Video: Money and Inflation (Dr. Lawrence Reed )

Transcript Below:

Lawrence Reed:                   I have a couple of props I want to share with you before we get into this talk about money. This first one, I have to ask that as I pass it around that you handle it very carefully, because it's only bound by two sets of strings. And if it came apart, I'd never get it back together again. So just be very careful. Don't twist it. Pass it carefully.

This is one million Bolivian pesos from 1985 in Bolivia. Here's the story to this. In 1978, just seven years before I bought this, this would have been worth 40,000 American dollars, because the peso in Bolivia in 1978 was about 25 to the dollar as I recall. Maybe it was 40 to the dollar, which in any event, I know it was $40,000. One million - what does that work out to? Is that 40 or 25 pesos to the dollar. In any event, $40,000.

In 1985, when Bolivia had, at one point, while I was there, 50,000% inflation. Bolivian pesos on the day I arrived in April of 1985 were going for 150,000 to the dollar. Ten days later, when I went to leave the country, they had fallen to 200,000 pesos to the dollar. So if there are one million pesos here, what did I pay for this on the day I left the country? Five bucks. So it went from US $40,000 in value to $5 from 1978 until the day I left in April 1985.

Bolivian inflation accelerated it from there, and by late summer, the Bolivian peso became completely worthless and they had to have a new currency. I don't recall what the ratio was by which they offered to give you new ones if you turned in so many old ones, but that's what they ended up doing.

It was the second time in Bolivian history since the second world war that they have destroyed a currency. They did it in the 1950s and they did it again in the 1980s. So each one of these notes in here is a 1,000-peso note, and there are 1,000 of them. So that's one million pesos. You can take a look at it.

How many of you have seen the largest paper note denomination ever issued from Zimbabwe? Is this now the second largest? I don't think that they printed one bigger than this, but this is from just about four or five years ago. This is from Zimbabwe. It's the 100 trillion Zimbabwe dollar note. Yes, sir?

They came out with a $200 trillion? I've got to get that then. Needless to say, this is completely worthless. I think they even have changed the currency since then. They had inflation that was in the millions of percent just a few years ago. So until the 200 then, this was the largest denomination note ever issued anywhere even in excess of that from Germany 1923 in their famous hyperinflation of that year.

Then, finally, afterwards-- I won't pass this around since it's glass and rather fragile, but you're welcome to come up and look at this afterwards. Framed here are six privately issued bank notes from the early 19th century and all from the state where I lived for 33 years before moving to Georgia a year and a half ago. These are all from private issuers in the state of Michigan during the free banking period when dollars were issued privately. You'll see there's Adrienne Insurance Company. There are private banks, railroads issuing currency, which of course, had to meet the definition at the time, in most cases, described on the note itself. That's six examples of privately issued bank notes, something we are not accustomed to today needless to say since everything we use is federal reserve notes.

In this hour, we're going to talk about money and inflation. There'll be economics in this talk as well as history. I'll start with a few background concepts about money itself. I think everybody here would readily give the classic definition if I were to ask, right? It's a medium of exchange. By that, we mean that money is a middleman. It is something you trade for not because you intend to use it or consume it for its own sake, for the utility that it directly, physically provides you but rather as a means to get what you're ultimately after. It's a medium of exchange, which suggests to you that the value of it has something to do with the value, as you perceive it, of what it can get you.

If you can't get you anything, it has no value at least as money. So its value is related to the value as you perceive it of what it will get for you. But its value is also buffeted by its own factors such as its own supply as you'll see in a few moments.

But money, as a definition, I think medium of exchange is good. Sometimes you see history or econ texts suggest a variety of definitions. It's a store of value, it's two or three other things. But I think if money, first and foremost, has to be a medium of exchange and if it is that and reliably so, it then takes on some of these added functions. If it's a good money, it's also a store of value. You can hold it for some period of time, knowing that its value will not dissipate totally. If it does, people will abandon it and find something to serve as an alternative.

There is a sense in which you can say that money is the most important commodity in a market society. Now that, for those of you who are planning to be economists, that may sound rather far-fetched. How can you say that money is the most important commodity in a market society?

We've already said that money is only useful for what it gets you in exchange. Therefore, surely what it gets you is ultimately what we're really after and that's a greater importance. But there is a narrow sense in which you can say that money is the most important commodity, and it's this. It is at least one part or one side of every non-barter transaction. Money is at least one side or one part of every non-barter transaction. Barter, of course, is exchanging a good for a good. You trade a pen for a pencil - no money, no middleman involved at all. But money is at least one part of every transaction in which barter is not a factor.

Sometimes it's both parts or both sides of a transaction. If you buy German marks with Swiss francs, you've got money on both sides. Why does that suggest a great importance? Because whatever affects money will affect everything else. It's only in that sense that you can say it is the most important commodity in a market society.

