In response to my article on Mises Daily, Mr. Zarlenga did another interview with Gnostic Media host Jan Irvin. It started out with briefly discussing Mr. Zarlenga’s book, which they both regard as the definite work on monetary history. Here I wish to point out that I never set out to criticise Mr. Zarlenga’s book. The point of my article was to discuss the flaws in a monetary system, which far predates Mr. Zarlenga and his book, i.e. government issued paper money. Mr. Zarlenga is certainly not the first person to advocate government issued money, and I am certainly not the first one to criticise it.
Historical evidence in favour of government money
Mr. Zarlenga eagerly cite two examples of government issued money in American history, and hail them as great successes. The first is the Continental Dollar and the second is Lincoln’s Greenback. These were also discussed at some length in the hour something long interview. HE claims that in both instances, only the approved amount of dollars was issued, which proves the viability of the government money system.
They did not discuss the fact that stringent legal tender laws bankrupted thousands of Americans who were obliged to accept the worthless Continental Dollar as payment for debts. Legal tender laws are a key factor in any government money system. Even if it was true that the Continental Dollar was destroyed by a British counterfeit operation, the fact that the legal tender laws were not repealed goes to show how failed this particular government run system was.
The Greenback, of course, funded Lincoln’s invasion of the South, leading to a war in which more than 600,000 Americans died. To Mr. Zarlenga’s credit, he does point out that the government shouldn’t create money for war, but nevertheless reminds us that the Greenback eventually exchanged on par with gold. Even so, I would like to raise one issue in connection to the Greenback, something that illustrates one of the risks with government paper money, and that is the money issued by the Southern Confederation.
After the South had lost the war, the Confederate money became completely worthless. The reason for this is that the government power behind the Confederate money disappeared. This shows the inherent worthlessness of government paper money. It only has value as long as the government that issues it retains its power and prestige. If the government loses its power and prestige, its money is immediately reduced to its basic fundamentals: ink on paper. Whatever value it had as medium of exchange is gone. This in sharp contrast to gold or any other commodity backed money, which retains its value regardless of changes in the political environment, as long as the people value the commodity.
The problem of inflation
At one point in the interview, the host asks Mr. Zarlenga to address the risk of inflation. Here I peaked my ears, because this was my most central point of criticism. I am big enough to admit that Mr. Zarlenga is capable of presenting a pretty good case for many of the things he argues, but here, in the most important issue of all, he fails. (Note that Mr. Zarlenga uses the common definition of inflation, i.e. rising prices.)
He begins with asserting that newly printed money doesn’t dilute the value of the existing money. He supports this rather bold claim by pointing out how much new money the banks have created, and that the world is still not falling apart. This proves that money creation isn’t destructive.
Well what can you say about that? First, it is an undeniable fact that the money supply has risen enormously since the creation of the Fed. It doubled last year alone. As a consequence, the US dollar has lost almost all of its purchasing power, another undeniable fact. Considering how highly Mr. Zarlenga values empirical evidence, it is a bit strange that he doesn’t mention this.
Second, the world may not be falling apart just yet, but the US monetary system and the US economy certainly are, and that can be largely blamed on the unprecedented growth in the supply of money and bank credit, courtesy of both the Fed’s printing presses and the fractional reserve system. So to point to the activity of the banks to support the claim that money creation is not destructive, is a very strange position to take.
One might also argue that Mr. Zarlenga contradicts himself here to some degree, because later in the interview, he says that the present banking system has crashed the system. In other words, the present system is indeed horrible, but it still somehow proves that creation of money doesn’t lead to disaster. That doesn’t really sound right. I argue that creating money does indeed lead to disaster, and it makes very little difference who is running the printing press.
Money vs. Credit
He tries to defend his position by stating that we presently don’t have money circulating. Instead we have bank credit circulating. Banks are creating bank credit out of thin air through fractional reserves, and this is the main engine of inflation. Money and bank credit are two very different things, Mr. Zarlenga reminds us. His proposed reform will abolish the fractional reserve system, thus eliminating the main cause of inflation.
