How Privatized Banking Really Works

!
!
!
"!#$%&!'$(!%)&!*+,!-&(./$0!$'!
1$2!*(/34%/5&6!7408/09!!"#$$%!:$(8.!
7;!<=!>4(?$.!<4(4!@!A$B&(%!*=!CD(E);!

1he followlng pdf flle ls provlded for educaLlonal purposes. 8eclplenLs of Lhls flle are encouraged Lo
dlsLrlbuLe lL, wlLh Lhe undersLandlng LhaL Lhe auLhors do noL approve of Lhe physlcal producLlon of Lhe
conLenLs for resale.
1hose lnLeresLed ln purchaslng physlcal coples of Lhe book may do so aL Lhls webslLe:

hLLp://www.usaLrusLonllne.com/

!
!
!
"##$%&'!()*!+%*%!%,-!./*01234!5))6!
!

"#$%$! $&'! ()%*+,! +$-.! '/&.! $&! .01.22.&3! 4/5! 6)77$%898&:! 3+.!
*%/52.76! ;83+! /)%! 1)%%.&3! <8&$&18$2! 6,63.7! 8&! 2$&:)$:.! 3+$3! $&,/&.!
1$&! )&'.%63$&'=! >+.,! +$-.! '.7,638<8.'! <%$138/&$2! %.6.%-.! 5$&?8&:@!
$&'! 7$'.! 83! 12.$%A! B.C%.! :.338&:! %8**.'! /<<D! >+.8%! 6)::.63.'! 6/2)38/&!
/<! E.26/&! E$6+F6! G&<8&83.! H$&?8&:! I/&1.*3! 86! $! 3$&3$2898&:! *%/*/6$2!
3+$3!'.6.%-.6!1$%.<)2!61%)38&,=J

!!!!!!"! #$%! &'()*+! ,%! -((.+/! 0$%/! *12'($! (3! 2'4! 546! 7($8! &9)4+!
:4+2+4;;4$+! .7$8-)9,! *<.! :17! ;)$&8&#%$$2! <,#)**7#8! =/&-7! 8)!
"'7*&#%,!>&48)*2?!
!

"Bow Piivatizeu Banking! K.$22, Woiks! 5%8228$&32,! .0*2$8&6! +/;!
:/-.%&7.&3! 8&3.%-.&38/&! 8&! 7/&.,! $&'! 5$&?8&:! +$6! $2;$,6! 5..&! $!
*2$:).! /&! 3+.! .1/&/7,@! $&'! *%/-8'.6! $! %/$'7$*! </%! 3%).! 7/&.3$%,!
<%..'/7=! K.$'! 3+86! 5//?! $&'! 2.$%&! +/;! ,/)! 1$&! *.%6/&$22,! 6.1.'.!
<%/7! /)%! 1%)7528&:! 7/&.3$%,! %.:87.! $&'! 87*%/-.! ,/)%! <8&$&18$2!
<)3)%.! ;+82.! )&'.%78&8&:! 3+86! 8&68'8/)6! 6,63.7! /<! :/-.%&7.&3!
1/&3%/26=J

!!!!!!!"! #$%! &'()*+! #9=($4<>(/! ?$(34++($! (3! ,@(<()9@+/! =(A(;*!
B<9C4$+92A! D*$A;*<./! *12'($! (3! >)9! @%0&8%$&4'! A%B7-! "'7*&#%/!
:17!C7%$!+&,#)$,/!*<.!>%'&$8),D4!@/*47%!
!
!
!
!
!
"G&! $&! .1/&/781$22,! <%8:+3<)2! $:.! ;+.%.! :/-.%&7.&3! $)3+/%838.6! $%.!
:%$558&:! </%! .-.%7/%.! */;.%! $&'! 1/&3%/2! /-.%! /)%! 28-.6@! #$%$! $&'!
()%*+,!+$-.!5%/):+3!3/:.3+.%!5/3+!6/)&'!.1/&/781!%.$6/&8&:!;83+!$!
6/)&'!*%8-$3.!63%$3.:,!3/!'8%.13!3+.!8&'8-8')$2!3/;$%'!3+.!.61$*.!.083=!
L&,/&.!;8228&:!3/!+.$%!3+.8%!;$%&8&:!$&'!6..?!3+86!.083!;822!'861/-.%!$!
&.;!2.-.2!/<!8&'8-8')$2!<%..'/7!3+$3!1/)2'!&/3!+$-.!5..&!87$:8&.'!8&!
3+.!<$1.!/<!3+.!*%.6.&3!3,%$&&,!$&'!'.6*/3867!/<!/)%!$:.=J

!!!!!!"! #$%! ?*1;! E%! F;4C4;*<./! ?$(34++($! (3! ,@(<()9@+/!
G9$)9<H'*)! I(12'4$<! F(;;4H4/! *12'($! (3! E,'%46&,F! 817! A%#*7-!
+&74!*<.!E,-7*48%,-&,F!817!.)-7*,!@/$8/*7!G%*4H!:17!I447,8&%$4!
)(!G7487*,!@&B&$&J%8&),%!
!
!
"L3! 2/&:! 2$63@! 3;/! *%/78&.&3! 3+8&?.%6! /<! 3+.! FL)63%8$&! M1+//2! /<!
>+/):+3F! 6..! 3+$3! '8-8'.&'N*$,8&:! B+/2.! #8<.! G&6)%$&1.! 86! FL)63%8$&!
.1/&/7816! 8&! $138/&=F! O%..! *./*2.! $%.! 687*2,! 1/&3%$138&:! ;83+! /3+.%!
<%..! *./*2.! 3/! 6/2-.! $! <8&$&18$2! *%/52.7=! PE/! /&.! 1/7*.26! *./*2.! 3/!
5),!28<.!8&6)%$&1.Q3+.,!$%.!-/2)&3$%82,!.&3.%8&:!8&3/!$!1/&3%$13!;83+!
28?.N78&'.'! *./*2.R=! B+.&! 3+.! G&<8&83.! H$&?8&:! I/&1.*3! 86! <)22,!
)&'.%63//'@! 3+.&! /&.! %.$289.6! 3+$3! 83! 86! %.$22,! $! *.%6/&$2! 7/&.3$%,!
6,63.7! 3+$3! +$6! $! '.$3+! 5.&.<83! $6! $! 5/&)6=! #$%$! $&'! ()%*+,! +$-.!
'/&.! $! <$&3$6381! 4/5! /<! 86/2$38&:! 3+86! 3%)3+=! >+.,! +$-.! <)2<822.'! 7,!
'%.$7!/<!/-.%!ST!,.$%6=J
!
!!!!!!"!J%!54;+(<!5*+'/!*12'($!(3!K7#)'&,F!L)/*!M9,!K%,67*H!:17!
<,(&,&87!K%,6&,F!@),#708%!
!

K(6!?$9C*29>4.!G*<89<H!!
C7%$$2!-($8+!
!
!
!
!
K(6!?$9C*29>4.!G*<89<H!
C7%$$2!-($8+!
!
<,87F*%8&,F!"/48*&%,!I#),)'&#4!9&81!
!817!<,(&,&87!K%,6&,F!@),#708!
!
!
!
!
!
!
!
!
=%!F*$;(+!=*$*
J(:4$2!?%!D1$L'A/!?'%#%!

!
!
!
!
!
!
!
!
!
@)02*&F18!N!OPQP!52!+?!@%*$)4!+%*%!R!C)57*8!;?!./*012!
!
U63!V'838/&NW%8&3.'!X)2,!SYUY!8&!3+.!Z&83.'!M3$3.6!/<!
L7.%81$!5,!A17*&-%,!K))64S!<,#?T",,!"*5)*!.&#1&F%,!
!
GMHE![\]NYN^UTN_S^]SNT!
!
I/-.%!L%3!$&'!`.68:&!5,!L2-8&!L5).2/)<!
$2-8&$5).2/)<a28-.=1/7!!
!
W+/3/!L%3!$&'!`.68:&!5,!M3.*+$&8.!#/&:!
;;;=63.*+1%.$38-.=1/7

O/%!8&</%7$38/&!$5/)3!)6.<)2!%.<.%.&1.!7$3.%8$26@!$''838/&$2!
%.$'8&:! 28636@! $&'! /3+.%! $-$82$52.! %.6/)%1.6! <%/7! 3+.!
$)3+/%6@!-8683!3+.8%!%.6*.138-.!;.5683.6:

#=!I$%2/6!#$%$A!+33*Abb;;;=)6$3%)63/&28&.=1/7!
K/5.%3!W=!()%*+,A!+33*AbbI/&6)238&:H,KW(=1/7!
!
!
Acknowleugments
!
In auuition to all the gieat thinkeis who have taught us so
much ovei the yeaiseithei in peison oi inuiiectly thiough theii
bookswe woulu like to specifically thank a few people who weie
instiumental in the cieation of this woik. The entiie teams at both
The Lafayette Life Insuiance Company anu Nutual Tiust Life
Insuiance Company giaciously alloweu us to visit theii offices in
oiuei to leain about the innei woikings of whole life insuiance. We
shoulu single out Baviu Fiancis of Lafayette who aiiangeu foi the
meeting in the fiist place. Rogei Baith anu Stephen Batza of Nutual
Tiust went above anu beyonu the call of uuty in fieluing oui
questions about cash values anu policy loans.
Baviu Steains, piesiuent of the Infinite Banking Concept
Think Tank in Biimingham, Alabama, has extenueu to us eveiy bit of
assistance as we completeu the book.
Baviu uoiuon anu Stephan Kinsella assisteu with the
Austiian siue of oui ieseaich.
Alvin Abuelouf anu Stephanie Long cieateu the giipping
covei uesign, which is aiguably the best attiibute of the book.
Finally, we woulu like to especially thank Anne Laia foi
acting as liaison with the publishing company, anu foi the scoies of
houis she put into the piepaiation of the manusciipt. Weie it not foi
Anne, this book woulu still consist of a collection of Woiu
uocuments on the authois' iespective haiu uiives.
!
!

!
!
!
CI;CIAIU:":<MUAH!
!
A:":EAH! ! >+.! L)3+/%6! /<! 3+86! 5//?! ;$%%$&3! $&'! %.*%.6.&3! 3+$3! 3+.,!
$%.!&/3!"5%/?.%6J!/%!3/!5.!'..7.'!$6!!"5%/?.%N'.$2.%6@J!$6!6)1+!3.%76!
$%.!'.<8&.'!8&!3+.!M.1)%838.6!L13!/<!U[__@!$6!$7.&'.'@!/%!$&!"8&6)%$&1.!
1/7*$&,@J!/%!"5$&?=J!!
!
+I="+S! :"VS! "@@MEU:<U=S! MC! <UWIA:.IU:! "XW<@IH! >+.! L)3+/%6!
/<! 3+86! 5//?! $%.! &/3! %.&'.%8&:! 2.:$2@! 3$0@! $11/)&38&:@! /%! 8&-.637.&3!
$'-81.=!L22!.0+85836!8&!3+86!5//?!$%.!6/2.2,!</%!822)63%$38/&!*)%*/6.6@!5)3!
)&'.%! &/! 18%1)763$&1.6! 6+$22! 3+.! %.$'.%! 1/&63%).! 3+.6.! $6! 3+.!
%.&'.%8&:!/<!2.:$2@!3$0@!$11/)&38&:!/%!8&-.637.&3!$'-81.=!
!
X<A@+"<.IC! "UX! +<.<:":<MU! MY! +<"K<+<:LH! >+.! L)3+/%6! /<! 3+86!
5//?! +.%.5,! '8612$87! $&,! $&'! $22! ;$%%$&38.6@! .0*%.66@! /%! 87*28.'@!
8&12)'8&:! 7.%1+$&3$58283,! /%! <83&.66! </%! $! *$%381)2$%! *)%*/6.! $&'!
7$?.! &/! %.*%.6.&3$38/&! /%! ;$%%$&3,! /<! 3+.! 1.%3$8&3,! 3+$3! $&,!
*$%381)2$%! %.6)23! ;822! 5.! $1+8.-.'=! G&! &/! .-.&3! ;822! 3+.! L)3+/%6@! 3+.8%!
.7*2/,..6@! /%! $66/18$3.'! *.%6/&6@! /%! $:.&36! 5.! 28$52.! 3/! 3+.! %.$'.%! /<!
3+86!5//?@!/%!836!L:.&36!</%!$&,!1$)6.6!/<!$138/&!/<!$&,!?8&'!;+.3+.%!/%!
&/3!3+.!%.$'.%!+$6!5..&!$'-86.'!/<!3+.!*/66858283,!/<!6)1+!'$7$:.=!
!
!

