What is money? Money means different
things to different people. On Main Street it may mean
the dollar bills in a wallet or the cash balance in
a checking account. On Wall Street it represents the
electronic digits in the interbank settlement system.
To others money represents credit, the ability to buy
a home with a mortgage, access cash through a credit
line, or the ability to purchase goods with a credit
card. Ask different people what money represents and
you will get a wide variety of answers.
In todays complex financial world the concept
of money gets lost in translation in the day-to-day
affairs of commerce and living. Somewhere along the
road of history as complex societies evolved mankind
shifted from direct to indirect exchange in order to
expand and conduct trade. The basic problem with direct
exchange (barter) is that it lacked indivisibility
and coincidence of wants. Under direct
exchange you could only conduct trade if both parties
to a trade desired the other's goods. Because commerce
needed a system of payment that transcended direct exchange,
money was invented as a medium of exchange. As societies
evolved and the division of labor became more complex,
the diverse needs and wants of the economic system became
more refined. The invention of money allowed a market
to develop for the trading of goods and services that
was able to meet the needs of developing societies.
Gradually money developed into a medium of exchange
used in trade. The invention of money allowed society
to expand and extend beyond the limits of an individual
household to that of a nation and indeed the whole world.
Money solved the two basic problems created by barter,
which were indivisibility and the coincidence
of wants. Money became a unique commodity used
to transact trade and commerce between diverse cultures
and nations. A secondary function of money was that
it also facilitated credit transactions which were simply
the exchange of present goods for future goods.
What we learn about money is that it was
a commodity in its own right, with its own unique properties.
As Rothbard states, "Money is not an abstract unit
of account, divorceable from a concrete good: it is
not a useless token only good for exchanging: it is
not a 'claim on society': it is not a guarantee of a
fixed price level. It is simply a commodity. It differs
from other commodities in being demanded mainly as a
medium of exchange. But aside from this, it is a commodityand
like all commodities, it has an existing stock, it faces
demands by people to buy and hold it, etc. Like all
commodities, its 'price'in terms of other
goods--- is determined by the interaction of its total
supply, or stock, and the total demand by people to
buy and hold it."  [Emphasis added]
The best explanation of the origin and role of money
is given by the Austrian school of economics. For we
have no definitive or historical event as to its origin.
No king issued an edict that created money nor is there
some inventor who is credited with its invention. The
Austrian economists Carl Menger and Ludwig von Mises
have given us the best explanation as to the origin
and development of money. According to Menger, moneys
origination was spontaneous. No king, government, or
person created it. The origin and development of money
came into being through barter. Eventually, as trade
developed, one particular commodity became more desirable
to own than another. Items such as wheat may be more
desirable than a ceramic vase, and a metal that was
durable might be more desirable than a bushel of grain.
Before there was money, there was credit.
Credit preceded the coining of money. Historical documents
dating back to the Sumerian civilization, circa 3000
B.C., reveal that the ancient world had developed a
formalized system of credit based on two major commodities,
grain and silver. Before there were coins, metal loans
were based on weight. Archaeologists have uncovered
pieces of metal that were used in trade in Troy, Minoan
and Mycenaean civilizations, Babylonia, Assyria, Egypt
and Persia. Before money loans came into existence loans
of grain and silver served to facilitate trade. Silver
was used in town economies, while grain was used in
the country. For nearly 2,500 years throughout Sumerian
and Babylonian history, the rate of interest on grain
and silver loans remained constant. The customary rate
of interest on a barley loan was 33 1/3% and for a loan
of silver it was 20%. 
Although interest rates would occasionally vary, the
legal maxima embodied in the Code of Hammurabi, established
33 1/3% per annum on loans of grain and 20% on loans
of silver. These rates lasted for more than 2,500 years.
THE BIRTH OF MONEY
Eventually, the demand for a certain type of good outstripped
the demand for other commodities. In matters of trade
certain type of commodities were in high demand and
became universally accepted in trade between buyers
and sellers. As explained above, loans of silver and
base metals were already used as a means of facilitating
credit. Eventually precious metals emerged as the commodity
of choice. At this point money came into existence as
a commodity used as a medium of exchange.
