The Gold Standard Journal 12

The Gold Standard The Gold Standard Institute
Issue #12 15 December 2011 1

The Gold Standard
The journal of The Gold Standard Institute

Editor Philip Barton
Regular contributors Rudy Fritsch
Thomas Allen
Louis Boulanger
Occasional contributors Michael Moore
Thomas Bachheimer
Jason Keys
Sandeep Jaitly

The Gold Standard Institute

The purpose of the Institute is to promote an
unadulterated Gold Standard

www.goldstandardinstitute.net

Patron Professor Antal E. Fekete
President Philip Barton
President Europe Thomas Bachheimer
Editor-in-Chief Rudy Fritsch
Senior Research Fellow Sandeep Jaitly

Membership Levels

Annual Member 75 per year
Lifetime Member 2,500
Gold Member 25,000
Gold Knight 250,000

Contents
Editorial ........................................................................... 1
News ................................................................................. 2
You Can Print Paper but You Cant Print Gold ....... 2
Does Discount Rate Control Money Supply? ........... 3
Interview with Frank Schffler ..................................... 4
Reflections on Gold and Economic Freedom .......... 6
A Four Legged Stool ...................................................... 7
Coordination of the Natural Social Interaction ....... 10

Editorial
I attended the Mises Seminar in Sydney on
November 25th. None other than the legendary
Hans Herman Hoppe spoke incisively and brilliantly
for 2 hours over dinner. Yes, it was mainly
(wholly?) to the converted, and also largely to the
educated, but still there was spontaneous applause
for his simplicity of explanation always followed
with an apt example that clearly demonstrated his
point.
Whilst, like anyone with an understanding of
economics and money, Hoppe is a great admirer of
Ludwig von Mises, he is not nailed to the dogma of
the US based cult of Mises. He spoke freely and
without the need to prove his intellectual credentials
by talking over the heads of his audience. He is also
not burdened by the air of solemn intensity that
hangs over so many Libertarians. He came across as
a fun-loving anarchist and the audience hung onto
every moment of his speech.
Congratulations to the Libertarians in Sydney for
bringing in such a brilliant speaker. Next year try for
a more contemporary venue. No matter the validity
of the product, it still has to be marketed.
Positioning Libertarianism in a petit bourgeois
environment is not great marketing.
It would be wrong to finish on a criticism,
constructive though it is intended to be. Hans
Herman Hoppe was, for me, a once-in-a-lifetime
experience and the odd choice of venue was no
more than a passing curiosity. This was one of the
most enjoyable evenings that I have spent in a long
while. I also sat with a number of supporters of The
Gold Standard Institute which increased the
pleasure.
Amongst some other excellent offerings in this
months The Gold Standard, we have an article by
Rudy Fritsch called A Four Legged Stool. It should
serve to clarify the widespread confusion that exists
about fractional reserve banking.

News
"Our government doesnt have enough spare cash to
bail out a lemonade stand. - Peter Schiff

Bloomberg: Romano Prodi calls for gold bonds, but
not real gold bonds of course. Prodi refers to paper
bonds with a very tenuous link to gold and that pay
interest in Euros not the same thing as real gold
bonds that pay interest in gold.

"The Federal Reserve was never intended to
shoulder the entire burden of promoting economic
prosperity." - Ben Bernanke at Fort Bliss Town Hall
meeting.

Abandoned Storage: A Gold/Silver Horror Story!

Digital Journal: Republican candidate Ron Paul now
considered a front-runner.

Talk Radio News: Ron Paul Calls For a Return to
Gold Standard.

"What has become obvious in the last few years is
that debt-driven growth is a flawed business model
when financial markets no longer have an appetite
for it." - Bill Gross of Pimco.