This book is ueuicateu to
all those who
love #85.%3,!anu champion!M/)&'!(/&.,=
!
!
F!M!5!&!,!5!&!I!
!

?!E!J!&!!!M!5!,N!!!&'4!O1*<.*$A ................................................P!

Chaptei 1: Intiouuction..................................................................................... S
Chaptei 2: Assessing the Nain Pioblem.................................................. S1
Chaptei S: Losing 0ui Way ........................................................................... S1
Chaptei 4: Losing 0ui Spiiit ......................................................................... 67
Chaptei S: Noney .............................................................................................. 91
Chaptei 6: Beposit Banking ....................................................................... 1u9
Chaptei 7: Inflation........................................................................................ 127
Chaptei 8: Fiactional Reseive Banking ................................................ 147

?E!J!&!!!&!-!MN!!!&'4!I(1<.!D(<4A!I(;129(<.............. PQR
!
Chaptei 9: The Role of Social Institutions........................................... 167
Chaptei 1u: Piivate Piopeity.................................................................... 17S
Chaptei 11: Tiaue........................................................................................... 179
Chaptei 12: Noney......................................................................................... 18S
Chaptei 1S: Piices, Piofits anu Planning.............................................. 191
Chaptei 14: Banking...................................................................................... 2uS
Chaptei 1S: Insuiance.................................................................................. 21S
Chaptei 16: uoveinment Bistoitions..................................................... 22S
Chaptei 17: The Sounu Noney Solution............................................... 261
!
?!E!J!&!!!&!K!J!,!,N!!&'4!SGF!F(<2$9:129(<.................... TUP!

Chaptei 18: The Infinite Banking Concept .......................................... 28S
Chaptei 19: Common 0bjections to IBC............................................... S11
Chaptei 2u: The IBC Contiibution to the
Sounu Noney Solution....................................................... SSS
Chaptei 21: Conclusion................................................................................ S49

ELL4<.9@4+ ................................................................................... SS7
!
uieat Austiians................................................................................................. SS9
About the Authois........................................................................................... S79
!

!"
!"#$%&%
'()%*+",-"#.%
"
"
!"#$%&'$%("#)$)"$&'%*$%$#+,-#'$(""./$0)$1,22$(")3$*,%4+"5'$"#&$
+%),"+65$ '7"+"8,7$ 1"'5$ %+*$ )3'+$ "99'&$ %$ &'%2,5),7$ 5"2#),"+/$ 0)$ 1,22$
*,57#55$ )3'$ 5:8;)"85$ "9$ )3'$ -#%+*%&:$ )3%)$ %22$ <8'&,7%+5$ 3%='$
;'&7',='*>$(#)$,)$1,22$'?;2%,+$)3'8$,+$%$1%:$:"#$8%:$+'='&$('9"&'$3%='$
'+7"#+)'&'*/$<9)'&$:"#$#+*'&5)%+*$)3'$;&"(2'8>$)3,5$("".$1,22$'?;2%,+$
%$;&%7),7%2$7#&'$)3%)$:"#$7%+$,8;2'8'+)$,88'*,%)'2:/$
@3,5$("".$7"='&5$8#73$4&"#+*/$0)$53"15$)3%)$"#&$7#&&'+)$7&,5,5>$
%5$ 1'22$ %5$ )3'$ 4'+'&%2$ 9,+%+7,%2$ 5)&#442'$ %992,7),+4$ %28"5)$ %22$
<8'&,7%+5>$,5$+")$*#'$)"$7"58,7$7",+7,*'+7'/$0)$,5$%25"$+")$A#5)$B)3'$1%:$
)3,+45$%&'/C$
D">$ "#&$ -#%+*%&:$ 3%5$ ='&:$ 5;'7,9,7$ 7%#5'5E$ 9,%)$ 8"+':$ %+*$ )3'$
;&%7),7'$ "9$ 9&%7),"+%2$ &'5'&='$ (%+.,+4>$ %+*$ )3'$ 4"='&+8'+)$
,+)'&='+),"+5$ )3%)$ ;'&;')#%)'$ )3'8/$ 0+$ %$ ='&:$ &'%2$ 5'+5'>$ "#&$ 8"*'&+$
9,+%+7,%2$5:5)'8$7&'%)'5$8"+':$"#)$"9$)3,+$%,&>$%+*$7%+$*'5)&":$,)$A#5)$
%5$ -#,7.2:/$ @3,5$ 8%4,7%2$ %(,2,):$ 4,='5$ &,5'$ )"$ )3'$ 9%8,2,%&$ (""8F(#5)$
7:72'$,+$*'='2";'*$'7"+"8,'5/$
@3'$ &'7"4+,),"+$ "9$ )3,5$ )&"#(2,+4$ 9%7)$ ,8;2,'5$ +"$ 8"&%2$
7"+*'8+%),"+$ "9$ )3'$ 8,22,"+5$ "9$ ;'";2'$ 7#&&'+)2:$ '8;2":'*$ ,+$ )3'$
7"88'&7,%2$(%+.,+4$5'7)"&/$$G"5)$"9$)3'8$;&"(%(2:$3%='$+"$,*'%$)3%)$$
!"#$%&'()*%+,"-."#/%
HHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHH$
$
#"
"#&$ '+),&'$ 9,+%+7,%2$ 5:5)'8$ &'5)5$ "+$ -#,7.5%+*/$ @3'$ 8'73%+,75$ "9$
9&%7),"+%2$ &'5'&='$ (%+.,+4$ 7%+$ ('$ *,99,7#2)$ )"$ 4&%5;>$ %+*$ ,+*''*$ 8%+:$
;'";2'$ 1,22$ +''*$ )"$ &'%*$ )3,5$ ("".$ 5'='&%2$ ),8'5$ ('9"&'$ )3':$ )&#2:$
#+*'&5)%+*$,)/$I#)$"+7'$)3':$*">$)3':$1,22$('$53"7.'*/$$
J"#5'3"2*5$ 3%='$ )3'$ %(,2,):$ )"$ 5'7'*'$ 9&"8$ )3,5$ 73%"),7$
9,+%+7,%2$ 5:5)'8/$ @3':$ 7%+$ )#&+$ )"$ )&%*,),"+%2$ ,+5#&%+7'$ 7"8;%+,'5>$
&%)3'&$ )3%+$ 7"88'&7,%2$ (%+.5$ %+*$ K%22$ L)&'')>$ 9"&$ )3',&$ 9,+%+7,+4$
+''*5/$K'$'?;2%,+$%22$"9$)3,5$,+$*#'$),8'/$
!')$ ('9"&'$ "99'&,+4$ %$ 5"2#),"+>$ 1'$ 8#5)$ 9,&5)$ #+*'&5)%+*$ )3'$
-#%+*%&:/$0)$,5$8"+5)&"#5/$
$
"
S
!"#$%&'()(
*+%',-./%0,+(
123(!#'4,5(6#'#7(
(
!"#"$%#&'$#()$*#'#+'(%#,'-#"./#("0#
1)2+%3(# )(# +"&)%/-# )+# +,%%4)$5#
/",'0*+# *%+/0.&/)"$6# 71%0%("0%#
%8%0-"$%9# )$# 1)+# ",$# )$/%0%+/+9#
2.+/#/10.+/#1)2+%3(#8)5"0".+3-#)$/"#
/1%# )$/%33%&/.'3# :'//3%6# !"$%# &'$#
+/'$*# '+)*%# ,)/1# .$&"$&%0$;# /1%#
)$/%0%+/+# "(# %8%0-"$%# 1'$5# "$# /1%#
0%+.3/+6#
<=.*,)5#8"$#>)+%+
?
#
#
hy uo we have to have money.
As the late economics Piofessoi Claience
Caison explaineu, this is the type of question you aie most likely to
heai fiom a young chilu. Bowevei, when a chilu asks a question like
this theie is no ieal inteiest in knowing anything about the oiigin of
money, oi how it functions, oi even about the fact that it is only a
meuium of exchange. Actually, the question stems entiiely fiom the
iuea that the things the chilu wants cost money anu he uoes not
have enough of it. So in essence, the chilu's ieal question is why he
W
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
4
can't have whatevei he wants, when he wants it, without theie being
a cost attacheu to it.
2
#
Now, when we step back anu seiiously think about it, this is a
veiy goou question anu not only of chiluien, but also of auults. It is a
question that uoes not piess on us too much, so long as things aie
going well economically anu we all have sufficient incomes to pay
foi the things we want anu neeu, but what happens when all of that
changes, as in the type of changes we aie all expeiiencing touay. All
of a suuuen the alaim bells stait to go off anu eveiyone staits
clamoiing foi answeis about money.
It was actually the wiuespieau clamoi foi these answeis that
was one of the piincipal motivations foi the wiiting of this book. It
all began with the alaiming panic that spieau thioughout the woilu
in the eaily fall of 2uu8. Beie in the 0.S. it was eviuent eveiywheie.
Eveiy uay, foi weeks on enu, people weie tiansfixeu to theii Tv sets
as they listeneu to things they hau uifficulty compiehenuing, but
knew all too well that they weie expeiiencing a hoiiific financial
meltuown unlike any othei they hau evei witnesseu. The
unceitainty the ciisis cieateu foi eveiyone was impossible to hiue
anu it was appaient in eveiyuay conveisations. Nost notably was
the feai it geneiateu among schoolchiluien fiom simply obseiving
the state of anxiety in the faces of theii paients. Ameiicans, almost
in unison, came to iealize in a veiy peisonal way how fiagile oui
entiie economic system hau become as they witnesseu giant
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
S
financial stiuctuies ciumble. In fact, collapse of the entiie 0.S.
financial system uiu not escape anyone's minu, even the minus of
the most sophisticateu economic expeits.
Touay we aie left with the afteimath of the eaily phases of
oui piesent financial fiasco with many Ameiicans now having lost
theii businesses, theii jobs anu entiie life savings. The uiamatic
ciash of the stock maiket anu its eiiatic behavioi since, coupleu
with the collapse of the ieal estate maiket, has left people
eveiywheie asking: ,1%0%#)$#/1%#,"03*#*"#-".#4./#-".0#2"$%-#$",A
No one, howevei, is, oi can be, confiuent in his answei. Feai of
uouble-uigit inflation, even hypeiinflation, is on the minus of many.
uolu anu guns, giowing statistically high in uemanu, aie eviuence of
the unceitainty of oui futuie. As oui nation stiuggles with these
pioblems, as it attempts to ieuefine, oi cieate a new sense of
uiiection, many have alieauy lost all hope in the economic piinciples
that once maue this countiy gieat. The entiie iuea anu hope of a fiee
maiket economy is in ciisis. A iecent Biitish Bioaucasting
Coipoiation poll acioss 27 uiffeient countiies showeu 89% of the
29,uuu inuiviuuals questioneu weie uisillusioneu with capitalism.
This is why those of us who still believe in the maiket anu want no
pait of socialism aie uemanuing ieliable answeis to help uniavel all
of the financial confusion!
0f couise, this is not a new pioblem. As new as it may seem
to oui piesent geneiation in 2u1u, the stiuggle foi the contiol ovei
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
6
money is as olu as mankinu, but one suie place to begin the queiy
about money within the 0niteu States is with this staik anu
paiamount iealization: 00R N0NEY IS N0T F0LLY IN 00R
C0NTR0L. 8"&( /&+%'#4( 2#+9( ,:( %"&( ;+0%&-( <%#%&5=%"&( >&-&'#4(
?&5&'@&="#5( #( /,A$4&%&( A,+,$,43( ,+( ,.'( A,+&3( #+-( %"05(
/,+%',4(05(A#+-#%&-(23(,.'(:&-&'#4(B,@&'+A&+%C This uomination
of oui entiie monetaiy system has hau seveie economic anu moial
iamifications. The effects of this monopoly aie the piime ieason
why the value of oui money has fallen some 9S% since the Feueial
Reseive's founuing in 191S anu it is the uiiect cause of oui cuiient
financial ciisis. We cannot evei hope to begin to think anu see
money with claiity until this iealization is exposeu anu fully
unueistoou. To begin talking about the fiee maiket, money, savings,
inteiest, cieuit, investments oi banking without fiist having a
complete giasp of this tiuth, the fact that we aie unuei the giip of a
centially planneu money mechanism, leaus nowheie but to even
gieatei confusion anu uisenchantment. Bowevei, in oiuei foi this
tiuth to be fully giaspeu by the aveiage 0.S. citizento the uegiee
that public opinion can effect a ieal change at the top echelons of
goveinmentwill take nothing shoit of a miiacle. Bow in the woilu
uo you take the piinting piess away fiom goveinment once they
have hau full use of it all these many yeais. 0ntil this is uone, oui
0niteu States will continue to heau uown a path of social, political
anu economic uestiuction.
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
7
Yes, it is tiue. It is all so hugely oveiwhelming anu
hopeless.too big to fix. In fact, just how woulu one go about
changing such a monstious pioblem. When life is shoit anu the
moment of a possible victoiy so fai in the futuie, why even bothei.
What is the point of even tiying. Well, fiist of all consiuei this, anu
consiuei it seiiously. If change uoes not occui heie in this countiy, a
countiy wheie change is still possible, theie is no place else left on
this planet foi an escape. The entiie woilu opeiates by this same
closeu anu contiolleu monetaiy system. uoveinment manuateu
papei money anu banking systems aie eveiywheie! In the 0niteu
States the cential bank is the Feueial Reseive, in the 0.K. the cential
bank is the Bank of Englanu, in Italy it is the Euiopean Cential Bank
anu so on in eveiy majoi foieign countiy. The powei anu giowth of
goveinments eveiywheie aie fueleu by these monopoly systems
anu theii giowth has cut into the quality of life foi all inuiviuuals to
staggeiing piopoitions. It is like a viius, paiasitic in natuie anu
which will eventually kill the host. If we uo not make an effoit to
change it heie in oui countiy now, it will nevei change anu if we uo
not step foiwaiu to help change it, no one will.
Seconu, theie is no iational ieason to woik myself anu you,
the ieauei, up into a ievolutionaiy fienzy unless we stop long
enough to iealize that we aie losing something veiy piecious. B.0#
(0%%*"2C To biing this into peispective, consiuei that the abunuance
that we see anu have, oui high stanuaiu of living that most of us
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
8
enjoy touay, came into existence by a movement geiminateu fiom
the iuea of fieeuom. This movement exploueu heie in this countiy
fiom the colonial uays until 1914a veiy biief peiiou of some 1Su
yeais! Compaieu to the entiie histoiy of the woilu this is amazing!
We must, theiefoie, ieveise this tienu foi it is possible that we may
nevei have the oppoitunity to uo so again.

