How to Create Sound Money
Underlying asset is supposed to be understood when speaking of derivatives. As Henry Thornton explained, the underlying must have actual value, intrinsic or derived. (Thornton, op. cit., 81-89.) Thus, it is possible to have an existing inventory of marketable goods or services and turn it into money by "drawing a bill," that is, by creating a derivative, backed by the present value of the inventory. This process also holds true when the underlying consists of the present value of future marketable goods or services — assuming that the capital or labor that will produce the good or service has been properly scrutinized and valued.
This bill can be passed from hand to hand — discounted and rediscounted — in payment of debts until redeemed by the holder in due course. The bill thereby circulates as a medium of exchange. If the drawer of the bill or a holder in due course wants a more convenient form of money in place of the bill, he or she can take it to a bank of issue and discount the bill. The bank creates some form of currency, usually banknotes (although commercial banks have issued token coinages) or the equivalent to purchase (discount) the bill. The bill can then be rediscounted at the central bank to ensure a uniform, stable, and elastic currency, but that step is not essential to understanding the process.
These days the bank usually creates a demand deposit. This is because few commercial banks in the world have the authority any longer to print banknotes. The two of which this writer is aware cannot issue banknotes backed by anything other than non-productive government debt. In effect, the buyer and seller of the bill balance the debt created by drawing or receiving the bill, with the debt created by issuing the banknote or creating the demand deposit. Currency — and we necessarily include demand deposits in the definition of currency (as does the Federal Reserve in its definition of M1) — is thus a derivative of money, just as money is a derivative of production.
How to Create Unsound Money
It is also possible, as Thornton describes, for a bill drawn on the present value of properly vetted existing and future marketable goods and services (a "real bill") to be used as the underlying for another bill. The holder in due course can use the second bill as the underlying for a third bill, and so on, ad infinitum. This, however, is considered unsound, not to say dangerous. As Thornton explained,
Of all these bills, then, one only represents any actual property. . . . it is obvious, that the number of those bills which are given in consequence of sales of goods, and which, nevertheless, do not represent property, is liable to be encreased through the extension of the lengthy of credit given on the sale of goods. (Thornton, op. cit., 86.)In other words, a bill drawn directly on the present value of existing or future marketable goods and services can either be used as the medium of exchange, or transformed by a bank of issue into a more convenient form of the same thing. In that case, it is known as a "real bill." The same bill should not, however, itself be used as the underlying for another bill, and so on, in sequence. The original bill remains "real," but the subsequent bills are what Thornton termed "fictitious." This is because the private property right that ties all sound money to its underlying is not present in the subsequent bills except in extremely attenuated form. Consequently there is nothing to prevent the holder in due course of the real bill from rediscounting it, leaving the holders in due course of the subsequent bills hanging out to dry.
This sounds dishonest — and it is. This is because private property in the present value of existing or future marketable goods or services only backs the original bill, not the subsequent bills. Nevertheless, this is how a great deal of business has been carried on in the financial services industry in recent decades. Derivatives have been drawn on derivatives, and on extremely tenuous, sometimes non-existent underlyings. The result was that the financial markets were rapidly transformed into gigantic and extremely high stakes gambling casinos.
These arrangements have become extremely complex, with layer upon layer of intricate transactions. Most people do not understand the legitimate use of derivatives. Even the experts were in many cases baffled when derivatives began to be piled on top of derivatives. In consequence, some extremely intelligent and ethical brokers were put into the position of not understanding their products, and refused to sell them. (Vide Lydia Fisher, Cinderella of Wall Street. Chicago, Illinois: Galyda Media, LLC, 2009.) This left the extremely profitable dealings in derivatives, and derivatives with other derivatives as their underlying, ad infinitum, to the unethical, those willing to sacrifice anything and everything in pursuit of greater profits. If not the cause, the increasingly (and unnecessarily) complex financial transactions, designed more to obscure what was going on than to facilitate trade, were a strong contributor to the magnitude of the current global financial crisis.