Gold Bonds? - Not Quite! On top of their usual
deficit funding, the Japanese government has had to
sell more debt this year because of the devastating
earthquake and tsunami in March. This debt is sold
under the name of reconstruction bonds and it is
getting harder to sell all the time.
That being the case, on December 5, Japanese
Financial Minister Jun Azumi announced a prize for
those who are patriotic enough to go on buying
these reconstruction bonds. From now on,
individual investors who buy more than 10 million
Yen (about $US 130,000) worth of these bonds - and
hold them for three years - will be eligible to receive
a GOLD commemorative coin with a face value of
10,000 Yen (about $US 130). The coins weigh
0.55oz, making their real value on todays market
about 67000 Yen. While the Japanese wait three
years for their Gold - the bonds will be paying 0.05
percent.
You Can Print Paper but You Cant
Print Gold
Which is probably the reason why the banking
fraternity regard gold as a rebellious cousin to be
tolerated out the back, but not shown to the public.
Unfortunately printing money does not increase the
value of money quite the contrary, but it does
improve the price of gold.
Some banks still instinctively understand the value of
gold as evidenced by their continued buying of the
precious metal. According to the World Gold
Council central banks have been accelerating their
gold purchases over the past few months. Are they
shoring up their assets in preparation for an expected
fall? Can they see something on the horizon that we
cant?
The Bank of Korea for example. Which bought 25
tonnes of gold in June and July this year followed
that up with regular purchases including 15 tonnes in
November. "We bought the gold as part of our
diversification strategy and based on long-term
investment considerations," Lee Jung, an official at
the bank's reserve management group, told
reporters.
The bank said recently they bought gold in
November for the second time this year, to diversify
its foreign reserves, joining its counterparts in other
countries in seeking protection against financial
instability and inflation.
According to Arne Lohmann Rasmussen, the head
of rates, foreign-exchange and commodity strategy at
Danske Bank A/S, South Korea has huge reserves.
When they are buying gold, its supportive for the
market.
So with the instability in the financial markets caused
by excessive debt, even the central banks will turn to
the only stable of gold bullion to protect their
interests.
"Emerging economies including Russia and China
have been adding their gold reserves, as the situation
in the United States and Europe is not looking
great," said Hou Xinqiang, an analyst at Jinrui
Futures in China.
"Growing appetite for gold from central banks will
surely support gold prices to further rally in the next
few years, and gold is gaining an increasingly
prominent status on central banks' books."
"While the bulk of central bank gold is still held in
North America and Europe, a build-up of gold
reserves in emerging markets has been a consistent
feature over the last few years," said the council in a
research report published recently.
But Chinas gold accumulation is moving forward in
leaps and bounds. Gold purchases in Sept hit an all-
time high of 56.9 tonnes. In the July to Sept quarter
over 140 tonnes of gold bullion was bought by
China.
China has been encouraging its citizens to buy and
hold physical gold and has widened the number of
banks allowed to import gold. It has been
encouraging its citizens to buy gold and the
encouragement of gold investment has been
emphasised with gold exchanges now opening
around China with the first opened on Jun 28th this
year. In fact Chinas demand for gold has increased
25 percent, much more than the usual global average
of seven percent.
And Chinas Middle Class is growing by the day
buying more and more gold. With 320 million
Chinese introduced in to the gold market, the gold
purchases in the western world will pale into
insignificance.
What will that do to the gold price I wonder?
Indeed, is China going to be the first country to
adopt a gold standard? It seems quite possible that
the new gold standard may be hosted not by the US
or Europe (even Switzerland has bailed out) but by
Asia with its determination to reduce its exposure to
foreign debt. Converting this debt into gold is a
sound practice
Gold is the only money around. All else is simply
paper, Asia knows this, the banks know this. Astute
gold bugs know this. Even some parts of the
mainstream media are starting to wake up. And the
more people do, the more demand is going to be
placed for gold and the higher the value is going to
be placed on gold as real money. The rise is going to
be exponential and soon only the central banks,
institutions and the very wealthy will be able to
afford a simple ounce of gold. That is, if China does
not have it all.
The gold standard is not far away now.
Michael Moore
Michael Moore is the author of All About Gold. He writes
prolifically on precious metals and gems. His website is:
http://authorservices.org
Does Discount Rate Control Money
Supply?
One of criticism of the real bills doctrine is that
supporters claim that the state of business
determines the number of bills, and, therefore, the
number of bills is independent of bank policies. To
the contrary, according to these opponents, the
amount lent depends on the discount rate. Banks
decide how many bills to discount by the discount
rate that they set. A lower discount rate results in
banks discounting in more bills.
First, banks do not discount bills by lending; they
buy bills at a discount. The two actions are entirely
different. Second, banks may propose a discount
rate, but markets decide the discount rate. A bank
that sets a below market rate would not earn an
adequate return. If it sets a rate too high, it would
not do any business.
True, a lower discount rate normally results in more
bills being sold to banks and thus more bank notes
and checkbook money being placed in circulation.
However, a higher discount rate does not reduce
money in circulation. A real bill is commercial
money. It can and does, or did, circulate and
function as money until it matures. The quantity of
commercial money available for discounting
determines the discount rate. More commercial
money leads to lower discount rates. More
productivity results in more commercial money.
More consumption causes more productivity. Thus,
the discount rate depends on consumption and not
banks and savings.
With commercial money in circulation, the economy
can function without banks. Banks merely improve
the efficiency of the monetary system. With bank
notes, they divide commercial money into small
uniform pieces that are more easily spent. Also, more
people will accept bank notes in payment than bills
of exchange because the credit worthiness of a bank
is easier to judge.
Under the real bills doctrine, banks do not decide the
amount of credit money in circulation. Productivity
and consumption decide. Whenever a merchant
signs a bill of exchange accepting it, credit money as
commercial money is created. Thus, as more goods
are produced, commercial money increases. As fewer
goods are produced, commercial money decreases.
All banks decide is how much commercial money to
convert to bank credit, bank notes and checkbook
money. (In todays economy, most would be
converted to checkbook money.)
In summary, the discount rate depends on the supply
of commercial money, real bills of exchange.
However, it does not control the supply. Quite the
contrary, the supply of commercial money controls
the discount rate. Productivity and consumption
control the quantity of commercial money.
Therefore, productivity and consumption instead of
banks fix the discount rate.
The above discussion assumes the true gold-coin
standard accompanied by a decentralized
competitive banking system without special
privileges.
Thomas Allen
Thomas Allen has been a student and adherent supporter of the
gold standard and the real bills doctrine since 1972. In 2009, he
wrote and published Reconstruction of Americas Monetary and
Banking System: A Return to Constitutional Money. Many of his
writings on money and other subjects can be found at
http://tcallenco.blogspot.com/ and an index to these blogs is at
http://tcallenco.weebly.com/
Interview with Frank Schffler
The 25th Finanz Symposium in Alpbach as usual,
perfectly organised by the Finance Trainer team
boasted a very special guest. The farsighted Dr.
Enthofer, Finance Trainer partner, scored the coup
of the year in February by inviting the FDP member
of parliament Frank Schffler.
Frank Schffler. Born in 1968
in Schwbisch Gmnd, MP of
the Free Democratic Party
which for most of its
existence (since 1948) had
held the balance of power in
the Bunderstag. Herr
Schffler was part of the opening panel of the 25th
Finanz Symposium in Alpbach, Austria in October
2011.
Just a few days before the symposium started, Frank
Schffler was the focus of a commotion in Europe
because he voted against the insane expansion of the
rescue-funding programme. He also didnt miss the
chance to hold a probably historical speech in the
Bundestag. The German newspaper Die Welt
announced Schffler as a European key figure.
During the symposium Thomas Bachheimer, the
President of The Gold Standard Institute in Europe,
took the chance to interview Frank Schffler:

