Chapter 4 ECONOMICS FROM AN OBJECTIVIST VIEWPOINT Part One: History - Property - Capitalism - Money * Objective vs Subjective Economic Value * History * The Corporate Enterprise * Political Power vs Economic Power * John Locke on Property * Some Questions about Property * Information as Property * Capitalism * Wealth * The Need For Money * The Evolution of Money and the Nature of inflation * The Effects of Inflation * Objective vs Subjective Economic Value The economic ideology of the feudal system was contained in the phrases "just price" and "just wage." Prices and wages were seen as an ethical judgment of worth while supply and demand were viewed as economically irrelevant. The modern idea of prices and wages as pragmatic devices for allocating resources, implying no ethical judgment, came into existence only centuries later. Under the feudal system the economic influence of supply and demand on prices arose only in the worst possible times: during famine or war. And the steep rises in prices during those times were considered an outrage perpetrated by the sellers who set them. People had not yet learned that you can't get something for nothing. Most still have not learned this today. For hundreds of years men sought in vain for some objective standard of value, a "fair" price, a "just" wage, an unvarying measure of the intrinsic worth of an object. But no such measure exists, simply because "value" has no meaning other than in relation to living beings; the value of a thing is always relative to a particular person, not to any characteristic of an inanimate object. The most commonly proposed answer to their quest was that the exchange value of a product is the amount of time put into the making of it. For instance, if a baker worked an hour to bake a loaf of bread, anyone else should be willing to give up an hour's work for that bread. But this scheme leaves the baker with no way to decide how much of his time to devote to baking bread rather than cakes or tarts. Thus this "objective value" idea always led to economic nonsense - and it continues to do so today. The Marxian definition of value is absurd: all the work you care to add will not turn a mud pie into an apple tart; it remains a mud pie, with zero value. Likewise, unskillful work can easily subtract value: an incompetent cook can turn wholesome dough and fresh apples, valuable already, into an inedible mess with a value of zero. Eventually it was deduced (by Carl Menger) that the exchange value of a product is simply whatever anyone else will give for it in a voluntary trade. In a voluntary trade, each participant evaluates, in terms of his own personal scale of values, what he gives up and compares this with what he receives. The ratio at which these items compare can then become the basis for a price - the only possible realistic price. In this way the personal choices of each individual participant, all balancing against each other, comprise the dynamic flow of commerce which we know as the free market. Menger showed that the free market is just free people making free choices about their own values. From this was derived the concept of the market as an information system, and the realization that the evaluations underlying economic choices are of a subjective nature which makes impossible any objective measurement of their motivations. The related phenomenon of "cost" is also inherently linked to choice. It is that which the choice-maker gives up when he selects one alternative rather than another. Cost consists of his own evaluation of the enjoyment or use that he anticipates having to forego as a result of his choice. * History The failure of Charlemagne's successors to establish a consolidated regime in Western Europe and the eventual disintegration of real political power into the hands of a multitude of local barons resulted in a vacuum of centralized authority. With the decline of the feudal system at the end of the Middle Ages, the absence of centralized political power left a nascent merchant class with the opportunity to establish the commercial institutions which were the foundation of the industrial world we live in today. The prerequisite for the birth of these economic endeavors was the existence of a wide realm within which trade could be conducted with freedom from coercion by political authorities. This freedom also opened the door to the extensive development of towns and cities, some of which were virtually independent political entities outside the feudal system. During the 16th through the 18th centuries, maritime trade with overseas markets was at once a major field of economic growth and an area intractably resistant to medieval principles of political control. The efforts of the emerging nation-states to control maritime commerce lacked the universal recognition necessary to confer legitimacy and were, on the contrary, competing, contradictory, and mutually self-defeating. The political/economic situation in China was quite a bit different. The imperial examination determined entry into the bureaucracy and thus assured the continuation of a centralized elite, drawing into itself the best brains of each generation. The basic ideology of the mandarinate was opposed to the value-systems of the merchants. Capital accumulation in Chinese society could indeed occur, but the application of it to permanently productive industrial enterprises was strongly inhibited by the scholar-bureaucrats, as indeed was any other social action which might threaten their supremacy. It may not be a coincidence that modern Japan, which led in adapting Western institutions to its own economy, grew out of a politically decentralized feudal