# GOVERNMENT PAPER MONEY - The Mystery of Banking

The inventions of paper and printing gave enterprising governments,always looking for new sources of revenue, an “OpenSesame” to previously unimagined sources of wealth. The kings had long since granted to themselves the monopoly of minting coins in their kingdoms, calling such a monopoly crucial to their“sovereignty,” and then charging high seigniorage prices for coining gold or silver bullion. But this was piddling, and occasional debasements were not fast enough for the kings’ insatiable need for revenue. But if the kings could obtain a monopoly right to print paper tickets, and call them the equivalent of gold coins, then there was an unlimited potential for acquiring wealth. In short, if the king could become a legalized monopoly counterfeiter,and simply issue “gold coins” by printing paper tickets with the same names on them, the king could inflate the money supply indefinitely and pay for his unlimited needs.

If the money unit had remained as a standard unit of weight, such as “gold ounce” or “gold grain,” then getting away with this act of legerde main would have been far more difficult. But the public had already gotten used to pure name as the currency unit, an habituation that enabled the kings to get away with debasing the definition of the money name. The next fatal step on the road to chronic inflation was for the government to print paper tickets and, using impressive designs and royal seals, call the cheap paper the gold unit and use it as such. Thus, if the dollar is defined as 1/20 gold ounce, paper money comes into being when the government prints a paper ticket and calls it “a dollar,” treating it as the equivalent of a gold dollar or 1/20 gold ounce.

If the public will accept the paper dollar as equivalent to gold, then the government may become a legalized counterfeiter, and the counterfeiting process comes into play. Suppose, in a certain year, the government takes in $250 billion in taxes, and spends$ 300 billion. It then has a budget deficit of $50 billion. How does it finance its deficit? Individuals, or business firms, can finance their own deficits in two ways: (a) borrowing money from people who have savings; and/or (b) drawing down their cash balances to pay for it. The government also can employ these two ways but, if people will accept the paper money, it now has away of acquiring money not available to anyone else: It can print$50 billion and spend it!

A crucial problem for government as legalized counterfeiter and issuer of paper money is that, at first, no one will be found to take it in exchange. If the kings want to print money in order to build pyramids, for example, there will at first be few or no pyramid contractors willing to accept these curious-looking pieces of paper. They will want the real thing: gold or silver. To this day,“primitive tribes” will not accept paper money, even with their alleged sovereign’s face printed on it with elaborate decoration. Healthily skeptical, they demand “real” money in the form of gold or silver. It takes centuries of propaganda and cultivated trust for these suspicions to fade away.

At first, then, the government must guarantee that these paper tickets will be redeemable, on demand, in their equivalent in gold coin or bullion. In other words, if a government paper ticket says“ten dollars” on it, the government itself must pledge to redeem that sum in a “real” ten-dollar gold coin. But even then, the government must overcome the healthy suspicion: If the government has the coin to back up its paper, why does it have to issue paper in the first place? The government also generally tries to back up its paper with coercive legislation, either compelling the public to accept it at par with gold (the paper dollar equal to the gold dollar), or compelling all creditors to accept paper money as equivalent to gold (“legal tender laws”). At the very least, of course, the government must agree to accept its own paper in taxes. If it is not careful, however, the government might find its issued paper bouncing right back to it in taxes and used for little else. For coercion by itself is not going to do the trick without public trust (misguided,to be sure) to back it up.

Once the paper money becomes generally accepted, however, the government can then inflate the money supply to finance its needs. If it prints $50 billion to spend on pyramids, then it—the government—gets the new money first and spends it. The pyramid contractors are the second to receive the new money. They will then spend the$50 billion on construction equipment and hiring new workers; these in turn will spend the money. In this way, the new $50 billion ripples out into the system, raising demand curves and individual prices, and hence the level of prices, as it goes. It should be clear that by printing new money to finance its deficits, the government and the early receivers of the new money benefit at the expense of those who receive the new money last or not at all: pensioners, fixed-income groups, or people who live in areas remote from pyramid construction. The expansion of the money supply has caused inflation; but, more than that, the essence of inflation is the process by which a large and hidden taxis imposed on much of society for the benefit of government and the early receivers of the new money. Inflationary increases of the money supply are pernicious forms of tax because they are covert, and few people are able to understand why prices are rising. Direct, overt taxation raises hackles and can cause revolution; inflationary increases of the money supply can fool the public—its victims—for centuries. Only when its paper money has been accepted for a long while is the government ready to take the final inflationary step:making it irredeemable, cutting the link with the gold. After calling its dollar bills equivalent to 1/20 gold ounce for many years, and having built up the customary usage of the paper dollar as money, the government can then boldly and brazenly sever the link with gold, and then simply start referring to the dollar bill as money itself. Gold then becomes a mere commodity, and the only money is paper tickets issued by the government. The gold standard has become an arbitrary fiat standard. The government, of course, is now in seventh heaven. So long as paper money was redeemable in gold, the government had to be careful how many dollars it printed. If, for example, the government has a stock of$30 billion in gold, and keeps issuing more paper dollars redeemable in that gold, at a certain point, the public might start getting worried and call upon the government for redemption. If it wants to stay on the gold standard, the embarrassed government might have to contract the number of dollars in circulation: by spending less than it receives, and buying back and burning the paper notes. No government wants to do anything like that.

So the threat of gold redeemability imposes a constant check and limit on inflationary issues of government paper. If the government can remove the threat, it can expand and inflate without cease. And so it begins to emit propaganda, trying to persuade the public not to use gold coins in their daily lives. Gold is“old-fashioned,” out dated, “a barbarous relic” in J.M. Keynes’s famous dictum, and something that only hicks and hillbillies would wish to use as money. Sophisticates use paper. In this way, by 1933, very few Americans were actually using gold coin in their daily lives; gold was virtually confined to Christmas presents for children. For that reason, the public was ready to accept the confiscation of their gold by the Roosevelt administration in 1933 with barely a murmur.