It may be fair to suggest that Thier’s Law and Gresham’s Law are not necessarily opposing ideas. Rather they are both rule-based phenomena. Essentially, the nature of legal tender laws dictates which variety of money (higher-valued money or lower-valued money) is hoarded. How can we be so sure? Let’s take Thier’s Law for example. Let’s take the below definition of the monetary concept from an outstandingly well-written undergraduate thesis on cryptocurrency.
“Thiers’ Law, named after French historian Adolphe Thiers, asserts that in the absence of legal tender laws forcing them to accept both currencies, sellers will choose to transact with the currency of higher perceived long-term value. (P.9)”
In the context of this very description of the concept, the mention of the “absence” of legal tender laws comes into play. Meaning that given there are no rules coercively forcing us to accept the two currencies of varying degrees of intrinsic value at the same nominal value. Giving the observant reader the impression that the occurrence of Thier’s Law is the byproduct of the rules governing monetary exchange. In contrast, Gresham’s Law has always implied the existence of legal tender laws. The overvalued money with the distorted nominal value would never be assigned such a value by the market. Such a proclamation could only come in the form of government fiat. Gold and silver (bi-metallism) are of equal nominal value because the king says so. Regardless of the edicts of royal decree individual market participants are going to respond accordingly to the irrational rules set forth by the king. That would be to use the less valuable silver in day-to-day transactions and save the gold.
If Gresham’s Law applies to retain human capital in the job market, is it possible that Thier’s law (p.9) could also be applicable in certain contexts? On money, when legal tender laws forcing vendors to accept both forms of money at nominal value, economic agents will choose to transact with the higher valued currency. Presenting an axiom that is the opposite of Gresham’s Law, “ Good money drives out bad money”. Typically in the arena of monetary economics, the divide between advocates of Gresham’s Law and Thier’s Law is a sharply delineated dichotomy. Most proponents of one will not defend the possibility that the principle could apply to the circulation of money.
However, in terms of the circulation of human capital these concepts are not necessarily opposed. Employee retention is the byproduct of several highly qualitative attributes that are generally specific to a certain firm. In corporate vernacular, the term “culture” is thrown around so frequently that it has become a buzzword deeply embedded in the American psyche. Companies such as Google, go to great lengths to demonstrate that they have a flexible, open, and innovative corporate culture. The veracity of the claims is ultimately judged by the perceptions of the individual employees. One employee may adore working at Google, while their colleague completely despises the company’s ethos. Making the ebbs-and-flows of human capital even more complex. Employee retention at the individual level is based upon a multitude of various factors. The aggregated collection of the opinions of all the individual employees regarding their work-life satisfaction tends to paint a fuller picture. If while perusing Glassdoor, you happen to see a company with eighty-five two-star ratings, chances are this is not the petty slander of a few disgruntled employees. This is why oftentimes companies will periodically send out surveys to their employees in an attempt to measure overall morale throughout their organization.
Putting aside the highly individualized variable of career satisfaction metrics for an entire firm, if there is a pattern of talented employees leaving, there is a retention problem. Sometimes this may be isolated to a specific department even if the firm as a whole has no issues keeping competent and productive workers. Certain companies and even job roles select for specific attributes that may not be conducive to attracting skilled and reliable labor. Some industries are notorious for high turnover rates, one salient example being the hospitality industry. I remember a few years back, being in between jobs, so I briefly worked at a call-center. For me, this was an income stream until I found something else, for many of the people in my training class it was a lifelong career path. This path was a volatile one. Staying only a few months at one company and then abruptly quitting, generally with no notice. Upon receiving a new job offer, I gave my supervisor my two-week notice and he was astonished by the fact I even bothered to take this step. After only six months, only five people (including myself) out of the twenty-five in my training class remained. Industries and job roles with high turnover may be more willing to retain employees with fewer skills or with a poor performance history, due to the outflow of higher-skilled employees. Perfectly mirror the effect described in Thier’s law, instead of money, the commodity that is flowing out of the firms is quality human capital.
The question becomes how can these opposed ideas transpire concurrently in the same labor market or even the same company. The answer to this question is predicated upon a “rules of the game” type logic. Each company and each interior department within a firm operate as governing bodies directing the task of workers. Meaning both varying capacity function as “ruler-makers” within the company. Think of corporate policy as being analogous to the federal government, while the department formulated rules are similar to state law. Clearly, in most cases, corporate policy supersedes department policies. If these rules are too onerous or unjust there is little a qualified and skilled employee could other than leave. Either accept and abide by the rules set forth or resign. Resignation being a clear withdrawal of consent on the part of the employee. One relevant example of this is companies still drug testing for marijuana in states where it is legal. Granted, it is an organization’s prerogative to make employees refraining from drug use a contingency of employment. However, if enough high-caliber job candidates take to smoking cannabis they may be in a bit of a quandary. A few years back the FBI ran into this problem due to their “drug-free” employment policy.
If the rules governing the management of a firm are too oppressive, people with options are going to find another job opportunity. What the company is left with are those who lack the skills, ambition, and conscientiousness required for productivity. The employer is left with the staff that clings to their jobs for dear-life as odds are they do not carry too much value on the job market. Much how department policies such as catering to senior and skilled workers can impose an effect similar to Gresham’s Law the opposite is also true. If you create rules that disincentives tenure and self-development, odds are you will lose a lot of great workers. The kind of workers that can be a game-changer in managing strategic customers. As we have observed with the call-center example, frequently due to the oppressive rules, low pay, and dismal work environment people with potential tend to leave these positions. Leaving you with the unskilled and the desperate who are locked-in to the role due to their circumstances. Keeping this dynamic in mind, it is a wonder why people expect quality service whenever they call tech support.
