Misleading Statement Hunter: Round 1

1. From Michael Norton and Dan Ariely, Building a Better America – One Wealth Quintile at a Time, Association for Psychological Science, Abstract:

“Disagreements about the optimal level of wealth inequality underlie policy debates ranging from taxation to welfare. We attempt to insert the desires of ‘‘regular’’ Americans into these debates, by asking a nationally representative online panel to estimate the current distribution of wealth in the United States and to ‘‘build a better America’’ by constructing distributions with their ideal level of inequality. First, respondents dramatically underestimated the current level of wealth inequality. Second, respondents constructed ideal wealth distributions that were far more equitable than even their erroneously low estimates of the actual distribution. Most important from a policy perspective, we observed a surprising level of consensus: All demographic groups—even those not usually associated with wealth redistribution such as Republicans and the wealthy—desired a more equal distribution of wealth than the status quo.”

Response: These results are perhaps interesting as a factual description of public opinion, but they should not, as I think many people would be inclined to, be interpreted as any kind of argument in favour of egalitarian wealth confiscation and redistribution. Most “regular” Americans are utter illiterates when it comes to economic theory and the “regular” people of almost every other country in the world as well. Most don’t even realize that the government printing money is what causes the inflation that has been a constant feature of all modern economies since World War I. Given this, one would not expect them to realize the negative effects that egalitarian wealth redistributions would have, or realize that most of this wealth, while owned by rich people, is actually invested in business ventures to best serve them, the ordinary consumers. Not learning economics is fine, provided that your economic views do not affect the formulation of economic policy. As such, “regular” people’s economic views on wealth inequality, and whether most desire “a more equal distribution of wealth or not”, is based on an incomplete picture of the costs and benefits of such a policy due to most people’s ignorance of economic theory, and as such does not constitute any argument in favour of such policies.      

2. From 'Lord Keynes', http://socialdemocracy21stcentury.blogspot.ca/2009/11/financial-deregulation-and-origin-of.html:

“The era of globalisation between about 1980 and the early 2000s was characterized by extreme financial liberalization in comparison with the 1945–1980 period of tight and effective financial regulation.”

And:

“In the case of the US, we can point to a number of important acts of financial deregulation that were the direct causes of the [2008] crisis”

Response: These two statements are true, as far as they go, but while avoiding the error of commission, they commit the error of omission. Not mentioned is the fact that the financial industry, and the banking industry in particular, throughout the modern world, including in the US, does not at all run on free-market principles. Rather, in the US, the members of a banking cartel, headed by the government-linked central bank called The Federal Reserve, are protected from bankruptcy and are encouraged to inflate the currency and reap the benefits. The big firms in the financial industry are some of the main beneficiaries of these easy money inflationary policies, and as we saw in 2008, apparently have the privilege of being ‘bailed-out’ should their wild speculations based on easy money illusions turn sour in the face of reality. The banking and financial industries in the US are not paragons of free-market capitalism, but of crony capitalism, where the State heavily favours certain market participants and corporations with special privileges attained through coercion. Given this reality, perhaps ‘deregulation’ was a bad thing, as it could well have led to even more reckless behavior on the part of banks and financial institutions. But rather than trying to walk the policy tightrope between imposing hampering, inflexible financial regulations and letting the crony institutions run wild with their government privileges, why not just restore the best system of regulation of all, the free-market system of profit-and-loss, success and bankruptcy? (See: http://thinkingabouthumansociety.blogspot.ca/2013/03/a-superb-regulatory-system.html)

     

3. From Paul Krugman, “Myths of Austerity”, http://www.nytimes.com/2010/07/02/opinion/02krugman.html?ref=paulkrugman:

“For the last few months, I and others have watched, with amazement and horror, the emergence of a consensus in policy circles in favor of immediate fiscal austerity.”

And:

“And real-world policy — [austerity] policy that will blight the lives of millions of working families — is being built on that foundation.”

Response: In recent economic policy debates, there has been a misleading use of language running rampant, the use of the word ‘austerity’ to describe the economic policies of certain countries like Britain, Ireland, and sometimes even the US! Also, the economic policies that EU leaders allegedly seek to ‘impose’ on troubled countries like Greece, involving tax increases and spending cuts to pay back their sovereign debt, are also labelled as ‘austerity’. To a genuine supporter of the free-market such as myself though, this represents a misleading abuse of language. Let us take Britain: the alleged poster child of ‘damaging austerity in the wake of an economic crisis’. According to the data Sean Rosenthal in this article (https://mises.org/daily/5939/Krugman-and-British-Austerity) gathered, this government ‘austerity’ consisted of raising tax rates significantly and barely cutting government spending at all. Spending as a percent of GDP fell from the mammoth 51.1 percent in 2009 to the hardly-less mammoth 49.8 percent in 2011, still significantly higher than the also-mammoth 43.9 percent of GDP the leftist Labor government was spending before the 2008 crisis. I don’t know what such a policy should be designated as, but ‘fiscal austerity’, with its implications of a free-market policy intended to shrink government’s role in the economy significantly, is an utterly misleading label. Part of it stems from the  Keynesian idea that one should never, ever cut government spending in a ‘recession’, no matter how much of the economy it is currently engulfing or how wasteful the spending appears to be. Thus, any proposal to cut government spending at all, and even the failure to increase government spending fast enough during a depression is labelled ‘fiscal austerity’ by the Keynesians. For the ordinary reader, unencumbered by Keynesian theories though, the term is downright unhelpful and fraudulently misleading.    

4. From Paul Krugman, “Myths of Austerity”, http://www.nytimes.com/2010/07/02/opinion/02krugman.html?ref=paulkrugman:

“What’s the evidence for the belief that fiscal contraction is actually expansionary, because it improves confidence? (By the way, this is precisely the doctrine expounded by Herbert Hoover in 1932.)”

Response: Though from the same article as the previous misleading statement, this misleading statement is not about ‘fiscal austerity’ per se, but about the historical economic policies of US President Herbert Hoover. According to Keynesian mythology, Herbert Hoover was a doctrinaire free-marketeer who, when the Great Depression hit in 1929, misled by his outdated laissez-faire views, refused to intervene. The results were disastrous, and it took the free-spending President Roosevelt and his New Deal, and ultimately World War II, to lift the United States out of the Great Depression. For a book-length refutation of this utterly false account of the economic policies pursued by the Hoover administration in the face of the Depression, I would recommend Murray Rothbard’s America’s Great Depression, available for free here: http://mises.org/document/694/Americas-Great-Depression. Basically, Rothbard points out how Hoover actually originated many of the big-spending, interventionist policies that are typically associated with Roosevelt’s New Deal, had always been a fan of government regulation of business, and cajoled business’s into not reducing the wages of their workers in the face of the Depression and the monetary deflation, which in turn led to mass unemployment. For the busy reader though, I would point to Franklin Roosevelt him self’s indictment of Hoover’s economic policies when he challenged him in the 1932 election: "I accuse the present Administration of being the greatest spending Administration in peacetime in all our history." That’s right, Roosevelt’s criticism of Hoover wasn’t that he was a laissez-faire ‘liquidationist’ as Keynesians would have you believe, but that he was a big spender, the biggest peacetime spender in fact! That Roosevelt would, after the election, completely change his policy orientation from that put forward as his campaign platform and proceed to surpass Hoover in economic interventionism and government spending is only a testament to Roosevelt’s political duplicity, not to Hoover’s credentials as a ‘laissez-faire liquidationist’ who favoured ‘fiscal contraction’.           

5. From Paul Krugman, “The lost generation”, http://krugman.blogs.nytimes.com/2009/11/05/the-lost-generation/:

“the best quarter-century of growth America has ever experienced, the postwar generation — which happens to be the era during which many of the founders of neoconservatism came of age! — has gone down the memory hole. After all, it’s impossible that living standards would double under a regime of high marginal tax rates, generous minimum wages, and strong unions. So it just didn’t happen.”