What you do to money can have far-reaching implications. It will affect everything else. Everything else is denominated or its price is expressed in terms of units of the money. So you can derange an economy. You can screw it up royally. Or you can create conditions in which the money is so solid, people are so confident in it, it really performs its function well. People have confidence in saving it. You can actually, through what you do with money, create a fantastic situation in which economic growth is possible - and sometimes spectacular rates of growth if money earns the confidence of the people using it.

So what you do with money has a profound impact on everything else in the economic world. In that sense, it's the most important commodity in a market society. But don't confuse it with wealth. We've already talked about wealth being goods and services, money as a convenient way to acquire them, to claim them. But money is not wealth in itself.

Money is so important, furthermore, that it is in a category of economic good all of its own. We speak, as economists, of different kinds of economic goods - capital goods and consumer goods in particular. Money is not within one of those two camps. It is an economic good of its own. It's in its own category. In fact, if somebody were to ask me, "What kinds of goods are there in the economic world," I would say, "There are free goods, which command no price because they're in such super abundance, like the air you're breathing." Only under certain rare circumstances like underwater will somebody pay for air provided for them in a canister of some kind. But typically, it's a free good.

Then you have economic goods. They do command a price. They do have value. We do see people trading them. Among economic goods, you can identify consumer goods, which is at the end of a line of production. It's what we're ultimately after. Capital goods, they're needed to make consumer goods. But then you have money in a category of its own.

It's different from all other goods for at least two important reasons. Money is different from capital goods and consumer goods for a couple of important reasons. One is, it's only useful for what it gets you in exchange. It's not something you devour, consume for its own sake, its own utility. You use it, you get it in order to use it to acquire what you're really after. It's only useful for what it gets you in exchange. The second reason it's different from all other capital or consumer goods is that its supply must remain scarce to perform its function. Its supply must remain relatively scarce in order to perform its function, for it to retain its definition and its use as money.

That's different from capital and consumer goods for reasons that really require a momentary explanation here. If you could, somehow, tonight double the quantity of capital goods - of tools, dies, equipment, factories, machinery - or if you could double the supply of consumer goods - everything from say ice cream to clothing - we could say, very roughly, that society at the end of the day would be doubly wealthy. We'd have problems of where to put some of the stuff. Doubling the supply of everything isn't necessarily in accordance with people's real wants or desires, but it would be a nice problem to have, wouldn't it? Where to put all the stuff that is now in such super abundance that we have previously saved for, invested, worked hard to produce. Now, we've got suddenly twice as much of it - capital goods, consumer goods. We'd be doubly wealthy generally speaking.

But if you doubled the supply of money, you would not be doubly wealthy. If you go back to that example I used, I think, in the Adam Smith talk about the guy at the concert hall who's giving you a ticket for the coat you leave on deposit. If he suddenly doubles the number of claim tickets, it's not the same as saying people are doubly wealthy in terms of coats. No. We just have twice as many claims on the same supply of coats. We're not doubly wealthy. Money, in a sense, would be the same. Money is a kind of claim to the real stuff. You double the supply of it, it's not synonymous with doubling the wealth of the nation. If it were, then we could simply-- I'm in favor of ending foreign aid anyway. But instead of sending what we do send, we could just send printing presses to Bangladesh or other poor countries and just say, "Here. Print your way to prosperity. If you want more wealth, print more claims to it."

All that does, as you'll see later, is derange the economy, send false signals, put some people in a position where they can claim what they shouldn't at the expense of those who don't get what's theirs. You redistribute wealth in a very painful way, and you, in the long run, erode the very value and usefulness of the stuff you've just created.

Money is different. It's in a category of its own. Another important thing about money is to think of it as the most marketable commodity in a society. It's the most marketable, meaning it's the one thing that almost everybody will accept. You can get almost anything with it. And the sounder it is, the more confidence people have in it, the more that's the case. It's the most marketable. Your house is not as marketable because there, you may have to wait months to find a buyer, somebody who will give you something for it. Money, almost by definition, is the most marketable commodity. You can get rid of it anytime with anybody. It's just a matter of haggling over the price. But you don't have to get stuck with it for very long. It's the most marketable commodity in a market society.

Now, having said that, this is just a few of the background basic elemental economic principles of money. We should say a few words about where it came from. How many here think that it was an invention of a king or a parliament or a Congress or a president or a government somewhere? Good. I'm not surprised.

And yet, today, what do most people sort of assume? Well, hasn't government always been in charge? Shouldn't it be? How could it work otherwise? Most people have come to accept the notion that money is properly the monopoly province of governments. And yet, that's not where money came from as you'll see in a moment.