society. For the European governments, the timing was wrong; they came to power too late to prevent the rise of capitalism, and their only recourse for expressing statist values was a gradual, Fabian assertion of authority over the aspects of capitalism not too mercurial to elude their grasp. * The Corporate Enterprise The conduct of economic affairs over time periods of substantial length required the emergence of an independent economic organism, above and beyond the individuals engaged in economic activity. The huge enterprises (railroads, steel mills, factories) that evolved during the Industrial Revolution required the tying up of capital in amounts, and over periods of time, unprecedented in medieval commerce. The life of the assets and the time needed to recover the investment often exceeded the life expectancy of the mortal charged with their management. The two great authorities of the Middle Ages were the feudal aristocracy and the Church. Neither produced the relationships of trust and confidence needed for long-term economic association. To the medieval merchant, accustomed to keeping his wealth protected against the hazards of political extortion or war, a tie-up of capital for a period far beyond the range of foresight would have seemed insane. But gradually, appreciable numbers of these merchants (those who invested in corporations) came to believe that other businessmen (those who managed the corporations) were honest, diligent, and could be trusted. As this trust developed, many business transactions that had formerly occurred in separate ways in various distinct ventures came to be included in one conceptual unit, the corporate enterprise: the publicly-held corporation with marketable stock. Such trust presupposes a widely shared sense of business ethics, and that sense of business ethics could hardly have been inherited from the teachings of the Catholic Church or from the feudal aristocracy. The contempt which the clergy and the aristocracy felt for the merchant class could only have encouraged the merchants to develop a code of honor based on punctilious business relationships - a behavior strikingly absent from the aristocratic code and emphasizing the profound difference between the two. * Political Power vs Economic Power All political systems rest upon the foundation of theft. The ultimate source of political power is the weapon which is used to commit the act of theft (called taxation) that provides the wealth of the state. The distinction between politics and economics is the distinction between the power to coerce and the power to produce. Politics is also characterized by other types of coercion than the theft of wealth, but it is this act of theft that constitutes the economic foundation of political systems, whereas other forms of economic activity (excluding non-institutionalized theft) rest on the production of wealth rather than its expropriation. On the one hand lies economic power, exercised by means of a positive: by offering men a reward, an incentive, a payment, a value. On the other hand is political power, exercised by means of a negative: by the threat of punishment, injury, imprisonment, destruction. The businessman's tool is values; the government's tool is fear. The power of a politician is the power to impose punishment on people who fail to obey his commands. To the extent that he can grant rewards, those rewards consist of expropriated wealth. The power of a businessman is the power to grant rewards (in the form of produced wealth) to people who agree with him. His only power to punish is the power to withhold the reward. The businessman must produce something consumers are willing to buy at a price that consumers are willing to pay, and he must compete for the favor of the consumers in a market with other businessmen offering similar goods or services. He must persuade consumers to buy his product, while the politician can coerce them into buying something whether they want it or not. There is so little clarity in either economic or political analysis because in the minds of most people the two are all muddled up together and when people speak of "power" they make no distinction between the power to coerce and the power to produce. For man to achieve a human state of life and civilization, three conditions are necessary: freedom, capitalism, and a rational code of ethical principles to guide his social behavior. To men who use reason and are free to interact cooperatively, nature gives more and more. To those who turn away from reason, are not free, or who interact destructively, it gives less and less. With the Enlightenment and the Industrial Revolution, the first two of these conditions were achieved, to a considerable extent. The result was the transformation of the world. It was the people of the USA, with a government too small and weak to significantly inhibit economic activity, who implemented the principle of laissez-faire capitalism - of free trade in a free market - to the greatest extent. In America, prior to the 20th century, men's productive activities were predominantly left free of governmental restrictions. The result was the creation, in the brief period of a century and a half, of a standard of living unequaled by the sum total of mankind's development up to that time. Capitalism - and civilization - are declining because men failed to achieve the third condition necessary for a human state of existence: a rational code of ethics appropriate to man's nature. It is a principled foundation for such a code that Ayn Rand has provided. Most people today have not learned to distinguish between government wealth transfers and wealth earned