Response: Krugman is here implying that it was the high marginal tax rates, generous minimum wages, and strong unions that caused the postwar quarter-century to be the fastest period of per capita GDP growth in American history. He does not actually offer a plausible, logical explanation for why high taxes, generous minimum wages, and strong unions would lead to rapid economic growth, nor does he refute the explanations of free-market economists of why these things would retard, not strengthen, economic growth and lead to unemployment. Rather, he commits the grave epistemological mistake of trying to refute logic with statistics, taking a correlation and assuming it equals causation without any theoretical explanation for why it should. In the spirit of Krugman’s logic-free empiricist methodology, I will offer a few relevant correlations of my own:

1. In the post-war years, marginal tax rates may have been high, but few people actually paid those tax rates. Government revenue taken in as a percent of GDP was actually lower in Krugman’s vaunted 1950s and 1960s than in the proceeding decades, as this chart shows: http://www.usgovernmentrevenue.com/downchart_gr.php?year=1950_2008&view=1&expand=&units=p&fy=fy12&chart=F0-total&bar=0&stack=1&size=m&title=&state=US&color=c&local=s

2. Leftists like Krugman are always going on about how government should regulate private businesses. But in the 1950s and 1960s, government regulations were cranked out at a significantly slower rate than in the proceeding decades, as this chart shows: Page 17 of: http://cei.org/sites/default/files/Wayne%20Crews%20-%2010,000%20Commandments%202012_0.pdf 

3. While the US economy did indeed grow very quickly in the 1950s and 1960s, it also grew very quickly and probably in even more life-changing ways from 1865-1914. As Robert Higgs, in his detailed empirical study of the period, The Transformation of the American Economy notes: “The economy grew spectacularly in the half century following the war. Real GNP per capita advanced at an average rate of 2 percent per year, and on the eve of World War I it stood at about three times the 1865 level”. The governments of this period are ones that, by the standards of today, would be considered radically libertarian, and there were barely any economic policies that one would today recognize as ‘Keynesian’ to speak of.  

4. While private sector unions were indeed more prevalent in the 1950s and 1960s than they were in proceeding decades, they were legally strongest in the mid 1930s in the midst of the Great Depression with the passage of the pro-union Norris-Laguardia Act and Wagner Act in 1932 and 1935 respectively. The Taft-Hartley Act of 1947, passed despite the attempted veto of Democrat President Harry Truman, took away some of the special privileges granted to labour unions in the 1930s by restricting the kinds of coercive strike-actions they were allowed to engage in. Could we not say then that the period characterized by the strongest labour unions was the 1930s, while the 1950s and 1960s were only characterized by moderately strong labour unions?

5. We must not forget that Medicare and other social welfare policies associated with Lyndon B Johnson’s ‘Great Society’ program, beloved of contemporary leftists, were only really introduced in 1965, near the end of Krugman’s postwar rapid period of growth. The programs were not repealed, but expanded under the Nixon and Ford administrations in the stagnant 1970s, and most of them have survived until this day.

6. The monetary system in place in the postwar period until 1971 was the Bretton Woods System, a system tied very loosely and precariously, but tied nonetheless, to some kind of gold standard, for the US dollar at least. If the 1950s and 1960s were so great, then, according to the crude empiricist methodology, couldn’t we assert that the last vestiges of the gold standard helped make this period more conducive to economic growth than the proceeding decades, where the monetary system lost all ties to gold and became a purely fiat system?    

6. The general leftist narrative is that everything was great in the allegedly statist/leftist postwar period, but all went to hell with the ‘Reagan Revolution’ in the 1980s and the rise of ‘free-market neoliberalism’ as the dominant economic ideology. Besides misleadingly implying that the period from the 1980s to the present has been one characterized by free-market principles and the lack of government intervention, which is completely false as point #1 and point #2, among other pieces of evidence, suggest, this narrative also seems to forget that the economically stagnant 1970s happened. If the policies of the 1950s and 1960s were so great, why did they not continue to have great results in the 1970s, before the evil Ronald Reagan and his allegedly ‘free-market’ revolution struck?

           

           If we were to use Krugman’s rhetorical strategy, given these correlations, couldn’t we just as easily assert that 1950s and 1960s prosperity was due to less revenue collected by the government, less economic regulation, less powerful labour unions than there had been in the terrible 1930s, the relative lack of extensive social welfare programs, and the last vestiges of the gold standard being in place? How do we reconcile Krugman’s statist interpretation of the postwar period with the fact that a relatively libertarian period in the late 19^th century also resulted in rapid economic growth? How do we account for the economically stagnant 1970s, which witnessed no real changes in the policies Krugman lauds, being before the dreaded ‘Reagan Revolution’?

            

           The point is that historical periods, based on the ‘facts’, can often be interpreted in many different ways, some diametrically opposed, and whether we accept an interpretation as true or not must be based on some kind of logical theory, not just on correlations masquerading as causations. Mount Vesuvius erupted in 79 AD, utterly destroying the Roman city of Pompeii. An exceptionally prosperous period in Roman/Ancient History was to follow. Here is a correlation, so according to logic-free empiricism, couldn’t we seriously consider the proposition that the eruption of Vesuvius caused, and was not just correlated with, the subsequent century of unusual prosperity? If we employ logic to evaluate this theory though, we must find it preposterous: how can a destructive volcanic eruption cause a century of empire-wide prosperity? We must conclude that the prosperity happened despite the volcanic eruption, not because of it. Though not quite as absurd, a similar argument could be used against Krugman’s attempt to use the historical record of the 1950s and 1960s to ‘prove’ that high taxes, powerful labour unions, and high minimum wages lead to prosperity. Someone armed with free-market economic theory would, rather, conclude that the prosperity happened despite these generally economically harmful policies, and look for explanatory factors for this prosperity elsewhere, which are not too hard to find if one is really looking.                                      

Six Fatal Flaws of Keynesianism

            The economic theories of British economist John Maynard Keynes, made popular during the 1930s Great Depression when his General Theory was published, and the theories of a school of economists he has inspired known as the Keynesians, have proved damaging to the cause of economic freedom. Luckily for the defender of the free-market order, Keynesian theories of the economy are based on a number of untenable assumptions that serve as the intellectual fatal flaws of Keynesianism. We will discuss these flaws, and through them why Keynesianism is unsound, in the following post.  

1. Failure to treat the interest rate as a market price, and failure to recognise its economic significance as the price of time:

According to John Maynard Keynes, the interest rate is determined by ‘liquidity preference’, the interest rate being the ‘reward for parting with liquidity (command over cash)’. This explanation is superficially plausible; after all, when one loans money at interest, it is at the price of giving up control over liquid cash assets temporarily. It becomes less plausible though when we realize, as Henry Hazlitt pointed out in his book dedicated to refuting Keynes’ General Theory, that the price of every commodity in a monetary economy could be explained as being determined by ‘liquidity preference’. Thus, if someone buys a movie ticket for $14, one could say that the ‘reward for parting with liquidity’ in this case is movie tickets, at the rate of one ticket for $14 of liquid cash given up.

The more relevant question is: what determines whether a person decides to buy a movie ticket with his $14 or instead, whether he decides to lend his $14 out at interest? The answer is that if he buys the movie ticket or any other consumption good, the person shows that he wishes to use the $14 for present consumption, while if he lends at interest or otherwise invests his savings, the person shows that he wishes to use the $14 to invest in the production structure in some way, with the hopes of increasing his disposable wealth when the loan is returned with interest payments added on or returns are made on the investment. What, then, determines the interest rate? It is determined by the degree of future-orientedness of all market participants involved in the loan/time market. If our individual is quite future-oriented, perhaps a 2% interest rate is enough to induce him to hold off consumption, while for a less future-oriented person, perhaps only a 10% interest rate would be high enough. If the general market interest rate, tending towards a rough uniformity as all market prices do and determined by the degree of future-orientedness of all market participants involved in the time market, is 5%, than the first person will invest the $14, while the second person will not and will choose to consume it instead.