Money is involved in what we call indirect exchange. That's to be contrasted with direct exchange, which is barter - a good for a good, a service for a service. Indirect exchange was born the first time somebody said, "I'll trade you for that not because I'm going to use that. I'm not going to eat it. I'm going to hold onto it. But I'll trade for it because I know I can get rid of it to get what I'm really after. The first time a medium of exchange was used, we had indirect exchange - whatever that may have been.

Now, we do know that whenever money first appeared, it wasn't at the very start. Presumably, there was no money in the Garden of Eden with Adam and Eve. Somewhere along the line, very early, we don't know when, people discovered that trade could be greatly facilitated if they used a medium of exchange. But we can surmise-- based upon what we know to be human characteristics and desires and the characteristics of money, we can surmise how it might have developed in primitive societies. You can imagine something emerging as money but only if people knew what it was. It's hard to imagine all of a sudden somebody saying to a society, "Hey. Start using this stuff when you make exchanges. Exchange in a roundabout way. Instead of direct, use this stuff. You don't know what it is, but I'm telling you, it's good stuff. Use it."

It's hard to imagine that such a substance would be widely accepted. It's not hard to imagine, however, that people might begin using, as money, a commodity that they were very familiar with. In fact, that's an important point. Money, as it emerges freely, arises from familiarity. People know what it is. They know what it will do for them. They know that, yes, I can use it myself or if I choose not to, I know other people who will use it. So it has marketability. I can pass it on.

We know from writings from a long time ago that certain substances that may seem primitive to us did serve as money. Homer, in his Iliad and the Odyssey, talked about cattle being used as money. In Iron Cauldrons, large pots, pots of various sizes being used as money.

It's important to recognize that, although, we could easily criticize these weird, exotic, primitive forms of money, they surely represented an improvement over what came before or they would not likely have developed. And it's not difficult to imagine that a primitive society would develop something like cattle as money, because everybody knew what they were. Everybody knew that there was a demand for them. They could consume them themselves or trade with others for what they wanted. Iron Cauldron, same way.

But cattle and cauldrons, in spite of whatever virtues they had as money, their familiarities still left a lot of room for improvement, right? They have inherent difficulties. How can you make change, for instance, if your money is cattle or cauldrons? We have a lot of examples besides those two in history. How many of you here could name some examples of substances that have emerged as money at one time or another?

Yes. Large stones, yes. There's a book called The Evolution of Money by Rupert Ederer. It's the best book I know if you want a thorough compendium of all the weird stuff that has ever served as money. He talks about stones on the island of Yap being used as money.

Yes, sir. Yes. Wampum, which are beads. Fur, whiskey - I know they've all been used.

Yes, sir. Salt and seashells.

Yes, sir. Jade and obsidian? I wouldn't doubt it. I'm not familiar with that. Maybe in China?

Yes, sir. Pelts. Yep, pelts - like beaver pelts.

Yes, sir.  Beer in ancient Egypt. That's one I hadn't heard.

Yes, sir. Honey. I hadn't heard that one either.

Yes, ma'am. Tobacco. Yes. In fact, I'll quickly digress and tell you that in early colonial Virginia, not only was tobacco used as money for a time, but they actually had a tobacco hyperinflation, which caused them to depart from tobacco and find something else. But at first, until they learned the soil and ways to increase the quantity of tobacco, the early Virginian colonists used tobacco. They reckoned prices in terms of quantities of tobacco. But then, they realized that they could make so much of it, prices soared through the roof, and it became an unstable medium of exchange, and they departed from that. But yeah, that's right. It was used in Virginia.

Yes, sir. Wood, split in half. Okay. Do you know where? England. Okay.

Yes. Labor hours as money. Maybe so. I'm not acquainted with that.

Yes, sir. Hemp. You're right. Hemp was used as money because you knew that if you couldn't exchange it with somebody, you could always smoke it.

Yes. Cigarettes in prisons, in prisoner war camps.

These are a lot of exotic examples. I'll give you a few more from Rupert Ederer's book. He talks about women were used as money in parts of the Middle East for a time. That leaves a lot to the imagination. Can you imagine women circulating as media of exchange, prices reckoned in terms of women?

What would be some of the problems with that? Making change. That's right. Yeah.

How about durability? Transportability? What's that? Divisibility. Yeah.

Also, rats were used on Easter Island as money. Mahogany logs in British Honduras, now Belize, were used as money. Lots of examples.

Each one of these surely represented an improvement over what came before, but with lots of room for further improvement. But you should recognize that this was an evolutionary process. As people discovered, in various parts of the world, that this stuff worked as money better than that stuff, only later to discover, here's something even better. This happened in various stages at various times around the world. But there has been a constant search for the best money, you might say.

