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Monetary Central Planning and the State, Part 33: Murray N. Rothbard and the Case for a 100 Percent Gold Dollar

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In 1962 there appeared a collection of essays edited by Leland B. Yeager entitled In Search of a Monetary Constitution. It contained contributions by such leading members of the Chicago school of economics as Milton Friedman and Jacob Viner and the originator of public-choice theory, James Buchanan. They each advocated a central monetary authority that would be assigned the task of managing the monetary system, with limited discretion to maintain a desired level of price stability. The volume also included a contribution by a young Austrian school economist, Murray N. Rothbard, whose essay was entitled “The Case for a 100 Percent Gold Dollar.”

That same year — 1962 — Murray Rothbard published Man, Economy, and State, a two-volume treatise representing the most systematic presentation of economic principles from within the Austrian tradition since Ludwig von Mises’s major work, Human Action, in 1949. The following year — 1963 — Rothbard published America’s Great Depression, in which he presented a detailed Austrian interpretation of how Federal Reserve monetary policy in the 1920s created the economic imbalances that resulted in the economic downturn that started in 1929 and of how the misguided interventionist policies of the Hoover Administration in the early 1930s prevented a normal recovery and instead turned it into the worst economic contraction of the 20th century.

The theme of Rothbard’s 1962 essay was the question, What type of monetary system would eliminate the possibility for government manipulation of the money supply, reduce the likelihood of the business cycles of inflations followed by depressions, and be most consistent with the principles of a free society grounded in the market relationships of voluntary exchange and the fulfillment of contractual promises?

Rothbard emphasized:

We should keep in mind that money, in any market economy advanced beyond the stage of primitive barter, is the nerve center of the economic system. If, therefore, the state is able to gain unquestioned control over the unit of all accounts, the state will then be in a position to dominate the entire economic system, and the whole society.

In the processes of private market exchange, money is acquired by supplying desired goods and services and by offering them for sale to others in the society who are willing to pay a money price for them. Then with the money earned by supplying and selling demanded commodities, the income earner proceeds to offer money in exchange for what those others, in turn, are presenting to the market for purchase. The circle of exchange is closed, with goods ultimately trading for goods and each participant in the market arena able to acquire what he wants from others only by providing them with things that they are willing to buy.

The only exceptions to this process are the producers of the money-good itself. Following Carl Menger and Ludwig von Mises, Rothbard argued that money originates out of the market process, in which some commodity emerges as the most widely used and generally accepted good to overcome the inconveniences of direct barter transactions. Thus, those who manufacture this commodity began as the suppliers of some good desired originally as a consumer or producer good, which now has an additional use and value as a medium of exchange. (See “Monetary Central Planning and the State, Part 5: The Austrian Economists on the Origin and Purchasing Power of Money,” Freedom Daily, May 1997.)

In the market, the producers of the money-good, say, the miners and minters of gold and silver coins and bullion, are supplying something that has actual market value to demanders, for which they are willing to pay a price in the form of other goods offered in exchange. And on the private market, the amount of the money-good mined and supplied is determined and limited by the profitability of extracting that commodity from the ground, given that the resources and labor to do so have alternative uses in the economy for which input prices must be paid.

The inconvenience to people of carrying and storing actual quantities of gold and silver coins and bullion resulted in the development of warehousing, in which the money-commodity was placed, for a fee, on deposit for safekeeping. The depositor would receive a receipt or “claim check” recognizing his right to redeem his money-commodity fully or partly on demand. After a time, as such warehousing establishments developed reputations for reliability within communities, market transactors began to transfer the receipts in market transactions in place of actually withdrawing some quantity of gold or silver before every exchange. The warehouse claims to the money-commodity on deposit began to be used as money substitutes viewed by the market participants as being “as good as gold.”

The problem, Rothbard explained in his 1962 article, as well as in other writings, including his monographs What Has Government Done to Our Money? (1963, reprinted 1990) and The Case against the Fed (1994), is that the owners of the warehousing facilities often also operated as lenders of their own funds to potential borrowers in the market. That is, they began to function as bankers also. But these emerging bankers soon came to realize that they could extend additional loans to borrowers in the form of “notes” that looked exactly like the warehouse receipts issued to their gold and silver depositors. And that the look-alike notes were accepted in trade on the market, since they too were viewed by sellers of goods as money substitutes that in principle could be turned in for redemption for gold and silver at any time at the warehousing-bank establishment.