in a free market. This ignorance, coupled with Christianity's inherent aversion to business, induces people to feel envy when others become rich through market activity. The consequence of this envy is a clamor for increasing government intervention in the marketplace. But that intervention is always counterproductive, causing more problems than it was intended to solve. The line which divides our area of wealth from our area of poverty is roughly that which divides freely produced and marketed goods and services from government controlled activities. The solution to economic problems caused by government does not lie in devoting still more wealth to an institution inherently unfit to be a producer. The bottom line is that, just as people can use a TV without understanding anything about how it works, America has become rich but Americans don't know why. And in their ignorance they are destroying the economic foundations that made their wealth possible. Much of the rest of the world suffers from a related form of shortsightedness. The belief that the wealth of the West springs from its factory system gives rise to an impulse in the countries of the Third World to equip themselves with the trappings of modern technology - an impulse exemplified by the Soviet Union's five-year plans a half-century ago. The severely limited success of these ventures results from their lack of appropriate economic foundations. In the West, the development of commercial relationships preceded the rise of modern industrial institutions by many years. Western economies had been growing with striking success for more than a century before the large industrial corporations emerged. This growth, and its concomitant capital accumulation, were the foundation for the subsequent immense corporate enterprises. * John Locke on Property "Though the earth and all inferior creatures be common to all men, yet every man has a property in his own person. This nobody has any right to but himself. The labour of his body and the work of his hands, we may say, are properly his. Whatsoever, then, he removes out of the state that nature hath provided and left it in, he hath mixed his labour with, and joined to it something of his own, and thereby makes it his property. He that is nourished by the acorns he picked up under an oak, or the apples he gathered from the trees in the wood, has certainly appropriated them to himself. Nobody can deny but the nourishment is his. I ask, then, when did they begin to be his? When he digested? or when he ate? or when he boiled? or when he brought them home? or when he picked them up? And 'tis plain, if the first gathering made them not his, nothing else could.... And will any one say he had no right to those acorns or apples he thus appropriated, because he had not the consent of all mankind to make them his? Was it a robbery thus to assume to himself what belonged to all in common? If such a consent as that was necessary, man had starved, notwithstanding the plenty God had given him....'tis the taking any part of what is common, and removing it out of the state nature leaves it in, which begins the property, without which the common is of no use." * Some Questions about Property "Locke argues that mixing labor with the unowned will convert it to the owned - without defining what kind or quality of labor per material is necessary." What is necessary is to mix in enough labor to "remove it out of the state nature leaves it in." When I have done this, I will have made my property observably distinct from the unowned. The act of asserting ownership is a contextual process, depending on the nature of the society in which ownership is asserted. For example - if I put a fence around something, and put labels on the fence, then I will have noticeably separated out my part from the unowned. But such an action would be meaningless in a society of barbarians who did not recognize the significance of a fence or who did not possess the tool of literacy. The property right of a landowner is contingent on the general agreement of his community that he is the rightful owner, an agreement based on whatever are that society's institutionalized principles for establishing ownership. If he held the land by force only, that would be mere possesson, not property. It's property when he is able to remain in peaceful possession. Thus ownership is more than mere possession. It's possession which is protected by the existing social institutions. "If you take a boat out to sea and catch fish, the fish are properly yours, since you used your labor to get them, but mixing your labor with that part of the ocean does not make the ocean itself yours." But it is not the ocean I have mixed my labor with - it is the fish. If I were to gather in some of the ocean water and run it thru a desalinizer (or in any other manner to distinctly separate it from the unowned), then it would indeed be mine. "The land under a building is not properly yours even though the building is." If the land under my house is not mine, then whose is it? And by what right can he claim ownership if I cannot? "What claim do you have to water that flows across your land? Or to the wind which blows over it?" This is a question to which I must admit I do not have an answer. * Information as Property Jerry Pournelle: "We're all agreed that information piracy is a growing problem, and there appears to be no ready solution for it. I admit to being a bit scared, since I make my living from intellectual property, and that's becoming hard to impossible to protect. In a very real sense, we're all going to have to depend on ethics - and the last I heard, that isn't even being