Let me give you an example of three farmers. This is how money, in whatever form, probably first emerged through the use of a familiar object. But I can imagine a wheat farmer raising wheat, having a little extra, deciding he'd like to get some corn. He goes down the road to the corn farmer and says, "I've got a bushel of wheat here. How about a bushel of your corn?"

And the corn farmer says, "Sorry. I really don't need any wheat. Have you got any oats?"

Then the wheat farmer says, "Well, wait a minute I'll be right back." So he goes down the road a little further, finds an oats farmer, who, fortunately would like to have some wheat. So the farmer trades his wheat for the oats, takes the oats back to the corn farmer and says, "I've got what you want. Now, let's make a trade."

What served as a money in that particular example? The oats, because the wheat farmer traded for the oats, not to consume them himself, but rather to use as a means of getting the corn.

Now, a single example like that doesn't make a substance in money. But if it becomes a generally circulating medium, lots of people using it, recognizing it for its value and its own utility or as a useful item in trade, then a substance can emerge as a money, a widely circulating medium of exchange.

Now historically, the demand for a reliable medium of exchange-- and this is a remarkable development. It happened in every corner of the globe at one time or another. After using so many weird things, the demand for a medium of exchange came to be centered upon the precious metals. You should not think of gold and silver, in particular, as emerging by some dictate, mandate, decree of parliament or Congress. Rather, they emerged as freely chosen monies in one place after another. And for very good reasons. Can you give me some? Why would gold and silver eventually be regarded as better than any of these other things?

Yes. Harder to find. Now, that's a very good point, because today, a lot of the opponents of gold as money would say, "Well, that's a drawback. That's why you can't have it today, because there just isn't enough of it." We'll get back to that in a moment, but you're right. I see that as a virtue. Many free market economists see that as a virtue. The fact that Mother Nature doesn't give it up very easily and that the annual supply of gold, at least-- silver may be a little more pliable-- but the annual increase in the supply of gold is pretty much between 2 and 4% a year. It's tough to get more of it. But that's actually going to preserve its value. That's a virtue. It helps to explain why it emerged as money.

What might be some other qualities? Yes, sir. Very durable. Yeah, you can bring up a Spanish galleon that sunk 500 years ago. You might have to clean the stuff off, but it's just as good as it was when it was first minted. Unadulterated. It just needs cleaned up and you can use it again.

Yes, sir. That's right. Easy to transport, meaning that it has high value in very small quantities. A very small quantity represents a lot of potential purchasing power.  That's important if you're a society on the run. If you're a minority group that's persecuted and you have to, from time to time, pick up your wealth and leave, if you can transport it in very small quantity, that's a virtue. And gold and silver certainly have had that.

Yes, sir. That's right. It won't lose its value. It tends to stay stable in value over long periods of time. Nothing's perfect. Value is very subjective and ever fluctuating, but gold and silver don't suddenly lose large quantities of value very often. They tend to retain it over long periods.

Yes, sir. Easy to store. Yeah.

Yes, ma'am. Good question. Who's buying all this gold? I notice in my little town of Newnan, Georgia, about 50 minutes south of here, even there in two or three places, there are these guys out along the road with these signs, "We buy gold," doing all kinds of maneuvers with the sign to get your attention.

I can assure you it's not the mint. Because we no longer are minting gold and silver coins. These are people who are using the gold or get it into the hands of those who want to use gold and silver for its industrial or jewelry or other non-monetary purposes. And they're hoping to get it from you at a little less than what it's really worth, take advantage of the rising prices of today and probably sell it to somebody else, ultimately to be used in everything from maybe fillings in your teeth to jewelry.

I saw a hand up here. Yes, ma'am. Yeah. That's true. Bolivians can say that about their paper pesos too. That all came to a screeching halt. But you're right. It's finite in supply no matter how much there may be, it's not infinite. The question is if you allowed money to continue to evolve freely and there were no government interventions that said, "This is going to be it, nothing else," but if you allowed it to freely continue to evolve, might there be a day when people in the marketplace would say, "We don't want that anymore. We think this stuff will work better." It's entirely possible.

Many of us believe that markets should be free to make such judgments. It's a question of either markets making such assessments or politicians making them for you. I'd much sooner trust the track record of market forces in determining what substance works best as money. There's nothing inherent in being a politician that says you know better than what millions of people might know about what should serve as money.

So precious metals came to be the focus of attention because of all these various characteristics. They just seem to work best - better than what came before. So all over the world, gold and silver emerged as money.

What about paper? We haven't said anything about that. We're not accustomed to using metal today, except cheap junk metals for subsidiary coinage. But our main currency - the dollar - is a paper note. And most of the cash transactions involve paper in terms of dollar volume. When did that emerge? Anybody know where paper money first appeared?