Thus, the interest rate is really the price for selling time, a crucial factor of production in every economy above the ultra-primitive. Austrian economists call the degree of future-orientedness of market participants their individual time-preferences, with a lower time-preference meaning more future-oriented, and thus they say that the general interest rate on the market is determined by the time-preferences of market participants, not by their ‘liquidity preferences’.

It should also be noted that time is not just sold on the loan market, but is involved in every act of investment. Thus, all of the factors of production necessary to produce a certain consumer good, say a car, are going to be worth less than the final product, not just due to entrepreneurial profit, but also because there is an implicit time transaction involved. It takes time for the factors of production to be combined into the final product and then sold, thus the person who advances the money to buy the factors of production in exchange for ownership of the final product, no less than the person who lends money to the car manufacturer, are selling time and will tend to be compensated at the market’s roughly uniform interest rate, whether they are lending money or investing in factors of production.

The lower the market interest rate, the more, other things equal, time-consuming processes of production market participants will be able to profitably engage in. These more time-consuming processes are often more productive, or can produce things otherwise impossible to produce, than less time-consuming processes. Thus, imagine if someone with no personal savings wanted to produce a car from scratch. Starting from the mining of the iron ore from the ground and the raising of cows for leather, going all the way through to the final assembly of the car, this production process would take a very long time if started from scratch. Someone with no personal savings would have to be able to borrow money for a very long-time in order to complete the car (probably longer than a life time in this case, but luckily in the real world we already have a complex economy where many of the necessary factors of production are constantly being produced, with the time element already factored into their prices). If the interest rate were too high, the necessary price that the man would have to charge to make a profit on the completed car would probably be too high for most consumers, and hence the car would probably not be produced. With a lower interest rate, it would be possible for the car to be profitable though, as the crucial factor of production, time, wouldn’t be as prohibitively expensive in this case.

Creating a car absolutely from scratch is admittedly a far fetched example, but it points to the crucial role of time in the production processes of our modern economy, and to the interest rate as the price of time as a factor of production, which pervades the modern economy.

The Keynesians, with their mistaken theory of interest, ignore most of this. They don’t tend to treat the interest rate as the market price of the factor of production/consumer’s good time, and the rate as determined by the time-preference of market participants, but as some ‘macroeconomic variable’ that government officials have to manipulate to keep the economy on course. During economic depressions, they call on the government and the central bank to ‘reduce the rate of interest’ by printing money and throwing it on to the credit markets first, not realizing that the interest rate is a market price like any other, set by suppliers and demanders of time through mutually beneficial transactions.

2. Disregard of Austrian Business Cycle Theory:

            This brings us to the second fatal flaw of the Keynesians: their disregard of Austrian Business Cycle Theory. Briefly, Austrian Business Cycle Theory (ABCT) postulates that when fractional-reserve banks or a government monetary authority (the central bank) extends credit via the creation of money that had not existed before, the market interest rate is temporarily reduced below what it would have been without the money creation, because the new money starts as credit on the time markets and only later flows through the rest of the economy and raises prices all-around. There is nothing inherently wrong with low interest rates, in fact, if achieved without money creation they would mean more rapid capital accumulation leading to a more capital-intensive economy that could engage in longer and more productive production processes, which would become more prosperous all-around as a result. The problem with the inflation-induced low interest rates is that they are not achieved through a lowering of time-preferences (more future-orientedness) among market participants and the corresponding increased saving of resources to be invested in longer production processes. There is no reason to believe that more resources have been saved up as a result of the inflation, and in fact there are compelling reasons to believe that fewer resources have been saved up. Inflation, by inducing people to mistakenly believe that they are richer than they actually are, and by undermining less risky investments such as low-yield bonds, actually tends to lead to more consumption and possible capital consumption, even though the initial dose of the new money starts out by masquerading as saved funds in the loan/time markets.

            

           Thus, we have a situation where business entrepreneurs, through the lower market interest rates, are induced to act as if more saved up resources are available and engage in more time-consuming production processes, while there is no reason to believe that there actually are more saved up resources, and compelling reasons to believe that there are less as a result of the inflation. In Austrian terminology, during this ‘boom’ period, the genuine saved up resources are invested unsuitably, malinvested, in an unsustainably long, time-consuming structure of production, while through inflation, people are led towards overconsumption, the opposite of what would be necessary to make the structure of production the investors are trying to build up sustainable. Something has to give, and does when the fractional-reserve banks and/or the central bank is forced to stop inflating as quickly due to the foreseen risk of a catastrophic hyperinflation leading to the destruction of the currency. Without the inflationary monetary steroids, the structure of production is revealed to be unsustainable, and thus many of the investments and businesses must be liquidated, making it vital that the resources and the labor they were using be shifted and repurposed to build up a more realistic and sustainable structure of production, not based on artificially low interest rates. This is what Austrians call ‘the bust’, and what everyone knows as a recession or a depression.

            

           The Keynesians, due largely to their neglect of capital theory and their faulty theory of interest, disregard this theory, either ignoring it or, like Paul Krugman, contemptuously rejecting it through snarky, superficial, unscholarly pot-shots at it. This, as well as other flaws in their thinking, leads Keynesians to advocate inflationary credit expansion to get the economy out of recessions/depressions. But credit expansion is the cause of the unsustainable boom followed by the painful bust in the Austrian Theory, and if the Austrian Theory is correct (which I think it is), than the Keynesian remedy is just a policy of attempting to kick the can down the road, causing damage to the economy as they do. Thus, in 2000, when the dot-com bubble collapsed and the US economy entered recession, the central bank followed a Keynesian policy of printing money to foster credit expansion and artificially lowering the interest rate. The result was a more serious bubble in the form of the housing bubble that developed and an even more painful bust in 2008, just as the Austrian Theory predicted. Given this, there can be no reconciliation between the theory schools of thought. If one thinks that there is any plausibility to the Austrian Theory, than the Keynesian ‘remedies’ must be rejected as silly and counterproductive. Pretending that such things as an economy’s capital structure and structure of production don’t exist, and pretending that the interest rate isn’t a real market price but can be manipulated with no negative consequences by bankers and government officials, and ignoring the Austrian Business Cycle Theory as a result, is very dangerous if you like economic prosperity and fear recessions and depressions.         

3. Assumption that a harmful ‘Deflationary Spiral’ could occur:

            A key aspect of Keynesian thought is its benign view of monetary inflation and great fear of monetary deflation. Its fear of monetary deflation is largely based on the construction of a nightmare scenario known as the ‘Deflationary Spiral’. According to Keynesians, if the money supply, largely through the contraction of the outstanding loans or the actual bankruptcy of fractional-reserve banks during a recession or depression, should be reduced, a vicious ‘Deflationary Spiral’ will set in unless it is counteracted by central bank inflation. When the money supply is reduced, the money that remains will tend to be able to buy more goods, or increase in purchasing-power, as, other things equal, less supply tends to lead to a reduction in price (in this case the goods-price of money, the same thing as an increase in the purchasing-power of each monetary unit). So far so good, this is all true. But now, the Keynesians and other deflation-phobes contend, people, seeing that money is growing in value while their investments are turning sour or being revealed as riskier than they thought, will be led to stop investing in productive assets and start hoarding money for speculative purposes instead. Even once the money supply has physically stopped being reduced; money will continue to increase in purchasing-power as more people increase their demand for money for speculative purposes, leading to more and more people piling into money. Consumption and productive investment will stagnate, and the economy will be stuck in a vicious spiral of poverty.

            

           The first problem with this nightmare scenario is that nothing like it has ever been observed in the recorded history of humanity. There have been serious monetary contractions before, but rampant speculative hoarding leading to a prolonged period of rapid deflation (increase in money’s purchasing-power) has never been the result. What tended to happen was that after the physical monetary contraction had stopped, people didn’t keep piling into money but started using it to consume and invest again, and the economy recovered from its temporary slump. This was the pattern of most recessions and depressions in 19^th century America, where fractional-reserve banks, favoured by government privileges, were in a position to engage in inflationary credit expansion and thus set in motion the boom and bust cycle, but there was no central bank to rapidly ‘reinflate’ the money supply, as Keynesians would prescribe, in the depression period. These recessions were typically short-lived, the worst usually being over in about six months to a year after the initial ‘Panic’.