taught in the schools any longer." Pournelle identifies a critically important fact: the problem of information as property cannot be solved "out of context," that is, outside the general context of the social institutions that shape our culture. Before such problems can be fully solved, society must be restructured away from institutions of government and toward ethically rational social institutions. Property has traditionally been something that can be transferred from place to place or person to person. Theft can be defined as depriving the owner of the use thereof. But in an electronic environment, although a piece of software or a component of a data base may be valuable, the intruder who accesses it without authorization is not depriving the owner of its use, although he may well be making the product less valuable to its owner. Knowledge is the only product that is not subject to diminishing returns. You can give software away over and over again, and you still have it. This loaves-and-fishes quality of information has no place among the parables of capitalism. Our culture's economic system gets its axioms from the idea of property. Whereas property is by nature scarce, information has no inherent scarcity, consequently traditional economic ideas do not adequately encompass the phenomenon of "information as property." Publishers, film companies and broadcasters will have to find new ways to cope with a distinctly different environment from the one that existed in the past. How are those publishers who recognize that their commodity is information, not paper, to make money? Traditional publishers have been involved in printing for so long that they have forgotten that they are a branch of the information and entertainment industries, and not the wood pulp and paper industry. One suggested alternative: The seller puts her titles on a disk in encrypted form, locking each title with a separate RSA key. She presses these disks in small batches, changing the keys after each batch, then sells the disks at retail. The customer then decides, from the promos on each disk, which titles he wants. Over the phone, the customer can provide the job lot number, the titles desired, and his credit card number. The seller then gives him the decryption keys. In considering such schemes, keep in mind that most people pirate for one of two reasons: a large cost difference or a large convenience difference. Therefore it's not enough for the legal copy to be cheap, it must also be convenient. * Capitalism In thinking about capitalism I started by considering all the definitions I could find. None of them, not even the one derived by the Randites, seemed fundamentally valid. They all try to distinguish among supposedly different forms of economic behavior, but actually just make spurious distinctions based on the type of social organization in which economic behavior occurs. I had also been thinking about the fundamental nature of rationality, and I observed that there is a connection between wealth-creation and rationality: before you can create material wealth you must know and understand at least something about reality. I realized that rationality and wealth-creation are two correlative aspects of human behavior. Rationality is the means by which man uses his mind to know and understand reality. Wealth-creation is the means by which man manipulates reality to fulfill the physical requirements of his existence. Rationality and wealth-creation go hand-in-hand and both are fundamental requirements of man's life. One of the distinctive differences between man and the other animals is his much greater ability to conduct his behavior with reference to time periods of substantial length. From this observation there arises a useful, if not precisely specifiable, distinction to be made between two general categories of wealth-creation - a distinction which ensues from man's ability to act through time: is the wealth to be consumed immediately, or is it to be used later on to produce more wealth? If it is to be used later on, as a tool for the creation of more wealth, then it can be called "capital" and the process can be called "capitalism." Thus I will use the term to mean: "The process of using wealth not for immediate consumption but for the creation of more wealth." Conducting wealth-producing activities deliberately through time is the essence of capitalism. If you save your wealth and use it to create more wealth, you are doing capitalism. If you merely consume the wealth you are not doing capitalism. Observe that capitalism is not a Boolean phenomenon. All human cultures practice at least a tiny bit of capitalism - even if it's only the manufacture of stone knives and arrowheads. The economic development of a culture depends on the extent to which this practice is implemented. A society can have more or less of it. The more it has (i.e., the more that wealth is accumulated through time) the more the society will prosper. Capitalism can be as small as flaking one flint knifeblade. Or it can be as huge as General Motors and IBM. Observe also that this definition is politically neutral. It doesn't matter WHO does capitalism - nor WHY they do it. It only matters that the act is performed. Capitalism is an economic tool, like a hammer. Anyone can use a hammer: a Libertarian, a Fascist, a Communist. From a strictly economic point of view, in considering only the production of wealth, the political philosophy of the person who uses the hammer doesn't matter. All that matters economically is how efficiently he uses the hammer. If he uses it well, wealth will be created; if he uses it inefficiently, less (or no) wealth will