The official birth of coined money was around the first
millennium B.C. It is believed to have originated in
Lydia in the seventh century B.C. King Croesus of Lydia
(560-546 B.C.) has been credited with coining gold and
silver ingots. Eventually, the innovation of stamped
metal coins spread to the Greek world. Because the Greeks
developed an urban economic system based on commerce
a money commodity became necessary to facilitate trade.
From this point forward, the use of precious metals
as money used to conduct commerce was institutionalized
between the developed societies of that day and has
been used ever since. In matters of commerce, silver
was used for smaller exchanges, while gold was used
for larger transactions.
The reason that silver and gold began to be used as
money was based on their unique characteristics. The
use of money required several properties. It had to
be divisible. It had to have utilitarian value separate
from the whims of any king, emperor, or government.
It had to be durable. It couldnt perish or be
consumed. It also had to be relatively scarce to maintain
its value. Finally, it had to be made of material that
was ductile and malleable. Both silver and gold held
these properties, which is why they began to be used
as money. Ludwig von Mises tells us, "For hundreds,
even thousands, of years the choice of mankind has wavered
undecided between gold and silver. The chief cause of
this remarkable phenomenon is to be found in the natural
qualities of the two metals. Being physically and chemically
very similar, they are almost equally serviceable for
the satisfaction of human wants.
Universal Standards of Value
Because of the necessities of trade, standardized weights
and measures had to be developed. Here again Ludwig
von Mises clarifies through his theories on money
that the reason why individuals began to value money
was because they expected money to hold its value. This
meant purchasing power. People would only surrender
goods or provide services in the present only if that
money unit could be expected to purchase the same goods
and services in the future. Money functioned as a medium
of exchange only if it maintained its purchasing power.
A standard weight and measure had to be maintained or
else money ceased to function as a medium of exchange.
Eventually, standardized weights and measures were
developed for the coins of each country. The shape and
size of the coin made no difference. What mattered was
its content. Various coins of different nations were
valued on the basis of their silver and gold content.
The coins that maintained their silver and gold content
became the coins of preference used in commerce. Any
nation that expected to grow and expand its economy
needed to maintain the standard of its money.
THE DEBASEMENT OF MONEY
As the use of money became widely used in commerce,
standards of value were established trade and commerce
flourished. As long as honest weights and measures were
used, trade between nations and between peoples went
on unencumbered. However, eventually kings, emperors
and their governments began to debase their money. In
order to finance a war, build monuments or palaces,
or fund welfare programs, rulers required larger amounts
of money. Wars were costly and could not always be funded
through taxes. The money required to pay soldiers, buy
armaments, and finance a campaign often required additional
methods of financing. If the government couldnt
raise the money through additional taxes on its people,
governments learned the art of debasing their currency.
In the ancient world before the invention of printing
presses, emperors and kings resorted to nefarious ways
to fool their own people. The common measure used to
debase their own currency was through coin clipping
and mixing inferior base metals into gold and silver
coins. The government would simply chip away a part
of a silver or gold coin and appropriate the shavings
for itself. The shavings would then be melted down and
made into new coins, which would increase the supply
of money without having to mine more of it.
Another measure used was reissuing new coins that had
lower amounts of silver and gold content. Lesser valued
base metals such as copper would be mixed in with the
silver and gold. Governments would also issue smaller
size coins and declare they had the same value as the
larger coins. Clipping, shaving, mixing base metals
in coins became the standard method used by governments
to inflate the money supply. No matter the method used
to debase the currency, governments tried to fool the
people hoping that nobody would notice. Eventually the
populace caught on. The additional supply of money eventually
drove up the price of goods. The price of everything
went up as a result of additional demand brought on
by an artificial increase in the supply of money.
An important concept to understand as it relates to
money unlike other commodities is that an artificial
increase in its supply confers no social benefit. The
price of moneylike any other commodityis
by eternal laws of supply and demand. Like any other
commodity an increase in its supply lowers it price.
Conversely an increase in demand raises its price. As
Rothbard reminds us, What makes us rich is an
abundance of goods, and what limits that abundance is
a scarcity of resources: namely land, labor, and capital.