The premise behind Gresham’s Law is that money of a higher intrinsic value will be hoarded while the money of a lower substantive value but legally recognized as having the same nominal value will be circulated throughout the economy. Succinctly put, “..bad money drives out good money…” pithily sums up this economic phenomenon. However, is this occurrence solely confined to the commodity of money? Doesn’t the observations convey in Gresham’s Law applicable to other goods? For example, unless a baseball card collect is presented with an astronomically large monetary offer, odds are they will be unwilling to part with a limited-run rookie card of a legendary major league player. This scenario reflects many of the assumptions regarding commodity value implicit in Gresham’s Law. Generally, rare collectibles are held on to, while mass-produced memorabilia is readily available at the local garage sale or swap meet. Most collectors will hang on to the items that are considered valuable unless another interested party can provide a commodity in exchange that exceeds the perceived value of the collectible held by the hobbyist in possession of the coveted item.
However, how does Gresham’s Law interact with the intangible commodity of human capital? A firm or a business unit within a firm would want to retain top-level talent and let go of the mediocre/poor performers. Before we can delve into this analysis we must distinguish what human capital is. Human capital is the economic value that the employee brings to the firm. Typically through their experience, education, certifications, knowledge of company procedures and policies, position-specific “tribal knowledge”, critical thinking skills, and other pertinent soft skills. For readers who have never worked in a corporate environment before tribal knowledge is the informal and unwritten knowledge of best practices of how to perform within a specific job role. It stands to reason that a potential employee possessing all of these attributes would be a hot commodity on the job market. If currently employed by a company would be an employee of a high value.
If human capital is valued in a similar sense to other commodities such as money, how do businesses act in a manner to retain this high-quality talent? The answer most human resources representatives would give is that their organization creates an environment that fosters career advancement. Stressing the perks such as tuition reimbursement, possession of company stock options, and opportunities for placement in vertical job positions. While these factors may play a role in some employees choosing to work long-term for the same company, there is another variable that HR will not be forthright about. That is oftentimes exceptional employees with a high degree of human capital end up getting pigeonholed to the same role. Oftentimes these individuals are blocked from transferring to other business units or positions within the company by the request of middle and executive management. The reason behind limiting this MVP’s potential is quite pragmatic, the business unit cannot afford to lose this individual. Their skills and knowledge are essential to the day-to-day operations of the business. It would be nearly impossible to fill the void if they were to get promoted or transition to a lateral position within the firm. In the corporate world, this individual may be referred to as a subject matter expertor colloquially known as a SME.
It should be noted that the desperate attempts of management to relegate this individual to the same job role has the propensity to backfire. Why? Because this individual gets fed up with their limited job prospects and ends seeking career advancement at another firm. In a free market for employment, a high-quality employee has many prospective options when it comes to their career. If a firm stubbornly, confines them to a shallow career path they will simply look for employment at another company.
One of the biggest mysteries of 2020 was the change shortage. Why were so many retailers requesting that patrons either use a card or have exact change? Many of us were puzzled by these signs that have become a common fixture of many checkout lines across the nation. What is the explanation for such a monetary phenomenon? Within my nearly thirty-two years on this planet, I have never been requested by a brick-and-mortar vendor to have exact change. However, in the era of COVID-19, there are many strange things are happening. Never mind the change shortage, a few months back the United States was grappling with a toilet paper shortage. One commodity nearly everyone has taken for granted.
As one could predict, the national coin shortage is related to the COVID-19 pandemic. This calamity of a coin shortage can be linked back to the precautions taken to limit the spread of the virus. The shelter-in-place orders resulted in the shutdown of many stores and restaurants. Resulting in an overall lull in economic activity. In other words, the cash registers of many retail outlets were not be replenished by circulating cash (include metal coins). Some may surmise that due to the uncertainty of pandemic many people may opt to hold cash balances. Coins generally are circulated throughout the economy through bank deposits and are recirculated back to banking customers through the change provided by retail stores and restaurants. Per the U.S. mint, 83 % of the coin supply is recirculated through stores and third-party coin processors.
The downturn in economic activity during the shutdown left only meager coin reserves in the cash registers of American stores. Meaning that once stores reopened, they would quickly exhaust their coin supplies. This was only compounded by the fact that the banks could not fulfill the retail demand for coins due to fewer customers depositing them. The mint falling behind on coin production left retailers had no other option but to request that customers either pay by a card or exact change.
A shout out to the Ludwig Von Mises Institute for the Free books. Yes, I have read Economics in One Lesson in the past. However, I didn’t own it. The Mises Institute edition is a beautiful hardcover that does the book justice.
The debate over whether Fractional Reserve Banking is ethical to proceed over approximately a decade (the late 1980s/ early 1990s to the early 2000s). Resulting from subsequent papers repudiating the previous claims over the researchers on the other side of the issue. It should be noted that in these series of retaliatory papers that technical arguments were presented in tandem with ethical justifications for or against this practice. For the sake of brevity, I chose to focus on the ethical considerations of the topic. However, this does not exclude a potential technical comparison of Fractional Reserve Banking in the future.
To any reader who has never thoroughly examined nor given a second thought to Fractional Reserve Banking, I hope reading this series of essays was illuminating. Fractional Reserve Banking is arguably the most prevalent banking system globally. Yet, something that impacts our lives daily we never think to question its inner mechanics let alone whether it is ethical. The ethics of banking extend beyond whether the patrons are benefiting at the expense of someone else, either through easy access to loans or interest payment on savings. There are potential ramifications to the economy.
