Gresham's law, extended by force

A few weeks ago, a man by the name of Bernard von NotHaus was in the news. If you Google the phrase "unique form of terrorism", you can read all about him. In short, he minted coins in a variety of metals and offered to "exchange" them for Federal Reserve Notes -- those pieces of paper you carry around in your wallet, usually referred to as "money". (His original site is here, but Wikipedia is probably the best place to start if you want to know more.) In 2007, the government arrested Mr. von NotHaus and charged him with a number of crimes amounting to "counterfeiting". He wasn't actually minting pennies, nickels, etc.; he was simply minting coins in denominations similar to U.S. currency that the government claims bears too close of a resemblance to official U.S curency. The government accused him of trying to "replace" the official currency of the U.S. He was eventually convicted of these "crimes", with the government going so far as to declare him a terrorist, and his case is now on appeal.

This whole episode seemed to me to be an interesting application of Gresham's law. Gresham's law is the idea that "bad" money chases out "good" money. What that means is that if there are both "bad" and "good" money in an economy, the good money will eventually disappear from that economy. Since anything could be money (as Lew Rockwell points out: shoes, shells, flash drives, or books) and people can assign whatever value they want to that money, how do we define good vs. bad? That's where the government comes in. Instead of the people assigning value to their money, the government has assumed that role (and the authority to occupy that role). Thus, Gresham's law is more accurately stated as (looking again to Wikipedia): bad money drives out good if their exchange rate is set by law.

Let me give you a personal example of how this is so. Just last week, I was cleaning up one of the bedrooms in my home when I came upon a container full of coins. They weren't particularly special in any way; it was just the type of accumulation that occurs when you come home at the end of the night and toss the change in your pocket into a jar. Thinking I might come across some rare coins -- I was hoping for some old pre-1964 silver coins -- I decided to sort through them. I happened to know that pennies used to be made of copper and nickels, of all things, of nickel and copper. A quick Internet search turned up the fact that pennies were made out of copper up until 1982 and that nickels are still made out of copper and nickel. It also revealed that copper pennies are currently worth approximately 3 cents each and nickels about 6 cents. These coins are worth more as metal than the value given to them on their face. You can probably guess what happened next. I put all of the nickels and pre-1982 pennies into a separate pile. The rest are slated to go off to the local Coinstar machine.

Let me give you another, more obvious example. Let's say the government issues two one ounce coins, one in silver and one in gold, and stamps $50 on their respective faces so that each can be exchanged for $50 in goods. Would you spend the silver coin or the gold coin? Hopefully, you answered, "silver". At current spot prices, an ounce of silver is worth just under $40 while an ounce of gold is a bit over $1,400. When a monetary unit's face value exceeds its intrinsic value, as the silver does in the example, it is "bad" money. It will be spent, i.e. stay in circulation, as the spender believes he/she is getting a "deal" since the seller is forced by law to value the unit greater than the worth that would otherwise be assigned to it by the "market". Gold, whose intrinsic value exceeds its face value in the example, would leave circulation as people would hoard it and/or try to sell it for its intrinsic worth (i.e. they could obtain it for $50 but sell it for almost 30 times as much). This would likely remain true so long as the gold's intrinsic worth exceeds the face value, no matter how slight that excess might be. Even if gold was intrinsically worth less than its face value but still more than the silver, you would still find the silver to be in much greater circulation than the gold for the reasons explained previously.

So, what does all of this have to do with Mr. von NotHaus's situation? Let's first (try to) understand exactly what it was he was doing. To the best of my understanding, a silver Liberty Dollar one-ounce coin would be minted with some denomination on it, let's say $10. It would be produced so long as the intrinsic value of the silver in the coin remained under $10 as denominated in official U.S. currency and sold/exchanged for $10 in official U.S. currency. When the intrinsic value of the coin exceeded $10 (in U.S. currency, due to inflation of the U.S. dollar), Mr. von NotHaus would mint one-ounce silver coins with $20 stamped on their faces (and sell them for the $20 in U.S. currency). He would also exchange existing $10 coins for $20 coins. Based on the previous paragraph and definition(s), Mr. von NotHaus was actually creating his own form of "bad" money, with one important difference. There was a limit to how bad his money would get.