Multiplying coin will not whisk these resources into
being. We may feel rich for the moment, but clearly
all we are doing is diluting the money supply
Thus we see that while an increase in the money supply,
like an increase in the supply of any good, lowers its
price, the change does notunlike other goodsconfer
a social benefit. Whereas new consumer or capital goods
add to standards of living, new money only raises pricesi.e.
dilutes its own purchasing power. The reason for this
puzzle is that money is only useful for its exchange
its utility lies in its exchange value, or
What is even more important is that when money is depreciated,
it leads to the moral and economic decay of a country.
In the final days of the Roman Empire, its currency
was depreciated repeatedly by successive emperors. During
the first century A.D. the metal content of Roman coins
was reduced by 25%, and during the second century A.D.
it was reduced substantially more. Silver coins were
reduced to the status of token coins. In the third century
A.D. monetary inflation on a grand scale accompanied
a succession of revolutions and civil wars
chaotic years, fifty years before Diocletian, 284-305
A.D. were, in the opinion of Tenney Frank, the period
when Rome fell. There was anarchy and looting. Provincials
lost faith in Rome. Industry and trade disintegrated,
and even the Latin speech decayed. As a reminder
of this truth I have on my desk at home a collection
of Roman coins from the 3rd and 4th centuries. The coins
feature the portraits of the last twenty Roman emperors.
The coins are all bronze.
Debasement and Inflation: Modern Methods
For thousands of years of recorded history silver and
gold served as money. Eventually, as commerce and trade
expanded, money substitutes began to replace silver
and gold. In order to facilitate large transactions,
it became too cumbersome to carry and transport large
gold deposits. Gold warehouses were created. Owners
of gold deposited their gold at a warehouse (later banks)
and received a warehouse receipt for their gold. The
warehouse receipt entitled the owner of that receipt
to demand payment of his gold at any time. The warehouse
or bank in this case made its money by charging a storage
fee. Eventually, as commerce and trade expanded, warehouse
receipts representing stored gold came into use more
frequently. The transfer of warehouse receipts replaced
the transfer of gold.
These warehouse receipts eventually evolved as money
substitutes and the modern era of banking was born.
Eventually, paper money backed by gold and silver served
as money in transacting commerce on a larger scale.
Silver and gold coins still functioned and were used
as money in day-to-day transactions by the common man,
but in matters of commercial trade letters of credit,
claims on bank deposits became commonplace. Instead
of the transfer of paper receipts, the transfer of title
or a book claim on the bank took their place. The owner
of the claim had an ownership right in the stored gold
at the bank. Thus the modern era of paper money and
banking came into existence. As long as depositors had
faith in the bank or currency of a country and a standard
of value was maintained, the system functioned and prospered.
Standards of value erode over time.
What gold warehouse owners and eventually banks found
out is that the goldor in todays era, paper
depositstend to remain at the bank or warehouse
for long periods of time. Since gold deposits remained
stationary, the bankers could loan out their depositors'
gold for a profit. This in effect invalidated the gold
warehouse receipts because not all of the gold remained
on deposit. If all of the owners of the gold showed
up at once and demanded their gold the bank or warehouse
would be in default. This is what happens when there
is a bank run today. When the owners of money demand
withdrawal, the bank no longer has the gold [prior to
our going off the gold standard] or paper money to satisfy
all depositors claims. As of June 2004, bank reserve
requirements are only 10% on transaction deposits in
the U.S. Reserve requirements on time deposits and savings
accounts are zero.
Fractional Reserve Banking System
By adopting a fractional reserve banking system, the
money supplyand thus the standard of value of
that moneycan be expanded tenfold by every dollar
on deposit. For example, in the case of a new $100 deposit,
a bank can loan out $90 of that deposit, keeping $10
(10% reserve requirement) as a reserve. The bank receiving
that $90 deposit can also make an additional loan of
$81 keeping 10% of the deposit or $9 in reserve. This
process can continue expanding the initial deposit of
$100 into a maximum of $1,000 of new money. The process
becomes more complex since reserve requirements are
applied only to transaction accounts such as checking,
which is a component of M1. Savings accounts and time
deposits, which are components of M2 and M3, representing
broader measures of money, have zero reserve requirements.
