In this post, DragonLZ asks a very important question:

What was so much better back in 2003 that justified the incredible bull market that lasted four and a half years, from March of 2003 until October of 2007?

A related question that DragonLZ could have asked is what was so great about Zimbabwe in 2007 that caused it to have the best performing stock market in the world?  But we’ll get back to that.

Little does dragonLZ know that he is at the start of journey that leads to Mises, Hayek, and the Austrian School of Economics, for it is that very question that only the Austrian School can answer.  As he pointed out, there isn’t a very good economic reason why the market kept going up and up.  We agree.  So what did happen?  Here is the Austrian School answer, known as the Austrian Business Cycle Theory (ABCT):

Excessively low interest rates exacerbate the boom and bust cycle

These low interest rates cause an increase in the available funds (business capital.)  From these funds, malinvestment occurs as companies take on projects that would not be justifiable under a system of free market interest rates.  (Rates higher than the prevailing rate.)  This expansion can occur because the Fed (or any central bank) holds rates too low for too long, or through unchecked fractional reserve banking.  If it persists long enough, economic activity can BOOM, but it is an illusion.  Many of the projects are unsustainable, excessively risky, and pull resources away from more efficient alternative uses.  In other words, economic activity gets distorted.  The result is a predictable crash.

Do you think the Fed’s rates don’t have an impact on economic activity?  Then why do they bother manipulating them?  Ask Krugman.

From this most recent boom/bust to the dot.com boom/bust all the way back to the late 1920′s boom/bust…. and guess what…. the panic of 1819, the inflationary boom/bust of John Law’s Mississippi System and the Tulip Bubble before them…

Every single one has the same characteristics.  Easy money at the beginning, resources drawn into sectors that wouldn’t normally justify it, unsustainable development due to scarcity, and it all comes crashing down as entrepreneurs miscalculate risk.  The lyrics from the famous Hayek-Keynes Rap Video explain it better than I can:

The place you should study isn’t the bust
It’s the boom that should make you feel leery, that’s the thrust
Of my theory, the capital structure is key.
Malinvestments wreck the economy

The boom gets started with an expansion of credit
The Fed sets rates low, are you starting to get it?
That new money is confused for real loanable funds
But it’s just inflation that’s driving the ones

Who invest in new projects like housing construction
The boom plants the seeds for its future destruction
The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few

So the boom turns to bust as the interest rates rise
With the costs of production, price signals were lies
The boom was a binge that’s a matter of fact
Now its devalued capital that makes up the slack.

Whether it’s the late twenties or two thousand and five
Booming bad investments, seems like they’d thrive
You must save to invest, don’t use the printing press
Or a bust will surely follow, an economy depressed

And that’s how the Austrian School knew that we were headed for trouble.  The Fed had merely reinflated with cheap credit, which Austran scholars knew was unsustainable.  Another bust was sure to follow, worse than the bust which preceded it.

So the story continues, and this is why we urge caution once again.

However, it is foolish to view the Austrian School as anti-stock market.  Nothing could be further from the truth as the following quote shows:

One time, during Mises’s seminar at New York University, I asked him whether, considering the broad spectrum of economies from a purely free market economy to pure totalitarianism, he could single out one criterion according to which he could say that an economy was essentially “socialist” or whether it was a market economy. Somewhat to my surprise, he replied readily: “Yes, the key is whether the economy has a stock market.” That is, if the economy has a full-scale market in titles to land and capital goods. In short: Is the allocation of capital basically determined by government or by private owners? – Murray Rothbard

Now look at this Austrian School examination of the Fed and the stock market in May 2009.  Pretty consistent with what I have been saying all along. This rally is built on cheap money.

This is very dangerous.  Consider that the best performing stock market in the world in 2007 was Zimbabwe.  I’m surprised dragonLZ didn’t ask us why that was justified.  You can see now that it was for the same reason.

While I don’t want to disparage other bloggers that may have libertarian leanings and an affinity for sound money, without an Austrian School perspective on the boom/bust cycle they may sound like PermaBears to the untrained ear.  But just like me, they want economic growth. We all however would just prefer it to be sustainable.

Neither 2003-2007, as dragonLZ pointed out, nor 2009 was sustainable.