Thomas Bachheimer - The state Europe finds itself in is
due to decades of failure, concealment and cover-up.
Of course that raises some questions: Have our
parents failed in the oversight of politicians,
especially with regard to the wasteful use of national
wealth?
Frank Schffler - No, the reason for our present
situation lies with the manipulation of our monetary
system, the production of money out of nowhere.
This fact leads to inflation of asset prices, produced
by the cooperation of state and banks and the
politicians benefit by lower budget financing costs.
Thomas Bachheimer - The successful generation of our
fathers has created the framework by just leaving the
design of the monetary system to the politicians.
Frank Schffler - Yes, the deeper cause of the crisis
lies in the closing of the US gold window in 1971. Of
course we are now prematurely consuming the fruits
of tomorrows labour.
Thomas Bachheimer - It is always said that the upkeep
of European freedom depends on the present
currency system, the Euro, and that one has to
accept the accompanying unconstitutional acts and
obvious theft of property from the people. Would
peace in Europe really be endangered by the collapse
of the monetary system?
Frank Schffler - Actually the opposite is the case. The
rescue funds are going to cause diverging
developments in Europe. If you define a Europe of
law and then stick to this law, the rules are perfectly
clear. Conflicts only occur when institutions start to
bend the law to their own benefits. Protecting the
rule of law helps secure peace. After all, one of the
main tasks of the state is to uphold the rule of law.
Thomas Bachheimer - As the European president of the
Gold Standard Institute I experience the same events
in Vienna and Zrich: Groups are forming to protest
against the despotism in politics, the dominance of
the interests of the banks, but mostly, against
breaches of the constitution. More and more young
people are starting to analyze the situation and
discuss potential alternatives. The concept of a fair
monetary system is moving to the centre of public
attention. Do you think people are waking up?
Frank Schffler - I am a supporter of Friedrich August
von Hayek and his theory of a market-based
monetary system. Those theories have been
forgotten for a long time. Within the last few years, a
certain scene has been growing around the world,
including Ron Paul in the US, which puts this topic
center stage. The discussion is falling on more and
more fertile ground as people feel that something is
wrong. The constant doubling and tripling of
(monetary) resources cannot have a happy ending.
Everybody knows this, but not everybody
understands that the reasons for the crisis lie in the
monetary system itself. Thats way one has to create
a broad awareness for these issues.
Of course, one has to put up a stiffer resistance; in a
way, we all have been sinners. Germany has softened
the Maastricht criteria in 2003, the foundation of
which was that each member has to rely on itself in
the first place. It was never intended that one
country should help another out of its self-created
dilemma.
Thomas Bachheimer - No one can predict the future,
but could you describe a possible scenario as to how
this crisis and this unfair monetary system is going to
be dismantled and how we will go on from there?
Frank Schffler - We are going to resort deeper into
the transfer union and bailouts as the rescue funds
are going to expand even more. The bank licenses,
which are necessary for the fund, are going to create
a perpetuum mobile and therefore allow the banks to
sell their weakest stocks to the national banks in
order to receive fresh money. People are going to
realise that, which will cause massive damage to the
trust in money. Eventually, the transfer union is
going to lead to inflation unless Greece and Portugal
exit the euro zone voluntarily. Therefore, changes
will have to take place in the periphery, which could
happen faster than we think.
Thomas Bachheimer - Do you see an end of the top-
down currency system (politics defines one valid
currency currency monopoly economic actors
cannot decide which currency they use) or do you
think the introduction of gold bonds could be a
passable solution for the euro zone?
Frank Schffler - I support competition between
currencies, the monetary system should not be
predefined, therefore the state monopoly has to be
dismantled. There also should be the possibility for
emitters to circulate money and then let the market
decide which one becomes prevalent. The state has
to abolish the legal-tender-laws and has to stop
persecute those trying to introduce new currencies.
The new system of the Swiss Gold Franc gives an
idea of what the foundation of this system is. Parallel
and regional currencies are a step in the right
direction, because different scenarios are tested.
Thomas Bachheimer - I emigrated from the EU-area to
Switzerland due to currency issues six years ago.
Since September 6 (pegging the Swiss franc to the
euro) my idea of living in an honest currency system
has vanished at least by half. Do you see the action
of the SNB as interference with the freedom of the
country? Has the European system prevailed over
Switzerland?
Frank Schffler - No, because Switzerland cannot
sustain this intervention for any length of time. The
decision was only made due to pressure from the
export economy on the national bank and one must
not forget; Switzerland is moaning in a very
comfortable position. The biggest problem lies with
the major banks being too big to fail.
Thomas Bachheimer - The standing of banks and
understanding for their actions has massively
declined in public opinion. The well-known NZZ
wrote 3 years ago Switzerland has to support its
banks. Now it states the banks actions are deeply
suspect and describes the Swiss people being at the
mercy of theirs banks. So one can observe a trend
away from big banks. It seems that the Swiss are fed
up with dubious actions and related risks.
Frank Schffler - On the whole, Switzerland advanced
the regulations in a rather intelligent way, e.g.
exchanging forced loan with equity. But if the two