            

           These empirical results can be explained theoretically. The main thing to realize is the incredible risk someone would be taking by dropping his investments and piling into a money which was increasing in value only based on other people’s speculation, after the physical monetary contraction was over. If people were really desperately dumping investments to pile into money as the ‘Deflationary Spiral’ scenario assumes, the value of money, due to all the extra speculative demand, would increase at a very steep rate, very rapidly, as everyone tried to get their hands on a limited supply. After a short period of this, it is almost guaranteed that a bunch of savvy investors would realize that the value of money has increased far beyond what people really want to hold in their cash reserves if they weren’t holding it speculatively, and would move to cash in on their gains before everyone else did. They would use their high-valued money to invest in a lot of real productive assets or to buy luxurious consumer goods that they couldn’t afford before their speculation. As soon as enough people started catching on and doing this though, the speculative demand pushing up the value of money would vanish, and the demand for money would fall back to the level of the purchasing-power that people and businesses actually wanted to hold as cash reserves. Latecomers in the speculative stampede that the ‘Deflationary Spiral’ predicts would lose really big, as they traded their real investments for a money that received a substantial portion of its great value only from the speculative demand of people who thought that the money would continue increasing in value solely based on other people’s speculative demands. When that value collapsed, these people would suffer great losses. The risk of these great losses would be the primary thing that would prevent such a speculative stampede from getting out of hand in the first place.

            

           Indeed, if the ‘Deflationary Spiral’ myth were true, one should have seen it play out in the recent rapid rise in gold prices. Gold, while not currently money, used to serve as such and is not a perishable commodity, thus making it suitable for long-term speculation. In the last few years, its value has been raised tremendously, but then it stopped rising in value once it reached a certain point. Even Jim Rogers, an investor famous for his bullish views on hard commodities and gold and silver, eventually came to be of the opinion that the gold price had reached as high as it would go for the new future, and ceased buying it as a result. What happened was that people, due to a fear of fiat money inflation and currency instability, piled into gold, and then more people piled into gold because they saw its price rising rapidly. But this process was over in a short period of time. Once the price had risen to a certain level, investors cooled down their enthusiasm because they realized that enough was enough, and that the fundamentals simply did not support a higher price for gold at the moment. The same would happen in a free-market monetary system, probably one where gold was the main currency, and no ‘Deflationary Spiral’ would occur, even if fractional-reserve banks and government intervention succeeded in creating a boom-bust cycle in the first place.

           

           It should of course be noted that in a free-market monetary arrangement, characterized by the separation of fractional-reserve banking from the money supply and the prevalence of 100% reserve banking instead, and characterized by a gold standard, a money that governments wouldn’t have the power to inflate, the chances of serious contractions in the money supply would be severely curtailed. This is because money would be gold, and unless people had a strange penchant for hurling gold into the deep sea, there would be no particular reason why the physical money supply of gold should ever contract significantly. The loan-policies and financial stability of fractional-reserve banks would not, as they do currently, be able to affect the growth or contraction of the money supply.

            

           Of course, if people wanted to keep generally higher cash reserves for non-speculative and non-depression-related purposes, they could increase their demand for money, leading to an increase in its purchasing-power. But this would not tend to be very dramatic or sudden, and would certainly not set off the speculative stampede that the ‘Deflationary Spiral’ fear-mongerers warn about.

The purchasing power of money, in a free-market system, would generally increase on the goods-side, due to increased production of goods which must be able to be bought with the same supply of money, as happened in the US in the late 19^th century. But this would certainly not lead to a surge in speculative demand for money for the simple reason that interest rates would not need to be reduced in the face of such a ‘growth deflation’, as ‘growth deflation’ does not lead to a reduction in general sales revenues, and hence does not make it any harder to pay off debts as a monetary contraction deflation would. Thus, the interest rate received by the creditor would just be added on to the increasing purchasing-power of money that he would be paid back in, thus not reducing the attractiveness of investing in real assets.

Without the ‘Deflationary Spiral’ myth, the deflation-phobia that characterizes most Keynesians, and many other economists as well, appears more groundless.

4. Assumption that prices, and especially wage rates, are rigid downwards, and that it is impossible to do anything about it:

            This Keynesian assumption is another reason why they fear deflation, but it is just as groundless as the first. They assume that prices, especially wage rates, will not adjust downward in the face of a deflation caused by monetary contraction or increased demand for money for holding, thus leading to unemployment and the stocking up of excess inventories. Their assumption that prices will not adjust downward in the face of less monetary demand and lead to unsold inventories piling up does not accord with reality, where money prices are constantly reduced to get rid of excess inventories whenever a ‘Sale’ is held. Whether it’s in a deflationary environment where everyone must eventually reduce his prices or a non-deflationary environment when some retailers must due to a drop in demand that they did not anticipate for their particular product, sellers are typically ready and willing to reduce their prices in order to get rid of excess inventory.

            

            The rigid wage rate hypothesis is a bit more plausible, but only because we live in an interventionist age. Minimum wage laws and the coercion that unions are permitted to employ to maintain artificially high wages for their members serve to introduce institutional wage rigidity into the economic system. If wage rates are not allowed to fall in a deflationary scenario, there will indeed be problems of unemployment. This happened historically in the Great Depression. But rather than fearing deflation and advocating inflation, with all of its associated problems, to solve this issue, why not just remove the institutional rigidities that create the problem in the first place? It is disingenuous for an economist to take a certain economic policy that results in wage rigidities (often supported by Keynesian economists themselves!) as a given, and tailor their analysis of other issues around this given. Why should an economist accept an economic policy as a given, when it is precisely his task to support or not support certain economic policies based on his analysis? Without the economic policies resulting in rigid wage rates, workers would just have to accept that in a deflationary environment, where the prices of the consumers goods they want their wages to be able to buy anyway are being reduced, they would just have to accept nominal wage cuts at times, which would just mean a retention of the same real wage as before.         

5. Failure to really consider the differences between government and private resource-use when making policy prescriptions:

            Chances are that if you’re a Keynesian, you have at one point in your career come out in favour of some government ‘stimulus’ program or another, where the government, through inflation or through amassing more debt, usually both, spends money to ‘stimulate’ a depressed economy. But the Keynesians do not fully consider the implications of this policy, so focused are they on their (faulty) remedies for getting out of a depression via inflation. They do not tend to stop and consider the vital differences between government resource-use versus private resource-use. Government resource-use has many disadvantages over private resource-use in most economic fields, disadvantages which I discuss in the first section of the following post: http://thinkingabouthumansociety.blogspot.ca/2013/04/dissecting-leftist-statism.html

            

             This neglect leads Keynesians to tragically underestimate the economic disadvantages of their proposed remedies. Of course, one could make the argument that most Keynesians have socialistic leanings anyway, as exemplified by Keynes’ call for the ‘euthanasia of the (private) rentier’ and call for the ‘socialization of investment’. But, unlike the socialists, Keynesians do not usually even attempt to make the case for why government resource-use will be better than private resource-use outside of the government’s role in ‘stimulating’ the economy, which is based on the faulty premises outlined above anyway.