Europe hasn’t solved a thing. Propping up a bankrupt system does not make it solvent, it simply transfers the system’s failure a few years down the road. Europe will have its day of reckoning just as the U.S. will. Governments are certain they can bail each other out even if they themselves are hundreds of billions of dollars in debt. These practices will not and cannot end well.

With the announcement of “rescue packages” for Greece and other European countries facing ruin, we have heard cheers from the Usual Suspects, beginning with the New York Times, which declared in an editorial:

Europe’s leaders stared into the abyss and finally decided to act. The nearly $1 trillion bailout package, arranged over the weekend, is intended to head off Greece’s default and stop the crisis from dragging under other weak economies — Portugal, Spain, Ireland and Italy are all vulnerable.

The European and American markets celebrated on Monday. The CAC-40 index in Paris rose almost 10 percent. The Dow Jones industrial average rose 3.9 percent. It was certainly the right thing to do. Coupled with the European Central Bank’s promise to buy bonds from stricken European countries, it arrested the financial turmoil — at least for now.

The last sentence is unintentionally prophetic, for whatever “good effects” the bailout supposedly will create, they will be short and will pave the way for future crises. While Greece and other European countries have been facing disaster, it is nothing like the disaster that looms because the economic piper has yet to be paid.

Keep in mind that the European Central Bank (ECB) is buying bonds with printed money, which means inflation. Like the United States, Europe is broke, and will be even more so once this “bailout” goes through.

For all of the talk of “rescuing” Greece, Spain, and Portugal, one wonders how the plan is supposed work. These are countries with bloated public sectors and militant public-employee unions. They also have stringent workplace rules for private firms and other government policies that raise business costs, contribute to high unemployment, and shackle private investment. The “rescue” packages supposedly deal with the public sector — although I am skeptical they will — but don’t address the barriers to economic growth.

Keynesians say all that is needed is a new dose of government spending. People will receive the money, spend it, clear inventories, and then companies will make more goods. The process will continue. In that view, all that matters is spending.

The ECB move smacks of what the Federal Reserve did in the 1920s when, in response to the overvalued British pound, it inflated the dollar, leading to the stock market bubble and collapse. By expanding the currency, the ECB will use inflation to prop up high union wages (and high business costs) in Greece, Spain, and Portugal.

However, the inflation also will produce at least a mini-boom in Germany and other European countries with somewhat stronger economies. While Keynesians see that as a good thing, Austrian economists see this policy as simply extending the errors of the previous boom, and at the end of the new booms another crisis awaits.

http://campaignforliberty.com/article.php?view=857

“I remember a German farmer expressing as much in a few words as the whole subject requires; ‘Money is money, and paper is paper.’” – Thomas Paine

America’s monetary situation is becoming fairly ridiculous.  This Monday, the Wall Street Journal carried “Will Nickel-Free Nickels Make a Dime’s Worth of Difference?” on its front page.  The article shares the government’s dilemma that minting each $100 box of nickels costs very close to $200, and that the metal content of the coin is worth more than the face value of 5 cents.  The penny, which was already debased from almost 100% copper to 2% copper in 1982 also costs more to mint than its face value.  The pre-1982 pennies are now worth over double their face value.

The nickel’s mass is 5 grams and consists of 25% nickel and 75% copper.  It is the only US coin to never have been devalued by using cheaper metals since it was first minted in 1866.  At that time, both the penny and nickel were worth far, far less than their face value, but were used as placeholders for gold and silver coins.  America’s dimes, quarters, half-dollars were all 90% silver up until 1964 when the silver content became worth more than the face value.  Today’s dimes, quarters, and half-dollars are nickel plating – done on purpose to resemble silver – sandwiched over a cheap copper core.

While the WSJ hems and haws between substituting wood, plastic, aluminum or zinc in the coins, one of the issues with “toy money” or devaluing the coin currency is that it could cause a psychological trigger as citizens realize Congress and the printing operators at the Federal Reserve intends to pursue its permanent monetary policy of inflation, which is a hidden, insidious tax on all Americans who hold dollars.

From my overseas experience in China, one oddity is bank accounts and many restaurants or shops still issue receipts with two decimal places, even though there is no coin in wide circulation that is worth 0.01 yuan.  These coins stopped being used by the public simply because this amount no longer has any practical purchasing power.  A similar situation now exists in the USA today.