system-relevant large banks start to cough,
Switzerland will catch pneumonia.
Thomas Bachheimer - Thank you for your time Herr
Schffler
Reflections on Gold and Economic
Freedom
This past week saw the ideas of the New Austrian
School of Economics unleashed upon the University of
Auckland Business School in a five-day symposium
entitled: Gold and Economic Freedom.
Professor Antal Fekete acted as featured lecturer and
delivered a series of talks covering Coordination of the
Social Interaction, A Brief History of the Gold Standard &
Imposters, Hoarding and Golds Role in Finance, Gold
Bonds to the Rescue, and the Unadulterated Gold Standard
Explained.
The Professor repeatedly brought attention to the
work of Carl Menger, a man universally successful
in all he touched. Mengers emphasis on the spread,
Fekete contended, provides the key to economic
understanding. His focus on the individual nature of
money, how the recognition of different degrees of
saleableness of goods leads to the discovery of money
(the most marketable good), is central to
understanding economic action.
The Professor described the social coordination of
economic actors as a system of cobwebs, where
disturbances are distributed throughout the system
and felt by all points. He spoke in detail about the
Unadulterated Gold Standard, also known as the Gold
Coin Standard, and discussed the imposter gold
standards of the 20
th
century, the Gold Bullion
Standard and the Gold Exchange Standard.
He explained the concepts of marketability in the large
and marketability in the small and outlined how these
concepts represent the duality of money, the practice of
using two types of money together in indirect
exchange. He declared that hoarding has a place in
even the most sophisticated financial system and
noted its integral role in regulating the interest rate, the
measure of the efficiency of the exchange of income
for wealth over hoarding.
Illicit interest arbitrage, borrowing short to lend long, and
risk-free bond speculation were all discussed in detail,
and it was explained how these forces create a
situation where both the supply of, and demand for,
government bonds is infinite.
In the afternoon lectures, the ideas of Menger and
Professor Fekete were expanded upon by several
ferocious minds. Highlights included Sandeep Jaitlys
remarks around social interaction, a process of movement
which takes different forms and has different
frequencies. Jaitly described the natural extension of
credit, supported by gold money, and the creation of
higher-order money of various durations.
He defined borrowing short to lend long, a practice
whereby dealers of debt create a mismatch of
durations in their bond/bill portfolios and cause
non-uniform expansions & contractions of credit
and business cycles.
Symposium organizer Louis Boulanger discussed
Why Gold Is Money and centered his lecture on Carl
Menger's essay On the Origin of Money. He talked
about how debt growth represents the ever-
increasing promise of future goods to service the
present, how measures of value are relative, and how
fiat currencies are elastic measures of value.
Keith Weiner led a technical discussion on Gold
Backwardation with particular emphasis on the gold
basis and co-basis. He defined how these metrics are
calculated, as well as the terms contango and
backwardation, which represent normal and abnormal
relationships (respectively) between the spot and
future price of gold. He explained how gold
backwardation has thus far been solved by higher
prices and described what to look for when gold
backwardation turns permanent.
Rudy Fritsch presented Gold Standard: A Stable 3-
Legged System and centered his talk on a brilliantly
simple, informative diagram that captured the three
components of the (unadulterated) gold standard:
bonds, bills & money. He defined debt, or credit, as
the exchange of present goods for future goods
(promises), money as that which extinguishes all
debt, and explained how legal tender laws equate
present and future goods.
Given the depth of original thought and the
completeness with which the ideas of the New
Austrian School of Economics were presented in
Auckland, it is clear that a once dismal science has
given way to a vibrant, highly engaging, social
science that is just now taking flight in the minds of
men en masse.
We need no longer look to the heavens for answers
to the financial problems we face in todays world.
The answers have been worked out and assembled
by the New Austrian School of Economics. Be on
the lookout for when its ideas invade a city near you.
Jason Keys
A Four Legged Stool
My last article talked about the natural stability of the
triangle, both as a structural element and as the basis
for a stable, three legged stool. Clearly chopping off
a leg or two will make a three legged stool unstable;
but adding an extra leg, making it into a four legged
stool, also undermines the stools natural stability.
If the floor is uneven, or if one leg is longer or
shorter than the other three, a four legged stool will
rock. This is a pretty good analogy for how the
Classical Gold Standard worked. Rocking is seen
in recurring booms, panics and recoveries
experienced throughout the nineteenth and early
twentieth centuries. This rocking of the economy
between overheat and collapse is generally called the
business cycle.
This name is highly misleading; what correlation is
there between cycles of widely disparate businesses
making up the economy? What correlation is there
between an apple orchard and a hair comb
manufacturer or between a shoemaking business
and a ship line? In fact, there is only one; money, or
more precisely credit.
Credit is the only factor that affects all businesses;
thus the so called business cycle is actually a credit
cycle. If we take a look at how credit influences all
business, we can see that there is not only correlation
but causality between the availability of credit, or
rather excess credit, and the boom/bust credit cycle.
The roots of the credit cycle can be traced back to
seventeenth century England. At this time, English
common law set the noxious precedent that if
anyone deposits money in a bank, that money is no