The lesson is clear. For a money supply to be sound and stable, the underlying — the present value of existing or future marketable goods and services — must be linked to the money by private property in something with real, definable value. The currency must, in turn, be linked through private property to money linked to something with real, definable value. There must be something of definable value behind the property right that money in all its forms conveys, or the money is illegitimate.
The Role of the State
Somewhat ironically, when the State backs its currency issues with government debt, with the debt backed by future hoped-for tax revenues (Tax Anticipation Notes), it is doing the same thing as the merchant who draws a bill on something in which the merchant does not have a private property right. That is, the State is backing the currency with fictitious bills. This has the expected result. The moment the tax base erodes and the State is unable to make good on the promises it made, the currency rapidly loses value and the economy begins to implode. Efforts to wrest more taxes out of the economy, or inflating the currency to transfer what wealth remains in a frantic effort to restart the economy, are doomed to failure.
The role of the State in money creation is properly confined to a certification and regulatory function. The State is thus limited to making certain that there is equal opportunity for everyone who qualifies to use money and credit, to ensure that the currency has the same value everywhere where the State's writ runs, and to enforce contracts on those relatively rare occasions when a dispute arises. Really. Despite Keynes's assertion and Knapp's beliefs (Vide Georg Friedrich Knapp, The State Theory of Money. London: Macmillan and Company, Ltd., 1924), the vast majority of contracts are carried out, and money created and canceled without any involvement whatsoever on the part of the State.
Nor, despite the claims of the Monetarists and the Austrians, is the case any different when the currency consists of specie, that is, gold and silver. The State does not create the metal nor, in many cases, own the mines from whence come the gold and silver out of which coins are struck. Instead, the State either strikes the coins as a public accommodation, sometimes for a fee, or purchases the metal out of which to strike the coins. If the amount of metal in the coin has a value less than that stated on the face of the coin, there is significant opportunity for fraud through depreciating or devaluing the currency, as Henry VIII Tudor discovered, and thereby attained eternal, if somewhat dubious numismatic fame by debauching England's currency. There is also the problem that, as the amount of gold and silver in the economy only matches the present value of existing and future marketable goods and services by chance, the danger of inflation or deflation is always present.
Money and Production
Not to stress the point too much, but this thing we call "money" is not valuable in and of itself. Money is only valuable in consequence of the private property right it conveys in the present value of existing and future marketable goods and services that we have produced or that we have the reasonable expectation of producing. This is as the French political economist Jean-Baptiste Say explained when he responded to some criticisms of his work by the Reverend Thomas Malthus:
Since the time of Adam Smith, political economists have agreed that we do not in reality buy the objects we consume, with the money or circulating coin which we pay for them. We must in the first place have bought this money itself by the sale of productions of our own. To the proprietor of the mines whence this money is obtained, it is a production with which he purchases such commodities as he may have occasion for: to all those into whose hands this money afterwards passes, it is only the price of the productions which they have themselves created by means of their lands, capital, or industry. In selling these, they exchange first their productions for money; and they afterwards exchange this money for objects of consumption. It is then in strict reality with their productions that they make their purchases; it is impossible for them to buy any articles whatever to a greater amount than that which they have produced either by themselves, or by means of their capitals and lands. (Jean-Baptiste Say, Letters to Mr. Malthus on Several Subjects of Political Economy and on the Cause of the Stagnation of Commerce. London: Sherwood, Neely & Jones, 1821, 2.)Of course, Say's analysis assumes as a given that anyone who so desires can produce "either by themselves, or by means of their capitals and lands." This is not necessarily the case, especially in a technologically advanced society in which capital is rapidly replacing human labor as the predominant physical factor of production. When that happens, of course, people must have the opportunity to replace their income from labor, with income from capital. This in turn requires that the State ensure that everyone has equal opportunity to become an owner of capital — and that means making certain that everyone have democratic access to money and credit, as long as certain objective criteria are met.