The most sensible solution for Congress to pursue is to halt the inflation and stop minting pennies and nickels altogether.

However, Congress is not sensible.  For reasons briefly outlined here, Congress will continue inflation for as long as it can to maintain this charade of “desperado economics.”  Note the gold price rising to all-time record highs yesterday in dollars, British pounds, Swiss Francs, and Euros.  However, gold’s value is not really rising – it is just the devaluation of the dollar becoming more and more visible to the general public as posted recently in “The Haunted House of Fiat Currencies.”

Today’s dollars are mere shadows of what America’s money once was.  Money made with a printing press is nothing new – Thomas Paine and the rest of the founders were aware of the dire dangers – the phrase “worth less than a Continental” refers to script currency Washington issued the troops which quickly became worth nothing. This campaign has specifically about the nickel debasement two weeks ago, again in January, and well before this campaign started way back in August 2008 when I was just beginning to figure out what the government has done to our money.

While the masses will eventually catch on, forewarned is forearmed.  Here is a snippet from Chapter 17 of Human Action written by economist Ludwig Von Mises:

“The course of a progressing inflation is this: At the beginning the inflow of additional money makes the prices of some commodities and services rise; other prices rise later. The price rise affects the various commodities and services, as has been shown, at different dates and to a different extent.

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against “real” goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German Mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.”

[Suggested further reading: the campaign's Federal Reserve plank, Sound Money and Jobs plank, and "One Step Clower to the End of the Yellow Brick Road"  Towne is one of the few writers brave enough to address the transition to sound money here.  While the end result of the crack-up boom predicted by Mises is as above, during the path towards it anything can happen as the amount of credit could be contracting at a faster rate as I wrote about in "'Credetary' Inflation and Deflation" and "Bring Light to Dark Derivatives!!" last year.]

Jake Towne is running for U.S. Congress in eastern Pennsylvania’s 15th district in 2010. Prior to returning home, he had been living in Shanghai as an engineer in the semiconductor industry for over 3 years. As part of defending liberty and championing the Constitution, Towne is offering the citizens in his area a novel form of accountable government called “Our Open Office.”

In my long running feud with pro-Federal Reserve and pro-Inflationist economic commentators, I am always amazed at their ability to ignore economic history when making their arguments.

Inflation in American history, even considering the unprecedented actions of the Fed since 2008, pales in comparison to just about every country in the globe. In the 20th century, nearly every government in the world devalued their currency at a faster rate than America.

Before the Federal Reserve, under the gold standard, America suffered from deflation for most of its first 140 years (interrupted only when the government went off the gold standard to pay for wars.)

Considering this history, if inflation was a good thing, wouldn’t America be economically backward, handicapped by its strict, unforgiving monetary policy in comparison to the rest of the world, which has been markedly pro-inflation over the last 230 years?
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There is a buzz going through the Interwebs. Deflation is back, they say.  The core CPI numbers declined for the first time since 1982, down 0.1%

I’m going to discuss 5 topics today so let’s dive right in.

1  Why Deflationists are always wrong.
2. Why deflation, in normal circumstances, is a great thing.
3. Why the CPI is a useless statistic
4. A realistic assessment of current price levels
5. Why the Federal Reserve wants you to worry your poor little head about a 0.1% drop in price.

Why Deflationists are always wrong

According to deflationists, falling prices are right around the corner.  The inflationists, on the other hand, predict rising prices but often say that the rise may not come for some time.  You won’t hear a deflationist predicting prices falling by massive amounts.  They can’t tell you how long it will last or how severe it will be.  You never hear the term “mass deflation.”
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It’s hard to not go gaga over the ideas and intentions of “stimulus packages” and ramped up government programs. After all, won’t it create a lot of jobs, boost the economy, and lift us out of a rough spot? This is what we’ve constantly heard from politicians and the media especially over the past couple years. “Government needs to do something.”

Never forget how government gets its money. It does not earn it. It does not work for it. Every penny that goes to government must come forcefully from a productive area of the economy. Government can’t take money from a failing business or struggling individual, it must forcefully take money from wealthier (i.e. productive) businesses and individuals.

