From: Hal <hfinney@shell.portal.com>
Date: Sun, 1 May 94 10:07:14 PDT
To: cypherpunks@toad.com
Subject: Re:  The American money capture
Message-ID: <199405011708.KAA16423@jobe.shell.portal.com>
MIME-Version: 1.0
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There are a couple of things I disagree with in Gary Jeffers' post.
(Mild spelling flame - it's "fiat" money, not "fait" money.)  I am
interested not from the conspiracy aspects, but from the private-
versus public-money angle.

> PAPER MONEY BACKED BY PAPER
>    There is only one cause of inflation; it is officially - but not
> constitutionally - authorized counterfeiting of money, the official
> issue of paper money substitutes that are not fully backed by &
> redeemable in the real lawful money they purport to represent.

Until 1850, there was no official paper money in the United States.
The US government controlled coinage, but they had a lot of problems getting
enough money into circulation, especially in the fast-growing frontier
area.  Between 1800 and 1850 a great number of private banks were started
whose main function was to issue paper money.  Although this money was not
a legal tender (meaning simply that people could refuse to accept it) it did
circulate widely as cash, often displacing coins.

Although ostensibly backed by lawful money (e.g. US coins), this did not stop
the bankers from engaging in fractional-reserve banking.  Indeed, if they had
not done so, their banks would have been of no value, as they would not have
helped remedy the shortage of circulating money.

(Today, with our experiences of inflation in the 1970's and 1980's, it is hard
for us to appreciate the problems with deflation.  But I think deflation was
much worse.  The effects are similar to what we see today when the Fed
tightens the reins on the money supply - a halt to economic growth, business
bankruptcies, growth of unemployment, debtors unable to pay off their debts,
mortgage foreclosures, etc.)

(Also, note that a constant money supply in a growing economy is effectively
deflationary.  The money supply must increase at least as fast as economic
growth or it will serve as an active brake on the economy, IMO.  I don't
know what economic school this view comes from, but I first heard it from
Milton Friedman.)

Even though the cash was not "official", inflation was a problem.  In fact,
it was a chronic, overwhelming problem.  Once a bank realizes that it can
buy things simply by printing money, it takes more self-restraint than most
institutions (private _or_ public) have to keep from doing so.  Things were
made worse by the fact that our understanding of the inevitable bad results
of such inflation was simply absent back then.  The bankers did not under-
stand that printing more money would inevitably devalue the currency.  They
thought that the inflation they saw was due to psychological factors, people
not trusting the bank, or greedy merchants trying to take advantage of the
public.  (These arguments were echoed in the 1970's and 1980's, but they
have of course been widely discredited now.  The issue was far less clear in
1850.)

Throughout the private-banking era, runs on banks, booms, busts, and panics,
all the traditional extreme manifestations of the business cycle, were seen.
And all this occured at a time when the only lawful, legal tender money was
hard currency: gold, silver and copper coins.  Clearly having such a money
is no proof against the pernicious effects of inflation.

Despite this historical record, I think that private currencies today
would have the potential to succeed.  The increased economic
sophistication about the effects of different monetary policies would
help bankers steer clear of the most egregious errors of the 1800's.
Digital cash signatures avoid the widespread counterfeiting and
discounting which also plagued that era.

Hal Finney
hfinney@shell.portal.com