The Role of a Common Currency
If we recall John Locke's premise that governments are formed primarily for the protection of property as the chief support of life and liberty, this makes sense. Politics comes and goes, but the basic need to make a living, whether through ownership of labor or ownership of productive assets, goes on forever.
Money, a derivative of production, as the vehicle for the transfer of wealth between individuals, organizations and institutions, thus has an endless fascination for even the most apolitical person. Currency, a derivative of money, has an even more immediate fascination, while coin, the chief form of officially issued currency before the invention of the printing press, can create an almost hypnotic state in the student of history, economics, finance or politics. After all, as Aristotle remarked, man pays most attention to what is his own, and coinage is one of the most graphic symbols of ownership. The key, of course, is to ensure as far as possible not only individuals, but also political entities are securely based on private property in the means of production.
Given a secure foundation on private property, it is possible to have a uniform currency for a region or nation and still allow a great deal of leeway with respect to local autonomy. A good example of this from the past is the coinages of the Bœotian League (or Confederacy, depending on which source or translation is used). The Bœotian League was a loose confederation that came together for common worship and defense in the mid-sixth century BC against the real and present danger represented by the imperial ambitions of Athens, the political and military powerhouse a little to the south. (Michael Grant, The Founders of the Western World, A History of Greece and Rome. New York: Barnes & Noble, 1991, 27.)
The Bœotian League
About ninety years before the great life and death struggle of the Peloponnesian War between Sparta and Athens, the small agricultural municipalities of the Bœotian League north of Attica began to use coined money. Financially the most important member of the League was Tanagra. Because of its proximity to Aulis and its important harbor, as well as its control of the rich agricultural region of Oropus, Tanagra had attained the position of the most prosperous member of the Bœotian League.
The harbor of Aulis is familiar to readers of classical literature and modern opera because of the sacrifice there of Iphegenia in order to obtain a fair wind for the Greeks to sail to the Trojan War. It gave the Bœotian League its only access to the Ægean, and a direct line of communication with its friend and ally, Ægina. The Attic enemy on land — Athens and its allies — could safely be bypassed by using the sea route. Consequently, when the time came to mint coins, the Bœotian League first used overstruck Æginetan staters, and later formally adopted the Æginetan standard as its official currency.
The coinage of the Bœotian League was probably the first official common currency in the world, as opposed to those imposed by force or default. While the religious center of the League was in the city state of Coronea and the political headquarters was Thebes, the economic center was Tanagra. It was there that what little manufacturing attempted by the Bœotian League was carried out. Much of this manufacturing consisted of its renowned cultic figurines and imitation Attic pottery, both black- and red-figured.
The first mint of the Bœotian League was probably Tanagra. Some authorities think that, due to the uniformity of style and consistency of the coin fabric of all the coins of the League, Tanagra may have functioned as the only mint for the entire confederation for the first fifty years. It is clear, however, that the city did not come to dominate its fellows politically — at least at this time.
All Bœotian League obverses were identical: the military shield of the League. This may have been boiled leather fitted over a wooden or wicker frame to form two semicircles joined at a narrower waist. The earliest reverses strongly resemble the abstract design that graced the reverse of the Æginetan "turtles," on which the Bœotian coinage was based. The shield on the Bœotian obverse also gave a certain similarity to the Æginetan turtle badge, which may have been intentional.
Soon, however, the reverses of the coins assigned to each of the League members began carrying identifying inscriptions. It may come as a surprise, but these Greek issues did not use the Greek alphabet, at least the Attic Greek alphabet that became standard. Possibly to demonstrate their independence of the Colossus of the South, the cities of the Bœotian League used the Chalcidian alphabet, an archaic version of Greek script closer to the Phœnician original. (B. F. Cook, "Greek Inscriptions" Reading the Past: Ancient Writing from Cuneiform to the Alphabet, Introduced by J. T. Hooker. London: The British Museum Company, Limited, 1990, 264-266.)