This brings us to the first problem with “stimulus projects” in the form of increased government programs, public works, and public spending in general. The only way any government can afford to spend billions and trillions of dollars “stimulating” the economy is to either tax, borrow, or print that money. In other words, people will either directly lose more money to government through taxes, the effect may be felt in the longer-term through debt and borrowing, or the currency will depreciate and prices will rise through the process of monetary inflation. Pick your poison; all three options for government to increase spending will inevitably pinch people the most either directly or indirectly.

“Stimulus packages” aim to boost the economy in the short-term. If government can provide jobs to build public entities (such as transportation options, buildings, etc.) the economy will correct quicker than if the market could work, right? The problem with this theory is people always ignore where that money comes from. Taking money from productive sources in the economy and throwing it to unproductive and expensive projects does not set the economy on a sustainable foundation.

Strong economies are not build on artificial spending. The more that government takes from productive sources in the economy and pumps it into unproductive government projects, the longer the correction and recession will be. Consider some of the projects being funded under Obama’s massive spending plan. One is building a light rail track. This is all well and good, but how is spending billions of dollars on a train track and system going to increase long-term productivity? Few people use government-operated trains as it is (witness Amtrak and its black hole of wasted money), it will simply require more funds sucked out of productive sources to survive.

People buy into the illusion that as long as people have jobs, regardless of productivity, it is good for the economy. Unproductive jobs do no good for the economy and will not expand sustainability and prosperity. Napoleon tried to create jobs and work just by paying people to dig up ditches and fill them back in. It’s a nice idea, but it won’t do a thing to improve the economic picture. It is when labor is efficiently and sustainably used that an economy will expand on a strong foundation.

Today we are seeing government promote and prop up unproductive entities like nothing else. First, we bail out companies who lived beyond their means, made terrible business decisions, and recklessly spent money. These companies were unproductive and hurting the economy. Second, we have the ongoing “stimulus package” pumping money into pork projects that will not be productive in the least. It may sound great to build roads and infrastructure to stimulate the economy, but it won’t create wealth and expand productivity. It is not beneficial to use productivity to fund nonproductive goals. It is a bogus and failed theory that we continue to follow. It will not help the long-term economic picture.

One does not need to look very hard to see how terribly these government shenanigans have failed in the past. The Great Depression is the first obvious example. Hoover and Roosevelt both increased taxes, public projects, and expanded government with hopes of curing economic ills. Subsidies, public works projects, and many other government programs were created and expanded in the 1930s. Roads were built, prices were propped up, and government would not let the market organize labor and money on its own. Despite the intervention and spending efforts from government, unemployment was higher in 1939 than in 1931. The New Deal cost billions of dollars and expanded the federal government like never before, but unemployment and productivity still did not improve.

Let’s take a brief detour to the recession of 1921. Few people have heard of this recession because government actually decreased its size, spending, and taxes during the rough economic period. The government and Federal Reserve did next to nothing as the economy began to correct after the government’s market intervention during World War 1. The government (to the disappointment of some interventionist politicians), rather than increase its role as it would do disastrously just eight years later, ended up sitting this recession out. Prices fell, unproductive businesses failed and reorganized, and the economy was back on its feet after no more than 18 months. The pain was brief, the correction and reorganization was quick, and it all happened largely because government reduced its size and let the market shift money and labor to productive areas of the economy.

In more modern times, Japan’s “Lost Decade” can be another example of the botched intervention of government and the central bank. Some believe that Japan did too little to “stimulate” the economy, when the government and central bank actually took a nearly identical road to the U.S. today. Failed businesses were propped up by government, the central bank lowered interest rates to 0% for a time and pumped cheap money and credit into the economy, and huge amounts of Yen were spent on unproductive and essentially worthless public projects. All of this did nothing but lead to huge government debt and a devastated economy.

It’s hard to understand how much money Keynesians want to spend on “stimulating” the economy. Paul Krugman, the front-runner of the Keynesian crowd, is calling for a second and larger stimulus package. The trillions of dollars already pumped into unproductive businesses and projects wasn’t enough? How much do these guys think we need to spend to bring about their Keynesian Utopia? Rather than realize that government intervention and central manipulation have done more to agitate the economy than help, people are crying for more of the same that historically has done more damage than good.