Distortions in the credit market are precisely the impetus for business cycle calamities such as the cataclysmic burst of the Housing Bubble in 2007. Providing loans backed up by fiduciary media is nothing more than a house of cards waiting to fall done. Artificially manipulating factors such as prices, interests, and money supply can only facilitate the misallocation of resources. Such indicators operate as unspoken signals to consumers and entrepreneurs. Due to this fact, these distortions create an illusory image of the loan market and naturally economic agents respond accordingly (p.108). A fact that both George Selgin and Lawrence White are too quick to refute and dismiss (p.102). This carries the implications of defrauding the economy as a whole versus being isolated to the bank’s customers. Even if you are the type to limit all your transactions to precious metals or cryptocurrency, it is worthwhile to read up on this topic.
Summary of Compelling Arguments From the Austrian School:
It is difficult to say whether the Free-Bankers or the Austrians are on the right side of the debate. Both camps provided some truly convincing arguments. The Austrian opposition notes how ownership can only legitimately be taken on by one person and Fractional Reserve Bank obfuscates this immutable law of property ownership. From a contractual standpoint, that the agreements between banks and clients in such an argument are illegitimate. Since the terms are not only unclear to the typical layman but are a categorical misrepresentation. Presenting fiduciary media as actual money. The disingenuous nature of this faulty contract is only compounded by the fact that these claims for money are based upon the banknotes that are not back by currency or specie. Attempting to redeem them for actual currency is analogous to using a deed for a boat and attempt to claim ownership of a house. Also that it is a false analogy to argue that any devaluation of present money caused by the issue of fiduciary media is no different than an increase in the supply of a good due to protection or harvesting.
This is because the increase in the supply of lumber from harvesting more oak trees is derived from legitimate market processes and in-turn does not seek to directly devalue anyone else’s property. Also, that in no way can Fractional Reserve Banking represent the Demonstrated preference of bank clients. Demonstrated preference can only be expressed with one’s property. Fractional Reserve Banking by its very nature disrupts this relationship.
Summary of Compelling Free-Banking Arguments:
The Free-Bankers also bring up some compelling moral defenses in favor of Fractional Reserve Banking. They are even bold enough to directly claim the practice is not fraudulent. Through a banking client electing to accept the terms of service regardless of their understanding, the contract is still valid. It would be one thing if these banks purported to practice 100 percent reserve banking, but function as a Fractional Reserve institution. These contracts are formulated between consenting adults, it would be antithetical to the principle of individual freedom to prohibit such arrangements. The real trouble comes from government interference. One only needs to look at the large array of protections awarded to backs through the FDCI to see the true culprit in shielding unsavory banking practices from insolvency or litigation. Also, the ignorance or the naiveté of the consumer is not a reasonable justification for banning a product or service. Even though the risk of a bank run is present, it is a relatively rare occurrence from a historical standpoint. If faced with a potential bank run the bank can issue an option clause suspending redemption, solving the issue through valid contractual recourse. Speaking of redeeming bank deposits. A customer assumes the risk of not being able to redeem money when they agree to open an FRB account. They assume the risk. In turn, for the opportunity cost of having their liquid money held and the potential risk of a bank run/ insolvency, they receive an interest payment. Overall, patrons must prefer Fractional Reserve systems to 100 percent reserve banking. There have never been any governmental decrees in modern history that all banking must be done via a Fractional Reserve System. Despite its flaws, ultimately, the people prefer being paid interest payments versus having to pay warehousing fees.
Can There Be a Compromise?
There are certain aspects of both arguments that appear to be flawed. The Free-Bankers are too lackadaisical when it comes to distortions in the credit structure enabled by Fractional Reserve Banking. The Austrians to some extent seem too rigid in their interpretation of property ownership. Under many of their arguments likening the practice to a Ponzi scheme. Yet, to be conceptually consistent would not these same economists also take issue with multi-level-marketing? Then again it could also be counter-argued that MLM schemes and Fractional Reserve Banking while present similar confusions, property rights have much greater degree clarity in MLM arraignments.
Back in 2000, the economist Jorg Guido Hulsmann wrote an article in the Independent Reviewrefuting the Fractional Reserve practice of creating “money”. Hulsmann (see page 108) much like his anarcho-capitalist counterparts Hoppe and Block are opposed to government intervention. If FRB is morally and technically flawed how can we address the issue of it short-comings without introducing state involvement? In this twenty-year-old article, Hulsmann presents a summary of points previously made by Hoppe and Block that would alleviate some of the issues relating to the categorical confusion. It should be noted that Hulsmann in that these suggestions for informal rules and norms of banking presume no state involvement in banking. Also, the author details the intimate relationship between the FRB and the government. Going so far as to refer to it as a “handmaiden” of government (p.108). Making it easy to infer that Hulsmann believes that the intertangled marriage between Fractional Reserve Banking and government is an unbreakable bond. However, let’s take these suggested conditions as theoretical and contingent upon a banking system free of regulation. See his suggestions below:
“…Fractional reserve banks would have to use a different language than they commonly use because words such as “deposit” are deceptive. They would have to make it clear that money “deposited” with them is, in fact, a credit of unspecified duration. And the “banknotes” they issue would have to be presented not as money titles but as some sort of very liquid IOUs..”
