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