I certainly agree with Mr. Zarlenga that the FRB-system should be abolished and that it indeed has been a great engine of inflation. I also agree that money and bank credit are two different things. However, bank credit is part of the total money supply. Thus, an increase in bank credit leads to an increase in the total money supply, and this brings with it all the ills inflation, such as higher prices. You don’t escape this inflationary woe replacing the fractional reserve system with the continual printing of new paper money. Either way, the total money supply will rise year after year, and every new bout of money printing will necessarily dilute the value of the existing money. This is unavoidable.
Combating rising prices and Hayek’s pretence of knowledge
Mr. Zarlenga disagrees. He claims there is a way to avoid rising prices despite the constant printing of new money. How could this be achieved? Why, it is simple, the government simply has to spend the newly printed money on “good things”, i.e. things that lead to increased productivity, output and general welfare. Things such as infrastructure, and not only roads and bridges, but human infrastructure too, by which he means health care and education. Healthy, educated people are more productive, he says.
Again, I certainly agree with Mr. Zarlenga on his last point, but I would submit that health care and education are perhaps not the best examples of “good things” the government can spend money on without causing rising prices. Few sectors of the economy are so controlled by the government as health care and education. Hundreds of billions of government money is channelled each year into health care and education through Medicare, Medicaid, government guaranteed student loans etc. This has lead to skyrocketing health care costs and tuition fees. When government gets involved and starts pumping in huge amounts of money, prices will shoot through the roof.
Of course, the whole idea that government officials would know which “good things” to spend money on is highly doubtful. Their record on capital allocation isn’t exactly stellar. It is of course impossible for any one person or group of people to determine what things are “good”, especially in such a huge and complex economy as that of the US. This is the very essence of Hayek’s pretence of knowledge, not to mention that such a system would all but destroy the last remnants of State’s rights and local government.
When talking about the inflation issue, Mr. Zarlenga also fails to remember that rising prices can also manifest through preventing prices from falling. This means that even if the continual money printing by the government wouldn’t translate into higher prices, it would prevent prices from falling, which they otherwise would, if the money supply stays the same. A good example of this phenomenon are the roaring 1920s, when the price level remained more or less stable despite a 70 percent increase in the money supply. The inflation was offset by the increased output, but had there been no increase in the money supply, the prices would have fallen significantly. This is illustrated by latter half of the 19th century, a time during which American industry flourished and output increased, but the money supply remained relatively stable. The consequence was an extended period of falling prices.
Democratic watchdog
Mr. Zarlenga argues that the voters will hold the politicians and the bureaucrats accountable for the mistakes they make, and punish them at the ballot box. Theoretically, this is of course true in a democracy. However, the voters have that same theoretical power now, and have had it for a long time. But when has the political class ever been held accountable? When was the last time the government was truly held accountable for its atrocities? The Revolutionary War? And even if democracy works, the politicians can only be voted out of office every two, four or six years. The bureaucrats remain. This is plenty of time to make disastrous decisions, not to mention that those who replace the incumbents are likely to an equally bad job. This has been the case for the last 200 years or so, with maybe a few exceptions.
A good and very relevant example of this is the infamous debt ceiling, which supposedly is there to limit government spending by limiting the national debt. We all know that the debt ceiling is a dead letter. Every time Congress even comes close to reaching it, they vote to raise it. Just recently, the debt ceiling was raised by 1,9 trillion dollars. There is no reason to think that Congress or the White House would be any more responsible with the printing press. First, they would be free to set the amount of how much new money they’d be allowed to print each year. Second, should they hit the limit, they could just vote to increase it, the same why they keep raising the debt ceiling.
Protecting productive debtors
To be fair, Mr. Zarlenga does say that the value of the money should be held relatively stable. Some inflation, a percent or so a year would be good, however, because inflation favours the debtors. Since debtors generally are the producers, as Mr. Zarlenga claims, it makes sense to favour them over creditors, who by that logic generally don’t produce anything themselves. Should the value of the money increase, it would hurt the productive debtors, because the value of their debts would also increase.
