Chapter III: Who Gains
And Who Loses?
If banks profit from paper money, you may be asking:
Who loses? This is an important question because some economists go so far as
to contend that no one loses. This is absurd on the face of it. If one segment
of the population is receiving values without producing anything in exchange,
then it follows that someone else must be producing without getting the product
of his labour.
But if one analyzes the situation purely in terms of
flows of money, it seems as though these economists are right. The banker, of
course, has more money; it is he who has issued it. The businessman to whom he
has made the loan benefits; the existence of more loanable funds through this
process has meant that he is able to get his loan at a lower rate of interest.
In addition, when the businessman starts his project, he employs more workers;
so these workers benefit. As the additional money gets spent and flows into the
economy of the surrounding area, the people of this area accumulate more money.
Everyone gains; no one loses.
This essential theory, in various forms, has
continually resurfaced again and again in history. Shortly after our country
was established, there was a revolution in the state of Massachusetts called
Shays’ Rebellion which advocated general prosperity by paper money. The idea
was that government should run a large budget deficit, which would be financed
by printing, paper money. To increase the deficit, it was advocated to abolish
taxes and to spend money on public works. The fallacy involved in this argument
consists of analyzing what happens only in terms of money. Since the essence of
the paper money scheme is to create more money, then when measured in terms of
money, everyone has more. What must be remembered is that money is not wealth.
Money is just a means to facilitate exchange. King Midas had all the money he
wanted, but it did him no good because he could not even eat an apple.
The advocates of bank paper praise it because, they
say, it gives the businessman more capital, and capital is productive. Capital
creates additional wealth. But it is important to distinguish between money
capital and real capital. Money capital are pieces of paper in a vault or
notations on a ledger. Real capital are steam shovels, which can help dig the
foundation for a building; trucks which help carry goods to market; and labour
saving machinery, which increases the productivity of workers. Real capital is
productive. Real capital increases the quantity of wealth in the world.
But the increased issue of bank paper does not
increase real capital. It only increases money capital. When the banks create
money to loan to businessmen., these businessmen use the additional money to
bid capital away from other members of the community. Let us consider a simple
example: There is a small community with ten farmers and one, bank. The bank
wants the extra profits from paper money so it persuades one of the farmers, more
(“enterprising” and “forward looking” than the others, to take a loan to expand
his farm. There are ten harvesting machines in this community of which the “enterprising”
farmer has one. He uses his loan to buy an additional harvesting machine.
The banker, of course, has gained. He has the
interest payments on the loan. In addition, the “enterprising” farmer has
gained. Because the banker had additional money to loan, he lowered the,” rate
of interest in order to induce borrowing. Before the issue of paper money the
productivity of a harvesting machine was 7 % of its value, and the cost of a
loan was 8% interest. But now the banker has reduced the interest rate to 6%.
Thus the “enterprising” farmer stands to make a gain.
In addition, by buying the additional harvester, the “enterprising”
farmer has bid up the market price of harvesters. Thus all of the other farmers
in the community think they are richer because their harvesters are worth more.
Even the conservative farmer who sold his harvester is happy. He, after all,
has sold his harvester for more than he reasonably could have expected to get
for it.
But while everyone is happy, it is clear that not
everyone could have gained. In real terms the community has exactly as much
capital as it had before. There are still ten harvesters in that community.
Since there is now more money in circulation but no additional goods, it will
take more money to buy the same quantity of goods. The law of supply and demand
has been operating on this community. Since the supply of money has increased,
the value of money has gone down. This is expressed in the fact that it now
takes more money to buy the same harvesting machine. The value of the currency
has depreciated.
So the conservative farmer is not as smart as he
thinks. He has sold his harvester for more money, but it is money of
depreciated value. The eight other farmers think their harvesters are worth
more; but they are only worth more in terms of depreciated money. As the extra
money circulates through the community into all the channels of trade, it
gradually raises the average price of goods.” When the conservative farmer and
the other farmers go to spend their money, they will find that they can buy
less. Although in money terms they are richer, their money has depreciated; in
real terms they are poorer. And the amount of their loss is (approximately)
equal (7) to the gain of the banker and the “enterprising”
farmer. As Jefferson said: capital may be produced by industry, and accumulated
by economy; but jugglers only will propose to create it by legerdemain tricks
with paper.” (8)
In actuality, the mistake made by the conservative
farmer is the same in kind as the mistake made by those who sold estates to
Andrew Dexter, Jr. in our previous example. They sold real wealth for
depreciated paper, and although the amount of money they got was higher, the
value they got was lower. This example serves to illustrate a number of points:
The basic thing which is going on as a result of an
issue of paper money is a transfer of wealth from the community as a whole to
the banker and the borrower.
In this transfer, a large number of people lose a
small amount, and a few gain a large amount.
If we look at the transactions only in money terms,
it appears as though everyone has gained.
However, what has really happened is that the value
of the money has depreciated. Thus in terms of money the average price of goods
is higher. When people go to spend their money, they will cry: “Inflation.”