be produced. Thus the term "State Capitalism" actually makes sense: a government CAN implement the procedures of capitalism. This will help explain why such dismal systems as the Soviet Union do not collapse outright, and why a mixed economy like the USA can muddle along for quite a while. You can see now why I must disagree with Rand. She always equated capitalism with a political system of her preference, but to do so deprives us of a valuable concept that can be applied to economic behavior regardless of the political context in which that behavior occurs. It also deprives us of a valuable cognitive distinction: that between economics and politics. The phenomenon Rand spoke of should properly be called "laissez-faire capitalism." That is, capitalism practiced in the context of a more-or-less free market. Although this is certainly the most efficient social context for the practice of capitalism, it is not the only political context in which capitalism can be implemented. Many environmentalists assert a significant distinction between consuming or conserving one's capital, but the important distinction to make is between two forms of capital consumption: dissipation or production. Mere conservation is economically irrelevant - to conserve something rather than to use it makes no contribution to prosperity. A sensible approach to the subject of human well-being is to USE capital, but in such a way that it is augmented or regenerated as much as possible (and thus, in a manner of speaking, "conserved" for future use) and in such a way that its present use PRODUCES future well-being. The real crime in this context is to destructively dissipate capital in order to achieve only a transient benefit. Perhaps the best example of this process is the gluttonous dissipation of the world's supply of fossil fuels, much of which is consumed for no other purpose than to transport imbecilic adolescents back and forth from one end of Main Street to the other. A sane practice would be to use the fossil fuels, to as great an extent as necessary, for the purpose of establishing a nuclear fusion or solar power technology. * Wealth Wealth is the result of transforming naturally existing entities into material that enables the achievement of human values. That wealth consists of money is a popular misconception which arises from two functions of money: as the instrument of commerce, and as the measure of value. But real wealth consists in what is produced and consumed: the food we eat, the clothes we wear, the houses we live in. Yet so powerful is the verbal ambiguity that confuses money with wealth, that even those who at times recognize the confusion will slide back into it in the course of their reasoning. Each man sees that if he personally had more money he could buy more things, and thus if he had twice as much money he could buy twice as many things; he would be "worth" twice as much. And to many the conclusion seems obvious that if the government merely issued more money and distributed it to everybody, we should all be that much more wealthy. What they do not see is that such a course of action would merely destroy commerce. * The Need For Money A stable currency that has real immediate and long-term value is an absolute prerequisite to the establishment and maintenance of an economically successful society. This is especially true with regard to a technologically sophisticated society. Whereas it is possible to maintain a simple agrarian society on a barter basis, barter will NOT suffice in an economy that produces king-size beds or is comprised of large industrial institutions. One of the most significant factors in the failure of a national economy to develop, and also a major contributor to the decline of an economy, is the lack of a medium for the measured exchange of wealth. Even if people are permitted to freely produce wealth, there can be very little rise in the general standard of living if they cannot exchange that wealth in any transactions more sophisticated than simple barter. To do so, they must have available a secure means of measuring the relative value (relative to each other individual's personal goals) of their products. This is the function of money. There are fundamental reasons why gold and silver were the first money media. Nevertheless, every time a government seizes control of money, the media are changed and eventually the money's value is destroyed. In almost all nations today, money is based on the empty promise of a government rather than on the firm foundation of a known and durable commodity (such as gold or silver). And throughout the world today, inflation is everywhere destroying the possibility of long-term investments in wealth-generating commerce. For a magnificent description of the function of money, see "The Root Of All Evil" speech in ATLAS SHRUGGED, Part 2, Chapter 2. * The Evolution of Money and the Nature of Inflation Excerpted from the book HOW YOU CAN PROFIT FROM THE COMING DEVALUATION by Harry Browne: If you were to find yourself alone on an isolated island, you would have no need for a medium of exchange. There would be no one with whom to exchange. You would go to work, as necessary, to produce the things you needed for your survival. You would produce some things that you would want to consume immediately, and you would probably produce other things to be stored for later consumption. You might also produce some other things that would be called "capital goods" - things that make further production easier. But you would only produce when you believed it would lead ultimately to something you wanted. Let's suppose now that there was one other person on the island