|Tjake.the gieat classical libeial.ievolutionaiy movement of
the seventeenth, eighteenth, anu nineteenth centuiies. These oui
ancestois cieateu a vast, spiawling, anu biilliant ievolutionaiy
movement, not only in the 0niteu States but thioughout the
Westein woilu, that lasteu foi centuiies. This was the movement
laigely iesponsible foi iauically changing histoiy, foi almost
uestioying histoiy as it was pieviously known to man. Foi befoie
these centuiies, the histoiy of man, with one oi two luminous
exceptions, was a uaik anu goiy iecoiu of tyianny anu
uespotism, a iecoiu of vaiious absolute States anu monaichs
ciushing anu exploiting theii unueilying populations, laigely
peasants, who liveu a biief anu biutish life at baie subsistence,
uevoiu of hope oi piomise. It was a classical libeialism anu
iauicalism that biought to the mass of people that hope anu that
piomise, anu which launcheu the gieat piocess of fulfillment. All
that man has achieveu touay, in piogiess, in hope, in living
stanuaius, we can attiibute to the ievolutionaiy movement, to
that "ievolution". This gieat ievolution was oui fathei; it is now
oui task to complete its unfinisheu piomise.
S
###

!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
9
Thiiu, anu most impoitant, is that a movement foi ieal
change cannot possibly be effective if it staits fiom the top uown
(goveinment uown to the inuiviuual citizen). The genesis foi change
must stait with the inuiviuual. It must have the inuiviuual as the
piincipal ciiteiion anu spieau out anu up fiom theie. This happens
only when the inuiviuual's economic suivival questions aie
answeieu to his full satisfaction anu when he expeiiences
immeuiate iesults foi himself in the enueavoi he embaiks upon.
That is what this book is about. This is of ciucial impoitance because
when theie aie immeuiate benefits to the inuiviuual fiom his
piouuctive effoits, the inuiviuual takes notice anu immeuiately
seeks to uuplicate it. When he sees that the benefits he gains also
help society as a whole, he is encouiageu anu motivateu to involve
otheis, beginning with his own family membeis anu then eveiyone
else within his ciicle of contacts. This type of goou news always
spieaus, slowly in the beginning, but then suuuenly it tuins into an
evangelistic explosion. A movement that woiks in this mannei can
quickly take on a life of its own anu spieau until public opinion
giows, foicing the uppei echelons of goveinment to make vital anu
necessaiy changes. In the enu, all economic policies aie ultimately
uepenuent on the views of the geneial public anu theii choice is
final! It is the masses that ueteimine the couise of histoiy, but its
initial movement must stait with the inuiviuual.
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
1u
Foi these thiee impoitant ieasons this book contains
infoimation to guiue anu empowei the inuiviuual. It uesciibes in
uetail thiee inuepenuent iueas that aie alieauy at woik spieauing
anu gaining momentum thioughout the giassioots of oui countiy.
The people anu institutions involveu with these iueas aie
wonueifully cieative! Although uistinct, these iueas aie so uniquely
inteitwineu that biinging them togethei as one poweiful multi-
uimensional element in this book was natuial. These thiee iueas aie
Austiian Economics, the Sounu Noney Solution anu Piivatizeu
Banking as best uesciibeu by the D$()$)/%# E'$F)$5# G"$&%4/, a book
wiitten by R. Nelson Nash. 0nce fully unueistoou, these thiee iueas
pioviue the basis foi a foimula with poweiful tuin-aiounu uynamics
that may be implementeu by viitually any inuiviuual. The iesult is a
piivate economic enteipiise anu self-peipetuating teaching tool that
pioviues the inuiviuual the savings, banking anu financing
capabilities he neeus to acquiie all of his mateiial neeus, plus the
powei to liteially ieconstiuct national monetaiy policy. It is these
benefits that aie the key to keeping the inuiviuual inspiieu as he
spieaus the message to otheis. As the message giows, public
opinion will change.
This poweiful combination is the "new"# iuea piesenteu in
this book. This is, finally, a solution that answeis the question of
what one peison can actually uo that will make a uiffeience in an
economic enviionment that has gone teiiibly awiy. When you begin
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
11
fiist with the inuiviuual's own piivate economic affaiis, things
change immeuiately foi the bettei. It becomes the inuiviuual's
escape ioute to fieeuom. Fuitheimoie, the Sounu Noney Solution
suppoits this iuea anu Austiian economics confiims it. Noie
impoitantly, the inuiviuual can go into the economic enteipiise
immeuiately iegaiuless of the biiuleu money system he may be in
anu what is going on all aiounu him in the piesent social, political
anu economic enviionment. Although his hope iests in the ultimate
tiiumph of the Sounu Noney Solution, which is changing the
national monetaiy policy, the piocess he is engaging helps thiust
foiwaiu the Austiian Economic message while auvancing his own
peisonal economic benefits in the heie anu now.
The iuea is so iational that it shoulu not at all be uifficult to
giasp. All that is iequiieu is an open minu, the unueistanuing of a
few unueniable economic piinciples, the use of sinceie conviction,
common sense, imagination, couiage anu, above all, uiscipline.
Bopefully, in these fiist few beginning paiagiaphs, the ieauei's
appetite has been whetteu enough to want to become moie
acquainteu with the piocess. Aftei unueistanuing the iuea cleaily
anu giving it seiious thought, it will natuially follow that the ieauei
will want to embaik upon the enueavoi. In acting, by implementing
the piocess in his own economic affaiis, the ieauei confiims the
immeuiate benefits of the iuea anu assuies himself that it uoes in
fact ieally woik! This, in tuin, leaus you into telling otheis about
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
12
youi new-founu inuepenuence anu fieeuom theieby spieauing the
solution foi oui countiy eveiywheie.
*
*B+,'0+B(%"&(D.5%'0#+5(E,%(;5(0+(8"05(F&55(

In biinging togethei all of the thoughts containeu in this
book, it is impoitant foi the ieauei to know that I have ieceiveu an
enoimous amount of help anu to iecognize the souice of that help.
This is impoitant because if the ieauei is to implement the iuea
piesenteu heie, he will iueally neeu to take veiy similai steps foi a
moie in-uepth anu complete unueistanuing of it. Fiist of all, I have
benefiteu immensely by being a stuuent anu passionate ieauei of
the wiitings of the gieat classical natuial law theoiists founu in
Austiian economics. These menseveial of whom pieuateu Auam
Smith, who famously gave expiession to 3')++%HI(')0% in 1776have
come uown to us thiough wiitten histoiy illuminating the uifficult
anu the unseen on all things having to uo with economics. In my
own peisonal seaich foi the tiuth in the economic anu financial
iealm, I have founu no paiallel anu only wish that I hau heaiu about
them eailiei in my life. What a uiffeience that woulu have maue! In
Naich of 2uu9, just six months aftei the economic ciisis occuiieu, a
iaie anu inteiesting aiticle appeaieu in the financial publication,
E'00"$J+, entitleu, "Ignoiing the Austiians uot 0s in This Ness."
4
The
aiticle# pointeu out that the Austiian piesciiptions to solve the
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
1S
woilu's economic pioblems weie fiist ignoieu by the New Beal of
Fianklin B. Roosevelt. That was seventy-five yeais ago! A giim
ieminuei that the iefusal to accept sounu economic thinking has
gone on in this countiy foi quite some time. Insteau, Keynesian
Economics has now become entiencheu in society eveiywheie.
Eveiy majoi univeisity fiom Baivaiu on uown is vesteu in this
eiioneous way of economic thinking. Acioss paity lines, as
substantiateu by the Bush anu now the 0bama auministiation, with
the $7uu billion uollai TARP in late 2uu8 anu the $787 billion uollai
stimulus a few months latei, the iejection of sounu economics
obviously continues. Theiefoie, without question, one of the
piincipal anu impeiative goals of this book is foi each ieauei to be
inspiieu by an uigent quest foi knowleuge of Austiian economics.
This uoes not imply that one must go back to school anu become an
economic scholai, but iathei to take up ieauing it on a iegulai anu
consistent basis. Touay, with the help of the Inteinet it is easy! 0nly
by seeing the woilu fiom the Austiian economic point of view is one
able to soit out anu uistinguish goou economics fiom bau
economics.

