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Source link: http://archive.mises.org/7258/the-rule-of-planned-money/

The Rule of Planned Money

October 4, 2007 by

There is a long history of monetary experience, writes Garet Garrett. It tells us that government is at heart a counterfeiter and therefore cannot be trusted to control money, and that this is true of both autocratic and popular government. The record has been cumulative since the invention of money. Nevertheless it is not believed.

There is also a history of sound money, and if its lessons are likewise disregarded, what shall one conclude but that monetary delusions are, by some strange law of folly, recurring and incurable? There was a century of sound money. During one hundred years preceding World War I, government touched money hardly more than to establish standards of weight and measure, to lay down the laws of liability and to license bankers. In that century the wealth of the world increased more than in all preceding time of economic man. FULL ARTICLE


JIMB October 12, 2007 at 11:54 am

Mike – The definition isn’t arbitrary at all and I believe you are in denial of the facts. Money is the ultimate settlement for indirect exchange for immediate spending – that’s observable and logical. In fact, Yen wouldn’t be money at all in the international market if it weren’t convertible to DOLLARS, one way or another. (Perhaps someday we will see dollars demonetized by the market). The “ultimate settlement item” IS money and everything else has value primarily in respect to it’s ability to command that ONE main medium of indirect exchange. Credit is not a reliable money substitute and isn’t money (obviously, factually).

Clearly dollars, either electronic money at the Federal Reserve or cash dollars ARE money and nothing else is. You see, you accuse “Austrians” of getting it wrong but you haven’t defined what money is in the first place (and it seems you are operating under some severe miscalculations) – You need to define money according to factual observable human action. If you don’t, it’s not economics, its fantasy.

How about you put forth a definition and we can talk about what the real issue is.

jp October 12, 2007 at 11:54 am

“If you want empirical studies, see…”

Alright Mike, I’ll take it from your reading suggestions that you don’t feel up to answering my questions about the real world applications of the RBD and want me to scram.

“They collect only data that quantity theorists would be interested in: Tons of data on various measures of the money supply, and almost nothing on the value of the central bank’s assets.”

That’s a bad exaggeration. A simple trip to the library and I found a record of all the Fed’s assets (broken into categories by type) from 1914 to present, as well as currency issued. These numbers are published every week by the Fed. I’m surprised that as someone interested in the backing behind dollars that you seem to have made no effort to acquire these numbers.

“If the fed chooses to maintain financial convertibility at a low level, then the value of the dollar can be much less than the Fed’s assets would lead you to think.”

Can you explain this further? Are you saying there is no point in looking at the Fed’s assets? The Fed maintains convertibility through open market operations and discount lending (points 1 and 2 on your list from earlier on), but you keep on bringing up this last point as if it is something magical and different from point 1 and 2. If not than how is it different? Please use actual Fed examples for clarity.

“Yes, cash can back cash, provided the backing cash is itself backed, which it has to be because its original issue occurred in exchange for genuinely valued backing.”

Ok. But the Fed cannot back cash with cash. See it’s note 3g to financial statements.

If I may, the problem with you and Jean Paul is you wax theoretic, but completely sidestep any attempt apply your theory to the reality of the last century or so. I’d suggest you work on that. If we can’t use your theory to explain reality then why should we believe you? The good thing about the quantity theory is that a lot of effort has been made to apply it to reality, and the correspondence between increased money supply and a decreasing purchasing power of the dollar is very much apparent.