with you. Each of you has his own area of the island and each of you is producing for himself. Sooner or later, you would probably begin exchanging things with each other. Perhaps you have produced more than you need of something he hasn't produced, and vice versa. You exchange your surplus with each other - and both of you profit thereby. Obviously, you won't trade your production for something you have no use for. Why bother working if your efforts don't eventually bring you something you can use? You'll trade only for those things you want to use now or can store for use at a later date. And here we have a very important rule at work: You only produce and exchange when you believe it will lead ultimately to something you want. But now let's suppose there are 100 people on the island - each with his own area. You will still have to produce to survive; there's no way to avoid that. But exchanges will probably take place on a much wider basis. In fact, it will be only a matter of time until a "specialization of labor" develops. That's where an individual no longer produces everything for himself. Instead, he concentrates on the production of only one or two items - and then trades his production with others for the products and services he wants. These trades with others are called direct exchange - the trading of some of your property for another commodity you intend to use yourself. This is also called barter - trading without money. But, eventually, you find yourself in a position where you're willing to accept in exchange an item you don't intend to use. Suppose you have butter and you're looking for wheat. I have wheat, but I'm not looking for butter. Instead, I need corn. So you go find a third person who has corn and is looking for butter. You trade your butter for his corn. Then you come back to me and trade the corn for my wheat. You have what you want; but it took two exchanges to get it. This is the beginning of indirect exchange - the trading of one thing for something you don't intend to use yourself. For example, one day Jones the nail-maker walks into the store of Smith the furniture-maker. Jones opens the conversation with, "Smith, I need a new workbench. I'll give you 2000 nails to make one for me." "Sorry," says Smith, "I have all the nails I'll need for a while. Come back in about six months." Jones goes on, "But I need the workbench now! Look, you're bound to use those nails eventually. But, even in the meantime, you can probably trade them to someone else for something you need. I'm always getting offers of trades from people wanting nails. They're a lot easier to exchange than furniture." "You have a point there, I do seem to have a lot of trouble exchanging kingsize beds for clothes. This way, I'd use only as many nails as I need for each purchase... well, okay - I'll try anything once." So he accepts the nails and makes the workbench for Jones. And then he goes out to find products for which he can exchange the nails. And, lo and behold, it works! He finds that trades are much easier to make. As a result, he enjoys life a lot more with a few nails in his pocket. He can stop at a store and trade for anything he wants to - without having to arrange an elaborate, long-term furniture purchase with the storekeeper. In fact, he merely points out to the merchant the advantages of nails as a trading medium in the same way that Jones pointed them out to him. And the final argument is that you can always use the nails sometime in the future; they won't lose their value. And if you don't use them, someone will. The merchant realizes this; and so he accepts the nails, confident that he can use them or trade them for what he wants. So nails have become money. And what is money? Money is a commodity that is accepted in exchange by an individual who intends to trade it for something else. Money is a commodity, just like anything else that's traded in the marketplace. What distinguishes a money commodity from other commodities is the intention of the person to keep it only until he trades it to someone else. It's only a means to a further exchange for that person. Not everyone intends to trade it, however. Some people receive the money commodity, intending to use it for its own natural purpose (in this case, nails for construction purposes). And this brings us to the key word in the definition of money: accepted. The commodity can become money only when an individual accepts it - when someone's willing to take it, confident that he can trade it ultimately for what he wants. But why gold and silver? There are five main attributes of gold and silver that give individuals good reason to accept these commodities confidently: 1. They are durable. They can be stored for long periods of time, if necessary, without perishing. 2. They are easily divisible. As we saw, it was easier to exchange nails than furniture because you could divide a supply of nails into small purchases. And gold and silver can be broken into smaller pieces or used as dust - without harming their inherent value in any way. 3. They are convenient to handle. Their naturally high market values make it possible to work with small quantities. Wood wouldn't do - because you would need so much of it to be worth a desired item that it would be inconvenient to carry and exchange. 4. They are consistent in quality. One ounce of gold is as good as any other ounce of the same fineness. 