G-./#%0+B(H,.'5&4:((

Leaining of the oiigins anu basic tenets of Austiian
economics is obviously the fiist step. It will not take long in one's
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
14
seaich to eventually be leu to 71%# >)+%+# D$+/)/./% (,,,62)+%+6"05K
anu 71%# L".$*'/)"$# ("0# M&"$"2)&# M*.&'/)"$# N,,,6(%%6"05K, two of
the leauing anu most iecognizeu inuepenuent oiganizations
committeu to spieauing fiee maiket iueas heie in the 0niteu States.
S

At these two websites you will finu a woilu of illuminating economic
aiticles, books, CBs, BvBs anu scholaily jouinals that can be
obtaineu fiom these fine piivate institutionsmuch of it foi fiee. If
the ieauei is heaiing of the Austiian school of thought foi the veiy
fiist time, these piivate institutions aie ceitainly the best place to
stait anu continue acquiiing the euucation neeueu. I,J&@&'K( :,'(
$.'$,5&5(,:(50A$40:0/#%0,+K("&'&(05(J"#%(A#3(2&(/,+50-&'&-(%"&(
A,5%( 0A$,'%#+%( -05%0+/%0,+5( ,:( %"05( $#'%0/.4#'( 5/",,4( ,:(
&/,+,A0/(%"0+90+BC(
Fiist of all it is impoitant to iealize that the Austiian School,
although woiluwiue, is now most centially locateu in the 0niteu
States. It is not a physical school oi place, but iathei an economic
way of thinking. Its pieuecessois fiist oiiginateu in Spain in the 16
th

Centuiy, but some of the moie influential Austiian scholais weie
fiom vienna, Austiia. As a geneial iule, the piinciple of +(,$()#-#anu
the concept of (.%)(/ aie at the centei of Austiian economics. Eveiy
action by eveiy actoi in an economy has its own set of values,
piefeiences, neeus, uesiies anu time scheuules foi the goals
intenueu to be ieacheu. Why. Because economic value is subjective
to the inuiviuual. This makes the Austiian economist see the
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
1S
complexity of an economy, anu especially the maiket, uniquely
uiffeient fiom all othei schools of thought. What is iemaikable to
me, even now, is that, contiaiy to the fact that Wall Stieet, the meuia
anu most of oui political leaueis in Washington weie caught
completely by suipiise when the financial ciisis hit us all in 2uu8,
the Austiians hau been pieuicting it all along, anu they hau been
uoing it foi uecaues!
Theie aie many gieat foieign scholais who coulu be
classifieu as "Austiian" economists, iegaiuless of theii nationality.
These incluue the Fiench classical economists }ean-Baptiste Say anu
Fieueiic Bastiat. The actual founuing of the Austiian School
occuiieu in 1871 with the publication of Cail Nengei's O0.$*+P/H%9#
oi Q0)$&)43%+# "(# M&"$"2)&+. 0thei foieign-boin "Austiians" incluue
Eugen von Bohm-Baweik, Wilhelm Ropke anu Nobel Piize-winning
economist, F.A. Bayek, to name just a few. Ameiican-boin Austiian
economists incluue Leonaiu Reau, Beniy Bazlitt anu Nuiiay N.
Rothbaiu with the list giowing anu too numeious to mention all
heie. Bowevei, the most celebiateu figuie of the Austiian School,
anu whose caieei began some 1uu yeais ago, is Luuwig von Nises.
This gieat Austiian economic scholai accomplisheu a feat nevei
befoie uone in the histoiy of economics. Be took centuiies of
scatteieu economic thinking anu biought it all togethei into one
complete fielu of stuuy, which he calleu 40'R%"3"5-, the science of
human action. In essence, this science unueiscoieu the fact that
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
16
A#+( #4J#35( #/%5( J0%"( #( $.'$,5&K( +&@&'( 0+( %"&( #BB'&B#%&K( 2.%(
#4J#35( #5( #+( 0+-0@0-.#4C Foi that ieason, man cannot be placeu
into a foimula, chaiteu on a giaph, oi placeu into a mathematical
calculation foi any type of centializeu planning oi foiecasting as
mouein uay economists insist on uoing. What you leain fiom
stuuying the woiks of Nises is that he was one of those inuiviuuals
of impeccable chaiactei that comes along only iaiely in histoiy. 0ne
coulu say that he spent his entiie life fighting an iuea within
civilization that was false. In fact, he believeu this iuea to be so
uelusional anu uestiuctive that he saw it as an evil that no one
shoulu give in to. In many obseivable ways, fiom his wiitings anu
lectuies, it became cleai that he was not so much thinking of
himself, but iathei looking aheau consiueiing us in oui uay anu
time.oui kius anu oui gianukius. The legacy that he left behinu, at a
gieat peisonal cost to himself, was the encouiagement foi all of us
to join into this intellectual battle anu eventually uefeat this evil
iuea. Be believeu it to be a moial iesponsibility that each of us, you
anu I, has to society.
Touay, it is the gieat woik of the Nises Institute, FEE, anu
othei such piivate institutes, funueu with no connections to
poweiful elites, that have become the centeis foi leaining the
economic piinciples that oui chiluien anu gianuchiluien must be
taught. They continue to fan the flame of libeity by publishing
scholaily jouinals, publishing books, holuing confeiences, teaching
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
17
stuuents anu holuing seminais. Because of theii effoits spanning
moie than 6u yeais heie in Ameiica, hunuieus of thousanus have
alieauy joineu in the intellectual battle anu the changes aie being
felt eveiywheie. Theie is faith, hope anu expectancy at these
inuepenuent scholaily institutions that a uiamatic change in the
political anu social lanuscape is iight aiounu the coinei anu can
happen neaily oveinight when the iueological conuitions aie iight.
These institutions continue to pioviue the euucational fuel to keep
the fiie buining. Eveiy conscientious citizen shoulu join anu become
a membei of one. Along with this book, these aie the places to begin
one's euucational jouiney of Austiian economics while at the same
time staying involveu in this battle ovei the minus of men.

8"&(*+:0+0%&(L#+90+B(!,+/&$%(

I acknowleuge othei goou fiienus anu fellow Austiians as
impoitant souices of help foi the wiiting of this book. Bi. Paul A.
Clevelanu, Piofessoi of Economics anu Finance at Biimingham
Southein College, who without question, is, anu has been, my
economics teachei. When we fiist met yeais ago he was able to
suimise quickly anu accuiately wheie I was in my jouiney into
economics. Be pioviueu the necessaiy guiuance foi me to continue
to move in the iight uiiection anu continues to uo that to this uay.
Theie is also Canauian-boin Bi. Richaiu }. uiant, Piofessoi of
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
18
Economics anu Finance at Lipscomb 0niveisity, who pioviueu
invaluable insights into cuiient monetaiy policy ielating specifically
to the Feueial Reseive anu the banking system. With his wiue
expeiience of having taught anu woikeu in eight uiffeient countiies,
his auvice was instiumental in helping with missing pieces I hau not
yet quite figuieu out. Anu then, of couise, theie is my co-authoi of
this book, Bi. Robeit P. Nuiphy. Actually youngei than some of my
own chiluien, Robeit's eneigy anu passion foi his woik makes him,
in my opinion, a hopeful glimpse of the futuie of Ameiica. Theie aie,
of couise, many otheis to whom I owe a gieat ueal of giatituue foi
the thoughts pioviueu in this book, but with many apologies will not
be listeu.
It is also piobably wise foi me to point out that in wiiting this
book, I have boiioweu iueas quite libeially fiom otheis. I uoubt
seiiously if theie is an oiiginal iuea in it. This is a soit of blanket yet
iespectful acknowleugement of all the cieatois of these iueas which
I have useu without stopping to give official cieuit. At best, Robeit
anu I have aiiangeu what we think aie biilliant iueas in a mannei to
suppoit what we believe. If the ieauei is taken by this book anu the
line of thought it pioviues, then we have accomplisheu oui puipose
in wiiting it. Let me make cleai, howevei, that theie is no gieatei
iuea in this book that pioviues the catalytic foice to empowei the
inuiviuual, to move him to take immeuiate action, than the iuea
pioviueu by R. Nelson Nash anu his Infinite Banking Concept (IBC).
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
19
Theie will be moie to say about Nelson anu IBC latei, howevei, I will
say now that it was Nelson who fiist suggesteu I wiite this book.
With each economic aiticle I wiote anu uistiibuteu thiough the
Inteinet, his encouiagement by way of a peisonal phone call woulu
follow. I woulu have nevei conceiveu of the iuea to wiite a book
containing my thoughts hau it not been foi his uigings, at least not
in the uiiection he kept pushing me. Nelson, a long time stuuent of
Austiian economics spanning S2 yeais, counseleu me anu spoke
with me about the mentoiing he hau ieceiveu eailiei in his life fiom
Leonaiu Reau, founuei of The Founuation foi Economic Euucation
(FEE). The iueas foi Nelson's book on the Infinite Banking Concept
hau come uiiectly fiom Austiian economics. It was these same
conveisations with Nelson Nash that I woulu in tuin begin to shaie
with Robeit Nuiphy. Slowly, ovei a peiiou of a yeai, Robeit became
convinceu anu convicteu of what he was heaiing. Bis fiist moment
of ieal claiity came one uay ovei lunch with Paul Clevelanu. Robeit
hau just finisheu ieauing Nelson's book anu by the time lunch was
ovei Robeit unueistoou the significance of what the book was
explaining anu soon theieaftei implementeu the piocess foi himself.
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
2u

(
(
(
8"&(<,.+-(F,+&3(<,4.%0,+(

The uay Robeit Nuiphy committeu to co-authoi this book
with me is a uay I shall nevei foiget simply because of the unusual
anu unexpecteu way in which it happeneu. Bowevei, it is piecisely
because of the way it happeneu that explains anu pioves the
explosive vision the iueas in this book piouuce. To iecount this
special uay anu begin to put it into piopei peispective, keep in minu
that up until then Robeit anu I hau been vigoiously involveu in
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
21
numeious conveisations about the human pieuicament in touay's
economic enviionment. Robeit, as a scholai anu expeit in Austiian
economics, coulu explain why things weie the way they weie
acauemically. Be obviously coulu expounu on these pioblems
piolifically having wiitten seveial books, incluuing stuuy guiues to
Nises' S.2'$# T&/)"$ anu Nuiiay Rothbaiu's >'$9# M&"$"2-# '$*#
U/'/%,#not to leave out the countless aiticles foi vaiious inuepenuent
libeitaiian think tanks.
Bowevei, thoioughly explaining anu uiagnosing the pioblem
of oui nation anu oui woilu was not the main issue. What eveiyone
uespeiately wanteu to know was how to fix it! Auuitionally, we both
unueistoou the Sounu Noney Solution well anu believeu in it
knowing that it was anchoieu by soliu Austiian thinking. We knew
all too well what was iequiieu to affect the kinu of national change
the Sounu Noney Solution calleu foi, but the pioblem was that the
Sounu Noney Solution's iequiieu steps weie highly unlikely to evei
be implementeu anu we both sauly knew it. Eviuence foi this was in
the fact that the Sounu Noney Solution was put foith uecaues ago
anu yet, in spite of all of the auvances anu giowth the Austiian
School has hau uomestically anu inteinationally, the Sounu Noney
Solution was next to impossible to evei see implementeu.
Robeit anu I weie both ceitainly uoing oui pait in spieauing
the message with each of us speaking to vaiious gioups thioughout
the countiy in oui iespective fielus, but the piocess, we ieauily
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
22
aumitteu, was slow anu uiscouiaging at times. We also knew oui
goal was not attempting to convince the entiie nation, ceitainly not
Suu million people. Austiian economists know that 1u% of the
population woulu most likely be enough to tuin public opinion in
oui favoi; we simply uo not have anywheie close to that 1u%.
0bviously we neeueu moie people, but not just anybouy. We neeueu
the iight kinu of people, iesponsible anu piouuctive people. We
neeueu people that woulu get involveu anu stay involveu. Also,
theie neeueu to be a buining passion insiue these people in oiuei to
see this change all the way to its successful enu. What was cleaily
missing was some kinu of inuiviuual incentive, but one that coulu
woik with the main tenets of the Sounu Noney Solution. What we
wanteu most was to bieak thiough the geneial pessimism that has
hung like a black clouu ovei oui School's pieuecessois. Beniy
Bazlitt, one of the most iecognizable of the Austiian economists
because of his affiliation with 71%# V'33# U/0%%/# W".0$'3, the !%,# X"0F#
7)2%+ anu !%,+,%%F, anu also the authoi of the best-selling book,
M&"$"2)&+#D$#B$%#=%++"$9 uesciibeu this paiticulai pessimism in one
of his last public speeches as he passeu the baton ovei to the next
geneiation:

When I look back on my own caieei, I can finu plenty of
ieasons foi uiscouiagement, peisonal uiscouiagement. I have not
lackeu foi inuustiy. I have wiitten a uozen books. Foi most of Su
yeais, fiom age 2u, I have been wiiting piactically eveiy
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
2S
weekuay: news items, euitoiials, columns, aiticles; some 1u,uuu
woius! Anu in piint! The veibal equivalent of about 1Su aveiage
length books!#
Anu yet, what have I accomplisheu. The woilu is
enoimously moie socializeu than when I began.yet in spite of
this I am hopeful. Aftei all, I'm still in goou health, I'm still fiee to
wiite, I'm still fiee to wiite unpopulai opinions, anu I'm keeping
at it. Anu so aie many of you. So I biing you this message: be of
goou cheei; be of goou spiiit. If the battle is not yet won, it is not
yet lost eithei. Even those of us who have ieacheu anu passeu
oui seventieth biithuays cannot affoiu to iest on oui oais anu
spenu the iest of oui lives uozing in the Floiiua sun. The times
call foi couiage. The times call foi haiu woik. But if the uemanus
aie high, it is because the stakes aie even highei. They aie
nothing less than the futuie of human libeity, which means the
futuie of civilization.
6