Government is great at managing the time, labor, and money of other people. It also guarantees that politicians won’t manage that time, labor, and money more efficiently than the people who own that time, labor, and money. The very concept that by taking from productive parts of the economy and spreading it to various unproductive jobs and projects is downright silly. The worst recessions and depressions have come in many countries when government prevents the market from reallocating funds from unproductive businesses and sectors to the strong and productive areas of the economy.

Preventing the failure of a large corporation because jobs would be lost is the equivalent of saying that government should have propped up horse and buggies and the many jobs in the industry regardless of its uselessness to society. The natural order of a free market is to shift funds to the strongest, smartest, and most productive businesses and industries. When government gets in the way with bailouts, “stimulus plans,” and countless other intervention methods, it only guarantees inefficiency, unsustainable activities, and prolonged suffering.

The answer to our economic problems does not lie in government spending as Paul Krugman and many other Keynesians would like, but in more freedom for the market and people to reallocate money and labor to the productive and sustainable portions of the economy.

We live in times when government and central banks monopolize money and make it next to impossible for viable competing currencies to arise, which can make it difficult to see the possibility of other currency alternatives.

Picture a new village, untouched by current monetary laws. People begin exchanging goods through the process of bartering. This makes it difficult to know what you can buy, because the milkman will only need so many of the pouches that you manufacture. Because bartering can be inefficient, unpredictable, and unreliable, the people decide to represent their goods with something of value. They find copper, silver, and gold nearby, all unique, relatively limited (therefore they hold more value than, say, granite), and quite durable. Thus, they can represent their goods with these valuable metals (and to make it more convenient, paper guarantees to those metals).

Money does not get its value through “force” as some believe. When the people in the village were looking for a more effective way to exchange goods, they were not trying to represent force. They were aiming to represent value through metals that were limited enough to have value, had durability, and could not easily be counterfeit (or inflated).  Currency is never originally brought about by force or through government.

Historically government has gotten involved in currency for one reason: greed. Kings would debase the metals that the market freely used and valued. Kings would inflate and devalue the currency that was once stable when the market was in control. Government could not debase metals, clip coins, and print unsound paper money and expect people to voluntarily accept it, thus force was necessary to make it happen. Legal tender laws forced devalued government money on the people and markets.

It is difficult for government to grow when people demand the money to be backed by hard goods (such as metals). It is difficult for government to expand its presence when the money supply is stable and in the hands of the people. History clearly shows us that when government wants to expand its state or military presence beyond its usual bounds, it cannot do so without control over the nation’s money supply. Without the control of money, government would have to take every cent it needed directly from the people and businesses, an approach that would become very unpopular in a very short amount of time.

This is why governments have always tried to take control and monopolize money. If people are forced to use government money and cannot create a competing currency, they must use the money the government gives them. Government can then indirectly “tax” the people through inflation and devaluation of the currency. This allows government to grow its boundaries and influence without directly feeling the repercussions of a people who see their property forcefully go out the door to the government in the form of taxes. Monetary inflation is a very indirect and gradual process for government to take money from the people. And it can only work if people are forced to accept the debased and often worthless money. As the money supply grows without solid commodity backing, prices begin to rise, impacting poorer citizens the most.

This brings us to the U.S. Some have argued that the Constitution allows the government to pass legal tender laws and control many aspects of monetary policy. However, on close inspection, this power has been greatly abused and misinterpreted. The Constitution states:

Article I, Section 8: The Congress shall have Power…To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.

Article I, Section 10: No State shall…coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debt.

Congress has the power to coin money, regulate its value, but nowhere does it have the authority to force people to accept that money. Congress can create and regulate its money, but it cannot mandate that people use it through legal tender laws. The states are prohibited from coining money and are required to make only “gold and silver Coin a Tender in Payment of Debt.”

Neither the powers delegated to Congress nor the states give them the authority to shove a currency onto the people. “Legal tender” means tender in the payment of debt. The states are given the duty to be sure that only gold and silver can be legal tender. For legal and juristic purposes, only gold and silver are acceptable in the payments of debt. But this does not give the state the power to dictate the forms of other monetary commodities or economic exchanges that the people and market might come up with. In other words, the state controls the legal use of money in the payment of debt, but neither the state nor Congress has authority over the economic exchanges of money in the marketplace.