This is of course true. An increase in the value of the money favours creditors the same way a decrease in the value of the money favours debtors. However, there is an easy solution to the debtor’s problem, a mechanism that is already in place. Today, we adjust entitlements (e.g. pensions, grants, financial considerations etc) for inflation, meaning that fixed incomes are increased by a certain percentage following changes in various indices such as the CPI. This practice could work the other way around. Lenders could compete by offering indexed debt reductions to reflect the increase in the value of the money.
Gold doesn’t work
Mr. Zarlenga briefly touched on the subject of the Bank of Amsterdam. He states that the bank was a gold deposit bank and it showed that gold doesn’t work as a money system. This because it was done at a time when the gold supply rose faster than ever. Gold and silver supply rose with 400%, chiefly due to imports from South and Central America, and so did prices. This was bad.
This is a very interesting statement by Mr. Zarlenga. He specifically points to the problem of a large increase in the gold and silver (i.e. money) supply, which in turn lead to higher prices, as evidence that gold and silver can’t work as a money system. He doesn’t mention that the influx of precious metals from the Americas subsided relatively quickly, making the gold and silver supply stable again. In other words, a sharp, one time increase in the money supply is bad, but a substantial, annual increase is good. I admit freely that I really don’t understand the reasoning here.
Conclusion
In my opinion, this interview showed pretty clearly that while Mr. Zarlenga may very well be a capable historian, theory isn’t his strong suit. He is very convincing when he talks about strictly historical matters, what happened when and where. He talks a lot about monetary theory, but he never really tries to support his views with that theory. His response to the inflation issue shows this. You can’t sweep aside the most obvious risk inherent in the system you are proposing by saying that all the politicians and bureaucrats need to do is to spend money on the right things, on “good” things. That doesn’t hold up to scrutiny even if you only look at it from an empirical, historical perspective.
Another thing you can’t do if you want to retain intellectual credibility is to claim that Austrians don’t check the facts, that they don’t study history. Murray Rothbard was almost as much a historian as he was an economist. He produced encyclopedic historical works. Even his economics books include a fair share of history. Austrians have always highlighted the importance of history, and not few of the most prominent Austrians today are historians. Mr. Zarlenga has written one book of 700 something pages. That is no small feat to be sure, but one 700-page book pales in comparison to the vast body of historical literature produced by the Austrian School.
Mr. Zarlenga and Mr. Irvin underline the importance of reading someone’s work before one criticizes it. I agree, one should do that, which is why I’ve always been clear on exactly what I am criticizing, i.e. the proposed monetary system. Mr. Zarlenga, on the other hand, launches sweeping attacks against the whole Austrian School, but for all his research, it seems clear that he really doesn’t know what he is attacking, because he hasn’t read it.
That said, I maintain that there is a lot of common ground here. Both Mr. Zarlenga and myself agree that the present system doesn’t work. What we don’t agree on is what we should replace it with. However, that is an argument neither side can win simply by pointing at certain historical events. The case for sound money vs. government paper money must be made on the theoretical level. I’ve heard Tom Woods make the case for sound money in 30 minutes. Zarlenga has now had more than three hours to make the case for government paper money. In my opinion, he hasn’t even tried.
vindician:He claims there is a way to avoid rising prices despite the constant printing of new money. How could this be achieved? Why, it is simple, the government simply has to spend the newly printed money on “good things”, i.e. things that lead to increased productivity, output and general welfare.
You don't need to resort to the "pretense of knowledge" to refute this nonsense. His argument ignores entirely the roll of real savings in the capital structure of the economy.
Even if the government had an entrepreneurial crystal ball, prices would rise for the simple fact that the new money does not constitute new savings. All the government can do with this new money is bid away available resources for its own entrepreneurial endeavors. No new resources were made available on the account of the issuing of new money, so even in Mr. Zarlenga's magic world of smart government planning, prices must rise due to the increase in money supply.
I am always tempted to just dismiss people like Mr. Zarlenga, and some of the other cranks like Ellen Brown, and just ignore them. However, then I remember that Keynes himself was just as a crank as any of them.
The reincarnation of Silvio Gissel!
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."