Yes. That's right. You've explained the origin of many banks. Banking typically appeared first as a warehouse function, safe keeping and grew from there to other provisions, other services.

Yes. Did you say the Great Khan? I think you're probably right. I was going to say China. I know paper money first emerged in China whether it was the emperor or the khan, whatever they called him. You're right.

It was mulberry bark. But at first, there is every reason to believe, from the records, that mulberry bark as money really represented sort of a receipt. The real stuff behind it was what was regarded as money, but the paper emerged as kind of a receipt, which people found to be more convenient. In fact, a gold standard incidentally, doesn't have to mean that the only thing that circulates in our pockets as money are bits of gold and silver.  It may well be paper. People may decide, "Let's put the metal on deposit, and we'll use paper receipts. As long as we know that the receipts are honest - you can get the gold upon demand if you want it - we'd rather use the paper. It's easier in our pockets." A gold standard certainly does typically mean that. It doesn't mean only gold can be money. It means that the paper's backed by the gold.

Now, that leads me to a quick discussion of government and money. Because what I've explained to you so far is really rather natural and evolutionary. I've explained for you the way markets developed a medium of exchange. Although, there is one other aspect of metallic money I should mention before we do that. I forgot to tell you this. When precious metals began to be used as money, they were often used as lumps of gold and silver, as they were found, often naturally, mixed together. And the name for that substance is electrum. That's gold and silver mixed together as it's often found naturally.

To use that as money, lumps of gold and silver meant that every time there was a transaction, you either had to guess at how much that lump was or you had to weigh it. And if it was a little more than the price, you'd have to shave some off. If it was a little less, you'd have to add some shavings. That's kind of cumbersome and awkward. What was the development later that would fix that issue? Coinage, which began first in a place called Lydia in western Turkey - Asia Minor. And the most famous king of Lydia was Croesus. You may have heard that famous old phrase, "As rich as Croesus." It was a fabulously wealthy trading kingdom in western Turkey/Asia Minor where coinage, we think, first appeared.

That was really an attempt to standardize it. Hey, now, all I have to do is look at it and I know what it is. I don't have to weigh it. That was a remarkable achievement. And by the way, that was 650 BC roughly when coinage first appeared in Lydia. So within 100 years, which means about 550 BC, the Mediterranean world was using gold and silver coins. It became the foundation for the prosperity of Ancient Greece - the use of reliable metallic money in the form of coinage by 550 BC.

By the way, the first rule of numismatics of coin collecting is you know it's a fraud if the date on it says BC. Never buy a coin that's marked 250 BC, because they didn't know it was BC. But we were using gold and silver coins for hundreds of years before the birth of Christ.

Now, back to paper money. First emerging as a receipt for the real stuff. And that will figure prominently in my discussion here for a few moments about government and money. How did it come to be that governments took control of money? If it developed naturally in the marketplace, how did we get to the point where today, almost everybody in the world thinks that it's a natural monopoly of the state and perhaps always has been, which is not true. Governments have, invariably-- even the best of them-- an insatiable appetite for revenue. This is one of the distinguishing features or one of the common characteristics, I should say, of all governments.

They all have an insatiable appetite for revenue. They never have enough. There's always another war to fight, another foreign adventure to finance, another program to inaugurate, a monument to build, a constituency to buy, fill in the blank. They always need more, which means there's always pressure to borrow or to tax or to, in some way, multiply the money that they can spend.

It's hard to expect that a government that has an insatiable appetite for revenue will stand aside and observe this stuff being privately provided, exchanged, leading to great wealth and so forth, great commerce and exchange and not wanting to get its hands on it. What are the steps that governments historically have taken to assume control over money? I'll give you several. Recognize that depending on the country and the time, they may have done it all in one fell swoop or they may have taken these various measures over periods of time.

Certainly, one of the important things that government has done, a real hallmark in the growth of government over money is to declare a monopoly of the mint. This is where the government says, "Here we are. We've got chaos in the marketplace with all this multiplicity of private providers, different private mints cranking out currencies and putting different faces on them. They all look so different. That's chaotic. Let's have just one mint and it'll be mine. And I, as the emperor, I get to put my image on the coin - the coin of the realm. And this will help eliminate chaos." The problem there is-- I'd take chaos over government monopoly any day of the week-- the moment you give to the police-- which is essentially what government is-- the moment you give government a monopoly over something so that no competitor can appear without prosecution, then you've handed an enormous power of abuse to that monopoly.

All of a sudden, if the monopoly issuer does some harm to the money, then you as a user might be prone to say, "I'd like to find something else, but there isn't something else." You've given a blank check to that monopoly issuer. That's the problem. The absence of competition is almost never a good thing, and it's not a good thing in money. But that's how governments, sooner or later, they declare a monopoly of the mint. They say, "Nobody else but me gets to do it."