The Founders did not give the federal government the ability to monopolize currency and force it on the people. There is no power in the Constitution given to the government to restrict currency production and choice of the people and marketplace. In fact, many competing and private currencies functioned efficiently for a good part of the 1800s. Today, however, we accept legal tender laws as a legitimate role of Congress, when in reality they do nothing but unconstitutionally force a worthless currency on the people.

Consider the basic principles of modern legal tender laws. No government force or mandates would be necessary to encourage people to use a widespread, valuable, and sustainable currency. Legal tender laws and government coercion over money are always used to force a currency that would otherwise be worthless onto the people and marketplace. Imagine if the legal tender laws enacted in the 1960s, forcing people to accept Federal Reserve Notes, were repealed today. Who in their right minds would continue using a currency whose value consistently decreases, is in the control of seven central bankers, and in reality is worth nothing more than the paper on which it is printed?

People will often reply that repealing legal tender laws would lead to the creation of hundreds of private currencies and economic chaos. But remember something. Especially in today’s digital, national, and even global economy, a currency would have to be simple, recognizable, valuable, and widespread to have a chance of surviving in the market. People will naturally encourage and use the currency that holds the most value and brings the greatest amount of ease to transactions. If that is the currency produced by Congress, so be it.

Monetary freedom simply gives people the option of throwing off the restrictive chains of a centrally manipulated, inflated, and drastically devalued currency, the symptoms of a government out of control. Competition in money would force government to stay in line, live within its means (both domestically and overseas), and maintain high levels of sensibility and responsibility. History has visibly painted the picture that without control over money, government’s long-term abilities are only as able as those that the people directly delegate to it. Freedom of money plays a major role in ensuring freedom and representation in government.

“With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people.” — F.A. Hayek

“Paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice.” — George Washington

“All the perplexities, confusion and distresses in America arise not from defects in the constitution or confederation, nor from want of honor or virtue, as much from downright ignorance of the nature of coin, credit, and circulation.” — John Adams

“Whoever controls the volume of money in any country is absolute master of all industry and commerce.” — James A. Garfield

“We are in danger of being overwhelmed with irredeemable paper, mere paper, representing not gold nor silver; no sir, representing nothing but broken promises, bad faith, bankrupt corporations, cheated creditors and a ruined people.” — Daniel Webster

The free market is constantly blamed for mistakes made by banks, when in reality the economic problems begin when a free market is overridden with excessive and unnecessary government law, intervention, and agencies.

To grasp banking we must first learn and understand fractional reserve banking.

The fractional reserve banking system gives banks the chance to keep only a portion of their deposits in reserve, allowing them to loan or invest the rest. Today U.S. banks are required to keep only 10% of their deposits in reserve. So if you deposit $100 in the bank, legally the bank is only required to hold $10 of it in reserve. This provides cash for “day to day” privileges and allows the bank to invest in securities and loan out funds, among other things.

You may have heard how the “panics” in the 1800s were a failure of the free market. Many of the “panics” were caused from bank runs, meaning that the banks had overextended themselves and their promises and could not provide the money when customers decided to withdraw their holdings. In the 19th century banks kept gold (primarily) in their vaults and issued paper promises, so to speak, guaranteeing people their gold. Banks would print more of the paper money, loan it out or invest it, creating monetary inflation (because the new paper notes were not backed by more gold; rather they were diluting the value of the gold held in the bank’s vault).

In the Panic of 1819, both local banks and the national bank joined in the practice of spreading themselves too thin through fractional reserve lending. When people wanted to withdraw their funds and realized they couldn’t, it led to the bank runs and harsh economic conditions as the economy was forced to contract after the unsustainable monetary inflation.

The inflation caused by the banks led to higher prices domestically, an outflow of gold from the U.S. due to the suddenly more attractive prices from foreign producers, and banks were therefore forced to draw back on their commitments. The law in 1819, and for many years following, allowed banks to neglect their depositors’ holdings while still continuing their operations. If they overextended themselves, banks were given a special privilege and protection from government that allowed them to ignore their clients’ rightful and original property, and instead pursue the unsustainable and destructive road of monetary inflation and the creation of artificial credit.