Michael A. Clem October 12, 2007 at 1:09 pm

Sure, I’d be okay with the existence of Disney dollars or Mike dollars, assuming that they were, in fact, money in their own right, and not merely a money substitute. Even so, I wouldn’t want to use them unless I thought their value (purchasing power) would remain stable or increase.
In free banking, I would, of course have more than one option for money, and this competition itself would help ensure that Disney or you didn’t devalue your currency through inflation of the supply, although you could also try other ways of ensuring me that the money would be stable, such as a gold standard. If you tell me your money is backed by “assets”, I’d need to know more about these assets and their nature to know if I’m assured or not of its stability. Of course, at that point, I could also look at the history of your currency and see how stable it’s been in the past. Counterfeiting, too, would be an issue to consider, and I would expect issuers to take reasonable anti-counterfeiting measures.

eric lansing October 12, 2007 at 1:22 pm


the silver that was deposited with the bank represents, say, 10 loaves of bread that have been saved by the baker. In receiving his 10 paper dollars, he retains his claim to those loaves. If the RDB bank issues an additional paper dollar backed by the farmer’s IOU (which is backed by the farm… lets drop the bushels of wheat since these are essentially saleable & liquid, whereas the farm is not), then there will be 11 paper dollars competeing for the same 10 loaves, no? If the farmer buys a loaf with his IOU dollar and then the baker tries to buy back his 10 loaves he will find that 10 dollars can only buy 9 loaves.

If the baker were to lend one of his paper dollars to the farmer, savings would support the farmer’s consumption.

Mike Sproul October 12, 2007 at 6:46 pm


I can buy a loaf of bread with one ounce of silver, with a bank note promising to deliver one ounce of silver, with a check that promises to deliver one bank note, with a credit card that promises to deliver one checking account dollar, with yen, etc. Trying to define what is money and what is not is just trying to draw lines where nature didn’t put any. But every one of those moneys that I mentioned is the liability of its issuer, and is valued according to that issuer’s assets and nothing else.

Mike Sproul October 12, 2007 at 7:01 pm


I don’t want you to scram; I just want you to listen to reason.

The Fed’s balance sheet tells us, for example, that they issued $100 and acquired $100 of bonds in exchange. We already knew that. Data that is relevant to the RBD would tell us whether those bonds have since risen or fallen in value, and that data is harder to find. I should add that Thomas Tooke, probably the most data-oriented economist of the nineteenth century, concluded that the real bills view was correct and the quantity theory was wrong. (As long as you’re scolding me about my lack of data, did you do what I suggested and look up those empirical articles?)

About maintaining convertibility at a low level: A bank could have 100 oz of silver backing $100, but if the bank chooses to maintain convertibility at $1=0.6 oz (which is an effective default) the value of the dollar will be less than the value of the bank’s assets would lead you to believe. The same is true if the bank backs dollars with bonds and maintains only financial convertibility. If the Fed uses its bonds to buy back dollars only when the dollar drops below .6oz, then the dollar will be worth .6 oz even if the Fed’s assets could justify a higher value. Needless to say, this creates empirical difficulties.

JIMB October 12, 2007 at 8:47 pm

Mike – Well you’ve already agreed with the Austrian position here although you appear not to have noticed it … You say financial securities have degrees of moneyness. So I must ask in reference to what? Clearly you are comparing securities to an actual existing money

You see, you (accidentally) blur the lines between money and credit and money substitutes because you’ve not considered what money is and it’s unique service in trade. Until you do, you cannot provide an analysis that makes sense, and you run the risk of large errors in logic.

Austrian economics provides a theory of money which is empirically verified, observable, logical, and known apriori all wrapped into one! So far I’ve haven’t anything that even approaches that in RBD.

renato October 12, 2007 at 9:41 pm

The Federal Reserve Notes are not counterfeit. They are inflationary, government-monopoly imposed money. But it is the Federal Reserve’s money to make.

I guess there are ways in which a real-bills bank could act to mantain the value of their notes. Offering their assets for sale against their notes and burning the proceeds will both cause monetary deflation and provide instant exchange-value for the noteholders.

There is nothing wrong with making your own money and profiting from it. What is wrong is forcing (or frauding) people to use it.