Let me explain this with another example. Let's say that you have a $10 bill (official U.S. currency) and a $10 Liberty Dollar which, for the sake of argument, is accepted at the stores at which you shop. Let's further assume that the food you'll eat today costs $10. Now, let's say that you stick both the coin and the bill under your mattress and wait some amount of time, during which the dollar inflates due to the Federal Reserve's money printing processes. You dig your coin and your bill out from under the mattress and go to the store only to find that the $10 worth of food you want to buy now costs $20. The $10 bill will only buy you half of what you want. On the other hand, Mr. von NotHaus will exchange your $10 Liberty Dollar coin for a $20 version, and you can buy all of your food.

As I mentioned before, Mr. von NotHaus's Liberty Dollar is still "bad" money since its face value would always exceed its intrinsic worth. However, at the point at which it becomes "good" money, the holder would actually be able to exchange it for more "bad" money, i.e. when a $10 piece's intrinsic worth becomes worth, say, $12, it could be exchanged for a $20 piece, a much better option than selling the coin for $12. In this way, while "bad" by our earlier definition, this money is a "better" option than the official U.S. currency which always loses value over time.

If the Liberty Dollar was "better", wouldn't it have eventually been naturally forced out by the market via Gresham's law? It's hard to say; that's (unfortunately) the way markets are. Markets are made up of individual actors, or people. People may have seen the Liberty Dollar as a better preserver of their wealth since it could be exchanged for greater denominations as the U.S. dollar fell in value. Had that been the case, the Liberty Dollar may have taken off. And this would not necessarily have been a violation of Gresham's law. It turns out that "good" and "bad" money (under Gresham's law) can only be compared when their values are both fixed by (the same) law. While von NotHaus may be creating "bad" money in an absolute sense, it would likely have been viewed as "better" than the current U.S. currency. Since the exchange rates of both monetary units are not set/fixed by (the same) law, it may have been possible for the "better/good" money to chase out the "bad".

Thus, the U.S. government extended Gresham's law by force. If another monetary system -- one not controlled by the federal government -- took off, the federal government's ability to print money to pay off its debt and fund its operations would have been severely limited, if not outright destroyed. I'm not sure exactly how to sum up the idea that challenges to a government-created fiat money system will be put down with force in a neat "law" like Gresham's, but if you have any ideas, feel free to share them in the comments.

***

Lew Rockwell wrote about this particular issue and had a few choice quotes:

A nation that is confident about its money’s future would not fear currency competition. A nation with a dying money uses every possible means to crush the competition.

and

[...] when the dollar became all paper, there has been a sense that its viability needs the backing of federal guns in order to thrive. This attitude is inconsistent with freedom. The right of private coinage is an essential part of free enterprise. Currency competition, especially in a digital age, is something that every country needs.

***

Bill Rounds also wrote about this issue. I think he makes a good case that Mr. von NotHaus drew the ire of the federal government, not necessarily by competing with the government, but by making his coins look a little too similar to real U.S. currency. He points out:

There are all kinds of alternate currencies in circulation in the US. Ithaca Hours, Potomacs, gift certificates, and Chuck E. Cheese tokens can all be used to barter and transact instead of legal tender coins and bills.

None of those coins have been or are being forced out of existence by the federal government. Arguably, they aren't trying to compete with the government, either, though.

It's not clear to me, from what I've read, that Mr. von NotHaus intended to defraud people or imply that his coins were legal tender or official U.S. currency. From what I can tell, he was simply trying to give them the same value as U.S. currency to make them easy to understand and trade. In the end, I have to agree with Lew Rockwell when he points out that the U.S. Constitution nowhere prohibits private coinage and even points out that it was commonplace during the settling of the West. Mr. Rounds even acknowledges that the law is, at best, nonsensical:

[...] the state of monetary law is almost nonsensical. Court opinions, federal statutes and the Constitution are logically inconsistent with one another.