I bring this up because people who support government and central economic intervention will often bring up the “financial panics” in the 1800s to show how disastrous a free market is. But the truth is that the government protections placed on banks helped cause a great majority of the panics. Because of the government protection, banks were able to take unnatural risks that never would have been possible in a free market. Government shielded banks when the fractional reserve process failed. In other words, the government protected the fractional reserve system in order to benefit banks, not the citizens.

Fast-forward to 1907. This was the time of the last “panic” before the Federal Reserve Act was signed into law, creating the central bank, in 1913. Once again this crisis came about because banks were unable to give customers their initial deposits. This caused a whole stream of withdrawals (or attempted withdrawals) by bank customers around the nation. Banks had placed the deposits into income-earning securities and did not have the necessary cash to meet customer demands.

After the Panic of 1907 and the umpteenth failure of fractional reserve lending, the attacks still were not aimed at the fractional reserve system. This system, when protected through law, gave banks the undoubted opportunity to inflate the money supply, overextend themselves in ways that would never be sustainable in a free market economy, and give little regard to the customers’ original property. Instead, economists began calling for a “lender of last resort” to bail out banks if they were caught overstretched in commitments. Many people don’t realize it, but the U.S. financial system has been in bailout mode for nearly a century since this event. In an otherwise relatively free market system, banking started as the largest sour grape of interventionism in the bunch.

What are the alternatives to fractional reserve lending, which has been criticized by free market, sound money supporters since its inception in the U.S.? Interestingly enough, the Romans sorted this out by making a clear legal distinction between “demand deposits” and “time deposits.”

Demand deposits are the deposits and withdrawals you and I make everyday. We expect to get the same amount of money that we initially deposited to the bank. Just as when you give $100 to a friend to hang on to for a week, you are not giving him the right to invest or spend it for his own personal gain at the risk of you completely losing that money.

Time deposits are essentially what we have today with Certificates of Deposit (CDs), where a depositor and a bank enter into an agreement of money guaranteed somewhere down the road (such as 1, 3, or 5 years). Time deposits represent fixed contracts where both parties know what they are getting into and what the terms and risks are.

Under a system similar to the Roman principles, banks would legally be required to hold 100% reserve rates with demand deposits. This guarantees that individual property is protected and not at risk of being permanently inflated or loaned away by the bank. With time deposits, however, the bank and the depositor agree on a certain time frame that the funds would be controlled by the bank, giving the bank the opportunity to invest or loan the money. If a depositor decided to withdraw his funds before the agreed-upon date he would be given a fee of some sort, just as we have with Certificates of Deposits today.

Understanding banking and monetary history in the U.S. is pivotal to understanding how booms, busts, and “panics” are initially created. Harsh economic times have more often than not, whether in the 19th, 20th, or 21st century, been created through government protections and privileges to certain industries, central manipulation of interest rates and credit, and unceasing government intervention in the economy.

People point to the failure of the fractional reserve system that occurred time and time again in the 1800s (through bank runs) and mistakenly shove the blame on the free market, and use it as an excuse to bring even more government intervention into the economy. History shows that when the free market is manipulated from outside forces the worst problems come about.

Today we are led to believe that a bailout-guaranteed, centrally manipulated, and government protected banking system is the most sustainable and sensible option. I have a very hard time believing this, just by looking through our own history. Government somehow fooled the majority into believing that it had absolutely nothing to do with causing “panics,” recessions, or any other rough economic situation you can think of.

It is long overdue that people cease buying into this ridiculous idea of an angelic government that knows the cure for every economic ill. Allowing the government and central bankers to freely mold and manipulate the economy is precisely what caused the many economic collapses over the decades and centuries. Freedom and the protection of private property represent the most solid and sustainable foundation for a prosperous economy.

We hear much chatter today about laying out the “blueprint for our future” through economics and politics. Many people have the idea that it is government’s responsibility to push forward anything that should change, but all of this is irrelevant if the central issue of economics is ignored: money. Freeing money in this country ranks at the top of the list of necessary action to bring long-term stability and sustainability to the economy.