In the 18th century there was a vehement debate over
whether, in these circumstances, it was the value of money which was going down
or the value of goods which was going up. The banking interests tried to
contend that their issues of additional paper money did not cause a
depreciation in the value of money. Faced with the fact that it took more money
to buy the same goods they responded that it was the value of goods which had
risen, with the implication that this rise in goods was spontaneous and
accidental and in no way related to the extra issues of paper money.
This theory appears plausible in our present society
— where honest money has been outlawed by the government and prices are only
stated in terms of depreciated currency. But the War of 1812 provides a clear
example of paper money and gold/silver money circulating side by side. During
this war, the Southern and Western banks overexpanded their note issues to lend
money to the Government, and when the war went badly, there were runs on these
banks; like William Paterson in 1696, they suspended their payments of gold and
silver. The New England banks, however, did not overexpand and were able to
continue redeeming their notes in gold and silver. The result was that the
price of goods in terms of New York or Baltimore bank notes was 10% to 25%
higher than their price in terms of Boston bank notes. Clearly it was the New
York and Baltimore money which had depreciated in value. As Daniel Webster
noted at the time:
The depreciation of bank-notes was the necessary
consequence of a neglect or refusal to pay them, on the part of those who issue
them. It took place immediately, and has continued, with occasional
fluctuations in the depression, to the present moment. What still further
increases the evil is, that this bank paper, being the issue of very many
institutions, situated in different parts of the country, and possessing
different degrees of credit, the depreciation has not been, and is not now,
uniform throughout the United States. It is not the same at Baltimore as at
Philadelphia, nor the same at Philadelphia as at New York. In New England, the
banks have not stopped payment in specie, and of course their paper has not
been depressed at all … This difference in relation to the paper of the
District where we now are, is twenty five per cent. (9)
The propaganda of the banking forces was ultimately
successful and the theory of a mysterious and accidental rise in goods
unrelated to the increase in the money supply took hold. It is this theory
which is implied in the word “inflation.” “Inflation” means a going up. To use
that word in connection with higher prices implies that goods have gone up. But
when we look at the economic universe at a time of large issues of paper money
we find that that is not the case. We find that values of goods bear the same
relationship to each other. We find that values of goods bear the same
relationship to hard money, which has not been increased in supply. We find
that in the whole economic universe only one item has significantly changed its
value: That is the paper money which has been issued to excess. And the value
of this item in relation to all other items is down.
For this reason, the correct word to use in this
circumstance is “depreciation,” which means a going down. When average prices
rise as a result of an issue of paper money, what is occurring is a
depreciation of the currency.
The relationship between paper money and currency
depreciation is vividly illustrated in the accompanying chart (see Illustration
1, page 24). Pro-bank economists are still trying to argue that paper money
does not depreciate the currency. They do this by only focusing on the short
range picture, where economic causes have not had time to show their effects or
where the inadequacies of their own indicators distort their picture of
reality. Study this chart carefully to see the long term relationship between
paper money and the value of the dollar.
There were three periods of “inflation” or currency
depreciation during this time; each of them was associated with a war and extra
issues of paper money, and each of them saw some abrogation of the gold
standard. But in each case, after the emergency, the money supply was
contracted and prices declined to their previous levels. Thus, over a period of
145 years, the U.S. currency retained its value. Prices in 1933 were
approximately the same as they had been 145 years earlier when the Constitution
first established a gold standard.
The reason for this is simple. During this period the
dollar was defined as a quantity of gold. The dollar maintained its value
because goldmaintained its value. And gold maintained its value because it
could not simply be printed up and issued to excess like a piece of paper. In
fact gold was chosen as money by people because, of all the economic goods circulating
in human commerce, it has the best record for maintaining its value.
But since the enactment of a legal tender law in
1933, there has been a continual depreciation of the currency. Since that time
the dollar has been defined, not as a quantity of gold, but as a piece of paper
declared to have value by the fiat of the state.
In addition to the direct benefit to the banker, who
issues the paper money, and the benefit to the debtor, who receives the loan,
the depreciation associated with the paper money also sets up additional
imbalances in the regular path of commerce:
The real value of your wages declines in a period of
currency depreciation. In a free economy, prices are always fluctuating in
response to supply and demand. But some prices are more responsive than others.
The prices of vegetables in your local supermarket and stocks in the stock
market are extremely responsive and change within a few minutes or a few days.
On the other hand, the price of a piece of real estate may not change for years.
It happens that wages are more like real estate in this regard. History shows
they are slower to change in response to changes in the value of the currency
than prices. In a period of currency depreciation, prices will move up before
wages, and in a period of currency appreciation, prices will move down before
wages. The following statistics illustrate this fact.10 (See tables below.)
Civil War currency depreciation
— change from 1861
The sharp rise in prices
early in the Civil War was not matched by the rise in wages.
But wages kept going up after
the war and caught up.
And the same thing happened
in WWI. But wages began to catch up in 1919 and 1920.
And they really caught up in
1921 by only slipping a little in the face of a major price decline.