longer the property of the depositor, but is deemed
to have become the property of the Bank.
Remember, the depositor does not sell or trade his
money to the bank, he merely deposits it. This is
staggering if you think about it.
Consider what happens to your furniture if you
deposit it in a warehouse does it become the
property of the warehouseman, to do with as he sees
fit? Suppose he sells your furniture, or lends it out
while it is in his warehouse? I think if you showed
up to reclaim your furniture, and were told that it
had been sold, but he has other furniture just as
good, you would not be a happy camper. Or
suppose it was lent out, and will not be available to
you till next month why you may call the police
and have the warehouseman arrested.
Furthermore, the law sides with you. If the
warehouse company went bankrupt, the bankruptcy
trustee would separate the furniture being
warehoused from the warehouse and its equipment,
like the fork lift truck or the building and after
returning all the deposited furniture to the rightful
owners, would sell the warehouse property to settle
with creditors. As a depositor of furniture in a
warehouse, you are not considered a creditor but a
customer and any property being warehoused
belongs to you and to other depositors not to the
warehouse. So why is Money different?
Oh, you say Money is fungible, and any coin of the
same weight and fineness (we are talking real Money
here, Gold or Silver) is as good as any other thus
you have no claim to a specific coin or coins and
this is true. Just like a grain elevator in fact; if a
farmer were to deposit 100 bushels of hard red
winter wheat with a grain warehousing operation,
then he will clearly not get the very same grains back;
but he will get back 100 bushels of hard red winter
wheat not corn or oats, and certainly not an
excuse that the grain has been sold or LEASED!
So why is Money different?
Is it just a simple coincidence that the Bank of
England was franchised at about the same time this
legal precedent was set? Indeed, this invasion of
property rights goes quite against the times. England
was leading the way in the recognition of property
rights an Englishmans home was his Castle, and
even the King of England had no rights there. The
Magna Carta was written in England not long before
this time. Even more tellingly, the Industrial
Revolution took off in England, not elsewhere.
Sure, England had coal but so did France and the
rest of Europe. England had scientists but so did
the Continent. The fundamental reason that the
Industrial Revolution started in England is that
property rights in England were extended to
intellectual property rights as well as physical
property rights. James Watt had a flash of genius in
understanding how to radically improve the
efficiency of Newcomens steam engine; but the
years of effort it took to develop and manufacture
the Watts condensing engine that kick started the
industrial revolution took much capital and much
perseverance.
This capital only became available through the newly
written patent laws. Profits for inventors who are
not tenured academics or government supported
bureaucrats but entrepreneurs competing in a free,
capitalist marketplace only became available
through the recognition of the inventors intellectual
rights. The enormous burst of energy devoted to
improving the machinery of the industrial revolution
sprang from this new recognition and respect for
intellectual property rights.
Why on Earth then were property rights to Money
invaded in the very same country and about the
same time?
It is no coincidence that his was also the time the
bank of England was chartered; had this invasion of
property rights not been legalized, then fractional
reserve banking as we know it could not have arisen,
the classical Gold Standard would have remained a
three legged, fully stable system and the current
catastrophic collapse of the world financial system
would have been pre-empted. This is how critical the
legal precedent regarding money, property rights and
banking is.
With the unethical transfer of property rights to the
banks, the banks could legally do what they pleased
with the money, with the depositor having only a
claim against the bank but no control over what
the bank did with the deposited money. Banks
inevitably lend the short term cash deposits out for
long term rates; the notorious and illicit practice of
borrowing short to lend long is thus legalized...
instead of being outlawed and punished. This
practice leads to creation of excess credit, leads to
the credit cycle and leads to runs on banks. A run
takes place when depositors ask for their money
back, but the deposit money is no longer there; it has
been lent out for the long term.
The so called inverted yield curve, whereby short
term credit commands higher interest rates than long
term a very unnatural event if you recognize that
longer terms involve greater risk and should and
naturally do command higher rates to compensate, is
a direct result of the illicit practice of borrowing
short to lend long.
Had property rights stayed where they belong, with
the depositor, then the banks would be obliged to
ask each depositor exactly what the depositor wishes
be done with HIS money; the choices are simple, but
critical. The banks could offer a vault service, like the
warehouseman does. This service would incur
storage costs for the depositor, but his money would
be fully guaranteed, segregated, insured, etc as safe
as possible, perhaps safer than home storage; after
all, banks have serious vaults, and guards, alarm
systems etc. to protect your wealth.
Alternatively, they could offer a fully liquid demand
deposit account. This account would offer a small
but non zero return to the depositor. Money so
deposited would be available in the form of demand
notes drawn against the bank, and offset in the bank
portfolio by only truly liquid current assets. The
assets behind demand notes could be only cash
Gold, Silver, or Real Bills that mature into Gold in
not more than 91 days. In fact, German banks
before WWI were expected to hold 1/3 Gold and
2/3 Bills against their demand notes. Real Bills are