Soon after this, the mint at Tanagra (or so it is assumed) began to issue coins for the individual cities, and also a coinage for the League as a whole. The reverse gradually "morphed" into an abstract design that authorities describe as a "mill sail" pattern, even though most people today have no idea, outside the pages of Cervantes' Don Quixote, that windmills ever used sails instead of blades. In the center of the "mill sail" a letter was impressed designating to which city the issue was to be attributed.
General coinage for the League had the letters BOI in a monogram on the reverse. What may be a "mule" resulting from a changeover to the new style shows the Tanagran obverse with the general League reverse. This was probably because obverse dies set in an anvil as a rule outlasted reverse dies that were struck directly with a hammer — and dies were expensive to manufacture. They would thus be used as long as they were serviceable, regardless of the technical accuracy of the product.
Another variety spells out the word for Thebes, the political center of the League. Possibly the coincidence of having the religious, political and economic centers of the League each in a different city helped diffuse power to such an extent that none of the partners came to dominate any of the others. This was not to last.
Fall of the Bœotian League
In 507 BC, Sparta traded on the envy that members of the Bœotian League harbored against Athens to persuade the northerners to join in their war on Attica. Coins were struck to commemorate the occasion, one of the few issues from ancient times that can be dated exactly. Because expected help from Corinth did not materialize, the Spartan attack from the south failed. Athens was able to turn its military might on its neighbors to the north and defeat them in detail. Chalcis became subject, and the Bœotian League lost what economic prosperity it had gained by access to the Ægean when the Athenians established a new colony in competition with Aulis. (Herodotus, The Histories. V.70-90.)
With the economic decline of Tanagra, Thebes had no check to its power. Consequently, it became the most powerful city in the League. It soon after abandoned any pretense of partnership, issuing its own coins with a special reverse, although the Bœotian shield was retained on the obverse. The shield was also retained for the rest of the other members of the now moribund League for a few more centuries.
Thus was Benjamin Leigh's dictum proven twenty-three centuries before he uttered it in the Virginia Constitutional Convention of 1820, during the debate over extending the franchise to white males who did not own property: "Power and Property can be separated for a time by force or fraud — but divorced, never. For as soon as the pang of separation is felt. . . Property will purchase Power, or Power will take over Property."
Unlike some mintages of the Greek City States, representative specimens of the Bœotian League coinages can be obtained fairly easily. Issues for some of the smaller members were probably struck only to demonstrate full League status and are consequently scarce. Denominations before the defeat by Athens, which were all in silver, range from the Tetartemorion (a quarter Obol, the Obol being 1/6 of a Drachma), to the Drachma.
During the decline of the League, the "Stater" standard was partially implemented, and other metals besides silver were used, such as electrum. In the final stages, bronzes of uncertain denomination were minted.
The silver Tetartemorion, while a tiny pinpoint of a coin, was not the smallest Greek denomination. That was reserved for the Hemitetartemorion, or "Half-Tetartemorion," of 1/8 Obol (1/480 of the largest Greek denomination, the Dekadrachm). These minuscule pieces of currency remind us that it was the custom to carry small change in one's mouth. This habit has persisted down to our own day. A lady, now in her 80s, whose family ran a store in central Virginia during the Depression, recalls country folk coming in and paying for their purchases with dimes and cents which they dug out of their mouths. They obviously felt they could not risk losing even one cent by carrying it about in a ragged pocket.
The history of the Bœotian League graphically illustrates how far a political union can be expected to carry matters if not based on widespread direct ownership of the means of production. Once again it is driven home that "power naturally and necessarily follows property." (Daniel Webster, the Massachusetts Constitutional Convention of 1820.) Without that secure foundation, the arrangement will eventually dissolve.
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