What Robeit anu I began to uo next was to get honest with
each othei. We agieeu that oui inuiviuual concein with iegaius to
what we aie expeiiencing in oui political anu economic affaiis
cuiiently coulu be summeu up in oui knowing what ill effects all
this economic upheaval is having on people's ability to make a
living. We uiu not shy away fiom this ieality. We hau seveial veiy in
uepth anu peisonal uiscussions about this concein. We knew that
foi most of us in Ameiica, the neeu to be able to make a living is anu
always has been a ciucial fact of life. It is the business fiom which
we nevei ietiie. In fact, it is uifficult to imagine any human being
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
24
who is not pieoccupieu with this economic enueavoi. In whatevei
mannei we tiy to explain oui society, oi oui goveinment, in teims
of the past, piesent oi the futuie, we cannot uo it anu ignoie
"economic man" anu his innate neeu to make a living.
Anu then it happeneu! All of a suuuen the entiie theme of this
book, fiom beginning to enu, hit Robeit like a 2 by 4 acioss the heau.
Bis eyes wiueneu with uttei amazement anu he exclaimeu with
excitement, "That's it!" Noments latei he aumitteu that the vision hit
him with such foice that he hau not even seen it coming. It hau
nevei uawneu on him until that veiy moment that what I, Paul anu
Nelson hau been talking about all this time was actually "step two"
of the thiee steps of the Sounu Noney Solution.01$)2,#)3/&*
4,"5)"678# Bowevei, the spectaculai anu unbelievable pait about it
was that an inuiviuual coulu actually go into piivatizeu banking
iight now! Theie was no neeu to wait on goveinment to change.
Theie was no neeu foi the Sounu Noney Solution to be accepteu anu
put foith into public policy. M'0@#%&( 2#+90+B( /,.4-( 2&( -,+&(
0AA&-0#%&43( #+-( 0%( /,.4-( 2&( -,+&( 23( @0'%.#443( #+3,+&N 0ui
cieative eneigy suuuenly soaieu anu the missing incentive we hau
been seaiching foi suuuenly became cleai anu appaient. The
answeithe missing linkwas simply the connecting of this innate
neeu within man, the neeu to make a living, with the Sounu Noney
Solution. The key was step two of the Sounu Noney Solution, the
business of banking, piivatizeu banking, the most piofitable
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
2S
business in the woiluit coulu be implementeu iight now by any
inuiviuual citizen!

In this intiouuction I shoulu also say a few woius on the
layout of the book. I have been giving PoweiPoint piesentations on
these matteis to vaiious auuiences of financial piofessionals, anu
the ieaction has been astonishing. Even gioups of :'$F%0+ aie
absoibing the infoimationmost of them hau no iuea how theii
own inuustiy ieally woikeu!
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
26
0n the othei hanu, Robeit's main aiena was in piint. As a
foimei college piofessoi, anu the authoi of seveial books, Robeit
obviously can piesent the Austiian iueas in the tiauitional foim. Be
too has founu giowing populai inteiest in these iueas, because of
the financial ciisis.
In the piesent book, Robeit anu I obeyeu the populai auage,
"If it ain't bioke, uon't fix it." That is to say, in Pait I of the book I am
the piimaiy authoi, anu I uiu my best to tianslate my PoweiPoint
piesentations into book foim.
Robeit, on the othei hanu, is the piimaiy authoi of Pait II.
Theie he tiies to uistill the most impoitant points fiom the Austiian
tiauition, in oiuei foi the ieauei to unueistanu the Sounu Noney
Solution. The simple listing of its thiee bullet points will make little
sense, without some backgiounu knowleuge of how a fiee maiket
economy actually woiks.
Because of the book's stiuctuie, it was unavoiuable that theie
is some ieuunuancy. Robeit anu I tieat many of the ciucial topics
inflation, fiactional ieseive banking, the natuie of money, anu so
onin oui own ways. We hope that Pait I pioviues a quick
oveiview of the ielevant topics, convincing the ieauei of theii
impoitance, without the use of intimiuating jaigon that too often
paialyzes compiehension. Then in Pait II we pass thiough many of
the same issues but in gieatei uepth. Finally, in Pait III we explain
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
27
the basics of Nelson Nash's Infinite Banking Concept, anu show its
contiibution to the achievement of the Sounu Noney Solution.
I am suie that some ieaueis, who alieauy have a ueep
knowleuge of monetaiy anu banking affaiis, may finu poitions of
oui tieatment simplistic. But I ask you to keep in minu that we neeu
to spieau this message to a laigei gioup of Ameiicans if we aie to
have any hope of tuining the tiue. These aie veiy impoitant issues
that will affect the type of countiy in which oui chiluien anu
gianuchiluien live. Especially in Pait I, we have tiieu to boil uown
these aicane anu intimiuating concepts into uesciiptions that
anyone can unueistanu. The fate of oui money anu inueeu oui
countiy aie too impoitant to be left to "the expeits."
All too often I have peisonally seen veiy intelligent women
who concentiate on othei iesponsibilities anu allow theii husbanus
to "take caie of the finances." Such women aie one of the piimaiy
taiget auuiences foi whom we aie wiiting. Inueeu many men will
ieject the commonsense anu conseivative financial stiategies we
explain in this book, because they'ie "too easy" anu too timiu. But
when it comes to a householu's savings, simplicity is goou! We have
seen what the "smaitest guys in the ioom" uiu on Wall Stieet. We
uige stay-at-home spouses to ieau ueeply on these matteis anu to
take a moie active iole in theii financial futuie.
As a final point in this intiouuction, let me acknowleuge that
oui book has an explicitly Ameiican bias. We aie wiiting this book
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
28
foi oui fellow Ameiican citizens, though of couise the lessons of
Austiian economics aie univeisally applicable. Theie aie thiee main
ieasons foi oui emphasis on the 0niteu States.
Fiist, theie is the simple pioblem that foieign ieaueis may
not be able to obtain whole life insuiance policies configuieu in the
way Nelson Nash iecommenus. In contiast, Ameiican ieaueis have
seveial appiopiiate insuieis to choose fiom, who can catei to a
client wishing to implement IBC.
Seconu, the Feueial Reseive is by fai the most poweiful foice
in the woilu economy. The folly of the Zimbabwe cential bank only
iuineu the lives of a small fiaction of the global population. In
contiast, if Ben Beinanke uoes not altei couise soon, billions of
people will suffei the consequences.
Thiiu, we believe that the loveis of libeity must make a final
stanu in the 0niteu States. To paiaphiase Ronalu Reagan, if we lose
libeity heie, theie's nowheie left to go. }ust as the fall of the Soviet
0nion pioveu the futility of communism to many "piagmatists" who
woulu not bothei with abstiact aiguments, by the same token the
collapse of the 0niteu States will convince the woilu that capitalism
too uoes not woik. It woulu be an eiioneous conclusionwe
ceitainly uo not have a fiee maiket in opeiationbut that is the
veiuict histoiy woulu give on Ameiica's biief fling with limiteu
goveinment.
!"#$%&'(#)%"*
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@#
#
29
The quintessential Ameiican political tiauition is one of
inuiviuual libeity anu economic fieeuom. Even as Ameiican
politicians tiample the Constitution, they still pay lip seivice to its
clauses. Although the aveiage Ameiican's commitment to the
piinciples of inuiviuualism anu piivate piopeity giow weakei with
each geneiation, even so theie is a iich heiitage that we hope to
iekinule. We &'$ succeeu. Anu we 2.+/ tiy.

L. Cailos Laia
Nashville, Tennessee
}une, 2u1u

1
Ludwig von Mises, Human Action: A Treatise on Economics (Auburn, AL: The
Ludwig von Mises Institute, 1998).
2
A good question put forth by Clarence B. Carson, Basic Economics (Phenix City, AL:
American Textbook Committee, 2003).
3
Murray Rothbard, The Meaning of Revolution, Libertarian Forum, Vol. I, No. VII,
July 1, 1969, p. 1. Available at: http://mises.org/journals/lf/1969/1969_07_01.pdf.
Accessed June 1, 2010.
4
Randall W. Forsyth, Ignoring the Austrians Got Us In This Mess, Barrons, March
2009.
5
There are many other organizations and think tanks in the United states dedicated to
free market economics, though not necessarily in the tradition of the Austrian School.
6
Henry Hazlitt, quoted in Fifteen Great Austrian Economists (Auburn, AL: The
Ludwig von Mises Institute, 1999), pp. 178-179.
!"#$%&'(#)%"*
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!"#
#
S1
!"#$%&'()(
*++&++,-.(%"&(/#,-(0'123&4(

!"#$% &'(% )#% "(*+,"*% ,)-.% -."% /)0-% +0% 1"'#+($% 23-%
."% )#% '4#+% 5+##"##"*% +0% '55"-)-"#% '(*% '(% '6"1#)+(%
-+% 4'2+1$% '(*% -++% +0-"(% .)#% 1"'#+(% 2"(*#% -+% .)#%
+-."1% 7.'1'7-"1)#-)7#8% 9."% 0')431"% +0% 3-+5)'(#% -+%
'77"5-%-.)#%0'7-$%+1%'77"5-%&'(%'#%."%)#$%(+-%'#%."%
+3/.-% -+% 2"$% /)6"#% -.")1% #7."&"#% '% *1"'&4):"%
;3'4)-<8%
=>1'(:%?.+*+1+6
@
%!
%
%
he most impoitant fact behinu the "new iuea" uesciibeu
in the pievious chaptei is that oui effoits to help
ouiselves, oui families, oui businesses, anu ultimately oui countiy,
iests entiiely on oui ability to see the natuie of oui pioblem with
complete claiity. Without this unueistanuing as a piimaiy step, it is
impossible to take the neeueu actions towaiu coiiecting it.
Theiefoie, the pioblem must be fully exposeu anu maue
compiehensible to as many people as possible, anu as quickly as
possible.
So let us begin to ueciphei this mysteiy anu point to some
obvious obseivations. Fiist of all, we must make a iathei bolu
statement which we will set out to piove in the chapteis aheau.
T
"##$##%&'!()$!*+%&!,-./0$1
AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA%
%
S2
What we aie uealing with is a ueeply hiuuen anu cleveily ciafteu
scheme by the few in political powei, past anu piesent, to
systematically uefiauu the nation of its wealth. It is nothing less
than a uiiect assault on piivate piopeity! This is oui bottom line. It
is the ciux of the mattei. Absolute powei always iesiues with those
who contiol the money. 0vei the couise of histoiy gieat families,
kinguoms, anu institutions have stiuggleu with one anothei to gain
this contiol. Touay, in viitually eveiy majoi countiy acioss oui
globe, goveinments lay claim to this centializeu powei.