In the Great Depression,
prices fell more rapidly than wages.
And in a price decline in the
1880’s, wages didn’t fall at all but merely rose less rapidly.
Thus, in the early stages of a currency depreciation,
the prices you pay will rise faster than your wages. The businessman then
benefits from a period in which the prices he charges for his goods go up while
the wages he pays Ms workers either remain the same or go up much more slowly.
This is a truth which seems to have been forgotten today as people are blaming labour
for the present “inflation.” But it was widely recognised in previous times. As
President Cleveland said: “At times like the present, when the evils of unsound
finance threaten us, the speculator may anticipate a harvest gathered from the
misfortune of others, the capitalist may protect himself by hoarding or may
even find profit in the fluctuation of values; but the wage earner — the first
to be injured by a depreciated currency and the last to receive the benefit of
its correction — is practically defenseless.”11 Even Keynes recognised this
when he said: “When money-wages are rising, this is to say, it will be found
that real wages are falling; and when money-wages are falling, real wages
arerising.”12 So, as the currency depreciates, the employer benefits at the
expense of the employee.
(2) Debtors gain at the expense of creditors. We have
already seen how debtors are enabled to borrow money at lower rates of interest
due to the surplus lending power of the banks (as in the case of the “enterprising”
farmer). But an additional benefit to debtors from paper money lies in the fact
that they are enabled to pay their debts in depreciated currency.
A debtor who borrows $1,000 may pay back the same
nominal sum. But if the currency has depreciated 20% in the interval, then he
is only paying back $800 in real terms. A debtor who borrowed $1,000 in 1861,
when the dollar was 25.8 grains of gold, was borrowing 25,800 grains of gold.
If he paid his debt in legal tender greenbacks (issued to help fight the Civil
War) in 1864, at a time when the dollar had depreciated 50% in terms of gold,
then he paid back 12,900 grains of gold. This meant that he had a profit of
$500.
(3) The unscrupulous gain at the expense of the
gullible. You have already seen how an infusion of paper money into a community
makes everyone at first think they are richer. As a result, many people purchase
luxury items, which they cannot properly afford, and a favorite luxury item is
a fling in the stock or commodity markets. Every period of paper money
expansion has seen some type of bubble whereby large numbers of naive newcomers
enter the speculative markets hoping to make a lot of money. To accommodate
these people, there arise fast buck operators who are always handy with schemes
for instant riches. Starting with the Mississippi bubble and the South Sea
bubble to the recent “new breed” (who rose to make profits from the paper money
associated with the Vietnam War), every period of paper money expansion has
seen some type of emotional mania on the markets. When the dust has lifted from
these manias and the overinflated stocks have collapsed down to their true
values, it can be seen that there has been a large transfer of wealth from the
gullible newcomers to the fast buck operators who promoted the schemes which
took them in.
We are now at a point where we can understand what
happens when paper money is issued. Some people do gain something for nothing,
but this is counterbalanced by a loss to the great majority of people, a loss
which shows up in a depreciation of the currency, which the average person
calls inflation. This loss cannot be seen by examining money. In terms of
money, everyone gains. It can only be seen by examining real wealth.
To summarise, there are those who lose and those who
gain from paper money. Bankers gain from paper money, of course, because it is
they who issue it. This main is made at the expense of the rest of the
community, which suffers from the depreciation of the currency.
Business, especially big business, gains from paper
money in three ways. First, since wages are slower to rise than prices in
response to the depreciation, the real wages of labour go down. Business
benefits because in real terms it is paying, lower wages. Second, it is not
widely known, but the major debtors in our society (or any society) are the big
businesses. An individual or a small business is not as good a credit risk as a
large corporation and cannot go as deeply into debt. In its capacity as a
borrower, business benefits because the creation of paper loanable funds
reduces the rate of interest below what it otherwise would have been. When the
rate of interest is artificially lowered, all debtors benefit at the expense of
those who save (primarily the middle class). Lastly, business also benefits in
its capacity as a borrower because, in a period of currency depreciation, it is
enabled to pay off its debts in money of lower value.
Promoters and fast buck operators, the hanger-ons of
any paper money scheme, take advantage of the gullible to create an emotional
turbulence on the markets.
As against these, the vast majority of people in the
society lose. In particular, the elderly in a society suffer from the
depreciation of the currency. It is they who have put away money for their old
age. As this money depreciates in value, they are reduced to poverty. For
example, in 1960 it was not unreasonable for a 50-year-old man to plan
retirement on a $3,000 annual income. But now, as retirement approaches, how
much will $3,000 buy? $3,000 is now below the poverty line. And if the “inflation”
continues until 1985, how much will $3,000 buy then?
The middle class also lose. Like the elderly, they
lose from the depreciation of their savings. However, they also lose from the
artificial lowering of the rate of interest. Since it is they who are the most
thrifty and do the real saving (saving of real capital), it is they who lose
most from a depressed interest rate.
And of course, the worker loses as his wages do not
keep pace with the depreciation of the currency.
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