an earning asset the face value or maturity value is
higher than the current or discounted value thus
the depositor would receive a modest but
worthwhile return.
Finally, if the depositor agreed to tie up his money
for a more extended period of time, then the bank
could offer interest, based on prevailing rates, which
is always higher than the discount rate. The amount
of money available to lend long is thus determined
by the individual depositors time preference.
There cannot be a run on the bank, as all notes are
backed by liquid real assets, and only long term time
deposits are available for longer term loans. The
term structures match perfectly, automatically. A
simple example of how this works is to assume 10
depositors show up at the bank, each with 100
monetary units they wish to deposit.
The first depositor decides that he wants to keep 20
units in his demand account, the rest in a time
deposit. Further, to keep the numbers simple we
assume that all ten depositors decide to do the same
thing; 20 units of demand deposit, 80 units long
term. The result is that the bank will end up with 200
monetary units in its demand account, and 800 in its
term account.
Now it is perfectly legitimate and proper for the
bank to lend out the 800 units; after all, that is what
the owners of the money want. Thus, 800 units of
money are available to be lent into circulation and
the borrowers of this 800 units will also decide what
they want with their newly borrowed funds; put
some into demand deposit, some into term deposits.
If the ratio that new depositors use happens to be
the same, that is 20% demand and 80% time, then
the next cycle of this iterative process will allow
another 640 units to be lent out 80% of the 800 is
640. Then another round, 80% of the 640 etc This
is the famous fractional reserve process but done
with no printing money from thin air, with no
arbitrary reserve ratios and no central bank needed
to try and ameliorate bank runs.
Deposits come and go, and money owners decide on
their split between demand and time deposits all the
time. If we simply add up all the time deposits and
demand deposits in the whole banking system, then
we can come up with a single number: the ratio
between demand and time deposits, as determined
by the myriad bank customer.
Today this number is called the Reserve Ratio. But
there is an enormous difference between a naturally
occurring number as determined by market
participants, and an artificial number set by
interested parties such as greedy bankers and power
seeking politicians. The difference is polar, as is the
difference between debt and money; the two
numbers are 180 degrees apart.
The power to influence the whole economy now
rests with one authority; the central banker. The
credit cycle is controlled by one party, the central
banker. No longer does the reserve ratio reflect the
wishes of the populace. Think about this for a
minute; the economy is solid, jobs are plentiful, the
future looks peaceful and rosy. As a result, most
depositors would be willing to keep a modest sum in
their demand deposit, and more in the time deposit,
happy to collect the higher interest available. Thus
the reserve ratio would remain low. Perhaps only
15% of all deposits would be in the demand account.
But suppose the economy is showing stress, the job
markets look less positive, the future looks more
risky; depositors would naturally want to keep more
money on hand, just in case; and the ratio would
automatically grow to reflect this concern. No need
for anyone in power to set or adjust this ratio; all
economic numbers like prices, interest rates,
discount rates etc in a truly free market are self-
regulating. The reserve ratio is optimized by simple
but vital market feedback mechanisms.
Today these natural feedback mechanisms have been
cut, and replaced by authority. In effect, the
numbers are set at the whim of the powerful, in the
interest of the powerful and the whole economy
suffers the consequences. Instability of the four
legged Gold standard was caused by exactly this; the
reserve ratio was set at the whim of the central
banker and the bankers interest is to create more
credit than the market needs or can support; in order
to collect more interest.
The Government backs this policy, because the
Government needs ever more cash to gain and
keep power. The only place they can get more,
virtually limitless cash is from the Central Bank so
the instability and monetary destruction proceeds
apace. Excess credit is force fed into the system
and once the debt reaches a level where the ability to
repay it debt is surpassed, the artificially induced
boom suddenly turns to bust. After the collapse, the
destructive cycle starts anew.
To achieve Economic Nirvana, a stable and honest
monetary system, we need to first restore property
rights; then central banks can close their doors, and
market participants can reclaim their legitimate
power over reserve ratios, as well as over interest
rates, over money supply over all economic
aggregates. The three legged stool of the
Unadulterated Gold Standard has only three legs
Really!
Cash Gold and Silver (Money), Bonds and Real Bills
are the necessary three legs. No fundamental need
exists for bank note circulation; but if bank notes are
to be used, then they must be issued against Money
in the issuers vault, and Real Bills in the portfolio;
not against long term promises especially not
against promises with no intent of being honoured.
Such false promises backing Notes were the
fiduciary component of the classical Gold Standard,
the forth leg that causes instability. No fiduciary
money, no excess credit; no excess credit, no credit
cycle. As simple as that.
The invasion of property rights is a slippery slope;
today not only customers money, but their futures
contracts are being commingled with the capital of
the depositories. The furniture held in the MF
Global warehouse was used by the criminals in
charge to try and save their own bacon. This theft
shows what road we are on; the odour of burning
sulphur grows stronger every day! If we do not
establish an unadulterated, stable Gold standard
under the world economy, our civilization is
doomed.