In oui own Ameiican expeiience, oui feueial goveinment
exeicises extiaoiuinaiy powei ovei oui money. 0nce it was maue
possible to tap uiiectly into oui pocket books with the passing of the
16
th
Amenument (the feueial income tax) in 191S anu the
establishment of a cential bank (the Feueial Reseive System) in the
veiy same yeai, the challenges of making a living anu accumulating
wealth changeu foievei foi all citizens of the 0niteu States. The
seaich to finu a way of escape fiom this bonuage has become the
haiu stiuggle of eveiy inuiviuual citizen since then. As Fiank
Chouoiov explains:

In 191S came the amenument that completely unshackleu the
Ameiican state, foi with the ievenues ueiiveu fiom unlimiteu
income taxation it coulu hencefoith make unlimiteu foiays in to
the economy of the people. The Sixteenth Amenument not only
"##$##%&'!()$!*+%&!,-./0$1
%
SS
violateu the iight of the inuiviuual to the piouuct of his effoits,
the essential ingieuient of fieeuom, but it also gave the Ameiican
State the means to become the nation's biggest consumei,
employei, bankei, manufactuiei anu ownei of capital. Theie is
now no phase of economic life in which the State is not a factoi,
theie is no enteipiise oi occupation fiee of its inteivention.
2

0n the othei hanu, it is not so simple as to ueclaie that "the
goveinment" contiols the money supply, foi technically the >"*"1'4%
B"#"16" contiols it. The Feu, though cieateu by the goveinment, is
nonetheless owneu by piivate inuiviuuals anu in impoitant ways
opeiates inuepenuently fiom the wishes of the goveinment. As
Nuiiay Rothbaiu iemaiks: "The Feueial Reseive, viitually in total
contiol of the nation's vital monetaiy system, is accountable to
nobouyanu this stiange situation, if acknowleugeu at all, is
invaiiably tiumpeteu as a viitue."
S
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
0vei the past seveial uecaues, the instigation of these two
significant laws has leu to wiuespieau economic fiustiation anu
confusion in Ameiican society. The aveiage citizen, in an attempt to
piotect his own wealth, constantly seeks all types of financial
stiategies to accomplish this, sometimes iesoiting to expoiting his
wealth to othei countiies. Auuitionally, he is inunuateu with the
enuless foims anu filings which aie manuateu by goveinment. Theie
seems to be a foim 1u99 eveiywheie! Touay theie aie
appioximately 746,uuu licenseu financial iepiesentatives in this
"##$##%&'!()$!*+%&!,-./0$1
%
S4
countiy iepiesenting ovei 7,uuu banks, neaily 1,uuu biokeiage
fiims, anu 2,Suu insuiance companies. The numbeis of public
accountants anu lawyeis aie legion. Yet with all the benefits of
piofessional assistance in navigating thiough a maze of tax laws, the
fine piint on financial piouucts anu iisk vaiiables in investment
piospectuses, the inuiviuual peison, moie than evei befoie, feels
betiayeu anu vulneiable. Bieams of financial secuiity anu
piospeiity evaue 0.S. citizens at eveiy tuin. The tax anu uebt buiuen
continues to giow annually anu has become unbeaiable. Eventually
the buiuen takes its toll anu causes the inuiviuual to lose hope. Be is
foiceu to succumb to even moie uepenuency anu subseivience to
goveinment.
Cleaily, auvice offeieu by many in the financial seivices
inuustiy is not pioviuing the help that is most neeueu because it
meiely sciatches the suiface of the ieal pioblem. A peison's pooi
juugment, unuisciplineu money management oi lack of time to
expeitly ieseaich eveiy aspect of financial uecisions may be the
culpiit in many cases, howevei, the ieal pioblem stems fiom a
completely uiffeient souice. It is .15&'-4&-%( ,-%'6+,1- anu,
especially,( 41-&%#'7( $13,87 which is at the coie of this money
pioblem. Eveiy inuiviuual, especially the financial auvisoi, has the
iesponsibility to unueistanu this connection, to leain specifically
,.< anu .+, the 191S tax anu banking laws aie systematically
stiipping away the value of oui money. It is goveinment action
"##$##%&'!()$!*+%&!,-./0$1
%
SS
instigateu thiough the cential bank that cieates the 2/..1!+&3!/4#(!
/4#%&$##! 5650$#7 that cause iecessions anu uepiessions! The
inuiviuual, not iealizing how all of this has come about, is left in
unenuing financial bonuage.
Aimeu with this tiuth, the inuiviuual is able to asses the ioot
of his monetaiy pioblems. No longei is he misleu by financial
expeits, meuia peisonalities, oi oui congiessional leaueis in
Washington. Knowleuge anu tiuth solve the iiuule, eliminating
peipetual confusion. Let us not foiget the famous statement of }ohn
Naynaiu Keynes:

Theie is no subtlei oi suiei means of oveituining the existing
basis of society than to uebauch the cuiiency. The piocess
engages all the hiuuen foices of economic law on the siue of
uestiuction, anu uoes it in a mannei which -1%( 1-&( 4#-( ,-( #(
4,33,1-(,+(#23&(%1(9,#.-1+&.
4

(
:16-9(;",-<,-.(

0bviously, if this mysteiy is to be solveu anu a solution
founu, a ceitain uegiee of uelibeiate thinking is necessaiy on the
pait of all of us. Bowevei, heie lies the fiist huge obstacle.
0nbelievable as it may seem, the oveiwhelming majoiity of people
heie in oui 0niteu States simply uo not think! It's tiue! Theie aie
"##$##%&'!()$!*+%&!,-./0$1
%
S6
unfoitunately numeious statistics that piove this sau point
eveiyuay. 0ne significant factoi is that ovei half the Ameiican
population is uepenuent on some foim of goveinment suppoit.
Theiefoie, the powei anu sway of the voice of goveinment has maue
ieal thinking viitually unnecessaiy foi many. Foi otheis, thinking is
simply inconvenient. It iequiies time anu effoit. 0f couise, what we
aie iefeiencing is "#+3(*% -.)(:)(/", inuepenuent thinking iequiiing
concentiation anu contemplation. It is a type of thinking that uoes
not easily jump to conclusions, noi takes as uoctiine the infoimation
that pouis out of the meuia, anu especially out of Capitol Bill. In a
society such as ouis sounu thinking has become extiemely iaie,
even in the infoimation age when ieal knowleuge has giown moie
accessible to the layman than evei befoie.
We must ieveise this tienu as an absolute fiist step anu take
up this uisciplinein small uoses of couise; otheiwise we will nevei
uo it. Like any othei uiscipline, a ceitain amount of time must be set
asiue each uay foi this piactice until it becomes habitual. The
staiting point is ieauing a book. Yes, you ieau coiiectly, 1"'*)(/! In
his gieat book, 9.)(:)(/% '#% '% C7)"(7", Austiian economist Beniy
Bazlitt makes it cleai that oui thinking is mostly foimeu by oui
ieauing. We shoulu select anu ieau only the most infoimative books
on the most enlightening subjects: "|Tjhe gieat thinkeis of the past
impioveu theii innate poweis, not by the stuuy of iules foi thinking,
"##$##%&'!()$!*+%&!,-./0$1
%
S7
but by ieauing the woiks of othei gieat thinkeis, anu unconsciously
imitating theii habitual methou anu caution."
S

%
=#+,8(>81-14,8+(

Likewise we also must ieau anu hone oui thinking by
selecting the subjects most woith oui "thinking" time. Anu, since
oui piimaiy subject mattei is oui cuiient financial system, we
stiongly suggest to the ieauei that he can uo no bettei than to select
the subject of economics.
Why economics. 0nlike any othei subject, economics ueals
with an essential anu piessing aspect of life, which is man's neeu to
make a living. Nost impoitantly, no subject of the 21
st
centuiy seems
to occupy moie of the political limelight than economic questions
anu theii answeis. The piesent financial ciisis is of couise a majoi
incentive foi the seiious stuuy of economics. A moie uaunting
ieason is the unueistanuing that goveinments anu iuleis aie also
veiy much involveu with these same questions; howevei, theii
uecisions iegaiuing economic policy can be a mattei of life anu
ueathlibeity oi seifuom. Foi self pieseivation, we shoulu be
knowleugeable in the basics of this veiy impoitant subject.
Auuitionally, the subject of economics ueals piincipally with
the piouuction anu uistiibution of goous. Questions follow having to
uo with the motivations to piouuce those goous, what goes into
"##$##%&'!()$!*+%&!,-./0$1
%
S8
theii piouuction, anu even why goous aie iefeiieu to as D/++*#8E The
stuuy of economics also pioviues answeis to questions as to who
gets what, how piices aie ueteimineu, anu how the maiket opeiates.
It is a bioau anu all encompassing science which by uefault piesents
questions anu answeis peitaining to public policy. This unique
chaiacteiistic is one of the main ieasons why veiy eaily in its
histoiical uevelopment, economics became entangleu with
socialists' iueas. In fact, it can be saiu that socialist iueas have
gieatly alteieu what is often taught touay as economics. 0ui
ieauing, theiefoie, must be selective anu uelibeiate.
The ieauei, howevei, must unueistanu cleaily that an
acauemic appioach to economics is not essential in oiuei to
unueistanu oui cuiient economic tuimoil. Noi is scholaily status
necessaiy foi leaining how we shoulu go about fixing it. It is not
necessaiy to uelve into the complexities of economics at the moie
sophisticateu levels of the science. Theie is no neeu to become
enmesheu in statistics, confusing giaphs, chaits, mouels oi
complicateu accounting calculations. These featuies all ceitainly
have a place in the stuuy of economics, but not foi oui specific
puipose. It is iathei to suggest that the stuuy of economics be
unueitaken in oiuei to gain a fiim giasp of ceitain key "economic
piinciples" that aie univeisal in theii application. This knowleuge is
foi the aveiage peison, not just the scholai.
"##$##%&'!()$!*+%&!,-./0$1
%
S9
The stuuy anu unueistanuing of economic piinciples is of
piimaiy impoitance, an effoit not to be taken lightly. These
unueilying economic piinciples can be saiu to be inuisputable
iegaiuless of "school" oi peisuasion because they aie ueiiveu fiom
funuamental conuitions which aie univeisal. In this iespect they can
be saiu to iesemble the laws of physics anu chemistiy. They aie
founuational concepts anu apply to all peoples, in all places anu at
all times. Bowevei, given the state of what we may iefei to as oui
"national ignoiance," these economic piinciples weie eithei nevei
leaineu, have been foigotten, ignoieu oi altogethei abanuoneu by
oui piesent geneiation.
(
;"&(;?1(>@%'&4&+(

Inteiestingly, economics as an acauemic uiscipline heie in
this countiy is ielatively new. It ieally uiu not become pait of
univeisity cuiiiculum until the last half of the 19
th
centuiy.
Economic thinking, howevei, has its theoietical anu philosophical
ioots uating back to the uieeks, staiting with Sociates (469-S99
B.C.), Plato (427-S47B.C.), anu Aiistotle (S84-S22 B.C.).
Even at this eaily stage, we can see uiffeient "schools" of
thought, such as the utopianism of Platowith his uesciiption of the
"philosophei kings" who woulu exeicise iule in the iueal Republic
veisus the iealism of Aiistotle. Biffeient schools anu iueologies littei
"##$##%&'!()$!*+%&!,-./0$1
%
4u
the fielu of political anu economic thought as well. Some of the moie
piominent ones aie the Classicists, the Neicantilists, the
Institutionalists, the Naixists, the Fabians, the Synuicalists, the
Keynesians, the monetaiists, the supply-siueis, anu the Austiians.
Specific iueologies incluue capitalism, socialism, communism, anu a
whole list of othei D)#&#8E Rathei than stuuying each example in
uepth, we can look at a spectium:

*-#'8",+%_______________________________________________;1%#3,%#',#-(

At one extieme aie those that believe that goveinment is not
essential anu that it can be totally ieplaceu by the maiket. These
woulu be classifieu as political anaichists. At the othei extieme aie
the auvocates of totalitaiianism. These inuiviuuals woulu have the
goveinment contiol the piouuction anu uistiibution of goous
theieby completely uisplacing the maiket. Although eveiy school of
thought anu iueology has its own sects, at a bioau level many self-
uesciibeu communists anu Naixists woulu fall on this enu of oui
spectium. The most impoitant questions to ask oneself aie these:
DF."1"%'4+(/%-.)#%#7'4"%*+%G%2"4+(/HE, oi DF."1"%'4+(/%-.)#%#7'4"%*+%G%
8+&(% -+% 2"4+(/HE We shoulu ask ouiselves these questions keeping
in minu that economics is not politics. 0ne is a science conceineu
with the piouuction anu uistiibution of goous. The othei is the ait of
"##$##%&'!()$!*+%&!,-./0$1
%
41
iuling; howevei, asking ouiselves these questions foices us to see
how quickly we can co-mingle the two.
Bistoiy uoes not iecoiu a time when theie was a completely
anaichist economic enviionment. Libeitaiian wiitei Fiank
Chouoiov iefeiences in the I++:%+0%J3*/"# a time when D-."1"%,'#%(+%
:)(/%)(%G#1'"4$%23-%-.'-%"6"1<%&'(%*)*%,.'-%,'#%1)/.-%)(%.)#%+,(%"<"#8E%
This wiitten account woulu ceitainly imply complete fieeuom in
economic affaiis as well as otheis. Bowevei, even the Isiaelites weie
not without the social contiols that aie the essence of goveinment.
In othei woius, fieeuom was not license. This was the significance of
the iule of juuges, although theii authoiity seemeu to have iesteu
solely on public opinion. DKC+% #')*% !'.,".L, hau the foice of, K#+% #'<%
,"%'448LE
Foi the most pait, histoiy has giavitateu towaius the othei
extiemetotalitaiianism. Bistoiically, goveinments have always
sought to expanu theii powei ovei theii subjects' lives, culminating
in the totalitaiian uictatoiships of Nazi ueimany, Soviet Russia, anu
Naoist China in the twentieth centuiy. uoveinment contiol of all
piouuctive piopeity, commanuing its piouuction, anu its
uistiibution is a total contiol of society. A totalitaiian system is by
its veiy natuie tyiannical. Within the confines of a totalitaiian
system theie is absolutely no economic fieeuom. As classical libeials
such as Luuwig von Nises stiesseu, once the goveinment abolishes
economic fieeuoms, all othei libeities uisappeai as well. "Fieeuom
"##$##%&'!()$!*+%&!,-./0$1
%
42
of the piess" is an empty slogan when the goveinment owns the
newspapeis anu iauios, anu it is nave to guaiantee citizens the
iight to ciiticize the goveinment, if at a moment's notice they can be
ieassigneu to a factoiy in Sibeiia.
(
AB(/&-(C&'&(*-.&3+(