The first essential step is to eliminate the secrecy of the Fed. It is mind boggling to allow such important policies of the economy be put in the hands of a central bank, and prohibit Congress from performing an audit of the agency. Allowing Congress and the American people to get the information they rightfully deserve is extremely important toward opening the many faults of the system to the public. Power itself is dangerous; but unchecked, secretive power is one of the most dangerous things known to mankind. Besides, it is Congress, not a central bank, who has the responsibility over money clearly laid out in Article 1, Section 8 of the Constitution.

The Congress shall have Power…

To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;

The second, and possibly most important step, is to the repeal the legal tender acts passed in the 1960s, which led the way for allowing only Federal Reserve Notes to be legally accepted currency in the U.S. Legal tender laws alone should be enough to make one question the quality and value of a currency. After all, if a currency is strong and preferred by the people, why would legal tender laws be necessary?

The U.S. was founded on the principles of individual freedom, which in a nutshell means the liberty to freely make individual choice. When it comes to economics, individual choice is starting to be thrown out in favor of government control. Monetary choice is vital for the long-term survival of any economy. Allowing choice means allowing competition, and as we have seen the free market demonstrate time and time again, competition strengthens a product. It is no different for money and currency.

Legalizing competing currencies does not mean requiring competing currencies. We have a system today along the lines of requiring everyone to shop at a national retailer like Wal-Mart, when we might find better deals and products with a local store or retail chain. Competition of a government-managed dollar would look a lot like competition to the Post Office. The inefficiencies of the Post Office led to the private creation of FedEx and UPS in the 20th century, giving choice to consumers but not taking away the option of the Post Office managed by the government.

What legal tender laws do is kill competition. It is then the government who decides what medium people use to buy goods, not the people. Except today, it isn’t even the government managing the money that we are required to use, but the Federal Reserve. History has shown us that when governments carry monopoly power over money, that power eventually leads to an overextended government unable to bring itself out of the hole it creates. This has caused or contributed to the collapse of great civilizations throughout history, including the Roman Empire.

The third step, and probably end objective, is to transfer the control of money from the Federal Reserve back to Congress and the U.S. Treasury, as we had with United States Notes as late as 1971. A currency backed only by gold and silver, as the Constitution outlines, is very important for keeping the monetary power in check. Since 1971, we have seen firsthand how a fiat monetary system lays out the road for growth and abuse in government at the expense of the people and economy. A great quote mentions how paper money always returns to its intrinsic value: zero.

We must realize that a backed currency alone will not keep government in check with monetary power. This is something that has been largely forgotten over the past half-century or so. Because, at the heart of it, monopoly power of money is no better off in the hands of the government than it is with a central bank. It would be pointless to get riled up over the failures of the Fed and simultaneously hand that power over to the federal government. This is why free, competing currencies play an important role in this whole equation.

A common argument against competing currencies is that it would supposedly lead to economic chaos because there would be so many different currencies. I would be highly surprised if this turned out to be the case. For one thing, the dollar managed by Congress and the U.S. Treasury (not the Fed) would still be provided, regulated, and available for use in transactions.

Competing currencies simply give people and businesses an option to opt out, so to speak, if Congress goes on a spending rampage and inflation destroys the purchasing power of the dollar, or any scenario of that sort. Rather than locking people into a currency with no questions asked like we have today, it is key that the potential choice to venture into other currencies and monetary systems, if necessary, not be put off the table.

One other item is taking away the Fed’s power over credit and interest rates. These are the last things a central bank or the government should be dealing with. Interest rates should be sorted out like anything else the free market manages: through the supply and demand of money. If people save more, interest rates go down. If people save less and the banks need more capital, interest rates adjust and go up to promote saving. In a free society, people can handle themselves with interest rates as well as credit. We don’t need a few central bankers or government bureaucrats deciding what the rate and supply of money ought to be.

By simply allowing the market to have more control over money, I am certain that a national currency provided by Congress would have to maintain stability in value and supply to not burn up in ashes. In the long run legal tender laws are helpful only to the government and not the people. If people were to decide which currency they use, the government would be much more accountable to the people, and as a result the currency would undoubtedly be managed in a more sensible and sustainable manner.

It is time that people embrace the ideas of monetary freedom, responsibility, and choice. When the power of money is denied from the people, no society or economy is truly free.