Mike Sproul October 13, 2007 at 11:06 am

Eric Lansing:

The farm can, of course, be sold. Otherwise the farmer couldn’t have borrowed against it. The farmer’s net worth is not affected by the loan, so he has no more demand for loaves with the loan than without it. If not for the loan, the farmer could have sold a square foot for 1 loaf. You say there are now $11 chasing 10 loaves, but before the loan there were $10 plus 1 square foot chasing the loaves, so the price of the loaves is unaffected. It’s the same with the silver. When the 10th ounce is deposited, there is one more paper dollar chasing the 10 loaves, but also 1 less ounce of silver. It’s the value of the item that matters–not its physical form.

Borrowers are not made richer by loans, so the overall demand for goods is unaffected by loans of newly-issued cash. If I have a $100,000 Tbill, I can buy a house with it, and the Tbill can trade from hand to hand after that. If I sell it to the fed for $100,000 in green paper, I can still buy the same house, and the green dollars can trade from hand to hand after that. If for some reason the additional $100,000 were not needed for circulation, the law of the reflux would take hold and the $100,000 would return to the fed.

jp October 13, 2007 at 1:10 pm

“Data that is relevant to the RBD would tell us whether those bonds have since risen or fallen in value, and that data is harder to find.”

How about this data:


This page basically lists every security the Fed holds by CUSIP number and par value. Most securities have risen over the last year, so according to RBD the backing of each dollar would have risen too.

By following this data over time one should get a good idea for backing, no?

I have read the suggested articles, interesting stuff, thank you. Those are old examples though and I am more interested in applications to the present. Incidentally, the Sargent paper relied on central bank balance sheet data to arrive at its conclusions and wasn’t concerned whether the bonds had risen or fallen in value.

Your comparison of dollars to GM stock is interesting. GM stock is equalized to its backing not through some mechanical process, but a psychological process whereby hundreds of thousands of traders arrive at conclusions about GM backing and act on these conclusions by buying or selling accordingly. Methods such as fundamental analysis and value investing help bring GM stock to the same level as it’s backing (or at least close to it).

According to you, the same occurs with dollars. Fed backing is analyzed by a large number of traders, the dollar falling or rising according to these trader’s perceptions of backing.

But in order for the backing theory to play out, people must be aware of what backs the dollar and able to price it. Ask the man on the street about what backs the dollar, and they won’t be able to tell you. How can they participate in this process of valuating backing?

According to you, there are many empirical difficulties as well as problems with data availability when it comes to analyzing backing. If it is so difficult (impossible?) to figure out backing, who is doing it and how? There seems to be no method such as fundamental analysis (which analysts of GM stock use) available to the Fed analyst. How is the process of dollar-devaluation- due-to-declining-backing occurring if no one can actually learn what backing is worth to begin with?

Jean Paul October 13, 2007 at 8:31 pm

“Ask the man on the street about what backs the dollar, and they won’t be able to tell you. How can they participate in this process of valuating backing?”

Individual participants in the market do not keep track of the value of the money’s backing in money terms, NOR do they keep track of the quantity of money issued (so I’m not sure how the point is relevant?)They don’t need to know either, because price signals tell them all they need to know.

…Not very related, but under free banking, you’d soon see appreciating dollars outcompeting depreciating ones, I am sure.

JIMB October 14, 2007 at 12:40 am

Mike – This is just fiction: “If I have a $100,000 Tbill, I can buy a house with it, and the Tbill can trade from hand to hand after that.”

You can’t count on one hand the number of “houses that settled in T-Bills”.

Trade is settled in cash, rarely with money substitutes, and those substitues (such as T-bills) are always discounted against cash (i.e. they must bear a positive rate of interest or they will not trade at par). Again, you appear not to properly connect RBD with any relevant facts of human action.

Had I the time, I’d love to take your class on money and banking (if you are still teaching it). I’ve been in the business for nearly 20 years. It would be an interesting run.

