The is an edited version of one of my businesses' Briefing Notes. Thoughts?
What is ‘sound money’? Or, perhaps more importantly, what is
‘unsound money’?
Unsound money can be defined
as money which has:-
- Overwhelming
counterparty risk, and
- Fails
to sustain its relative value over time.
To see why this matters we
have to understand what money is and what its function is.
Money is any thing which an
economy accepts to act a medium of exchange, a store of value and a unit of account
(a measure of value). Commonly this
thing that became universally accepted in most exchange economies was, is,
gold.
There is also a difference
we need to define between money and currency.
These two words are nowadays used interchangeably; as the same thing. But
to make sense of ‘sound money’ their meanings need to be differentiated.
1. Money,
is money. The fundamental store of
value, medium of exchange and unit of account.
2. Currency
is a medium of exchange and unit of account but has to be exchanged for money
as a reserve of value. Witness the
statement on a British Ten Pound note – ‘I promise to pay the bearer on demand
the sum of Ten Pounds’. That is such
‘paper money’ is not money but a ‘promissory note’. A ‘currency’.
Why does the counterparty
risk matter?
Firstly, in effect, no
exchange transaction is complete until the receiver of the currency goes to the
currency issuer and obtains his money.
Until he makes this exchange what he holds is a promissory note, not
money. Now, this may not matter if he
can then, at any time in the future, exchange this promissory note for other
real goods and services. And that the
promissory note maintains its relative value.
What do we mean by relative
value? Suppose the currency issuer
issues a lot more promissory notes than he has money at hand. This will increase the supply of currency
(and therefore the counterparty risk) relative to other goods and
services. If the number of promissory
notes is, say, doubled, then their value must halve. The currency holder will need twice as many
promissory notes to have the same purchasing power. And hence the prices of goods and services in
that reduced value currency must double.
In short, the counterparty has taken half the value of the currency holders’
money for nothing in exchange. This is theft.
Or in money terms, counterfeiting.
It used to be that the free
market had evolved over time a sound money system. Roughly, money was gold. Gold was held in warehouses, called
goldsmiths and latterly banks. Customers
would instruct banks to settle debts using written instructions - ‘please pay A
gold to the weight of X on this date signed B depositor’. As time passed it was realised by banks that
they could issue ‘bank notes’ based on the quantity of gold in their vaults
which customers could carry and exchange between themselves confident that if
at some point they needed to obtain their money they could present the bank
note at the bank for settlement in gold.
(I have ignored coin here for simplicity – but similar rules apply).
In due course it dawned on
bankers that as long as they did not overdo it they might be able to issue more
currency than the value of gold – i.e. money - they held in their vaults. This practice bestows enormous benefit to
currency issuing banks as obviously this new ‘currency’ / aka money, is money
for nothing.
Luckily Mr Market was wise
to this practice and under laissez-faire banks who pushed this currency
expansion too far, were called to account and failed. There were bank runs. Some depositors lost money. But the banks owners, in the age of unlimited
liability banking partnerships, lost everything or nearly everything and lost
their reputations. These market
disciplines generally kept banks honest and respected. And excellent example of how this worked is
the story of the failure of the Ayr Bank.(1)
Now, moving forward to
today. We live in an age of catastrophically
bad money.
In 1944 various of the great
and the good (including Mr Keynes) met at a place in the USA named Bretton
Woods(2) to sort out a post war international settlement and money
order. Very briefly they agreed that the
USD should be linked to gold at the price of $35 per ounce. And that all other currencies would be linked
to the USD.
This was all fine and dandy
(actually it was not – it was a huge accident waiting to happen) until the USA
got involved in the Cold War/The Korean War/The Vietnam War/and the Great
Society Program. They funded all this by simply printing more and more USD. Until the French got fed up and demanded
settlement of their USD balances in gold.
Which of course the USA did not have / would not do. This led to Nixon closing the gold window on
15th August 1971 and collapsing the Bretton Woods fake gold
standard. We, the West, have been using entirely fiat
money (currency) since that date.
The result has been
catastrophic. Sterling and the USD have
lost respectively about 99% and 98% of their relative value. (It is an economic saw that ‘all paper money
trends to zero value). We, the people
have been robbed by our governments.
This currency (money) debasement is also a product of the fallacies of
Keynesianism. You cannot operate Keynesian with sound money.
The worry for us as individual citizens is how far will this go? As currencies like the USD, GBP, Euro etc
fail (and fail they will) the currency authorities will replace them with programmable CBDC
(central bank digital currency), the day by day relative value of which can be
manipulated directly by those nationalised currency authorities. How will be able to grow and
preserve our wealth under such an assault?
Let alone our freedom?
Lobbying for a return to sound
money is one thing we should be doing if we want to preserve the free society.
Footnotes
(1(1) https://en.wikipedia.org/wiki/Douglas,_Heron_%26_Company
(2) https://en.wikipedia.org/wiki/Bretton_Woods_Conference
and https://en.wikipedia.org/wiki/Bretton_Woods_system