***

Finally, I hope that the example I gave of a $10 Liberty Dollar round being exchangeable for a $20 round as the U.S. dollar depreciates drives home the idea of the inflation tax. By depreciating the dollar, the government is essentially stealing money from people who hold cash. This is why our economy is driven by consumption instead of saving. If your dollar is worth less tomorrow than today, then it makes sense to spend it instead of saving it.

"Saving" capitalism

[I wrote the following in response to a friend who posted this article on his Facebook page. I apologize for the lack of annotated links in this post.]

The article starts by blaming Bush for a declining market. That's not really fair. Obama is doing exactly what Bush was doing when he left office (stimulus/bailouts). That is, if Bush had been President for two more years, the economy would likely be in the exact same place it is today. 9/11, coupled with the bursting tech bubble, is what originally sank the economy. Greenspan then held interest rates down, and the Dow Jones was back up to around 14,000 in late 2007. (How's that for one-sided reporting on the author's part... only pointing to the Dow at 8,500 on Bush's last day.) Greenspan's plan backfired, though. The low interest rates created a bubble in the housing market leading to all kinds of crazy gimmicks on the banks' parts. These fell apart in late 2007, and the market tanked again.

In response, the government began bailing out banks, the auto industry, anyone who could get get their hands into the proverbial cookie jar. Bush and Obama both did it, and it was a bad idea both times. Neither of them "saved" capitalism. The problem is that neither of them (or anyone in the government) has the backbone to let capitalism do its job. Capitalism means failure for those who can't compete and for those who do it fraudulently. The bailed out auto companies fall into the first category; the banks and insurance companies subsidizing their schemes fall into the second. Of course GM and Chrysler are making cars again! The government gave them the money to do it, and the government did it because it was politically better to try to save jobs (or at least that was the thinking at the time). Nothing about that investment other than the perceived political upside was a good thing at the time. To argue now that the fact that the government made (or possibly will make) money means the investment was a good one is to argue that the ends justify the means. That is the last argument anyone should apply to the state in any of its dealings.

The problem with the economy now is that Bernanke is making the same mistake(s) that Greenspan made. He's holding interest rates down at zero. (Remember the housing bubble? Why does no one see that Bernanke's cure is actually more of the poison?) Bernanke's got huge problem, though. The low interest rates aren't working. Banks are hoarding the cash because they still have more toxic assets on their books. What's his solution? He's turned on the printing presses and is using the new money to buy U.S. Treasuries in the hopes of bringing down long term interest rates. He claims he can do this because inflation is tame. That's because banks are hording the cash he's printing. Gold is continuing to rise in price, though; the market knows what is going on. Look also at other commodities like cotton, oil, etc. They're fairly stable now, but that's because producers hedge their bets by buying futures. Come Spring/Summer of next year, prices of those items are going to skyrocket (the same effect could probably be achieved by banks finally beginning to lend again all at once), and Bernanke won't be able to stop it. He can't raise interest rates like Volcker did, because unemployment is already high. (Volcker had the luxury of being able to drive unemployment up with interest rates so he could tame inflation.) The other alternative is that China stops buying up U.S. Treasuries (it's already making noises about doing that very thing) or the entire market just loses faith in the entire system (i.e. the government's ability or intention to repay its debt). When, not if, one of those things happens, the economy is going to collapse, not just tank. Think hyperinflation like in Chile in the 70's.

Yes, it would have been bad if the government had not intervened in the economy, but the government's "saving" of capitalism makes each attempt by the market to flush out the bad stuff even worse than the previous one because it (the government) won't actually let the bad stuff be flushed out. The government isn't saving capitalism. It is destroying it by making everyone think that what we have is capitalism.

[Here are some other witticisms that I sprinkled later on in the thread.]