This, Rothbard argued, was the beginning of “fractional-reserve banking.” The gold and silver on actual deposit with a bank represented the “reserves” against which the receipts and notes issued by that bank could be redeemed “on demand.”

But that also meant that the total face value of notes and receipts in circulation now exceeded by some multiple the amount of gold and silver against which they represented a claim. Why? Because there were the receipt-notes issued to those who actually deposited some quantities of gold and silver with the warehouse-banker, and there were the additional receipt-notes issued by the bank to borrowers, who used them to buy various goods.

If enough actual depositors and holders of a bank’s receipts and notes all were to demand payment in the form of gold or silver withdrawals in the same short period of time, the gold and silver available would be found to be only a fraction of the claims being turned in for redemption. The bank would then be faced with at least insolvency and possibly even bankruptcy.

Rothbard condemned fractional reserve banking as a violation of contract:

“In my view, issuing promises to pay on demand in excess of the amount of the goods on hand is simply fraud, and should be so considered by the legal system. For this means that a bank issues “fake” warehouse receipts — warehouse receipts, for example, for ounces of gold that do not actually exist in the vaults. This is legalized counterfeiting; this is the creation of money without the necessity of production, to compete for resources against those who have produced. In short, I believe that fractional-reserve banking is disastrous both for the morality and for the fundamental bases and institutions of the market economy….

“In sum, I am advocating that the law be changed to treat bank notes and deposits as what they are in economic and social fact: claims, warehouse receipts to standard [gold or silver] money — in short, that the note- and deposit-holders be recognized as owners-in-law of the gold … in the bank’s vaults.”

The money and banking system of the free society therefore, Rothbard argued, should be based on a system of 100 percent gold reserves. He also argued that this would eliminate the “business cycle.” Banking would have two divisions: one would be pure warehousing, in which the depositor paid a fee to store his actual gold or silver and for which the actual amount deposited would always be in the vault for 100 percent redemption on demand.

The other division of the banking establishment would be for saving and lending, in which sums would be deposited for a stipulated period of time during which depositors could not make a withdrawal (except under specifically prearranged terms and penalties). These saved sums would then be available for lending purposes for contracted periods of a loan. Only that amount of money income actually saved by members of a community would be available for investment purposes by those desiring to borrow from the banks. Thus, savings and investment would be kept in balance, with limited potential for the type of savings-investment imbalances that usually occur in the business cycle.

Setting aside the problem of the business cycle, Rothbard’s central argument against fractional-reserve banking was that it represented fraud — an issuing of bank notes and a publicly stated promise to pay on demand that could not be fulfilled if enough depositors were to want redemption within the same period of time. This argument, however, has been questioned by a number of free-market advocates. For example, Mark Skousen, in his thorough study, Economics of a Pure Gold Standard (1996), asked whether the fraud charge would be true if customers were told up front that some banks operated on a fractional-reserve basis and that they could make their deposits at a 100-percent-reserve banking institution for which they paid a fee or at one that offered them interest on their deposit but which could not guarantee continuous 100 percent redemption under certain circumstances, such as a heavy demand for withdrawals by some of these clients.

“What fraud is committed if a customer voluntarily agrees to lend his banker his funds with the contractual agreement that the customer can withdraw his loaned funds on demand? This is surely a strong possibility under market conditions and is free from force or fraud,” Skousen argued. “And, yet, by permitting such contractual arrangements, a fractional reserve system is sure to develop on a broad scale.” Furthermore, if a bank’s notes and checks clearly state that it operates on a fractional reserve basis, then no potential recipient of such a note or check could claim fraud if he were to accept it as a money substitute in a market transaction.

And, indeed, the case for a private, free banking system, probably with fractional-reserve banking, has been the primary focus of the opponents of monetary central planning for the last two decades.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).