Since time deposits and savings accounts have no reserve
requirements, they can expand indefinitely. Banks can
also expand the money supply by drawing down their reserves
and replacing their reserves through money market loans
at the prevailing cost of money (the federal funds rate).
By its very nature, a fractional reserve
banking system is inherently an inflationary institution.
Banks as shown in the example above can expand the money
supply by creating money out of thin air.
They enjoy a unique privilege under our present economic
system not available to you and me. As individuals the
only way we can expand our bank accounts is through
In addition to banks increasing the money supply by
expanding loans made through deposits, the government
can also expand and depreciate the money supply through
debt monetization. When a government needs money, they
have three ways of obtaining it. 1) they can get the
money by raising taxes, 2) they can issue debt, or 3)
they can issue debt that is monetized by its central
bank. In its simplest form, debt monetization is simply
the government issuing bonds, which are bought by the
central bank. The central bank buys the bonds by creating
money "out of thin air. The Fed did not earn
or save to get the money used to purchase the governments
bonds. They simply created it out of nothing. This is
commonly referred to as printing money. It is an anachronism
left over before the era of computers and digital money.
Today when the Fed purchases the governments bonds,
an electronic entry is made to the governments
bank account for the amount of money to purchase the
governments bonds. Issuing bonds does not increase the
money supply as long as existing savings are used to
purchase the bonds. It is only when new money is created
through fiat means that the money supply increases followed
by a concomitant increase in inflation.
THE ROOT OF INFLATION
As mentioned above, the government has three ways of
obtaining money. Unfortunately increasing taxes is not
a popular choice. Taxation is unpopular with the people.
The last two presidents to raise taxes in the U. S.
were George Bush senior and Bill Clinton. Bush Senior
lost his reelection bid over the tax issue and Clinton
lost Democratic control over Congress. Because taxes
are unpopular with the people, governments resort to
an indirect means of taxation. It is what we know as
inflation. If the government can find a means of expropriating
resources without the direct knowledge of its subjects,
they will do so. In effect what the government resorts
to is a form of counterfeiting. By creating money "out
of thin air, the government is creating its own
money that wasnt appropriated directly through
taxation. Counterfeiting is simply another name for
As I mentioned earlier, inflation creates no social
benefit for society. It is simply a means of redistributing
wealth from producers to nonproducers. Inflation creates
no new wealth. No new goods or capital stock are created
by it. Wealth is simply transferred to those who benefit
first from the creation of the new money. This is usually
the bankers and the financial system through fractional
reserve banking or the government through debt monetization.
It takes time for inflation to work its way through
the financial system and the economy. Those who receive
the new money first profit the most from it. By the
time the expansion of money works its way through the
system in the way of higher prices, the people are the
last to know. The inflation profiteers have long since
made their profits. Society as a whole must now bear
the cost of that inflation through higher prices.
However, in order to keep playing the game and expropriate
the people's money, the inflation profiteers must keep
the people fooled. That is why all government and central
bank actions are shrouded with an air of mystery or
secrecy. FOMC meetings are enshrined with a religious
reverence. The meetings are conducted under the air
of priestly secrecy. In his book Secrets of the
Temple, author William Greider says it well by
stating, Like the temple, the Fed did not answer
to the people, it spoke for them. Its decrees were cast
in a mysterious language people could not understand,
but its voice, they knew, was powerful and important
Publics confusion over money and its ignorance
of money politics were heightened by the scientific
pretensions of economics. Average citizens simply could
not understand the language, and most economists made
no effort to translate for them. 
To maintain the inflation game, it is important to
keep people confused. In his book Dying of Money,
author Adam Fergusson explained why the Weimar inflation
was possible. He wrote, The most notable thing
about the puzzlement of the financial world, not the
least the writers of the Frankfurter Zeitung, was complete
failure to consider the continuing flood of new banknotes
as one of the reasons for the marks behavior (depreciation).