Rudy Fritsch
Rudys book Beyond Mises was written to make
Professor Fekete's work and Austrian economics
accessible. It can be ordered directly from
http://www.beyondmises.com/
Coordination of the Natural Social
Interaction
The aim of this paper is to show that the monetary/financial
system that develops is a representation of some form of
productive social interaction. The monetary system is the
consequence, not the cause, of productive social interaction.
Money is defined as that substance which is the
ultimate extinguisher of any debt. As a consequence
the substance(s) used as money must have perceived
value in and of itself. Menger described the iterative
procedure by which a substance was promoted to
money by the people themselves in The Origin of Money
(1892.)
There is no record of the date at which humanity
first gave value to gold and silver because the
Sanskrit literature that first referred to them cannot
itself be accurately dated. However, we can be sure
about the mechanism that resulted in their
promotion to the monetary metals courtesy of
Menger.
The substance which is promoted to money will
necessarily have very high inventory to primary
production ratio (also known as stocks to flow ratio.)
This arises from the fact that incremental additions to
ones personal holdings of this substance do not
affect ones personal terms of acceptance of this
substance. This substance must exist, just as the
largest number amongst a set of numbers must exist.
If one arranges all commodities on earth by the
stocks to flow ratio, two metallic commodities stick
out markedly: gold and silver. The extent by which
these two metals differ from the next substance in
terms of stock to flow is astounding and testimony
to the exceptionally long period of time over which
humanity has valued these two metals. There can be
no other explanation.
With the monetary substance chosen, the evolution
of the financial and payment system merely a mirror
of the natural social interaction that arises from the
fact of our own existence can begin.
Economic activity is a base synonym for social
interaction: the farmer sending wheat to the miller
who sends flour to the baker who makes bread for
consumption. The crude extractor sending oil to the
refiner who sends on refined petroleum distillate to
the retail pumps. These are all examples of social
interaction. Interaction that is not related per se to the
medium used for money. Interaction that occurs by the very
nature of our existence. Interaction that must recur for the
maintenance of our existence.
A defined amount of the monetary substance is the
unit of account of multiple aspects of this social
interaction. An extended social procedure stretched
over countless millennia itself gave birth to the
monetary media, so it is quite clear to see that neither
the monetary substance itself, nor the amount in
existence, would influence that social interaction.
Social interaction occurs in different forms and
frequencies. For example, the sale of bread by the
baker is pretty much guaranteed whereas the sale of
the new jet engine to the aircraft company is not.
This is an example of differing forms of social
interaction.
The construction of an airport takes a different
period of time (usually) to the construction of a
residential home. This would be an example of
differing frequencies of social interaction.
Credit granted for the construction of a factory is
extinguished, usually, by the sale of the produce of
that factory. Credit granted for the sale of a fast-
moving good like carbonated drinks is extinguished
by the sale of the drinks themselves.
Notice the difference in the form of the two credits:
the credit for the former is not extinguished by the
sale of the entity that the credit was used to create,
whereas with the latter the obligation from the
drinks seller is satisfied upon the sale of the drinks
upon which the credit was granted.
Liquefying the Social Interaction
An often heard expression is that banks create
money. This is not true. To explain the origin of this
misconception, one must examine the process of
higher order money creation. Higher order money
is a misnomer, as the composite of higher order
money is not strictly money, however this
nomenclature will not be dropped. Money can only
be created by the arduous extraction of gold and
silver from the earth. The volume of money on earth
has a monotonic increasing character. Gold and
silver, once extracted from the earth, remain on the
earth for all intents into perpetuity.
Imagine an endeavour that will increase the general
standard of living. For example the construction of a
warehouse for a village to store out-of-season
perishable produce. This endeavour would alleviate
the potential for famine. The enterprising villager
who has insufficient access to the monetary
resources to build the warehouse by himself must
seek help. He approaches three other villagers who
each promise 1/3 of the money required to build the
warehouse. The three villagers all require the money
to be returned no later than two years from present.
The three villagers demand a tribute for the
abstention of having the money themselves and a
figure agreeable to all was fixed.
There are two facets to consider in this example: the
length of time the three villagers were willing to give
their money and the tribute required. If the money
were required back at any shorter period, the length
of time may be insufficient for the enterprising
villager to build the warehouse. If the tribute
required is too high, it may result in loss too severe
for the enterprising villager to handle. There is a
limit to the amount he can charge for the relatively
simple task of warehousing produce. The former
consideration represents temporal preferences, the
latter spatial.
The acknowledgement of the debt by the
enterprising villager to the three other villagers
creates the first form of higher order money. It is a
trust between all parties concerned that debts will be
honoured: credence is given to the relationship. That
credence can be represented by (three) chits possessed
by the three villagers. The total amount of money in
the village would not change during the initial
exchange or subsequent spending of proceeds.
However the acknowledgement of the three new
chits will create the first form of higher order
money. These chits disappear once the credit
originally given has been extinguished by the
enterprising villager from the profit proceeds from
his warehousing activities.
The continuance in the obligation between all parties
gives value to the chit. The chit does not have value
in and of itself. Higher order money does not have
value in and of itself, as opposed to money. The chit
can be sold if need be. It is not hard to imagine that
other villagers may be willing to buy the chits, nor is
it hard to imagine that different chits representing
credit behind different productive endeavours and
with different maturities would also exist. The
important thing to remember is that all chits
eventually get extinguished and disappear once the
credit that they represented gets discharged.