5. They have accepted value. They are used for such things as jewelry, dental work, electronics, art objects, ornamentation. soldering, photography, and other purposes. That previously determined value also tells you how much gold and silver are worth in relationship to other commodities. If the money commodity didn't have that separate value, you couldn't confidently accept it in trade for what you have produced, for you wouldn't know the worth of what you received. One enterprising fellow notices that individuals waste a lot of time measuring gold dust in exchange for their drinks at the bar. So he opens a mint. He buys raw gold or silver and converts the metal into coins. He stamps the coins with his name and the amount of gold in the coin. If an individual trusts the coin-maker, he will probably prefer to use the coin. Its recognizable weight makes it easier than measuring gold dust. Another ambitious chap opens a warehouse. "Bring your gold to me," he says. "I'll store it for you in my theft-proof vault. I'll give you a receipt for it, so you can claim it any time you want it. I only charge a small fee for the service of storing it for you." This means you can now keep your gold in a safe warehouse - rather than carrying it around or leaving it at home where it could be stolen. And as the use of the warehouse beomes more widespread, and the integrity of the warehouseman becomes known, the receipts can serve an additional purpose. You can exchange the receipts themselves. Why bother going to the warehouse to get your gold, only to trade it to someone who will probably take it back to the same warehouse for safekeeping? Instead, you simply hand over the receipt to him. At this important stage in the evolution of the money system, we must remind ourselves of an important point: It is the gold that is the money; the paper receipts are not money! Gold is money because it's a commodity with accepted value and is convenient to use in exchange. Paper could NOT be useful as money because the relative ease with which it is produced makes it inexpensive by nature; you'd have to use tons of it to obtain the same result served by a few ounces of gold. The paper takes on value only as it can be exchanged for gold. If the warehouse were to refuse to make the gold available, the receipt would eventually be worthless. It's similar to storing furniture. You can't sit on a furniture receipt; you can only exchange it for something to sit on. The paper receipts are not money; they are money substitutes. Along with the normal paper receipts, it is possible to have tokens. A token is a money substitute in metallic form, rather than in paper. The present U.S. copper-nickel tokens are a good example. These are not coins, since there is no significant inherent value in them (perhaps two cents worth of metal in a quarter). Like paper receipts, they can only have lasting, constant value if they can be readily exhanged for something of real value. Suppose you left your gold on deposit at the bank (warehouse) and received a receipt that you intended to spend in the marketplace. And suppose the dishonest banker issued a second receipt for the same gold to someone else. Two people are now trying to spend the same gold at the same time. You now have inflation - two receipts for the same supply of gold. One consequence of this would be the well-known "run on the bank." As soon as anyone became suspicious that the banker was doing this, he'd get jittery about his own money. If very many people became suspicious, you'd have a run on the bank. And those who arrived there last would be out of luck - if the bank really were cheating on the receipts. If it weren't, everyone would get his gold and the bank's honesty would be proven. This would probably result in increased business for the bank. An honest bank would not have to fear a run. So let's coin another definition of inflation, one more to the point: Inflation is the counterfeiting of money substitutes. Suppose you and I form a partnership, a company that prints paper receipts. We print 1000 new $20 bills. Then we go to Seattle where we are not known to anyone. We start spending the bills and are immediately praised by the local merchants and the newspapers. They proclaim that it is a great thing for Seattle that we have come to town, for we're bringing prosperity to a city that was in a recession. Two weeks later, we leave town with $20000 worth of goods. The townspeople bid us a grateful farewell for all the business we have brought to them, It's obvious the WE have benefited from the situation. We traded paper dollars with NO real value for products that HAVE real value. Assuming that no one ever learns our little secret, has our gain actually hurt anyone else? In other words, does anyone ever pay for our benefits? The merchants who received the counterfeit bills did not lose. They could pass the bills on to others for things they wanted. We gained; the merchants didn't lose. Apparently no one lost. But we've overlooked a few people. Not just a few, in fact. We've overlooked everyone else in Seattle. For everyone else will lose in order to make this gain possible. We can see this easily as we imagine our car leaving Seattle - loaded with goods removed from Seattle's marketplace. We leave Seattle's residents with less property than they had before we came. There will be fewer goods available to divide up among the people there. In exchange, they received additional money substitutes that will circulate in the community. But money substitutes are not wealth. This simply means there are now MORE money substitutes to pay for FEWER goods and services. Since the money supply has gone up and the goods and services have decreased, the result can only be higher prices in Seattle. The price increase will be irregular. Those who get their hands on the counterfeit money first will gain from it; for they'll have extra spending money, and