Then, you've got to assume that he'll have good faith and be honest and reliable and not over issue it or abuse it in any other way. That's asking an awful lot of any government with an insatiable appetite for revenue.

But there are other steps the governments have taken. Another is legal tender laws. We have them. Look at your dollar bill. It says, "This note legal tender for all debts public and private." Another way to look at a legal tender law is it basically says, "You must use the king's money. Any debt that is expressed in terms of the currency - the dollar - is just cancelled if you refuse to pay it in what has legally been determined to be the legal tender money. So you've got to use it."

Why do you need a legal tender law if your money is sound, honest, and reliable? You really don't. If it's the best around, you don't need a law that forces people to use it. They'll say, "Well, why wouldn't I use it? Why would I use an inferior money if this guy's producing the best stuff?" You need a legal tender law when people start looking for an alternative, when they say, "I don't know. I can't trust this. He's doing some funny stuff with it."

If Campbell's soup is making tomato soup today, and tomorrow, they water it down with a little extra water and the next day, a little bit more water and there's less and less tomato in it, you're going to start saying, "I'd like to get tomato soup from somebody else now." But if Campbell's is the only one making it, you've got to eat that or do without. Legal tender laws.

A third step the governments have taken is to divorce the name of the currency from the weight of metal. In other words, the name no longer has anything to do with a metal. Do you know that the origins of many national currencies, anyway, today go back to a term that described a weight of metal. The dollar was originally a thaler from Bohemia, which was thought of as a precise unit or weight of gold or silver. I forget which, but it was one of the metals.

The British pound was once a pound of silver. But today, do people think of these currencies as a weight of metal? When you think of the dollar, do you think, "Oh, yeah. That's about that much gold."? Nobody thinks of it that way. So if you don't think of your money in terms of gold any longer, that's giving government enormous power. Now, they're not disciplined so much by the metal. Nobody thinks of the metal that's behind it.

Another step is central banking. You can't expect a government with a sensational appetite for revenue to sit back and observe all these things called private banks that are taking deposits, issuing notes, what have you, a thriving business and not decide, "He who commands the banks, commands a very important height in the economy." So governments, sooner or later, either take the banks over or they're more sophisticated perhaps and they create their own central bank. They leave other banks in private hands, but they begin to regulate and use the banks for their own purposes. They have a central bank that acts as the orchestra conductor, and the private banks are sort of players in the orchestra, all singing from the same hymn book or playing from the same music book.

That's the typical order of the day around the world today. We have a lot of private banks, but everything from the reserve requirements to what they can borrow from the central bank and other practices and so forth are regulated by law or by regulations of the central bank.

The ultimate step when government does this-- you know it has total control over money is when it embraces fiat money. That's what we have today. Fiat money has to be paper, and fiat goes back to the Latin term, which basically meant, "whatever the kings says. Whatever he says is law. It just goes." Fiat paper money. That to economists means paper money that is issued by a monopoly mint or entity - the government - and which is not backed by redeemable and convertible into any kind of reserve or base of precious metal. Its value is whatever it happens to fetch at any given moment, and it is dependent for its supply upon the whims of those in political power. That's where we are today. We have fiat paper money.

How are we in time? I want to make sure I give some examples. Fifteen more? Okay.

Fiat paper money - this would not have emerged naturally, I don't think, in a free marketplace. It would be hard to imagine any society where somebody could come along and say, "Hey, everybody. Stop using all this other stuff you're using as money," - gold, silver, or whatever - "and instead use my paper."

I think people would say, "Wait a minute. What is it? How can I use it? What is it for? Is it a receipt for something? Is it backed by-- what will hold its value?"

It's hard to imagine fiat paper money emerging naturally. Why do governments historically not like the precious metals when they have, over time, been the market's chosen monies? Whole civilizations have risen and flourished with gold and silver as money. Why don't governments like it? It's hard to inflate. Because they can't print it.

Think of gold and silver as a kind of discipline. If that's your money and you want to have more of it, you've got to either produce a good that people will exchange their gold and silver for or you've got to dig a little deeper mine. But if you aren't so constrained, if your money is whatever you want to print, that's an incredible power to have.

I want to give you a couple of historical examples of an extreme paper fiat inflation. Maybe you could argue that with very smart government officials, they could maintain a fiat paper standard for a long time. They would be disciplined. Maybe you could argue that. I wouldn't want to try and make that case, but I do know that history is littered with examples of where people in power didn't exercise restraint, and it gives us a fascinating glimpse into what happens to an economy when its money is undermined or even destroyed. Does anyone know where the western world's first experiment was in unbacked fiat paper money? Where and when? Any guesses? Yes, sir.