What is at the ioot of such a glaiing uichotomy. Anu, why is
totalitaiianism favoieu. If we examine histoiy as a composite of
human behavioi ovei time, we concluue that the action of man
stems entiiely fiom an inclination of the K."'1-%+0%&'(Lthe way he
thinks. But why uoes he think this way. It is .3&'(%('-31", that fatal
tenuency of mankinu which neithei ieligion noi moiality can stop!
Natuial Law theoiists long ago pointeu to the pioblems of human
natuie. As Fieueiic Bastiat obseiveu:

Self-pieseivation anu self-uevelopment aie common aspiiations
among all people. Anu if eveiyone enjoyeu the uniestiicteu use
of his faculties anu the fiee uisposition of the fiuits of his laboi,
social piogiess woulu be ceaseless, uninteiiupteu, anu unfailing.
But theie is also anothei tenuency that is common
among people. When they can, they wish to live anu piospei at
the expense of otheis. This is no iash accusation. Noi uoes it
come fiom a gloomy anu unchaiitable spiiit. The annals of
histoiy beai witness to the tiuth of it: the incessant wais, mass
"##$##%&'!()$!*+%&!,-./0$1
%
4S
migiations, ieligious peisecutions, univeisal slaveiy, uishonesty
in commeice, anu monopolies. This fatal uesiie has its oiigins in
the veiy natuie of manin that piimitive, univeisal, anu
insuppiessible instinct that impels him to satisfy his uesiies with
the least possible pain.
6

The fiameis of oui Constitution weie awaie of this ieality.
They believeu that man is a limiteu anu fallible cieatuie anu that all
of his oiganizations, institutions, anu stiuctuies aie affecteu by this
limitation. Accoiuingly, they felt that the powei anu sway of
anything must be limiteu anu that goveinment, above all, must be
seveiely limiteu.
In ieauing the >"*"1'4)#-#%M'5"1#, a seiies of 8S aiticles which
appeaieu in newspapeis between 1787 anu 1788, we can
compiehenu foi ouiselves oui Founueis' philosophies anu
motivations foi the iatification of the 0niteu States Constitution.
Feueialist No. S1, wiitten by }ames Nauison, is consiueieu
unpaialleleu in scope as the cleaiest exposition of the Constitution.
0ne paiticulai paiagiaph is acclaimeu to be a shoit couise in
political science. A poition of that paiagiaph states the following:

Ambition must be maue to counteiact ambition. It may be a
ieflection on human natuie, that such uevices shoulu be
necessaiy to contiol the abuses of goveinment. If men weie
angels, no goveinment woulu be necessaiy. If angels weie to
govein men, neithei exteinal noi inteinal contiols on
"##$##%&'!()$!*+%&!,-./0$1
%
44
goveinment woulu be necessaiy. In fiaming a goveinment which
is to be auministeieu by men ovei men, the gieat uifficulty lies in
this: you must fiist enable the goveinment to contiol the
goveineu; anu in the next place oblige it to contiol itself.
7

%
The one fact that is being maue ciystal cleai is that man is
natuially inclineu to avoiu pain anu uiscomfoit. Since woik is anu
always has been painful, men will iesoit to stealing whenevei
stealing is easiei than woik. Since neithei ieligion noi moiality has
been able to uetei thieveiy, only the foice of N',% can stop it. The
foice of law must be maue to piotect piivate piopeity anu punish
stealing in oiuei foi a society to function anu piospei.
This was the classical, natuial law conception of the piopei
iole of goveinment, namely to help inuiviuuals secuie theii iights to
peace anu piopeity that weie ueiiveu fiom something &+1"%
03(*'&"(-'4 than the goveinment itself. If the goveinment evei
ueviateu fiom this assigneu iole of piotecting piopeity, anu itself
became the uespoilei, then it was no longei legitimate. This was the
unueistanuing of the Ameiican Founueis, anu it is why the 0.S.
Constitution is laigely a list of 51+.)2)-)+(# on the feueial
goveinment. In paiticulai, the Bill of Rights pioviues stiict
limitations on the activities of the feueial goveinment, anu the
Tenth Amenument makes it ciystal cleai that any poweis not
explicitly mentioneu in the Constitution aie ieseiveu eithei foi the
states oi the people.
"##$##%&'!()$!*+%&!,-./0$1
%
4S
0bseive, howevei, that oui piesent uay goveinment has
moveu away fiom its piopei constitutional iole anu is now
opeiating in similai fashion to ancient piactices anu uogmas. It is
involveu in aieas wheie it shoulu not be. Although some champions
of libeity, such as Lysanuei Spoonei, have questioneu the legitimacy
of the Constitution itselfaftei all, none of us touay evei signeu this
"contiact"!we can safely set asiue such philosophical questions foi
anothei uay. 0bseiving the actual behavioi of the 0.S. goveinment,
this much is cleai: Even foi those of us who ieveie the Founuing
Fatheis anu iespect the Constitution as one of the pillais of the
0niteu States, it is unueniable that the feueial goveinment .'#%
21+:"(%)-#%"(*%+0%-."%7+(-1'7-.
When we, the goveineu, aie able to iuentify that lawmakeis
take what is ouis anu give it to those that have not eaineu it, we, the
victimizeu goveineu, aie bounu to be affecteu by that injustice. It
woulu be a ciime if we uiu what goveinment uoes. We witness that
stealing is oiganizeu by the law foi the piofit of those that make the
law. The unlawfulness, committeu by oui own goveinment, foices
upon the goveineu to make the uifficult choice of eithei betiaying
theii moial chaiactei oi losing iespect foi the law altogethei.
Bepenuing on theii uegiee of unueistanuing of this ieality, the
goveineu will eithei wish to stop the legal theft they see occuiiing
with impunity, oi shaie in it themselves.

"##$##%&'!()$!*+%&!,-./0$1
%
46
D'&&(>-%&'$',+&(
(
In light of these iealities aie fiee maikets possible. Can fiee
enteipiise exist. In an attempt to answei these questions we must
fiist iealize that this piesent geneiation has nevei expeiienceu
completely fiee maikets, oi foi that mattei, a genuinely fiee
enteipiise system.
Fiee enteipiise is essentially "7+(+&)7% 01""*+&. This means
the fieeuom to piouuce whatevei one chooses with one's own
mateiials anu to offei them foi sale at whatevei piice one chooses
without any hinuiance fiom any souice, especially goveinment. The
only iestiaint is that one may not use one's faculties anu piopeity to
injuie otheis. In effect, fieeuom caiiies with it iesponsibility.
Auuitionally, piivate piopeity is absolutely essential to fiee
enteipiise. It is the pie-conuition of fiee enteipiise. Without piivate
piopeity theie can be no fiee maiket oi fieeuom of enteipiise.
Theiefoie, iestiaints on piivate piopeity aie iestiaints upon
enteipiise.
In the entiie histoiy of the woilu, the one peiiou that
appioacheu the closest to the classical libeial vision of inteinational
peace anu fiee tiaue blossomeu in the 19
th
centuiy, anu enueu with
the fiist Woilu Wai. The piospeiity associateu with limiteu
goveinment, fiee tiaue, the Inuustiial Revolution, anu the classical
golu stanuaiu staiteu in uieat Biitain but was soon auopteu by the
"##$##%&'!()$!*+%&!,-./0$1
%
47
0niteu States. Beie in oui countiy, with the notable exception of
slaveiy, fiee enteipiise was the uominant piactice fiom the colonial
peiiou until 1914. 0vei a centuiy of what we can tiuly call economic
fieeuom, at least as fai as the cential (oi "feueial") goveinment was
conceineu.
Bow was it accomplisheu. In what seemeu an impossible
expeiiment, the citizens of the young 0niteu States manageu to
ietain a faiily limiteu goveinment thiough the fiist half of the 19
th

centuiy. The outcome was not peifect; the goveinment enacteu
meicantilist policies, engageu in iailioau constiuction, anu so foith.
But by anu laige, especially by touay's stanuaius, enteipiise was not
iegulateu, contiolleu oi uiiecteu by the feueial goveinment. The
iesult tiansfoimeu the 0niteu States into the leauing commeicial
nation of the woilu! The aveiage Ameiican, the miuule class,
became wealthiei than evei in histoiy. In fact, all of the piospeiity
anu achievements we have touay we owe to the effoits of this class
of people anu to this system. Anu the genesis of that system began in
the 18
th
centuiy with an )*"'O the iuea of 4')##"P% 0')1"=3,4,%,-.(
.15&'-4&-%(#-9(B'&&,-.(4&-E(
This poweiful iuea took holu anu changeu the woilu! Fiee
enteipiise incentivizeu man to put his heait, his minu, anu his hanus
towaiu piouuction of his own neeus with his own best effoits. The
woilu witnesseu the iesults. uoveinment has nevei been able to uo
this, cannot uo this, noi can it foice men oi maikets to uo this.
"##$##%&'!()$!*+%&!,-./0$1
%
48
Bowevei, one funuamental iuea must be fully giaspeu: unuei
fiee enteipiise, people must be iesponsible foi theii own well being.
People who aie olu enough to woik anu aie able to uo so must
pioviue foi theii neeus anu wants by theii own effoits. Those who
aie not able to woik must be pioviueu foi by families anu voluntaiy
oiganizations. 0nless fiee men assume these iesponsibilities, they
foifeit them to goveinment poweis.
0nfoitunately, oui piesent geneiation has all but foifeiteu
theii iesponsibilities to goveinment. Eventually, when goveinment
has the people anu the maiket place unuei its complete contiol,
totalitaiianism sets in anu society is enslaveu. Boes this spell the
enu.

F1%(7&%G((
(
The geneial uecline in piouuction which goveinment inuuces
by its own covetousness uoes spell its own uemise. Bowevei, we
must not foiget that goveinment has no wealth of its own anu that it
can only suivive by taking wealth foim its own citizens. In a countiy
as iich as ouis, this squanueiing coulu go on foi some time.
Neveitheless, it is systematically taking place now. Bistoiically any
goveinment's ultimate uecline has usually been occasioneu by a
uisastious wai, but piioi to that event has been the continuous
uevaluation of its money, the inciease of uebt anu uiscouiaging
"##$##%&'!()$!*+%&!,-./0$1
%
49
taxation which ultimately uestioyeu the aspiiations, hopes anu self
esteem of its citizens. This is the ieal ciime, the ieal evil of it all. This
is the evil we shoulu not give into.