There is a class of chit in the village that is superior
to all other classes in terms of demand from
villagers: the chits that represent the credit behind
the production and sale of items continually in
demand by other villagers: bread; clothing; firewood
etc. This class of chit is superior to the others as it
only relies on the sale of a simple item for the credit
behind it to be discharged, as opposed to the other
chits that rely on the successful execution and
running of an arduous endeavour. The chits and the
superior chits are analogies for the bond and the
bill respectively.
The merchant bank is a synonym for a dealer in
chits or bonds and the discount house for dealers
in superior chits or bills. In our example, instead
of the villager keeping the chit himself he could
deposit it at the villages merchant bank against the
creation of a deposit: a deposit which turns into
money upon the settlement of the original credit.
The system of merchant banks and discount houses
arises as nothing more than the precipitation of
social interaction. They are the consequence of social
interaction not the cause. The balance sheets of
these institutions represent nothing more than [part
of] the aggregation of the representation of social
interaction through bonds and bills. As society
progresses with education, there is no limit to the
potential for productive social interaction.
Consequently, there is no physical limit to the size of
the bond and bill market (i.e. higher order money in
relation to money.)These institutions certainly did not
create the bonds and bills that they holdthey
merely liquefy (i.e. bring order to) that which would
exist anyway.
Evidently, bills and bonds do not make sense
without the monetary substance gold. The whole
system of financial institutions is meaningless
without the supreme measure of gold.
Perturbing the Natural Social Interaction
It is a mistake, as has been elaborated on above, to
assume that merchant banks, discount houses and
financial institutions in general dictate the level of
social interaction (or economic activity.) In
aggregate, they are merely a mirror of social
interaction of various forms and frequencies. The
only limit to the size of various frequencies of higher
order money is the boundary of productive social
interaction. This, naturally, is enhanced by a
philosophy of education amongst the people.
Errors and pitfalls are a part of human nature. The
system of money and higher order money is a mirror
of the natural social interaction. Consequently, it is
as sound as the interaction that it represents.
Therefore the expectation of a monetary system that
is absolutely perfect and free from any form of risk is
a chimera. To expect them not to occur is as
untenable as expecting humans not to make errors.
But the damage on the monetary system caused by
mistaken social interaction can be limited.
In our previous example, say two years has passed
and the repayment of the chits to the three villagers
from the enterprising villager is now due. The
enterprising villager has saved insufficient money
from his warehousing activities to pay off the credit
initially given in full.
The three villagers tell the enterprising villager not to
despair. They wish to endow a grammar school in
the village and provide it with an income into
perpetuity. The villagers tell the enterprising villager
to change the old chits for a new chit that represents
a fixed annual money sum into perpetuity. A rate
agreed by all was haggled and an agreement forged.
The newly founded grammar school held the new
chit which proclaimed an eternal bond from the
warehouse to the grammar school. The three
villagers who founded the grammar school reasoned
that the activity of the warehouse was likely to be
perpetual in nature just like that of the grammar
school itself.
Problems involving money are not always settled as
amicably as above. The sale of chits to parties other
than those that created them could produce
problems. If the chits are then possessed by people
who have no link or comprehension of the
enterprise which it represents then problems could
arise. The ultimate problem could be characterised
by issuing chits with no intention of ever repaying
them the drawer merely hoping that someone else
buys a new chit on expiry of the old one. These
mechanically simple problems pass with verbose
names in modern finance but the essence is no
different to the examples.
This paper has shown that the monetary system is nothing
more than a reflection of the natural social interaction. The
monetary system will only be as virtuous as the interaction that
it represents. Credit granted for the sake of alcohol
consumption is not as noble both from the perspective of the
borrower and lender as credit granted for the construction of
a warehouse.

Sandeep Jaitly
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The Gold Standard The Gold Standard Institute

Issue #12 15 December 2011 1

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