In response to a comment that Democrats lost the midterms because Obama/they failed to get the message out:

Getting the message out is not leadership. It's politics. And we don't need either.

And in response to a comment that Americans "got it right" in this most recent election:

Americans never get it right in any election. The government keeps getting elected.

Empire and its imminent demise

Glenn Greenwald writes today that the U.S is a collapsing empire. As evidence, he points to a number of surveys and studies showing the rapid decline in life expectancy, infant mortality, literacy in math and science, and the "soundness" of our banks and, by extension, financial system. He wrote a column a few months back on the same topic, though the examples provided there were more direct. On the bright side, though, he points out in the current column that the U.S. is only fifth in the world in executions and continues to best all comers in incarceration rates.

In addition, a few days ago, Ron Paul said that he thinks that a collapse of the U.S. currency system is "95% likely" and that a war with Iran would only hasten its demise. This all has a very "the sky is falling!" ring to it, but look back at the bank "soundness" rankings, mentioned earlier. The U.S. ranks 108th in the world, out of 133 countries on the list. That puts it 63 places behind Greece, a country that just received a 146 billion dollar bailout from the EU.

Peter Schiff, on a related subject, writes about the massive inflationary expedition on which the Federal Reserve is about to embark. Even I wrote about this a week or so ago. Unlike me, Mr. Schiff researches and writes about this stuff for a living (and does quite well at it), so when he speaks, it's probably a good idea to listen. Aside from the normal, "gold, silver, and commodities are rising; the dollar is falling" talk, he explains why bonds are currently acting the way they are:

A confounding factor is the strong performance of US dollar-denominated bonds. When the Fed creates inflation, that erodes the value of fixed-asset investments like bonds, which can't adjust their returns to the new price level. So many commentators are pointing to the record low bond yields as evidence that inflation is not a threat. But this is a misreading of the situation.

What is overlooked is that when the Fed prints more dollars, it typically uses them to buy bonds. Traders know this, so they are stocking up on bonds at ridiculous prices just to flip them to the Fed. They don't care that, in the long run, the Fed's policies will destroy the bonds' value because in the short run, the weak dollar policy serves as a tremendous subsidy to bond sellers.

I'll leave you with this quote, attributed to George Washington, and let you draw your own conclusion(s) about where our government is headed:

The last official act of any government is to loot the treasury.

Gold, subsidies, and syphilis

There were a number of news stories that caught my attention today, and I decided to just lump them all into a single post. I'm sure at least two of them will get better treatment in the future.

Gold

Gold reached another high yesterday against the the U.S. dollar. Many seem to be blaming the weak dollar and actions by the Federal Reserve. The Fed over the last few days and weeks has been hinting that it may embark on another round of quantitative easing or QE. Wikipedia has a pretty good explanation of QE, but in the most basic terms, the Fed is preparing to print more money. Lest you think that the rise in gold is a strictly U.S.-related phenomenon, take a look at this chart. Inflation and/or economic troubles/concerns seem to be widespread.

Subsidies

Yesterday, I was able to catch various pieces of Marketplace on NPR while driving through the hills. The station cleared up enough for me to catch this particular piece. The government, as part of its "stimulus package" has been giving money to private businesses to induce them to hire people. It sounds like a good plan, but here is the problem: the government is distorting the market. By providing subsidies, the government is causing businesses to hire and expand because there is no financial risk to not doing so, not because the economy can actually support that expansion.

I have a number of problems with this, but let me just leave you with this thought: If this policy is good for the economy, why not keep it going?

Syphilis

For those who didn't know (and I have to include myself in that group), the U.S. government deliberately infected Guatemalan prison inmates with syphilis back in the 1940's as part of an experiment to test the effectiveness of penicillin in the prevention of the disease. Well, yesterday, Health and Human Services Secretary Kathleen Sebelius and others issued an apology for U.S. participation in those experiments. Perhaps these people can expect an apology sometime around the turn of the next century?