As an aside, even the T-accounts in banking are messed up. An asset is something owned. The bank doesn’t own anything but the currency. If the bank buys 100 oz of silver by issuing new currency, the asset is the currency, the liability is the silver (the bank owes the silver to any person who wishes to redeem the currency for the silver).

And if the bank issues $100 in exchange for $110 IOU whose present value is $100, the $100 is the asset, the IOU is a liability (the bank owes the IOU asset back to the borrower upon presentment of payment).

Banking appears purposefully designed to deceive depositors into believing the loans the bank has are the bank’s assets when in reality, the primary asset is the power to issue currency, which in the U.S. the Federal Reserve possesses, at the service of the 12 regional and many member banks.

Mike Sproul October 14, 2007 at 11:42 am


Thanks for the link. My hat’s off to your data-finding ability. If the Ded’s bonds rise in value, then certainly the fed’s assets rise, and the dollar would either rise or fall by less. If, for example, inflation had been running at 4%, and the fed’s assets started rising at 1%/yr, then inflation should drop to 3%.

As I said, the real bills doctrine puts an upper limit on the value of the dollar, but not a lower one. If any currency were valued above the assets held by the issuing bank, you’d see a speculative attack like in Thailand, Korea, Mexico, etc. But if a central bank chose to conduct its open market operations at a rate below what its assets could support, it has effectively defaulted on its obligations, and can use open-market operations (aka “financial convertibility”) to maintain the value of the currency at a selected level. This can make investors’ opinions about assets and liabilities less relevant, though I think Jean-Paul makes a good point about security pricing. It takes surprisingly few informed investors to price a security

Mike Sproul October 14, 2007 at 11:49 am


My point was that issuing $100,000 cash for a $100,000 Tbill does not change anyone’s net worth, and so does not change anyone’s demand for goods because a person who owns a $100,000 Tbill can, for the trouble of crossing the street, use it to buy things.

I’ll leave you to argue with the accounting profession about why silver deposited in a bank is the bank’s asset, while the paper or credit dollars it issues in exchange are the bank’s liability.

JIMB October 14, 2007 at 2:15 pm

Mike – Yes it does. T-bills are not used to settle trades, money is. So creating new money against a T-bill means an increase in immediate spendable funds rather than a transfer of funds from the buyer to the seller, which would occur without the creation of new money. There is an increase in demand as opposed to a shift in demand from one economic actor to another.

This has the obvious effect of lowering the rate of interest (buying bonds with new cash will lower the interest rate on the bond), and discoordinating the prices of goods because the value gotten to buy the bond came from the existing holders of the currency – the new issuance of currency diluted the value of the existing currency to those that hold the currency. Hence the currency is actually the asset of the bank because the bank can take from it at will (by issuance).

This is really basic stuff, Mike. I suggest you think through the mechanism step by step before proposing that Austrians are wrong about their view of money.

eric lansing October 16, 2007 at 9:43 am


“It’s the value of the item that matters–not its physical form.”

would you agree that there is such things as capital goods and consumer goods? The 10 loaves were savings… the baker sacrificed consumption so that he could draw on the savings in the future… the square foot of land cannot be consumed – it does not contribute to the pool of available savings. It is just capital which can be used to produce svings in the future.

Mike Sroul October 16, 2007 at 11:34 am

Eric Lansing:

Frank Knight had some interesting things to say about the fallacious distinction between productive goods and unproductive goods. I don’t remember a citation, but basically it comes down to saying that goods I approve of are productive and goods I don’t approve of are unproductive. I think the same could be said of capital goods and consumer goods. I might eat the bread to get energy to do my work, and I might use the square foot of land to grow flowers for my own enjoyment.

eric lansing October 16, 2007 at 1:17 pm


apart from the Real Bills authors you have cited, can you share your economic influences? You mentioned you knew Murray Rothbard… did you ever read Man Economy & State or Human Action? Keynes? Friedman? Samuelson? Also, what role does the central bank play in real bills? It would seem there is no need for one.

What are you?

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