prices will not have gone up yet. But as those extra money substitutes pass through the community, they will bid prices upward. The other people in the marketplace will be paying for our gain - and they will do that through the higher prices they pay for each product. Suppose our arrival and departure were not noticed. In other words, no one was aware that an extra $20000 was suddenly coming into circulation. The individual merchants who received our $20 bills would have no reason to suppose that there was anything unusual or temporary about the increase in business. They would simply suppose that their long-standing promotional efforts were finally paying off - that success was on its way at last. They would most likely hire extra clerks to handle the increased business, maybe order a new sign and a better paint job for the store. And they would enlarge their inventories to meet the increased demand, of which we appeared to be an example. But as soon as it became evident that the sudden dose of new business was purely temporary, they would have to retract their expansion plans. They would lay off the extra clerks and cancel the orders for remodeling. The painter who was to have done the remodeling would, in turn, have to fire his new helpers. And what would he do with all the extra paint he had ordered? The net result throughout the area would be a state of gloom. Everyone would have extra commitments to pay off and shelves full of undesired stock - all because an illusory boom caused businessmen to gear up to a demand that never really existed. Would you call that a recession? Yes, indeed. Inflation is an increase in money substitutes above the stock of real money in storage; the counterfeiting of paper money. Inflation simply means there are more paper money receipts in circulation than there is real money with which to back them up. As we've seen, this will cause prices to go up. But rising prices are not inflation; they are an effect of inflation. * End of excerpts from Browne. What people today call inflation is not inflation, i.e., the increase in the quantity of money substitutes, but is instead the general rise in prices and wages which is the inevitable consequence of inflation. This semantic error is by no means harmless. First of all there is no longer any term available to signify what inflation used to signify. It is impossible to fight an idea which you cannot name - especially when you no longer have available a term accepted and understood by your audience as a descriptor of that idea. Second, those who wish to fight the cause of inflation are diverted in their struggle away from the fundamental nature of inflation and are forced to direct their attention to its secondary consequences. They end up snipping at the leaves of the weed rather than hacking at the root. * The Effects of Inflation A hard-money standard is an integral part of a system of free enterprise, of good faith and law, of promise-keeping and the sanctity of contract. It is this system - and the confidence to which it gave rise - that is being destroyed by inflation. Like every other tax, inflation acts to strongly influence the business policies we all must follow. But unlike specific and knowable taxes, inflation cannot be compensated for because it cannot be quantitatively specified in advance. It discourages prudence and thrift. It encourages squandering, gambling, and reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies, leading them to demand totalitarian controls, thus planting the seeds of fascism and communism. It ends invariably in bitter disillusion and collapse. Between 1963 and 1973, in 40 countries whose inflation rate reached 15%, 38 abolished their democratic institutions in one way or another. At first glance, you might think that inflation affects only the money supply, but the more you look at it the more convinced you will become that it is all-pervasive in its pernicious effects. In 1985, parents spent 40% less time with their children than they had spent in 1965. This is an excellent example of the insidious side-effects of inflation. Government inflates the money supply in order to appropriate the nation's wealth; thus working people are forced to spend more time earning money in order to maintain their standard of living. This of course leaves them with less time to spend with their children. I become more and more sympathetic with that majority of Germans who, when surveyed as to which was worse - WorldWar1 or the subsequent runaway inflation - replied "the inflation was much worse than the war!" Money substitutes are certificates of debt against the true wealth of an economy. As those substitutes decline in value, foreign holders of the paper may begin to unload it in exchange for other kinds of paper, thus starting an avalanche of similar domestic unloading in which a national debt (intended to be a legacy bequeathed to your children and grandchildren) would have to be paid NOW - or repudiated. In either case, the dollar would become worthless. The politicians have seized the wealth of the nation, and given the nation back a mortgage on itself. This seizure is not merely the theft of wealth, it is the theft of your children's opportunity, of their future, of hope. As Mises observed, the transition from Money to Wallpaper has five steps: 1. The bill is exchangeable for a specified amount of Au or Ag 2. The bill is exchangeable for N dollars in Au or Ag 3. The bill is N dollars - exchangeable for a specified number of another nation's bills. 4. The bill is N dollars - exchangeable at the open market rate (whatever you can sucker some poor fool into trading for it). 5. Katastrophenbausse.