Its latest fall was reckoned disastrous for the finances
both of the Reich and of the regional governments: all
efforts to restore order in the federal budget had been
rendered void. It meant the further impoverishment of
the classes on fixed incomes, state officials included,
and (as another newspaper feared) further recruits for
the radical circles of the Right from the 'social déclassés.
WHAT CAUSES INFLATION?
Ask any person today what causes inflation and they
will tell you that it is rising prices. Like many issues
on money, the inflation issue is clouded and confused.
That is because the inflationists want it that way.
By focusing attention on rising prices, it takes the
attention away from the cause, which is excess money
creation. Instead, all of the attention is focused on
the symptoms of the disease rather than the root of
There are only three ways that prices can rise. The
most important influences are as follows:
1.The supply of money and credit
2.Supply of goods and services
3.Demand for goods and services
Prices can increase by:
1.Increasing the supply of money
2.A decrease in the supply of goods
3.An increase in demand, i.e. population
Conversely, prices can decrease by the same three measures
1.The supply of money declines
2.The supply of goods and services
These are the only three ways that prices can increase
There is very little understanding of where inflation
comes from or where it originates. Most individuals
define inflation as rising prices. They speak about
symptoms rather than cause. If inflation is simply rising
prices, then what causes it? Youll find that inflation
is attributed to many sourcesnone of which are
accurate. The common misperceptions by policymakers
and the public is that inflation has three principal
1.Cost-push inflation as a result
of arbitrary demands of labor unions.
2.Profit-push inflation resulting
from the greed of businesses raising prices.
3.Crisis-driven inflation resulting
from acts of God or weather.
The general belief that inflation is the result of
something other than its true cause makes it hard to
understand and resolve. Most people believe that inflation
is conspiratorial such as OPEC raising crude oil prices,
businessmen wanting to make higher profits, or unions
looking to enhance worker benefits and pay. Somehow
inflation has become an evil caused by greedy individuals
and businesses. To most people inflation has become
a causeless phenomenon inexplicable and born of ill
LET'S GET THIS STRAIGHT
There is irrefutable evidence that government
is the source of all inflation. An undue increase in
the quantity of money is what stands behind a rise in
prices. The source of all money or credit is government.
Thinking of inflation only in terms of rising prices
is similar to looking at the symptoms of a disease rather
than the disease itself. A more exact definition of
inflation would be an increase in the quantity
of money and credit relative to available goods resulting
in a substantial and continuing rise in the general
price level, an increase in the quantity of money caused
You will notice that this definition doesnt say
anything about cost-push, profit-push, or crisis-push
inflation. It simply states that the supply of money
expands leading to higher prices. It is the expansion
of money and not rising prices that leads to inflation.
This also points to the real cause behind inflation
as government intervention in the economy and financial
system by expanding the supply of money and credit in
When the government increases the supply of money and
credit in the economy, it increases demand for goods
leading to higher prices. Higher demand or lower supply
is the only conceivable cause of higher prices. It can
be demonstrated by the formula below: [Price Level =
To expand and elaborate on this formula, we must add
a time factor, which is how long and how fast the holders
of money decide to make it available. Lord John Maynard
Keynes referred to this as liquidity preference,
or how much and how long the holders of money liked
to keep it on hand. The reverse of this is called the
velocity of money, which measures the volume of purchases
relative to the supply of money. Money velocity is the
hardest to understand because it is dictated by psychological
factors. The volume of spending within an economic system
is not only determined by the supply of money, but also
by the demand for money. The greater the demand for
money, the greater is the preference to hold it. (Keynes
liquidity preference) The smaller demand there is for
money, the less preference there is by holders of money
to want to hold or store it. Simply put, the greater
the demand for money, the lower the velocity and the
smaller the demand to hold money, the greater the velocity.
When individuals decide not to hold money and instead
have a preference to spend it, the velocity of money
increases. Likewise, when there are desires to hold
money instead of spend it, the velocity of money decreases.