“..On the “FR notes,” one would have to find a promissory note of the following type:
The FR Bank promises the holder of this note to try to redeem it out of its gold reserves. Because FR notes are not 100 percent covered by gold presently in our bank, in case we cannot redeem, the following rules apply. . . . (p.108)”
It is quite clear at this point that followers of Austrian economics view Fractional Reserve Banking as nothing more than a Ponzi Scheme. However, proponents of the Free Banking School (arguably an outgrowth of the Austrian School) believe that this practice is legitimate providing there isn’t any government interference in banking. Even the uninitiated observer will admit that this contingency is a highly unrealistic one. In the modern era, banking continues to be a heavily regulated industry. Free Bankers may have a relatively cogent ethical argument from a theoretical standpoint. After all, it is the responsibility of a mentally competent adult to be aware of the terms of service for any product or service they choose to receive. Ignoring the fine is not an exculpatory factor. Either from a legal standpoint or from an ethical perspective. Also, to be conceptually consistent one should scrutinize multi-level marketing schemes. Such a business model mirrors similarities to Fractional Reserve Banking. Hence why opponents liken it to a Ponzi scheme or pyramid scam.
Argument #1: It Isn’t Fraud.
From the Free Banking perspective, Fractional Reserve Banking is not a fraud. If the banking establishment makes it clear that the services provided constitute Fractional Reserve Banking, then the arrangement is legitimate. This is because the terms of the contract were not violated (p. 87). It would be problematic to present your services as 100 percent reserve banking if it encompasses the practices of the Fractional Reserve System. Fraud would entail a misrepresentation of the bank’s services.
Taking any measures to prohibit this system of banking is antithetical to the principle of individual freedom. Any such interference would be obstructing an existing contract between consenting parties. Doing nothing more than disturbing the economic liberty of freedom of contract, which is a pillar of private property rights (p. 87). Individuals who oppose the practice find the freedom of contract argument to be farfetched as few patrons have a firm comprehension of what Fractional Reserve banking entails (p. 88). The naivete of the consumer does not sully the legitimacy of the arrangement. Even Murray Rothbard himself has stated that historically banks have rarely retained a 100 percent reserve system (p.88). Why? Most likely because the banks clients preferred a Fractional Reserve system. If customers prefer an interest payment on their savings versus a maintenance fee for warehousing, so be it (p.88). The market for banking services has responded accordingly.
Circling back to the issue of misrepresentation of services, even the hardline naysayers believe that such a banking system could be admissible under certain conditions. Most notably if there was the further elucidation of the specific details of fractional reserve services. A long-standing concern of economists such as Hans Hermann Hoppe and Walter Block being that such ambiguity makes the practice fraudulent. Creates categorical confusions between money and fiduciary media (p.20-28). Professor Block asserts that the redemption requirements need to be clarified to set aside the concerns of fraud (p. 89). Whereas Block’s counterpart Hoppe stresses that banking institutions should present a warning regarding the suspension of redemption. He analogizes this precautionary courtesy to an option clause. Unfortunately, this concern does not comport with the facts of history. As is evident by the Scottish period of Free-Banking in which specie payment was suspended for decades (p. 89-90).
Another argument that grapples with the question of whether FRB is fraudulent pertains to the ability of the banks to fulfill redemption obligations. Keeping low percentages of reserves on hand turns money redemption into a gamble. However, this concern is inconsequential. Historically even in the absence of government intervention few banks have failed to fulfill any redemption obligations to patrons (p.90). For one, solvent banks are not prone to bank runs. Even in the event, a solvent bank runs out of currency, they can issue an option clause to temporarily suspending redemption. Resolving the issue through contractual channels (p. 91).
Argument #2- The Concerns Over Third-Party Effects Are Not Substantial
The most salient third-party effect or “spill-over effect” confronting the practice of Fractional Reserve Banking is a decreased likelihood of successful redemption. Obviously, in a Fractional Reserve Banking system, the more money that is lent out the fewer reserves the bank will have on-hand. Resulting in adverse consequences for the individual demanding to withdraw money from their account. It should be noted that the depositor agrees to this argument upon opening a bank account. Therefore, by signing on the dotted line of the terms and services of the bank, they choose to assume the risk (p. 93). Despite the risks, bank patrons continue to bank with these institutions. Alone based upon the Rothbardian theory of Demonstrated Preference the individual bankers must benefit from this arrangement. After weighing the benefits concerning the costs (p.93).
The spill-over effects of Fractional Reserve Banking are not solely confined to banking transactions. The practice has also been claimed to create other distortions throughout the economy. Through how loans are funded it compromises some say the credit structure is compromised. It should be noted that the risks are somewhat minimal. If anything it aides the economy by providing a larger stock of capital (p.94). The issue with this criticism is that much of the instability in the economy comes from the intervention of central banks and governments and not Fractional Reserve Banking. This form of banking is not prone to instability or “cylindrical over-expansion”(p.94). These claims underestimate the fact that the amount of “nominal money” issued offsets the “.. changes in the velocity of money..”. Fractional Reserve banking works to alleviate the disequilibrium and “ business cycle consequences”. Hoppe and the company also assert that any injection of fiduciary media will ultimately result in a business cycle. However, if the increase in fiduciary media is matched by demand a disequilibrium will not arise (p.101-103).
Argument #3: The Popularity of Fractional Reserve Banking.
The popularity of Fractional Reserve Banking is another factor to contend with. Banking customers have demonstrated their preference for FRB. Historically, few banks have remained a 100 percent reserve system. However, customers continued to do business with these institutions (p.95). Contributing to this popularity has been the incentive of banks paying interest on deposits versus requiring a warehousing fee (p.95). Banking patrons also held faith that their bank had sufficient funds to fulfill withdrawal demands. Bank runs were generally triggered by other factors signally insolvency to bank clients. Countries such as the United States with greater propensities towards bank insolvency tend to have many protective laws shielding the banks from market pressures (p.95-96). It should also be noted that back in the 1800s when banking legislation was being discussed in the press the banking system was openly described as a fractional reserve system (p.96). Not only fully informing the average constituent of the details of the Fractional Reserve system, even with this knowledge doing little to dampen its prevalence (p.96).