6. Lack of understanding of the vital importance of savings and the capital accumulation/capital maintenance that they lead to, and the vital roles these play in economic growth and prosperity:

            It would not be an exaggeration to say that Keynesians almost never call for people to save more, but routinely call for people to consume more, again, to ‘stimulate the economy’. This hatred of thrift stems from their non-existent capital theory and faulty theories of interest discussed above, and their refusal to recognize that before one can invest resources, one must first save them, and without this savings-investment, any production process beyond the ultra-primitive hand picking of berries would be impossible. For more on the importance of capital, see Tip 27 here: http://thinkingabouthumansociety.blogspot.ca/2013/03/how-to-think-about-human-society-tips.html      

Note: For the reader interested in finding more critiques of Keynesianism, I would recommend the following:

1. Henry Hazlitt’s Failure of the “New Economics”, available for free here: http://mises.org/document/3655/Failure-of-the-New-Economics

2. This excerpt from Murray Rothbard’s America’s Great Depression, where he defends Austrian Business Cycle Theory against Keynesian criticisms and provides his own critique of Keynesianism in the process: http://mises.org/rothbard/agd/chapter2.asp

3. Robert Higgs’ critique: http://mises.org/daily/5216/Six-Fundamental-Errors-of-the-Current-Orthodoxy

4. Jonathan Finegold Catalan’s critique: http://mises.org/daily/4578

5. George Reisman’s critique: http://mises.org/daily/3424

Henry's Gold: A Monetary Tale: Part 2

Chapter 7

            King Franklinvelt was happy with the results of Korgan’s plan. Though the Gamerigan economy was not recovering very dramatically, the King had plenty of funds, both in the Treasury and borrowed, to use on putting his unemployed subjects to work, building grand dams, canals, highways, and pyramids. The people were grateful to the King for this opportunity to make some money for themselves.

            

           One year later, King Franklinvelt died, beloved by his people. His son, Nick Richardson, also known as Tricky Nicky for his crafty and slippery ways, came to the throne. Not long had elapsed before the new manager of the Royal Gameriga Reserve, Greenly Alanson, came to the king with a problem: “Your Highness” he began, “The King of Franconia, Gaul DeKarl, has been busy exchanging Franconia’s holdings of Gameriga Dollars for gold, these actions are severely depleting our gold supply, what should we do?”.

            

           “Hmm,” pondered King Tricky Nicky, “We can’t let a bunch of foreigners bankrupt the great kingdom of Gameriga! How dare they be so audacious as to demand gold from us! I say that we refuse to give foreigners any more of our gold”. “But Sir,” replied Greenly, “ Isn't that just admitting bankruptcy to the world?”. “Greenly, my friend” replied the King, “Where is your sense of finesse? Of course we don’t admit bankruptcy. First, we get a convenient scapegoat to blame for our action, in this case, ‘international monetary speculators’ will do the trick, no one likes speculators. Second, we say that these speculators are trying to attack Gameriga’s prosperity and strength, this will arouse a sense of indignation in our loving, patriotic subjects. Finally, we get a bunch of money experts to say that our money must be more flexible in order to keep the Gamerigan economy strong. It worked when my great father did it.”

            

           “Your Majesty” Greenly said in awe, “you are truly the greatest statesman the world has ever known”. “I like to think so” said King Tricky Nicky.

Chapter 8

            And so, on a broadcast to every television in Gameriga, the King made his announcement and gave the reasons for it. Henry was at home, watching the announcement. The announcement didn't shock Henry too much, after all it only applied to foreigners didn't it? This was just a confirmation that Henry would not see his gold again, he just hoped that the full faith and credit of the King of Gameriga was worth as much so that he could pursue his dreams.

            

           However, over the next few months, Henry noticed an odd thing. Every month he went to buy materials for his architectural project, but every month the price of these materials would go up by a noticeable amount. Now, this unnerved Henry, as he had always been a careful planner, but with the prices of everything changing every day, poor Henry didn't know if he really had enough Gamerigan dollars to finish his modest architectural project after all! Certainly if prices kept going up as they had been, there would be no way that Henry could finish with his current amount of money.

            

            Not one to give up though, Henry decided to supplement his current savings with some new money, which he got by taking a job as a waiter at a nearby restaurant. Unfortunately, this meant that Henry had less time to work on his project, but he had to do what he had to do.

            

            However, a few months later, the restaurant owner told Henry that he could no longer afford to employ him, for the economy had slumped again. Henry offered to work for lower wages, but the restaurant owner said: “I wish I could Henry, but the King has ordered that we are not to pay workers below a certain amount”. “But surely the King would prefer that I make something than that I make nothing! Please Sir!” pleased Henry. “Sorry Henry, I don’t make the rules, I just follow them” said the restaurant owner.

            

           Now Henry was truly dejected. His saved money was becoming more and more worthless every month and he had no job to make supplementary money with. He feared that he would never be able to complete his project.

            

           Henry decided that he would seek help, and who better to seek help for money matters than the famous money expert, Saul Kruggerman? So, Henry paid a visit to Kruggerman’s house, and was invited in. “Hello my friend, you have come to seek my advice?” asked Kruggerman. “Indeed Mr. Kruggerman” said Henry, “You see, when I first came to New Cork City, I had 1000 gold coins in savings that I had gotten from selling my farm. I deposited these coins in the People’s Bank and I thought that those savings would be enough for me to complete an architectural project. But now, I don’t know what happened to those 1000 golds coins. It seems that my Gameriga Dollars that I got in exchange for them are worth less every day, I can’t find a job, and I fear that my dream of constructing a beautiful building is becoming more unlikely every day.” “I see” said Kruggerman, “ I'm sorry but you are another victim of misguided economic policies. You see, if I was advising the King, I would tell him to expand the amount of Gameriga Dollars and spend like crazy on royal projects. That way, we could employ people and get this economy moving again!”

            

           Henry thought about this for a second, and then responded: “But Mr. Kruggerman, I don’t really want to work on a royal project, with all due respect. What I want to do is have the gold that I saved back so I can pursue my dreams the way I want to.” Hearing this, Kruggerman flew into a rage: “You’re just a greedy swine! You want to hoard gold and deprive this country of credit! You want unemployed people to starve in the streets while you sit on your stash of shiny metal! You don’t care about this country, all you care about is yourself! People that have tired old mentalities like you, they are the reason that we’re in the dark age of money thought!”.

            

           Henry tried to protest that he didn't want people to be unemployed, he just wanted to use his hard earned money to follow his dream, but before he could, Kruggerman’s guards roughly escorted Henry out of the residence.

           

           Poor Henry was now even more dejected. On top of having seen his savings erode away in value, being unemployed, and having his dreams put on hold, he had been scolded by a pretentious bearded man for wanting to use his own, hard-earned money! Henry sat down in the town square, curled up in a ball, and, for the first time since inheriting his father’s farm, Henry cried...

Chapter 9

            Henry cried in the square for an hour, then dried his tears and just sat dejectedly in the square. After a while, a foreign man wearing gold-coloured clothing walked into the square. “Gold! Gold for sale!” shouted the man. Henry looked up, and thought to himself: “Let’s face it, my Gameriga Dollars saved up are getting more worthless every day. I should like to hold some gold once again, even if it is not very much”. Then again, holding gold was illegal, but who would know if he just bought a little bit?

            

           So, Henry went up to the man, and proceeded to use all of his remaining cash and bank deposits to buy gold. Henry managed to get 50 gold coins out of the man, not the 1000 he started with, but at least he held something real instead of just pieces of paper! Over the next few days, Henry noticed that many other townspeople had the same idea as he had. They were withdrawing money from their banks and stock market investments in order to stock up on gold. But, people had to take care to hide their gold carefully, for the king’s men were on the lookout for people holding gold illegally.

            

           Noticing this, Henry had an idea: Why not try to get together some of the townspeople’s money in order to start a secret gold bank? So, Henry told his friends about the idea, his friends told their friends, and so word spread quickly throughout New Cork City of Henry’s idea. Many enthusiastic people came to visit Henry at his house, pledging their support for the endeavour.

            

           With their financial help, Henry was finally able to complete his architectural project. It was a modest building, yet it was elegantly designed, and Henry was proud of it. But Henry was even more proud of the fact that this building would serve as the secret gold bank. He placed a sign outside the building reading “Henry’s Diner”. The bank would masquerade as a small restaurant, but, in the large basement, Henry stashed the gold of his depositors. The whole operation was done very discretely, and the King’s men were none the wiser.