Therefore, to our quantity theory of money,
we must add velocity to the equation. The new formula
for price levels can then be stated as follows:
The new equation shows that the general
level of prices moves in direct proportion to the quantity
of money and its velocity. Price levels move in inverse
proportion to the aggregate supply of real values. If
money velocity is held constant, then price levels will
depend on the quantity of money. It is only when
people begin to distrust money and feel that the security
of their money is being threatened that money velocity
increases. When the value of money is insecure, the
demand for it falls. There is less of a desire to hold
it because its value is depreciating. People dispose
of their money and find a replacement for it in tangible
goods that are real. The desire to own commodities or
real goods increases because these goods represent a
better source for meeting future cash needs.
During the latter stages of inflation,
money velocity increases because people no longer have
faith in their currency. As shown in the chart below,
the depreciation of the Reichmark increased as the supply
of money expanded as did money velocity. Money velocity
is a direct reflection of the degree of confidence that
people have in their currency. A sharp increase in velocity
normally takes places during the final stages of an
More will be written about this subject in later installments
of this Perspective series. Suffice to say that when
the money supply begins to rise money velocity lags.
Stated another way, quantity leads and velocity follows.
During the early stage of an inflationary cycle, price
increases are muted by a reduction in money velocity.
This is because the holders of money are willing to
hold on to their money unaware that supply is increasing.
Initially, interest rates fall due to the extra supply
of money, which induces forced savings. The drop in
money velocity during the initial stages of inflation
represents unrealized depreciation of the currency.
Later on as prices work their way through the financial
system and economy, both money quantity and velocity
begin to increase simultaneously. It is only during
the final stages of inflation as shown in the chart
above that velocity rises faster than the quantity of
money. Therefore, during the early stages of an inflationary
cycle, it is important to focus on the quantity of money.
It provides us with a clue as to what follows afterward.
For this reason we return to the quantity theory of
money for a greater understanding.
This theory states that the general level
of consumer prices equals the aggregate demand for goods
divided by the aggregate supply of consumer goods. Therefore,
the resulting rise in consumer prices is a function
of a numerator (demand) divided by a denominator (supply).
If there is a resulting change in price, it is the result
of either a rise or fall in demand or a rise or fall
When the government or actions by the Fed increase
the quantity of money in the economy, the demand for
consumer goods is increased through the supply of new
money being spent and re-spent within the economy. Since
there is greater demand than supply, the price of most
goods will go up. In the U.S. the rise in prices has
not been commensurate with the supply of money and credit
in the system because of imported goods. The trade deficit
is a function of increased demand being satisfied by
increasing imports. If the U.S. economy was self sustaining,
self sufficient and able to meet all consumer demand,
prices would have risen more substantially. Goods inflation
has been somewhat tame only because excess demand in
the U.S. has been satisfied through imported goods.
Without the ability to import goods, prices would have
been driven dramatically higher.
However, goods inflation eventually surfaces
because a country with an expanding trade deficit eventually
experiences a declining currency which raises the costs
of imported goods. The graphs below of the money supply,
budget deficit, trade deficit, and declining dollar
Source: Federal Reserve Bank of St. Louis, StockChart.com
They are all attributable to an expansion of money
and credit in the economy and financial system. Inflation
and higher interest rates are often associated with
government deficits. If these deficits are financed
by selling bonds to the public or to institutions, there
is no increase in the quantity of money. The existing
supply of money stock is simply diverted from private
to public consumption. Government budget deficits become
inflationary when they are financed through new and
additional money. This occurs when the Federal Reserve
purchases government debt. In effect this is known as
monetization. The full inflationary impact of the U.S.
growing budget deficit has been mitigated by the purchase
of government securities by foreign central banks and
foreign financial institutions. The Fed hasnt
had to resort to debt monetization because of direct
foreign intervention in the currency markets.
As shown in the chart on the right, foreign
intervention in the currency markets through direct
purchases of U.S. Treasuries has prevented the full
inflationary impact of government deficits from materializing.
This enables the U.S. government to export its inflation.
Japan and Chinas central banks purchased $300
billion in U.S. Treasuries last year.