The use of Fractional Reserve Banking has never been compulsory. There has never been any laws or penalties compelling banking in the United States to levitate towards this specific banking system (p.97). Patrons voluntarily assume the risk of engaging in this variety of banking for the trade-off of being rewarded with an interest payment (p.97). The argument that clients are unwittingly tricked into patronizing an illusory form of banking is dismantled by the fact that banks compete for business. Nothing is stopping an enterprising individual from persuasively selling 100 percent reserve services (p.97).
The key arguments against fractional reserve banking being a moral system came from a 1998 paper co-authored by Austrian economists Hans Hermann Hoppe, Jorg Guido Hulsmann, and Walter Block. The white paper entitled Against Fiduciary Mediawas a response to a previous paper written by George Selgin and Lawrence H. White. Hoppe at al. crafted a repudiation against Selgin and White’s 1996 paper In Defense of Fiduciary Media or, We are Not Devo(lutionists), We are Misesians.In which both scholars provide a normative and positive defense of fractional reserve banking. Even utilizing Murray Rothbard’s Title-transfer Theory of Contract to defend the practice. However, this application of the Rothbardian contract theory did not sit well with Hoppe and the company. All being devoted and unwavering followers of Rothbard believed that Selgin and White’s interpretation of Title-Transfer Theory of Contract to be incorrect. Making their justification of fractional reserve banking on grounds of contract theory to be inherently flawed. It is worth noting that Hoppe was a direct protégé of Murray Rothbard and even owed his career and position teaching at the University of Nevada, Las Vegas to the late Austrian economist.
Rothbard’s Title-Transfer Theory of Contract:
Before claims that Selgin and White did not faithfully adhere to or misinterpreted Title-Transfer theory, it is important to thoroughly explain this concept. A reader without a firm comprehension of this idea cannot adequately determine if free-banking proponents of fractional reserve banking suffer from profound confusion. The proceeding section will provide a brief overview of this theory. Hereby providing the reader with the requisite background information to justly assess this debate.
Before diving into Rothbard’s theory, it is important to note his ideological disposition. Murray Rothbard was the modern father of an ideological subset of libertarianism known as anarcho-capitalism. Rothbard and his followers hold that there should not be limited government, but rather no government. All services and products can be produced by private industry with no necessity for government intervention. This even includes services that have been traditionally provided by the government. This includes defense/security services, law enforcement services, charity, resource management, infrastructure, private legal adjudication, and so on. Rothbardians even go so far as to assert that the government possesses a monopoly on such services. It is imperative to understand this aspect of Rothbard’s political economy and political philosophy. It illustrates the fundamental philosophical precepts that govern his theory of contract.
Rothbardian Contract Theory is expounded upon in his 1982 book The Ethics of Liberty. Rothbard derides that the concept that all contracts in a just society need to be enforced( P.133). He draws a sharp line of delineation between “promised” and “conditional” contingencies in matters of exchange. Per his logic, the utilization of legal channels to enforce a promise is wholly illegitimate. Constitutes the use of government force in a situation in which no property has been transferred. Making it equivalent to state enforcement of morality (p.133-134). The reason why the property needs to be involved for a contract to be valid pertains to the distinction between what is intrinsically alienable and inalienable to the individual. This has to do with the fact that a person cannot alienate their own will or relinquish control of their mind and body to someone else. Humans can quite easily dispense with tangible property, including money (p.135). Due to the fact enforcing a promise is a compulsion because it interferes with the free will of the individual. It is not technically a breach of contract. On the other hand, if the agreement included a transfer of property for non-compliance then it would be another story.
In instances of conditional contracts and agreements, noncompliance is equal to a form of theft. One salient example Rothbard provides is the circumstances of service providers receiving advanced payment but never providing the service (p.137). For example, if I were to offer to paint your house and I received an advanced payment of $300.00 and never show up your house that is theft. One contractual contingency that can shift a promise to a conditional agreement would be a performance bond clause within the agreement. For Rothbard’s example, if a movie theater has a meet and greet event with a famous actor, they can put into the agreement a clause where the actor agrees to pay the theater a sum of money for abdicating this obligation (p.137). Since a property can be transferred and not the will of the actor this is an ethically binding agreement. However, failing to fulfill a property-related obligation is not always necessarily deemed as implicit theft. In instances where a creditor provides immunity to a debtor who cannot pay their bill this is legitimate (P.144). Why? The creditor reserves the right to forgive debts due to the fact they are the ones who transferred their property under the condition of repayment. Please note that this scenario details circumstances in which the credit lent out their funds.
It should be noted that a Rothbardian conception of contractual property rights does not preclude someone from selling off a portion of their property. For example, if I own 100 acres of land in Montana. It is well within my rights to transfer you 5 acres for $20,000.00. Concurrently, retaining my claim on the residual 95 acres of land. This does not mean that mean I in any way still own those 5 acres. Through the sale of this land, I have effectively transferred ownership to you. In turn, I have relinquished by entitlement to the lands sold.
“Another important point: in our title-transfer model, a person should be able to sell not only the full title of ownership to the property but also part of that property, retaining the rest for himself or others to whom he grants or sells that part of the title. Titles, as we have seen above, common-law copyright is justified as the author or publisher selling all rights to his property except the right to resell it.”