Confederate states? Nope. Before that. It was in France. Louisiana figured into it. The notes were issued in Paris. You're onto it. Do you know when? You're very close. It was in France, but beginning about 1715. It's an interesting story, because it involves a very colorful figure. There have been a couple of biographies written of him I recommend. His name is John Law.

Here's the story of the western world's first experiment in paper fiat money, which ended in utter disaster in about a five-year period. Louis XIIII had been the son king, the king of France for quite a few years. He fought a long series of wars with the rest of Europe, built the palace of Versailles, spent like there was no tomorrow. He died in 1715. And Louis the XV, now, is in power. He's facing a French treasury that is essentially broke, and there's very little confidence in his regime. He needs a lot of money to pay his bills.

Along comes this guy from Scotland who gets in to see him with a scheme in mind. His name is John Law. He gets in to see Louis XV, and we don't know how that conversation went precisely, but we do know the outcome of it. So we can imagine it might have gone like this. John Law probably said, "You're in a pickle. You've got these horrendous financial troubles and these bills you don't know how to pay. I've got an idea for you. Print paper money."

And Louis might have said, "Wait a minute. We don't have the gold and silver to back it. We can't print paper without the gold and silver."

It was John Law's scheme to print the stuff irrespective of any backing, and he sold Louis on the idea. He said, I'm sure, something like this. "Look. You're the king. You've got the army, you've got the police, you've got the guns. Just print the stuff. Tell the people they have to use it. It's their money. If the dog eats it, it's dog food. Make them use the paper and back it up by the force of government."

Louis bought into it. He made John Law an important figure in the government. He was in charge of the printing presses. They took a lot of the newly created money and invested it in places like Louisiana, producing the Mississippi bubble of that time. As they issued this paper money, at first it seemed to be very salutary. The very first beneficiary of it was the central government itself. Louis was able to pay off a lot of debts. He printed it, so he got to spend it first.

But they kept belching out the stuff in the theory that, "Hey, this commands great wealth. It promotes prosperity. It's a good thing. It pays our bills." But of course, prices soared reflecting the decline in the value of the money, stemming from the flood of creation of it. And within five years, the paper money of that period became utterly worthless. John Law became a hunted man. The French who had celebrated him as a great financial savior, now run all over Europe trying to catch him. Presumably, if they had, they would have lobbed his head off or something. He died a pauper in Italy some years later. The French never quite caught up to him for that.

That's the first experiment in paper inflation, and of course, the French learned their lesson. They never did that again, right?

The next experiment is also from France. This is in the 1790s during the French Revolution - an even more colorful episode of runaway inflation. You'll recall from your history that in 1789, the French Revolution broke out, which would eventually claim both the king and the queen.

Radical revolutionaries, by the early 1790s, are firmly in charge. These guys are really nut cases. They are so antimonarchy, so revved up with this thirst for blood, for revenge, for power, they decide, even though France's economy is in a shambles, to declare war on the rest of Europe. Because they're going to help remove monarchies and bring on republics all across Europe. So now, they've got the huge tab of paying for a war. How are you going to pay for a war on top of all kinds of domestic programs and domestic insurrections you have to put down and what have you?

There's a debate that takes place in the French Assembly, chronicled in a wonderful little book - I believe it's on our website, you can get it in our bookstore -called Fiat Money Inflation in France by Andrew Dixon White. It's a little book, maybe 100 pages, written 100 years ago by a professor who went back and looked at the debates and the Assembly and recounted the discussions over paper money in France. And in the early discussions, when somebody suggests, "To pay our bills, let's print money," the sentiment is expressed by others that, "We can't do that. We did that before. I remember my grandfather talking about it. They did it under Louis XV and it became worthless. We can't do that again. It has to be backed by something."

That sentiment, based on that experience, did hold sway, and so when they finally decided to issue paper money, they did back it with something. Does anyone know what it was? What did they "back it with"? Land from where? The Catholic church. They backed it with confiscated Catholic church properties. So they thought, "We'll issue this paper money, but it will retain its value because we'll declare that behind it is the wealth that we've seized from the Catholic church."

That was their plan to back the money so it would retain its value. But in practical terms to the average citizen, it didn't mean anything. You couldn't take your assignat as it was called-- the paper assignat. You couldn't take it down to a bank and say, "I'd like to claim it for my share of Catholic church property." It was just a scheme, a marketing ploy to hopefully cause people to have confidence in the money. But as they issued more and more of it, the value of it fell further and further as expressed in ever-rising prices. The paper became utterly worthless by the late 1790s.

In the chaos of the destruction of the money, who arises on horseback, a famous figure who brings order out of this chaos? The white knight who saves France in the ashes of its hyperinflation? Napoleon Bonaparte, who then will rule for the next 16 years and continued to fight with the rest of Europe. To his credit, tyrant though he was, he never resorted to fiat paper money in all the 16 years he ruled France until 1815.

