I thought I might hold up for a moment before examining the Austrian School of Economics and follow up on Keynes a bit. Remember from the last post that he was a major proponent of Macro-Economic planning. This basically involves control of the economy through various forms such as government subsidies, government purchase of goods, and taxation. However, there is something else which the government can control which is much more pervasive. In a few installments I will examine money, what it is, what it is not and the role the Federal Government has played in its history.

What is the one thing that governments can use to control the economy that EVERY person in a society uses? The one thing that would guarantee near-total control of every single market transaction, from the buying and selling of corporations to the unreported lemonade stand of American?

The answer to that is money. Everything that is bought or sold in American is obtained in one way or another through the exchange of our little greenback friend. It is used to buy penny candies, purchase groceries, to gamble in the World Series of Poker, etc. Control of the money supply is a macro-economic planners dream come true, and something Keynes advocated when the Federal Reserve Bank was established in 1913.

But before we give an overview of what money has become, lets talk briefly about what it should be. What is money in and of itself, regardless of today’s unnecessarily complicated market? Money is simply put a means of exchange. Every society that has advanced to a certain point uses money.

Picture a small island where there are say 50 people. In our little island community, everyone farms. Some people are better at producing certain things than others. Joe is really good at growing corn, and grows so much he eats it 5 times a week day. Sally on the other hand raises chickens, and has chicken every day. She is really tired of it, and even though most meats on the island taste like chicken, she wants variety. So she takes the excess chickens she has and trades them for Joe’s excess corn. Both need what the other has, and this facilitates trade. The only reason they trade is that each has something of low value (or low marginal utility) and sees something the other has of high value. The valuable thing the other has leads to exchange or barter.

But how about milk? Or eggs? Or other perishable items? It’s hard for Sally to find a trading partner for her eggs, and they go bad and she loses out. So all our happy island dwellers come to a consensus. They all value a certain mineral that is yellow in colour and shiny. Women wear it as jewelry, and men take time out of their leisure hours to go and dig it out of the ground to impress the women. They decide since everyone values this metal anyway and wants it, they will use it as a means of exchange or substitute for goods and services. I am speaking of gold which has become the new money for the islanders.

Most civilizations throughout time have chosen gold or some precious metal as money or a means of exchange and substitute for barter. Gold or silver is good as we avoid the perishable factor, it is easily divided, and portable. Most importantly it is valued by all. Civilizations, especially when they get more complex, need a system of money. It allows for trade with different nations and makes it easier to act economically.

Why did I just go off on a long tangent on the meaning and use of money? To make this one profound point inextricably clear. I did not use the word “government” once while talking about the theory or practical applications of money, did I? I used the word “people” and here is where Keynes and the federal Reserve Bank make a principal error. Money originates with people and what they value, not with the government. When the government uses, stimulates, manipulates, inflates and overall decimates a nations currency in order to serve its own selfish ends, a fundamental human right is violated, namely, the power of exchange.

So, how does the Federal Reserve Bank control our money today? Basically, The Federal Reserve was first conceived as a hedge against bank runs. When regular bankers who take in deposits from people who need a place to store a lot of cash loan out those deposits for their own personal gains rather than safeguard and store the money, problems happen. In fact historically, banks used to CHARGE depositors who wanted their money watched over and protected. It would cost a certain amount for individuals to transfer funds from the bank to a particular location, and a certain amount annually to house the money. When banks don’t do this, they can’t return the money that belongs to all those who deposited money there.

When economic times are hard, people tend to have trouble meeting their debts and need all the money they can get. If everyone runs to the bank at the same time and that bank has loaned out a fraction of the reserves of depositors (the standard today is to keep a 5-7% reserve ratio or loan out 95% of your money), only 5-7% of the money can be given to those “running” on the bank. You guess what happens to most people. They don’t get their money, and the bank is forced to close. This causes economic hardships, and those banks that don’t’ go under make it really hard to get a loan, or, the prime rate of interest goes sky-high. There is just not a lot of money floating around for people to invest with at this point and people tend to save their money rather than spend it or invest it. This slows down the economy (although note that all saving is not bad.) What are we to do? Check in next time for part two!