How The Free-Banking Argument For Fractional Reserve Banking Violates Contract Theory:
Selgin and White claiming that fractional reserve banking is consistent with Title-Transfer Theory suffer from some blind spots. Blind spots that are fully magnified by Hoppe et al. One of the fundamental chinks in the armor of the Free-Banking argument is that fractional reserve banking inherently violates Title-Transfer Theory. It assumes that two people can own the same piece of property simultaneously (p.21). By the very nature of how fractional reserve banking engages in lending, it creates ambiguity regarding ownership. Through issuing more promissory notes both the bank and the customer assume ownership of the same banknote, which is fraudulent by nature (p.22). Creating more claims to money against the present supply of money will not create more money (p.22). Rather, will only serve to redistribute the present supply of actual currency from client to client without increasing the amount of money in the vaults (p.22). Effectively creating fiduciary media (money-substitutes issued by a bank that is not backed by gold or paper money) out of thin air without transferring assets or liabilities (p.22). As detailed in Rothbard’s theory, we can sell off a portion of our property. However, we relinquish our own once we transfer it to the party purchasing it.
This illusory arrangement also conflates property with property titles (p.23). Treating and categorizing banknotes( fiduciary media, money claims) as money (physical property). This only enables this fallacy to continue. Keeping in tune with the Austrian tradition the Regression Theorem states that all money had a prior use value (p.34-36). For instance, tobacco and nails at various times in human history have been used as money. Meaning that these banknotes cannot be money in the actual sense, but a claim or title to money. Through this categorical fallacy, the banks can divorce titles from ownership resulting in the redistributive practices of fractional reserve lending (p.23). Even going so far as to promising future entitlement to goods against present goods that may or may not be fulfilled. It would be honest to label these claims to future goods or debt claims, but not a claim to money (p.24).
An inquisitive observer may question why it is dishonest or even outright fraud to categorize future claims to money as money titles or even as money? Hoppe et al. frame this from the standpoint of we cannot claim or transfer ownership from a title to a car for anything but a car and the same applies to money (p.25). If we were using more precise language what banks and customers have truly agreed to is debate claims versus money titles. Per the authors of Against Fiduciary Media Selgin and White adopted a hyper-subjective interpretation of contracts to side-step this discrepancy (p.26). The misrepresentation engaged in by practitioners of fractional reserve banking extends beyond labels of goods, but to actual quantities as well. By treating fiduciary media as money, it creates the false perception that clients own more than what they truly due on paper. The fabricated money quantities do not reflect the amounts present in the vaults of the bank (p.27). Free-banking proponents may believe that fractional reserve banking isn’t so much the problem, rather government intervention. As long as the withdrawal requests are fulfilled it cannot be tantamount to fraud. However, even without state interference, the transfer practices of fractional reserve banking blur the lines of definitive ownership (p.29). Making the system incompatible with upholding property rights or just contract enforcement.
One of the age-old questions in the field of economics is whether or not money is neutral. In other words, the introduction of new money into the economy only has a nominal impact . It only raises prices and does not impact variables on employment or output (Cecchetti, P.1) . The lack of influence of an increase in the amount of money on the aggregate economy is a core assumption of the Quantity Theory of Money. An economic theory that was exposited by no other than John Locke. Locke is renowned for his moral philosophy and political theory often is overlooked in terms of his early contributions to economics.
In a broad application, the theory simply entails that the quantity of money is the key factor in the “changes in purchasing power” (Humphery, 1974, P.1) . The theory stipulates that introducing new money will decrease the value of the currency resulting in higher prices (Humphery, 1974, P.1) . This observation pertaining to alterations in purchasing power is generally widely accepted.
Locke explicitly detailed back in 1691 that the Price Level (P) is “always proportional” to the stock of money (M) (Humphery. 1974, P.4) . Locke’s assumption the effects of introducing new money may have considered its impact on prices. However, it also assumes even that the changes in prices throughout the economy would be uniform. It is reasonable to question whether this assumption falls into the same folly that many other economic models suffer from. That is the gulf between theory and actual application. Wouldn’t it be possible for some actors in the economy to have access to the new money prior to the rise in prices? Shouldn’t be also be considered that how the money is distributed could only magnify such potential effects? Whether due to the mechanism of distribution or institutional advantages.
….The mistake of this plausible way of Reasoning will be easily discovered, when we consider that the measure of the value of money, in proportion to anything purchasable by it, is the quantity of the ready Money we have, in comparison with the quantity of that thing and its Vent; or which amounts to the same thing, The price of any commodity rises or falls, by the proportion of the number of Buyers and Sellers; This rule holds Universally in all Things that are to be bought and Sold, bateing now and then an extravagant Phancy of some particular Person, which never amounts to so considerable a part of Trade as to make anything in the account worthy to be thought an exceprion to this Rule. (Locke, 1691, P. 16) .
Locke may have been a brilliant thinker and the grandfather of liberalism, that does not make him above reproach. The likes of David Hume and Richard Cantillon expressed disagreements with the assumptions of Locke. Hume’s postulations are so similar to those of Cantillon that some have levied accusations of plagiarism (Bilo, 2015, P.4) . I will provide no further commentary on that claim. Both Hume and Cantillon did not see the role of money in the economy as being neutral. It can be argued that this is not a realistic view of the function of money. Cantillon suggests that the point of injection of new money and the velocity of circulation plays a role in its impact (Thorton, 2006, P.4) . A point that is clearly neglected in Locke’s account of the role of newly introduced currency. If money was neutral how additional quantities are introduced would not matter.
Both Hume and Cantillon noticed other factors that clearly demonstrated the nonneutral nature of money. Which include the following:
(1) the lag of money wages behind prices which temporarily reduces real wages, thereby encouraging increased demand for labor ; (2) the stimulus to output occasioned by inflation-induced reductions in real debt burdens which shift real income from unproductive creditor-rentiers to the productive debtor- entrepreneurs ; (3) so-called “forced-saving” effects, i.e., changes in the fraction of the economy’s resources diverted from consumption into capital formation owing to price-induced redistributions of income among socio-economic classes having different propensities to save and invest; and (4) the stimulus to investment spending imparted by a temporary reduction in the loan rate of interest below the profit rate on real capital. (Humphery. 1974, P.4) .