            

            Over time, Henry got more and more depositors in his bank. He operated the bank like old Anton had done at the People’s Bank a long time ago, Henry charged a small fee for safekeeping, and diligently guarded every bit of gold that was deposited in his underground vault. Henry also issued gold certificate notes, to be used in secret of course, but depositors trusted Henry’s notes because they knew he didn't lend out their gold.

            

           One day, a man came in to Henry’s bank/restaurant and said: “Listen Sir, I heard you have a lot of gold sitting in your vault. You see, I have this wonderful project that I am going to embark on, but I need some funds to get started. Could you please lend me some of that gold you have?”. Henry responded firmly but politely: “ I'm sorry, but that gold is not mine to lend out”.

One of Henry’s patrons, a keen businessman by the name of Hans Shoehorn, overheard the conversation and said: “Henry can’t lend you the gold he’s keeping. But some of the gold he’s keeping is mine, and I would like to hear about your wonderful project so I can decide whether to invest in it”. So the man told Hans all about his planned project and Hans liked what he heard, so he loaned some of his gold certificate notes to the man.

            

           The project turned out to be a fantastic success, and Hans more than made back what he had loaned. Soon, other patrons of Henry’s bank decided that they wanted to loan out their money too to make some profit like Hans, but they didn't know who to lend to. Hans offered his advice, and soon the investment wing of Henry’s Secret Gold bank was opened, under the leadership of Hans Shoehorn. Now, when depositors put gold in Henry’s bank, they could either choose to have the gold kept in safekeeping, to be withdrawn whenever necessary, or they could choose to lend their money to Hans and the Investment wing, who would try to choose the most profitable loans to make. Patrons of Henry’s bank knew that the gold they had on deposit would stay in the vault, while patrons who leant their gold to Hans’s wing knew that their gold was currently being used by someone else.

Chapter 10

            Inspired by what they heard about Henry’s secret bank, many other ambitious people in towns throughout the kingdom of Gameriga started opening secret gold banks like Henry’s. King Tricky Nicky and his courtiers knew about the banks, they were too prevalent to be secret any more, but he didn't dare to confiscate the gold like his father had done as he knew the people would revolt this time, so he decided to make the holding of gold officially legal again. The people rejoiced and the King enjoyed a spurt of popularity. Nevertheless, the King constantly encouraged the people to put their faith in the Gamerigan dollar, and only accepted taxes in Gamerigan dollars, not in gold.

            

           PJ Korgan and the managers of the other banks in the Royal Gameriga Reserve system were panicking. Their banks were losing customers fast to these gold banks, especially once the King legalized the holding of gold. In an effort to keep customers, these banks leant out even more of their money, offering higher interest rates for depositors at their bank. But Korgan knew that something had to be done to turn the tide, and so, as in the past, he turned to the King.

           

           He and the other bankers arranged an audience with King Tricky Nicky. “Your Highness” Korgan began, “There is a troubling trend in the realm of your subjects preferring to use gold, that barbarous relic of the past, as money again. They reject your great Gamerigan dollar, and all the prosperity that has come with it. Your Highness was wise to allow your subjects to hold gold to soothe them, but something must now be done to protect the Gamerigan dollar. I would suggest making the Gamerigan dollar the only legal tender in the realm, so all contracted transactions must be carried out in Gamerigan dollars. That way, your subjects will return to their senses, and will all start using the great Gamerigan dollar once again”. “I like the way you think!” exclaimed King Tricky Nicky, “Let the people hold gold, but make it impossible to use as a money!”.

            

           And so, the decree was promulgated, but this time, the subjects of Gameriga did not acquiesce so easily. Most transactions, ignoring the decree, were done in the gold certificate notes of the gold banks or in gold coins themselves. People were wary of the Gamerigan dollar and the old banks.

            

           PJ Korgan was distressed. His plans had always worked in the past, why not this time? King Tricky Nicky wasn't happy with the results either, the decree had made him more unpopular and it was not having its desired effects, the Gamerigan dollar kept becoming more and more worthless as people rushed to get rid of it and buy gold. With this, the King’s extravagant wars and royal projects were not getting the funding they needed, and printing more Gamerigan dollars, while it had helped with this in the past, now seemed only to make his problems worse.

            

          Korgan rushed to see the King and said: “Great King, we must act now. Gameriga is in a crisis, we must follow the example of your father and take an extraordinary measure. We must confiscate your subjects’ gold once again in order to save Gameriga”. “You’re right” the King replied, “I wish there was a more tactful way, but my subjects are being too unreasonable to not trust me, THEIR KING, with their money”. And so, the order was given to confiscate everyone’s gold again, but this time, the results would be different...

Chapter 11

            When the confiscation decree was announced, many Gamerigan people flew into a rage. They were not about to lose their savings again, not after working so hard to build them up again! People all over the kingdom rose up in arms, and rallied behind a peculiar nobleman who actually believed in a sound gold currency, named Paul Ronaldson. Ronaldson had always been the laughing stock of the royal court, always speaking out against measures which clearly were in the best interests of the royal court. He was particularly vehemently opposed to the whole Royal Gameriga Reserve scheme cooked up by Korgan.

            

           But now, this often ignored nobleman suddenly became the head of a popular movement. Faced with the threat of revolution, the courtiers reluctantly switched sides, forced King Tricky Nicky to abdicate, and threw their support behind Ronaldson. Ronaldson became king, and he repealed the legal tender laws of Tricky Nicky and dismantled the Royal Gameriga Reserve system.

            

           Without the backing of the King and the Reserve bank, many of the old banks were either forced to declare bankruptcy, or forced to become gold banks, following the model of Henry’s bank.

Chapter 12

            Henry and his friends greeted this news with delight. Henry’s bank became a world renowned bank, while Korgan’s People’s Bank was forced to declare bankruptcy. Henry decided he would buy the remnants of the People’s Bank.

            

           Henry tore down the old People’s Bank building and, in its place, had a brand new building built, as per his specifications. Henry was finally able to realize his dream, he designed a grand, beautiful bank building, on the very spot where, a long time ago, he had originally deposited those 1000 gold coins.

THE END.

Note: For any reader interested in the actual historical account of the changes in monetary policy in the western world, as well as the theoretical concepts of Austrian monetary theory that have inspired this story, I would recommend Murray Rothbard's, What Has Government Done to Our Money? available for free here: http://www.mises.org/document/617/What-Has-Government-Done-to-Our-Money. For a great look into how the various banking systems loosely described in the story operate in the real world, I would recommend Murray Rothbard's, The Mystery of Banking, available for free here:  http://www.mises.org/document/614/Mystery-of-Banking-The

Henry's Gold: A Monetary Tale: Part 1

Chapter 1

Once upon a time, there was a man named Henry, who lived in the kingdom of Gameriga. Henry had grown up on a small farm owned by his father. When his father died, the farm was passed down to Henry. Henry was an energetic fellow, and wasn't satisfied with the small farm. For the next ten years, Henry set to work enlarging the farm. He cut down a dense forest, drained a stinky swamp, battled with numerous animals. This done, he planted rows of his favourite crops in the new farmland. Henry was proud of his farm and the hard work he had put into it, but deep in his heart, he knew he still wasn't satisfied. You see, Henry had always dreamed of moving to the city and becoming an architect, building beautiful buildings.

One day, Henry was out working in the fields when his rich neighbour, Mister Riley, passed by and said: “My, my, Henry, this farm sure is looking great, you really did a number on this place!”. “Thanks Mister Riley, that’s very kind of you to say” replied Henry. “Now look Henry” said Mister Riley, “I have been looking to expand my farm, and I hear that you've always wanted to move to the city and become an architect. So how about this: I will give you 1000 gold pieces to buy this farm from you. People in the city use gold as their medium of exchange, and will exchange almost anything for it. So, with the gold, you’ll be able to move to the city and use it to buy what you need to get started on your new career as an architect! What do you say?”. “Wow, Mr. Riley, you would do that for me?” said Henry. “Of course, Henry, didn't I tell you I wanted to expand my farm? This deal is good for the both of us!” exclaimed Mr.Riley.