This year that figure could go much higher. Japans
Ministry of Finance has set aside $575 billion for dollar
purchases, while China has allocated $150 billion. The
two central banks combined have the ability of buying
up to $725 billion in Treasury debt. This could produce
a sharp reduction in the outstanding stock of federal
government debt in circulation leading to lower interest
rates. Intervention of this magnitude could give us
a bond rally at a time when everyone is expecting higher
interest rates. Indeed this is what has happened this
In a Nutshell
The point to understand is that the full inflationary
impact of excess money and credit in the U.S. has been
partially mitigated by foreign intervention. The U.S.
consumer increases consumption as a result of taking
on more debt. This increase in demand-side consumption
is made possible through cheap and abundant credit (inflationary).
Since the U.S. economy is unable to meet all of consumer
demand, excess demand is made up through foreign imports.
This also lessens the impact of inflation since foreign
goods help meet excess demand, keeping a lid on prices.
Foreign goods can also be manufactured at a lower price.
When new money and credit are created, they enter the
system through various avenues. The money and credit
can actually be spent on domestic goods and services,
foreign goods and services or financial assets leading
to higher asset prices. Goods inflation and asset inflation
are really two different sides of the same coin.
THE NEW CENTURY INFLATION IN FINANCIAL MARKETS
Unlike the inflationary 70s when money and credit
went into the real economy, since the early 80s
and accelerating into the 90s, this new century
money has been increasingly channeled into financial
assets, creating asset inflation. This was visible first
in the equity bubble of the late 90s. New money
created by the Fed to fight off a collapsing stock market
bubble, recession, and a major terrorist attack led
to additional bubbles in the bond market, mortgage and
housing market, and finally in excess consumption. Rising
bond, stock and real estate prices are simply another
form of inflation that has been created through excess
credit and money added to our financial system. All
of these related financial bubbles are what is keeping
the U.S. economy going. The fact that P/E multiples
on the major indexes are now at 48 on the NASDAQ, 20
on the S&P 500, and 18 on the Dow Industrials is
another manifestation of inflation. Just as increased
demand raises the price of goods, excess demand for
securities raises their price. In this case, the price
of bonds goes up, lowering their yield and the price
of stocks goes up, leading to higher market multiples.
The U.S. economy has morphed from a manufacturing economy
to a service economy and finally to a financial economy
consisting of multiple asset bubbles. It has been one
reason why job growth in this latest recovery has been
so anemic. Money and credit are no longer going into
the real economy in the form of new investment in plant
and equipment which would create new jobs. Instead credit
and money creation is fed into the financial markets
leading to multiple asset bubbles in the stock and bond
markets and real estate.
There's Only One Way Out
Given this new aspect of Americas economic life
and the fact that the Fed and the government have no
inclination to live within their means or curtail rampant
money creation, new asset bubbles are going to be inevitable.
While one asset bubble may deflate as was the case in
the NASDAQ and tech stocks from 2000-2002, other asset
bubbles in bonds, mortgages, and real estate took their
place. The only thing that can force a government to
balance its budget or prevent a central bank from issuing
endless money is to limit the power to create money.
That is possible only when the money unit of a country
is backed by gold and silver. With gold and silver backing
the monetary unit, the government is totally dependent
on the taxpayer for every dime it spends. Tax rates
would be far higher in order to support the governments
voracious appetite for spending. Its citizens might
not be as willing to accept tax rates that border on
Inflation is nothing more than an extension of taxes
through other means. Inflation, then, is a hidden tax.
Deficits and taxes are really the twin pillars of the
welfare state. It gives the appearance that government
benefits are free, making government out to be a benevolent
What We Can Expect
Printing Presses in Overdrive
Since governments are addicted to spending money and
central banks exist only to create new money and credit,
additional asset bubbles are inevitable. Since the U.S.
economy is now a financially-driven economy, we can
expect more money and credit to find its way into other
asset classes. In a financial economy such as the U.S.
where a disproportionate share of capital is invested
in the capital markets, additional credit leads to speculative
bubbles. Greenspan/Bernanke & Co. have argued that
the Fed has unlimited ability to create unlimited amounts
of new money (helicopter money) and intervene endlessly
in the financial markets to support asset prices of
stocks, bonds, or real estate. Therefore as long as
this ability isnt curtailed through constitutional
means or through gold and silver backing, the Fed can
create sufficient quantities of money to bail out any
financial entity be it a bank, hedge fund, or government
enterprise such as Fannie and Freddie.