He paid his bills in gold and silver even though it was often gold and silver he seized from other countries. But he did not resort to a paper unbacked money issue in all those 16 years.

Maybe I've said enough to prompt some questions in the few remaining minutes that we have. Those are just two of many examples of hyperinflations. Have we said enough about money to prompt some questions? Yes, sir. I'm sorry we need the microphone.

Question 1:                            The legal tender laws, the ones we have now in the United States, they typically say you have to accept this currency, but do they also say that you cannot accept any other currency?

Lawrence Reed:                   They say that in effect if your debt is denominated in dollars and you refuse to pay the debt in what the government declares dollars to be, the debt is canceled. So it has a monopoly over what a dollar is and how debts in dollars are paid. Who's next, Jim? A lot of hands here. Here's a new one.

Question 2:                            Can you comment on the same thing that happened in America during the Revolutionary War? They had the continental stuff they printed.

Lawrence Reed:                   Yes. In fact, if you want to read more about this, I did do a little article in The Freeman on this subject. I may have mentioned it yesterday. I'm not sure. It's called The Times that Tried Men's Economic Souls. The second Continental Congress authorized the paper issue of continental dollars beginning in 1775 even before the Declaration of Independence.

Ben Franklin was put in charge of the printing presses. The mandate from the Congress was, "Print this new currency but only $6 million worth." That was it. One issue, $6 million, to help pay bills.

To put somebody as honest of Ben Franklin in charge of it, you'd think maybe they'd keep their word. But the temptation was just too great. And in that article that you can see on our website, I have the numbers. Then they say, "Well, we need a little bit more. How about $13 million?" Before it was all done, they issued hundreds of millions of paper dollars, and by 1780/1781, the continental became completely worthless. You can make a case that the fortunes of the war changed for the better when we started getting honest with our money. My former professor actually made that argument and I think it has some weight. I would encourage you to read that for more detail in that episode.

We'll move around a little bit and try some new hands. Here's a new hand. Drew. Then we'll go up there. Yes, Drew, in the white shirt.

Question 3:                            I was just wondering do you think it would be better if there was no centralized money being put out and we had money like that where it's a bunch of different free, open-- wouldn't that make it harder to have things like markets on the Internet like eBay or something? Wouldn't it be harder?

Lawrence Reed:                   Take the market for what you could call near monies - credit cards. There's no government credit card issuer, no government credit card manufacturer. You have private credit card issuers providing purchasing power in the form of a credit card. And you have a multiplicity of private providers. That works fine.

Now, I have inferred without saying so explicitly just what you've said, namely that I'm suggesting that the market be in charge of money instead of government. I really would suggest that. So whatever the path you may have in mind for monetary reform, I would urge you to think that real monetary reform lies in finding ways to make money, once again, a market phenomenon so that it isn't a politically determined, politically issued, monopoly provided substance over which politicians have great sway.

I'm not saying there's only one path, one way to get there, or only one thing that should be money, but I do know that the real discussion over monetary reform ought to be, "How do we put the market in charge again?"

Just as, let's say, in the old Soviet Union. Take any commodity. Green beans. Maybe green beans were a government monopoly in the old Soviet Union. When that system ended, I'm sure they must have had discussions on where should the green beans come from. If not from commissars and government commissions, if not by decree, how will green beans be provided?

I'm pretty sure that they decided, "We'll just let that happen." And like every other commodity that people want, somebody will provide it. But it's subject to market forces. I think money should be the same.

Money, today, even our government-issued money is not immune from market forces. Let's suppose they over issue it. How do you know when governments over issue money? How do you know that? Because sooner or later, it starts to lose its value, right? The American dollar, right now, is plummeting in terms of other currencies, plummeting against many commodities, and it may soon plummet further and faster against goods generally speaking. Some of us think that that's probably soon to happen.

That's the market's way of saying, "Cut it out. You're putting out too much." In a marketplace where market forces are in charge, how do you stop the proliferation of something that people don't want as much of? You go broke if you're a producer. How come we don't have too many green beans? How come every time you go to the grocery store, there's just the right amount of green beans? You don't go one day and there are mountains of unsold green beans, the next day, empty shelves, no green beans. There's always just the right amount. Because prices, supply and demand, send signals to producers.

The problem is you can have plummeting value of government-issued paper money sending a screaming signal, "Stop it. You're doing too much." But the signal never strikes the producer in his pocketbook. Nobody in government goes broke when government ruins your money. That's the problem. We've broken the connection between market discipline and the issuance of the money substance. Next question.

Host:                                          That's all the time, actually, that we have for questions.

Lawrence Reed:                   Sorry. I'll be around though if you want to ask questions one on one. Thank you.