So the two men shook hands and the deal was sealed. Mr.Riley brought a big chest with 1000 gold coins in it and loaded it on to Henry’s wagon, and Henry signed over his farm to Mr.Riley. Henry then set off for the city of New Cork with his gold, full of excitement and big dreams.

When he arrived in the city, Henry knew he needed a place to store his gold. He asked around and was pointed to a building with a sign that said “The People’s Bank”. Henry went into the bank with his chest of gold and asked the bank manager, Anton von Hock, whether he could deposit his gold there. “Of course sir, we would be happy to keep your gold safe for you. You need only pay us a small fee for safekeeping and we’ll keep your gold safe, to be used whenever you like” said Anton. This seemed fair to Henry, so he gave the chest of gold to Anton, who gave him 1000 pieces of paper, which he called “Gold certificates”, each one signifying a claim to one of the gold coins deposited by Henry at the bank. “What are these for?” asked Henry. “Well” said Anton, “So that you don’t have to carry around gold coins, each of these pieces of paper will act as a substitute for a gold coin, so you can exchange these pieces of paper with people just as you would a gold coin.” “That’s convenient” said Henry, “Thanks for all your help”.

This done, Henry exchanged some of his gold certificates for a small apartment to live in while he planned the next move on his path to becoming a world famous architect.

Chapter 2

            The next week, at the People’s Bank, the bank manager, Anton, unfortunately got sick. He was old anyway, so he decided that he would retire from his position. In his place, the bank’s board of directors appointed an ambitious, crafty man named PJ Korgan. Upon taking up his position, Korgan took a look at the state of the bank. After taking a long look at the bank’s holdings, Korgan said: “It’s really a shame. We have all this gold sitting here, but we’re not using it for anything. We should invest this gold, and make this bank some real money!”. To this, Bill, an experienced senior staff member replied: “But Sir, we’re holding this money for people to use. The money isn't ours to invest, we are just holding it in safekeeping for our depositors”. “Where’s your vision Bill?!” replied Korgan. “We’re all money experts here, we’ll pick good investments. In fact, the depositors will be happier too, we’ll be able to drop the safe holding fees and even pay them to store their money in our bank! Everyone wins! We win, the depositors win, and the borrowers win, the plan’s bulletproof!”. Though he knew Anton would have disapproved, Bill had no choice but to go along with Korgan’s plan.

            

           Over the next few weeks, the People’s Bank printed more gold certificate notes than it had gold in the vault, and proceeded to lend the created notes out to people who needed to borrow money, for a fee of course. Money from these lending fees flowed into the People’s Bank, and everyone at the bank hailed Korgan as a banking guru.

Chapter 3

            Meanwhile, Henry was busy buying supplies and getting training to become an architect. One day, he went to the masonry store to stock up on some building materials, and, like usual, presented his People’s Bank Gold Certificate notes to the cashier. But this time, the cashier shook his head and said: “Sorry Henry, you’re going to have to pay me more of those notes for those supplies”. Henry scratched his head and said: “But, the price tag for these supplies says three gold coins, and I’m giving you three gold certificate notes that are worth one coin each, why do you need more?”. “Haven’t you heard?” replied the cashier. “Word on the street is that the People’s Bank has been lending out gold certificate notes like crazy, I hear there are about twice as many gold certificate notes as there are coins in the vault now. I can’t accept those notes at face value, you’d better pay me at least 4 notes to cover my risk, I'm sure you understand”. Henry did not understand, but he needed the supplies so he gave the cashier 4 notes. How could this be?

            

           Henry decided that he had better pay a visit to the People’s Bank to see whether they still had his gold stored safely. He was astounded to see a line up out the door of the bank of people waiting. “What are you here for?” Henry asked a woman standing in line. “Probably the same thing as you are, concerning those frightful rumours that the People’s Bank has more gold certificates outstanding than gold coins in the vault,” she said, “I just hope that my gold is safe and sound”. “Me too,” said Henry.

            

           After an hour of waiting in line and seeing numerous people walking out of the bank with their gold coins, it was finally Henry’s turn. A bedraggled looking bank employee asked wearily: “How can I help you sir?”. “I would like to withdraw my gold please” said Henry, handing the notes to the employee. Slowly, the employee opened up the vault door, and said with a sigh: “Sorry Sir, but there’s no more...” Just then, PJ Korgan burst through the door of the bank with a smile on his face and said: “Ladies and gentlemen, I know you’re all worried about your gold, so I bring you grand news! Our bank is proud to be one of the first members of the Gameriga Royal banking system! Your gold is safely stored away in the Royal Gameriga Reserve vault, and, as a claim to your gold, you will be given these brand new Gameriga Dollars, backed by the full faith and credit of the King of Gameriga himself! Dispense your fears, the new era of banking is here! Now, your money will never be lost!”.

           

            Henry was reassured by this news, and the new Gameriga Dollars were quite official-looking. Still though, not all of his fears were dispensed with, only holding those pieces of gold would truly do that...

Chapter 4

            Now, the reader must be wondering, what was PJ Korgan up to before he burst into that bank so triumphantly? For that, we must go back a bit. Korgan was delighted with the way his bank was running, it was profitable, depositors were happy, and so were borrowers, why hadn't anyone thought of this before? One day, Korgan was walking in the street when he overheard a conversation between two townspeople: “Have you been noticing more People’s Bank notes recently” said one. “Rumour has it that there are more notes out there then there is gold coins in the vault, is that possible?”. “Beats me, but just in case, I don’t think I'm going to accept those notes at face value anymore in my shop, in case the rumours are true. I’ll charge a little extra” said the other. “Good idea, I’ll do the same” said the first.

            

           Korgan’s heart sank, and then he got angry. When he got home, Korgan yelled: “How dare these peasants question the soundness of my bank! I’m the greatest banker alive! What do they know!? Not accept my notes at face value!? Ridiculous!”. As Korgan calmed down, he started thinking about what to do. He knew that if people started doubting his bank, the jig would be up, and the People’s Bank might even go bankrupt. “Not on my watch!” declared Korgan.

            

           As Korgan sorted through the possibilities in his mind, he came up with two options. He could stop printing gold certificate notes and gradually bring the notes and the gold coin reserves back into synchronization, but then he would have to admit that he was wrong, and old Anton was right. Korgan was crafty though, so, unsatisfied with this first option, he came up with another. “I’ll go to my friend, theKking, and get him to help me. Surely he wouldn't want to see the renowned People’s Bank go under!”.

            

           So, Korgan set up a meeting with the King, and invited his fellow bank managers from other big Gamerigan banks. The current King of Gameriga, Wilson Woodingham, known more colloquially as ‘Woody’, was a friend of Korgan’s, who often brought the King presents consisting of shiny swords and fine wine. Korgan knelt before King Woody and said: “Most benevolent king, I come to you with a proposition that will strengthen the realm for future generations”. “Well, Mr.Korgan, I would gladly hear your proposition. You have always been a loyal servant of the realm” said the King. “You see, your highness” said Korgan, “As you must have heard, my People’s Bank has been very successful recently, thanks to the new innovations we have adopted under my leadership”. “So I have heard,” replied the King, “You must be quite the bank manager Mr.Korgan”. “Thank you, your highness, you honour me” said Korgan, “But I am not satisfied simply with making my bank prosper. My first loyalty is to the kingdom, so I would propose a plan that could bring the great benefits of my banking practices to the whole realm, making all your subjects better off!”. “Please tell me your plan, Mr. Korgan, I’m intrigued” said the King.

            

           “Well” said Korgan, “I propose that a royal bank, for the whole realm, be set up, to be called the Royal Gameriga Reserve. This bank will act as a bank, for all the other banks in the realm. Gold will be kept in the Royal Gameriga Reserve vault and gold certificate notes will be issued, to be used throughout the land. They will of course be inscribed with the picture of you and other Great Kings of the past. This way, most of the gold will be centralized, and day to day activities, by both bankers and ordinary subjects, will be conducted using these notes. This centralization will allow you to issue many more gold certificate notes than you have gold coins in the vaults, which in turn will enable credit to flow freely throughout the kingdom, helping all industrious subjects get a loan, making the whole kingdom as prosperous as my bank!”.

