has relatively low value and it takes time and effort to covert it to the money, but this inefficiency is more than overcome by its convenience. With fiat money, on the other hand, pieces of paper have been declared by the ruling power to be the most valuable and universally valued commodity for the purpose of trade. Now, individuals can convert their pieces of paper to more valuable and universally valued commodities, but they cannot use these commodities for exchange. This eliminates the monetary potential of commodities-they must be used in production or to store value for a later date (but then they must be converted to the fiat money), not as media of exchange. This inability to use the optimal money causes inefficiency in the market.

Also, in the infinitely improbable case that the fiat money was optimally chosen, it cannot take into account potential changes in the relative values of commodities. If gold is the fiat money and all the copper mines are used up, then copper will overtake gold as the optimal currency over time. Immediate recognition of this development and a similarly swift change in the money are required to prevent the payment of significant opportunity cost, and of course, no government acts immediately.

Essentially, fiat money causes market inefficiency, especially in highly fluid markets. The cost is unseen because it is purely opportunity cost. A truly free market will always outproduce an otherwise identical market (which I know doesn’t actually exist) with fiat money.

newson June 6, 2009 at 10:25 pm

to cynicus:
you may find this work interesting. it answers the questions you raise -

newson June 7, 2009 at 3:32 am

to cynicus:
a fiat money with a fixed quantity (apart from being susceptible to corruption) is also problematic in the sense that how will the cost of re-printing worn notes be borne? free-bankers argue that the frb system is the only way to finance bank notes; a means-justify-ends argument. full-reservists don’t buy this. here’s a podcast on the theme -

Anonymous June 7, 2009 at 8:34 pm

Cynicus Economicus,

“regarding the origin of money, I do not believe this is an issue.”

You vastly underestimate the importance of this issue. Money can only originate in the processes of the market. In other words, the best money is chosen by the market. Moneys that don’t originate on the market are not good moneys. So the system you’re advocating would entail bad money because it cannot originate in the processes of the market.

“Electronic money is the obvious answer, not paper money”

Electronic money cannot originate in the processes of the market. The money commodity must have prior barter value before it can originate on the market. Electronic money doesn’t have prior barter value. Furthermore, electronic money does not possess an important characteristic of good money: scarcity.

To be blunt, the system you suggest has no promise.

P.M.Lawrence June 9, 2009 at 2:38 am
Bill B. May June 10, 2009 at 11:53 pm

It seems to me that having a fixed amount of money must have some traps, particularly when it comes to how fast money is moving around the economy and how big the economy is at any point.

Taking things to the limit, if we fixed the amount of money at one dollar for the US economy, it obvously would not be enough to sustain normal transactions. That one dollar could not move around fast enough to accomodate all the transactions that occur.

So the arguments for a fixed amount of fiat money are enticing, but it seems that the issue of how much is enough is pertinent as well as what happens when the economy grows.

Thoughts, anybody?

Gil June 11, 2009 at 12:30 am

Why would a fixed money supply be ‘ideal’? “Inflation sucks! Deflation rules!”? “I hate seeing zeroes on the left of the decimal point but love seeing zeroes on the right of the decimal point!”? Why is deflation a good form of ‘free money’ whereas inflation is a bad form of ‘free money’? As far as I’m concerned the money supply should equate to the good&services in a way that prices are stable for a given amount of goods & services. Gold coins may fit this role as deflation would spur gold miners to inject more gold coins into the economy whereas inflation would stop gold miners as they can’t get a return on their efforts hence a rough&ready equilibrium. However most people who do fast moving, long distance tranactions are probably going to balk at shipping gold coins to&fro and would prefer some sort paper or electronic money hence the problem would come full circle. :/

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