All of the listed observations are clearly distortions caused by the unequal distribution of new money throughout the economy. Those who have access to the new money first reap the advantage of the lower prices. As the reverberations of the new money have not echoed throughout the economy. In other words, prices have not increased to reflect the depreciation in the value of the currency. If the new money is introduced through highly centralized institutions this discrepancy will be quite salient. Versus being more evenly distributed. Those with early access to the new money will spend it prior to the rise in prices. Such consequences being indicative of Cantillon’s eponymous theory the Cantillon Effect.
It is possible that Locke may have potentially oversimplified the more intricate impact that introducing more money has on the economy. However, empirical research has not always yield findings congenial to Cantillon’s finding (Wagner & Daley, 2004, P. 8) . Veteran economists Richard Wagner and Steven Daley suggest that “…comparative statics of monetary or macro aggregates.. “are inappropriate for studying Cantillon Effects. Rather we should focus on the “… structural composition of economic activity..” (Wagner & Daley, 2004. P.17) . Despite my paucity of economic credentials, I would wholeheartedly agree. Locke’s Quantity Theory of Money lacks an acknowledgment of how money is circulated. If new money is distributed unevenly the adverse ramifications of inflation will be felt differently.
Gresham’s Law is seen as one of the many enduring laws of the discipline of economics. Much like the laws of Comparative Advantage, Supply and Demand, and Diminishing Returns. However, is it possible that Gresham’s Law is based upon a misconception? After all, there are several examples of undervalued and overvalued currency simultaneously circulating at the same nominal value. Do these exceptions invalidate Gresham’s Law? Depending on who you ask, yes. However, proponents claim that these outlying examples apply to conditions under which Gresham’s Law is not applicable. Both sides generating formidable arguments.
It should be mentioned that Natural Laws, Laws of Science, etc. tend to be perceived as being fixed. Immutable. Is this an accurate interpretation of such a variety of Laws (economic laws included)? By definition, a scientific law is an enduring observation that has been universally replicated. Contrary to the popular opinion it is not definitive. Meaning that is still subject to some variation and possible exceptions. Whenever a Profession Skateboard performs a particularly daring stunt, we refer to it as “gravity-defying”. Such a statement does not so much invalidate the Law of Gravity but demonstrates a mild momentary exception. Within seconds of completing the mauver, the skateboarder is pulled back down by the gravitation force of the Earth.
It is possible that I am mischaracterizing the exceptions of the Laws of Gravity. I am far from well versed in physics. I have never taken much interest in it as a field of study. Even the moon to some extent has gravitational force it is just to a lesser extent than Earth. Making the law exist in a continuum of applicability versus an outright exception. I would surmise the same is applicable to the laws of the social sciences as well.
There was a 1986 study published by the Minnesota Federal Reserve that put into question the veracity of Gresham’s Law. The controversial study was authored by Christopher A. Sims and Arthur J. Rolnick. Two particularly salient exceptions cited in the article were pertaining to Silver Dollars and Greenbacks in the United States. In the years between 1792 and 1853, the U.S. Silver Dollar and the Spanish milled Dollar simultaneously circulated at the same face value. The Spanish milled Dollar contained 373.5 grains of pure silver in contrast to the U.S. Silver Dollar only contained 371.25. Making the foreign silver coin heavier and possessing a higher intrinsic value. Despite the fact that Gresham’s law is considered axiomatically true the Spanish Silver Dollar was not driven out of circulation (P.4) .
The second notable exception to Gresham’s Law referenced in the study was the exchange of Greenbacks. Greenbacks were one of the earliest examples of purely fiat currency in the United States. Which the paper money that was not backed by specie was produced to help fund the Civil War . Per the contingencies of Gresham’s Law, we would assume that the Greenbacks drove currencies backed by gold and silver out of circulation. Some sources did claim that this was the case. Not so.
Did greenbacks drive out specie? Some textbooks claim they did (Prager 1982, p. 32, for example), but Moses, writing in 1892, makes it clear that in the West, despite the presence of greenbacks, gold remained the unit of account and a medium of exchange. He says that a contributor to the San Francisco Daily Herald wrote that greenbacks were also current there, but at a discount (Moses 1892, p. 18): “A writer in this journal, February 16,1863, found very little difficulty arising from the use of legal tender notes; for they had a market value, and most people were ready to receive them at that value.” In the East, it appeared that the money system was reversed. There, according to Moses (1892, p. 15), greenbacks were accepted as the unit of account and specie circulated at a premium. (Sims &Rolnick, 1986, p.5) .
Both researchers provided expanded upon how such exceptions could occur. They repudiate the claim that they did not cover any true exceptions. As in both instances, the rate of exchange in both examples was not fixed. They rebut this claim by stating that holding a fixed exchange rate is inoperable. Historically they aren’t any records of mints operating in such a manner. Also, if a mint has a large stock of commodity money offered at a “bargain” for the establishment will either run out of money and either go out of business or change course in coinage policy (page6-7) . Sims and Rolnick also disputed the claim that mints did not fix exchange rates but legal tender laws did. Such laws do not prevent prices from being calculated in “bad” money. Meaning vendors would make a larger profit at the expense of public ignorance of the difference in intrinsic value (Page 7) . Based upon these observations they concluded that the assumed conditions of Gresham’s Law were incorrect. Bad money drives out good money when the transaction costs are significantly high to use good money (Page 9) .