What weve seen so far is financial asset inflation
in the form of rising stock and bond prices. More recently
this asset inflation has spilled over into the housing
markets. Looking at the rise in commodity prices and
the cost of goods and services, it appears that money
and credit are feeding into hard goods. Judging the
policy decisions of Asian, European, and especially
the U.S. central bank to expand the supply of money
and credit, further currency depreciation is inevitable
Asset Bubbles in Natural Resources
What I believe that we will see later this year is that
the price of gold and silver will begin to appreciate
against most major currencies and not just the U.S.
dollar. Therefore if one views the current rate of monetary
debasement, I believe the next asset bubbles will take
place in the natural resource sector. Commoditiesand
especially the precious metalsare only in the
beginning stages of a new bull market. The charts of
the CRB Index, energy and precious metals are tell-tale
signs of the coming boom in natural resources. We are
close to the second phase of the boom when institutions
recognize that they have been fooled.
WHAT IS TO COME
It is my belief that we are now embarked on a journey
that will take us into a hyperinflationary depression.
There may be brief deflationary spurts that punctuate
this journey along the way, but an examination of history
leads me to conclude hyperinflation is much more likely
than deflation. Unlike the U.S. economy during the 1930s
or Japan in the 1990s, the U.S. economy is no longer
self sufficient in capital, manufacturing, and energy.
And unlike the 1930s, our currency is no longer backed
by gold. The U.S. is now the worlds largest debtor
nation versus the worlds largest creditor nation
as we were in the 30s. We are no longer self sufficient
in energy as we were during the last depression. We
import 60 percent of our energy needs, a percentage
that is growing each decade. We must also compete with
other nations for the worlds last remaining barrels
of oil as we enter into the twilight of the oil age.
During the 30s the U.S. created the Texas Railroad
Commission to regulate oil and prop up prices because
of the abundance of oil in this country. In contrast
to the 1930s, U.S. oil and natural gas production decline
each year. This forces the U.S. to import more of its
energy needs, energy we pay for with dollars. When the
world no longer accepts those dollars as payment, the
full impact of inflation will hit home.
I would like to end with a quote from Jens O. Parssons
book Dying of Money. It perhaps explains
best where we are today and where we are headed.
Everyone loves an early inflation. The effects
at the beginning of inflation are all good. There is
steepened money expansion, rising government spending,
increased government budget deficits, booming stock
markets, and spectacular general prosperity, all in
the midst of temporarily stable prices. Everyone benefits,
and no one pays. That is the early part of the cycle.
In the later inflation, on the other hand, the effects
are all bad. The government may steadily increase the
money inflation in order to stave off the latter effects,
but the latter effects patiently wait. In the terminal
inflation, there is faltering prosperity, tightness
of money, falling stock markets, rising taxes, still
larger government deficits, and still roaring money
expansion, now accompanied by soaring prices and ineffectiveness
of al traditional remedies. Everyone pays and no one
benefits. That is the full cycle of every inflation.
© 2004 James J. Puplava
THE GREAT INFLATION: Part 2 The Rhythms of History
 Rothbard, Murray N., What
Has Government Done to Our Money?, Ludwig von Mises
Institute, 1990, p.16-17.
 Ibid., p. 20.
 Homer, Sidney & Sylla, Richard, A
History of Interest Rates, 3rd edition, Revised,
Rutgers University Press, 1996, p.25-31.
 Ibid p.29-31.
 von Mises, Ludwig, The
Theory of Money and Credit, Liberty Classics, 1980,
 Rothbard, Murray N., What
Has Government Done to Our Money?, Ludwig von Mises
Institute, 1990, p.33.
 Homer, Sidney & Sylla, Richard, A
History of Interest Rates, 3rd edition, Revised,
Rutgers University Press, 1996, p. 49.
 Greider, William, Secrets
of the Temple: How the Federal Reserve Runs the Country,
 Fergusson, Adam, When
Money Dies: the Nightmare of the Weimar Collapse,
Kimber, 1975, p.86-87.
 Parsson, Jens O., Dying
of Money: Lessons of the Great German & American
Inflations, Wellspring Press, 1974, p.71.
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