            

           “Interesting, Mr. Korgan, but what if people ask to redeem their royal notes for gold and we cannot pay them?” asked the King. “But who would dare question the faith and creditworthiness of the great King of Gameriga. Surely no one would be so foolish!” said Korgan, “In addition, freely flowing credit will allow your highness to embark on even more heroic and benevolent projects for the betterment of the kingdom. Surely my plan can only better the kingdom if it makes people do what, if they were thinking correctly, they would do anyway. Lend money more freely to each other and to your highness, for the general betterment of the whole kingdom!”.

            

           The King, after hearing this, smiled a great smile and exclaimed: “Mr. Korgan! You truly have Gameriga’s interests at heart! We shall adopt this wonderful plan straight away! I shall be known forever as the King who brought great prosperity to the whole kingdom of Gameriga!”.

            

           And so it was decided to put PJ Korgan’s plan into action. The gold from the various banks was exchanged at the Royal Gameriga Reserve for Gameriga Dollars, backed by the full faith and credit of the King of Gameriga. Banks facing a shortage of gold coins, like the People's Bank, were given a loan of Gameriga Dollars to pay off their depositors and reassure them while the Bank was replenishing its cash reserves.  With this development, Korgan’s reputation and the People’s Bank he was managing was saved.

Chapter 5

Henry and all the other nervous bank patrons, Gameriga dollars in hand, returned to their normal business. Prices of ordinary goods went up a bit in these dollars, but no one much minded as anyone who wanted a loan could get one, and it seemed like people were receiving more and more of these dollars. Henry was able to finish his architect lessons, and, so positive about the way things were going, he decided that he would embark on a grand architectural project. With a combination of his saved up money and the aid of enthusiastic investors, Henry bought some land, bought the materials, and started laying the foundations of his grand building.

            

           The happy times rolled on for awhile. The courtiers at the Royal Gameriga Reserve bank printed more and more dollars, even though they didn't take in much more gold, while the member banks, such as PJ Korgan’s People’s Bank, kept some of these notes as a reserve and lent out the rest. Credit flowed, Korgan made lots of money, the King could finance all kinds of projects with the easy credit flowing around and with the assistance of his Reserve bank, and the common people seemed optimistic about the future.

            

           One day, the new King, Ross Franklinvelt, was sitting in his garden, enjoying the sun, when the manager of the Royal Gameriga Reserve, Benji Power, came in. “Your Highness” Benji said, “There’s trouble, our reserves of gold are being drained, but there are still so many Gameriga Dollars out there, I’m afraid we may have gone too far. I think it’s time to cut down on the number of Dollars out there until we can recoup some of our gold”. “Troubling” replied King Franklinvelt, “We shall do what you recommend”.

           

            And so, the Royal Gameriga Reserve cooled down their printing of Gameriga Dollars. In a few weeks though, Benji heard some shocking news. The stock market in New Cork city was crashing! In a panic, subjects of Gameriga started trying to reclaim their gold from all the banks, including PJ Korgan’s. The Royal Gameriga Reserve was forced to lend these banks the gold needed to repay the reclaimers, but the pool was getting drained fast.

            

           Benji invited all the managers of the major banks to an audience with King Franklinvelt. “Gentlemen” began Benji, “We have a problem on our hands, we simply do not have enough gold to repay all of your customers. I'm afraid the Royal Gameriga Reserve may soon have to stop lending our gold”. “What!” exclaimed an indignant banker, “You can’t just let us fail! We’re all in this together remember!”. The others grumbled angrily in agreement. Then, PJ Korgan spoke: “Gentlemen, no need to fret. I have a plan to get us out of this, with both the banks and the reputation of the kingdom of Gameriga intact”. “Quickly, tell us your plan Mr. Korgan” said the King.

            

           “Your Highness,” began Korgan, “Here is what we do: you declare a Gamerigan national emergency, saying that we must act in order to save the prosperity of Gameriga. Then, in order to combat this emergency, decree that Gamerigan subjects must no longer hold gold in their possession, but instead must use Gamerigan Dollars. That way, there will be no risk of your royal highnesses good name being sullied by being unable to pay out in gold on demand.”

            

            “But Mr. Korgan” the King responded, “While this will work for our loving subjects, how about foreigners that hold Gamerigan dollars? Surely we can’t simply deny them gold when they ask for it”. “Easy” replied Korgan, “Once we have 'bought' all the gold in the country at 20 Gamerigan dollars per ounce of gold, we then declare that the real value of gold is 35 Gamerigan dollars per ounce. This will net us a handsome profit, and will allow us to defend against foreigners who may want to reclaim their gold.”

            

           “But Mr. Korgan, won’t our subjects feel cheated?” asked the King. “Don’t worry about that, your highness” replied Korgan, “Your subjects are more worried about the slumping Gamerigan economy, simply get your resident money experts to declare to the public that this measure is necessary to revive the Gamerigan economy.” The King hesitated, but then said: “It appears we have no choice then, and I do have a solemn duty to keep the Gamerigan economy on course. Very well Mr. Kogan, we will adopt your plan!”

Chapter 6

            Meanwhile, back in New Cork City, Henry did not know of these goings on, but he had his own problems to deal with. He had just finished laying the foundations of his grand building when he heard about the stock market crash. As a result, investors fled from his project, and by his new calculations, Henry no longer had enough funds to finish his building. “How could this happen to me!?” shouted Henry in dismay “Everything was going so well, how could everything come crashing down like this so suddenly!?” But, Henry wasn't the type to sit around moaning. He still had a good sum of money left in the People’s Bank, and with it he could always go back to the drawing board and shift his endeavours to a more modest architectural project. He had noticed that a lot of people had been trying to reclaim their gold from the banks recently, so he decided that the best course of action would be to get his hands on his own gold, just to make sure nothing happened to it.

As he had done a few years ago, Henry marched to the People’s Bank and saw a line-up of people reclaiming their gold; it was almost a déjà vu. As before, Henry waited in line and when he had almost gotten to the front, a royal soldier walked up to the doors of the bank and read from a scroll: “By order of the great King of Gameriga, Ross Franklinvelt, Gamerigan citizens are no longer permitted to hold gold for monetary uses. All such gold must be exchanged at your nearest bank for the appropriate amount of Gamerigan dollars.”

            

           There was a stunned silence in the crowd, could they really no longer reclaim their gold, or even hold the gold they already had?  Then, a burly man in the crowd shouted angrily: “What’s this about! Why can’t we hold gold! I demand an explanation!”. A murmur of agreement rippled through the crowd. Then, a distinguished looking man with a white moustache came up to the stage. “I am Mayjohn Keyman!” announced the man, “I am the foremost expert on money in the world. The Gamerigan economy is in a slump, as you must all know”, the crowd murmured in agreement. “Now, remember the happy times?” he continued “Clearly, we must get credit flowing again, as it was in those times, if we wish to bring those times back, don’t we? Now, the only way to do so is with a flexible money. That is why you cannot hold gold, it is a barbaric relic of the bad old days! We will emerge from this slump and leap into the future! A future that has no place for such an old fashioned shackle as gold! We need a money that can expand in order to accommodate the expanding economy of Gameriga!”

            

            After this exposition, many in the crowd seemed to agree. After all, Mayjohn Keyman WAS the world’s foremost money expert, and if he said that gold was holding Gameriga back, he must be right. Most of the crowd dispersed happily after this, leaving only a few standing in the square angrily, not quite convinced by Keyman’s exposition. Among these stood Henry, scratching his head. Of course he trusted his King and the money experts, but he still wished to see his gold for himself, if only to make sure it was there, still ready to aid him on his next architectural undertaking...