Naturally, these arguments were not meet without resistance. Economist George Selgin provides some strong counter-arguments to the 1986 study. Selgin dispels the potential of the exchange rate claim causing naive customers to be duped by vendors. Acceptance of both monies at face value is based upon legal penalties for discriminating between them rather than a personal appraisal. Per Selgin Gresham’s Law only applies if customers and vendors are “legally compelled” to accept overvalued and undervalued money of the same face value. Pertaining to the exception of the Greenback-era in California local authorities refused to enforce federal legal tender laws .
Much like the physical sciences, economics has immutable laws. The Law of Supply and Demand is equally as well known as Newton’s Law of Gravity. In this essay, I will expound upon an economic law that is not as well known to the general public. Arguably, it is just as important as the Law of Supply and Demand. That is Gresham’s Law. Have you ever wonder why people invest in gold or tend to hang on to their cryptocurrency? Outside of legal constraints and vendors opting not accepting such mediums of exchange, Gresham’s Law provides some insight.
Colloquially Gresham’s Law has been oversimplified to being defined as “bad” money drives out “good” money. Essentially the introduction of “bad” money will replace “good” money in circulation. It is important to clarify what is meant by “good” and “bad” money. Bad money is a currency that has a higher nominal value than intrinsic value, making it overvalued (Sparavigna, 2014, P.1) . Vice versa is true of “good” money or undervalued currency. Gresham’s law does not come into effect until legal-tender laws designate that both varieties of money have the same exchange value (Sparavigna, 2014, P.1) . The undervalued currency tends to exit circulation in one of two ways. People either start to hoard the undervalued money (Sparavigna, 2014, P.3) . The undervalued currency leaves circulation through exportation. In the case of monetary metals, the coins are melted down and the bullion is sold abroad (Fetter, 1922, P.46).
The general premise behind Gresham’s Law predates its namesake. Tudor-era financier Sir Thomas Gresham. One of the earliest recorded observations of what became known as Gresham’s Law dates back to ancient Greece. In Aristophane’s play The Frogsa parallel is drawn between the substitution of gold coins for copper coins and the declining quality in politicians (Sullivan, 2005, P.5) . In the 1300s King Charles, the Fifth of France enlisted the help Nicole Oresme to resolve the economic instability caused by the fluctuation in the value of the French coinage. Oresme made the observation that when two coins present having the same face value but different intrinsic value, the higher value coin leaves circulation. The coins of a higher metal content were melted down and the bullion was sold abroad. Oresme believed that government-sanctioned monetary laws should prevent currency debasement (Sparavigna, 2014, P.6) .
Another theorist who posited a nascent form of Gresham’s Law was no other than Copernicus. He perceived money as ultimately as an estimated indicator of value. If the value was artificially manipulated would cause disruptions in the market (Sparavigna, 2014, P.7) . Copernicus suggested from a policy standpoint that any new money introduced into circulation should be of the same nominal and intrinsic value as the old money. If not the old currency will move out of circulation (Sparavigna, 2014, P.7) . Then there was Sir Thomas Gresham whom this economic law is named after. In 1858, Henry Dunning Macleod officially named this economic phenomenon after Gresham (Sparavigna, 2014, P.1) . Gresham famously wrote a letter to Queen Elizabeth concerning how reducing the weight of minted coinage encouraged the export of the older coins. Despite popular misconception and clumsy interpretation of Gresham’s letter, there was a stipulation. Good doesn’t necessarily drive out bad. Bad money will remain in circulation providing that the “baser” coins are produced in limited quantity and do not exceed “trade needs” (Sparavigna, 2014, P.9) .
The misapplication of Gresham’s Law due to careless interpretation has lead to many faulty claims. Attempts to invalidate the law or restructure its conditions have been predicated on such flimsy grounds (Selgin, 2003) . American economist Frank Fetter reinforces Gresham’s stipulation in his 1922 book Modern Economic Problems:
The law applies only under certain conditions and within certain limitations. The “ good” will be driven out only if the total amount of money in circulation is in excess of what would be needed if all were of full weight and of the best quality. Paradoxically speaking, if there is not too much money altogether, the bad money is just as good as the good money. But, even if good money is driven out, it may not leave the Country. It may behoarded, or be picked out by banks and savings institutions to retain as their reserves or be melted for use in the arts. (Fetter, 1922, P.42-43) .
Making it crucial to properly interpret the conditions under which Gresham’s Law holds. Good money drives out bad money is a far too rudimentary presentation of this economic law.
One novel interpretation of Gresham’s Law came from the grandfather of Anarcho-capitalism himself, Murray Rothbard. He stated that Gresham’s Law could not happen in a purely free market. That govenment intervention would be necessary to artificially overvalue one currency and then undervalue another other. That retaining full redemption value of even worn coins versus intentionally debased coins only takes place due to government decree. Valuing a new coin and worn coin at the same nominal value operated as a form of “imposed price control” (Rothnard, 1980, P.19) . Due to the fact that the government is setting a firm pricing floor and ceiling for the value of the worn coins. When by the pure monetary weight they have lost value.
Gresham’s Law certainly is an underappreciated economic law. Generally only acknowledged by monetary economists, gold enthusiasts, cryptocurrency enthusiasts, and proponents of the Austrian School of Economics. To really put it into context please consider the following example. An American Silver Dollar or Silver Eagle has a face value of $1.00. A 2020 edition of the U.S. Silver Dollar retails between $20.00-$25.00 . Which is substantially larger than its nominal value. This is why Silver Dollars are held and sold by collectors rather than used to buy a Big Gulp at the local 7-11 convenience store. Current Silver Dollars are approximately 99.9 % pure silver, 1 ounce by weight. The price of silver today (3/31/20) is $14.29 per ounce .