1
Frank Chodorov, The Rise & Fall of Society (Auburn, AL: The Ludwig von Mises
Institute, 2007), p. 153.
2
Chodorov, The Rise & Fall of Society, p. 8.
3
Murray Rothbard, The Case Against the Fed (Auburn, AL: The Ludwig von Mises
Institute, 1994), p. 3. Available at: http://mises.org/books/fed.pdf. Accessed June 2,
2010.
4
John Maynard Keynes, The Economic Consequences of the Peace (1919), pp. 235-
236. Available at: http://www.gutenberg.org/etext/15776. Accessed June 2, 2010.
5
Henry Hazlitt, Thinking as a Science (New York: E. P. Dutton & Co., 1920), p. 244.
Available at: http://mises.org/books/thinking.pdf. Accessed June 2, 2010.
6
Frederic Bastiat, The Law (Irvington-on-Hudson, NY: The Foundation for Economic
Education, 2004), p. 5.
7
James Madison, The Federalist No. 51 (1788). Available at:
http://www.constitution.org/fed/federa51.htm. Accessed June 2, 2010.
!""#""$%&'()#'*+$%',-./0#1'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!"#
#
S1
!"#$%&'()(
*+,-./(01'(2#3(

!"#$%&'#( )*$$+#,( *( -*$.( &/( ,&)+#.%( &'(
0+,(,0&123#$,4(5&(&'#(+,($#2+#"#3(&/(0+,(
,0*$#(&/($#,-&',+6+2+.%(6%(&.0#$,4(
78139+:("&'(;+,#,
<
(
!
!
conomic piinciples aie classical ieasoneu ueuuctions
maue by gieat thinkeis of the past as they obseiveu
man anu the woilu about him. They oiiginate fiom self-eviuent
tiuths. Self-eviuent tiuths aie those tiuths which aie theii own
eviuence. They aie not leaineu by iefeience to some othei tiuth.
Theie has been, howevei, a giowing assault on these establisheu
piemises ovei the last one hunuieu yeais, not only in this countiy,
but thioughout the woilu. This iejection of economic piinciples has
put oui civilization in gieat uangei. The neeu to tuin back to these
tiauitional stanuaius is gieatei now than it has evei been in the
histoiy of the woilu.

E
"#$%&'!()*!+,-!
==========================================================(
(
S2
45#'5-%3(.#/!671.8#.5&(

No othei economic piinciple uemonstiates the insightfulness
of a self-eviuent tiuth than the economic piinciple of ,)*$)+.%.
Nankinu lives in a woilu of scaicity not abunuance. Resouices, in all
places anu in all times, aie scaice. This is, anu always has been, a
fact of human existence heie on planet eaith. It is the piimaiy
ieason why we must all leain to be fiugal anu economize. In essence
we must $,01put something back fiom what we have piouuceu to
contenu with the unceitainty of the futuie.
Scaicity, howevei, can be a confusing concept foi people to
unueistanu in this uay anu time, especially heie in the 0niteu States.
Aftei all, look aiounuuo we not see abunuance eveiywheie. This
obvious fact is pointeu out to us on any given uay by simply walking
thiough any local supeimaiket. Eveiywheie we look, the shelves in
any aisle aie filleu to the biim with foou piouucts of eveiy type anu
uesciiption. Theie aie also fiuits anu vegetables pileu high on all the
counteis anu shopping bins. Neats, uaiiy piouucts, bieaus, the list
goes on anu on. Abunuance eveiywheie!
The same is tiue in shopping malls. Theie aie ietail shops
anu uepaitment stoies filleu with appaiel, footweai anu all types of
accessoiies foi men, women anu chiluien. Bunuieus, sometimes
thousanus, of uiffeient uesigneis anu manufactuieis have piouuceu
"#$%&'!()*!+,-!
==========================================================(
(
SS
these goous. Nost of them aie manufactuieu in uiffeient paits of
the woilu anu impoiteu heie especially foi oui consumption.
We also see cais eveiywheie, in paiking lots anu on the
ioaus. When we tiavel in oui own vehicles, going in any uiiection,
we can uiive by apaitment houses, conuominiums anu manicuieu
neighboihoous with beautiful homes. The high iises, office builuings
anu even skysciapeis make cleai what we see. It is not scaicity, but
iathei the opposite.abunuance!
What we aie seeing, howevei, is the -#$)#-.+&' of
abunuancean illusion of a soit. Yes, the items aie theie anu uo
exist, but we must go behinu these piouucts to see the unueniable
economic piinciple of scaicity of which we speak; foi if we weie to
$/#2 piouucing foi any length of time, all of this abunuance woulu
quickly uisappeai. What we finu behinu all of these piouucts, anu
the seivices associateu with them, is the piouuction that goes into
making them anu ieplacing them when they aie consumeu. 0nuei
closei inspection we uiscovei what ancient thinkeis anu economists
have always pointeu outthat human 9*'.,( aie enuless anu man
sets out to acquiie his wants, yet the >#*',( foi acquiiing them aie
themselves scaice. As Rothbaiu explains:

All human life must take place +'( .+>#..A man's .+># is always
scaice. Be is not immoital; his time on eaith is limiteu. Each uay
of his life has only 24 houis in which he can attain his enus.
Fuitheimoie, all actions must take place thiough time. Theiefoie
"#$%&'!()*!+,-!
==========================================================(
(
S4
time is a >#*', that man must use to aiiive at his enus..|Ajll
means aie scaice.
2

(
9"&(:&#.,(+;(<'+815%-+.(

The means of piouuction aie 2*'3?( 2*6&$( anu( )*-+.*2. Lanu
which incluues all natuial iesouices but also something as simple as
a place to stanuis scaice. The iesouices in the lanu, fiom the top
soil useu to giow foou piouucts to the oil oi golu we can extiact
fiom it, aie also scaice. We uo not neeu to be enviionmentalists to
iecognize this fact. But, suipiisingly, so is laboi. The scaicity of laboi
can be even moie uifficult to fathom than consumei goous,
especially in an economic enviionment wheie so many aie out of
woik anu we aie being bombaiueu with unemployment statistics
eveiyuay.
To see that laboi is scaice we neeu to look behinu the
statistics anu stuuy ouiselves as inuiviuuals. What we finu is that we
all have a gieat many moie things that neeu uoing oi those we want
to get uone, but we have neithei the time, eneigy, noi initiative to uo
them. Some of these tasks obviously iequiie mateiials, but all of
them iequiie laboi. If one meiely extiapolates this fact in one's
minu to extenu beyonu his own small woilu of activities, to the
activities of his city, his state, his nation, his woilu, one quickly
begins to see that the potential uemanu foi laboi is inueeu enuless.
"#$%&'!()*!+,-!
==========================================================(
(
SS
In the enu, this is piecisely why laboi is scaice. Even uuiing a seveie
iecession, it's not the case that people "have nothing to uo." Rathei,
what happens is that the potential job offeis aie consiueieu less
appealing than continueu job seaich. In this iespect, unemployment
is actually voluntaiy!((In latei sections we will see how goveinment
manipulation of money anu banking leaus to the familiai "boom-
bust" cycle anu thiows millions of Ameiicans into a position wheie
unemployment is theii best alteinative.)
Finally, theie is no gieat aigument neeueu to iealize that
capital is scaice. This is especially tiue if we aie thinking of capital
in teims of money anu cieuit. But actually, capital is the equipment
oi tools we use in piouuction. Capital goous aie what allow us to
piouuce even moie consumei goous, anu the piimaiy iequiiement
foi obtaining capital is ,*"+':,. When we iestiict oui consumption,
we save. When we tiansfei oui laboi anu oui lanu to the foimation
of capital goous, we aie +'"#,.+': in piouuction foi the futuie.
Savings, theiefoie, is an essential pait of a thiiving economy, even if
it is the economy of one peison. Again we quote fiom Rothbaiu:

In oiuei to illuminate cleaily the natuie of capital foimation anu
the position of capital in piouuction, let us stait with the
hypothetical example of Robinson Ciusoe stianueu on a ueseit
islanu. Robinson, on lanuing, we assume finus himself without
the aiu of capital goous of any kinu. All that is available is his own
laboi anu the elements of piouuction given him by natuie.
S

"#$%&'!()*!+,-!
==========================================================(
(
S6

<'-=#%&(<'+$&'%3(

"Piopeity is a necessaiy consequence of the natuie of man,"(
wiote the Fiench economist Fieueiic Bastiat, in the miuule of the
19
th
centuiy. This is like saying that owneiship of ouiselves anu oui
faculties is piimal, but then so aie all of the scaice natuial iesouices
we finu all aiounu us.
Economist Nuiiay Rothbaiu, in his gieat tieatise ;*'?(
!)&'&>%(*'3(@.*.#, makes cleai that

the oiigin of all piopeity is ultimately tiaceable to the appiopiiation of an
unuseu natuie-given factoi by a man anu his "mixing" his laboi with this
natuial factoi to piouuce a capital goou oi a consumeis' goou. Foi when
we tiace back thiough gifts anu thiough exchanges, we must ieach a man
anu an unowneu natuial iesouice. In a fiee society, any piece of natuie
that has nevei been useu is 1'&9'#3 anu is subject to a man's owneiship
thiough his fiist use oi mixing of his laboi with this iesouice.
4

Fuitheimoie, ueuuctive ieasoning tells us that without
owneiship of oui own piivate piopeity we woulu not be able to
exeicise the fiugal use of scaice iesouices to achieve as many enus
as possible. Even the ability to exchange oui piopeity in a maiket
place woulu be impossible, foi we must fiist own it outiight.
0ltimately, without piopeity owneiship theie woulu be no such
"#$%&'!()*!+,-!
==========================================================(
(
S7
thing as a maiket oi even an economy. Theiefoie, if we aie to have
an economy at all, owneiship oi contiol ovei piopeity by the
inuiviuual is impeiative.

>?-/"%(;'+@(A&#?-%3(
(
0vei the past one hunuieu yeais the emphasis in the
intellectual iealm of the geneial populace has been upon "change"
oi the "changing of things" iathei than upon the fixeu iegulaiities of
the univeise. This focus on change has hau the effect of unueicutting
the basis foi economic piinciples oi fixeu natuial laws. This
iejection of the metaphysical is a woilu view in which theie is no
oiuei except what man tempoiaiily ueciues to impose on things.
Piofessoi Claience B. Caison in his text, A*,+)( !)&'&>+),?
explains that much of this way of thinking was geneiateu by the
Romantic movement which gaineu stiength uuiing the Inuustiial
Revolution anu which stiesseu hainessing the powei of imagination
to escape the scientific iationalization of natuie. Also the wiitings of
Chailes Baiwin, which stiesseu that eveiything was unueigoing
change, weie tiemenuously influential. This tienu anu way of
thinking was an unfoitunate ieveisal of the tiuth because humans
aie anu always have been wholly uepenuent on theie being a
natuial oiuei to the univeise. We cannot act on any given uay
without these fixeu iegulaiities. They aie numeious anu all about
"#$%&'!()*!+,-!
==========================================================(
(
S8
us. The fact that A anu not-A cannot be simultaneously tiue, oi the
fact that 2 + 2 = 4, aie inheient in the way oui minus woik. 0thei
facts aie empiiical iegulaiities anu coulu conceivably be otheiwise,
yet they too pioviue us with a sense of an oiueily univeise. Foi
example, theie is the constant fact that the eaith iotates on its axis
ovei the couise of 24 houis each anu eveiy uay. Theie is the iising
anu setting of the sun. Theie aie the iegulai seasons, spiing,
summei, fall anu wintei which iecui yeai aftei yeai of the S6S plus
uays in each iecuiiing yeai. Animals anu plants go thiough cycles of
life, biith, giowth, matuiity, ueteiioiation anu ueath. These, anu
many moie examples like these, aie all aspects of oui ieality.
S

Theie aie thiee levels of ieality: the physical, metaphysical
anu the spiiitual. Caison, on the metaphysical says this:

It iefeis to the level of ieality between the spiiitual anu
the physical, that is at least an enuuiing iealm, that can be
ieacheu only by ieason, not by the senses, foi it cannot be seen,
felt, tasteu, smelleu, noi heaiu. It is the level of unueilying oi
natuial law, of that which gives foim anu oiuei to actual classes
of physical beings, the stiuctuial pait of ieality.
6

(((((((((((((((
Reason, that special faculty of man foi uealing with the
metaphysical, is how we aie able to unueistanu self-eviuent tiuths.
Bowevei, once this way of ieasoning is abanuoneu oi foigotten, we
aie left with no natuial laws oi piinciples anu, theiefoie, no
"#$%&'!()*!+,-!
==========================================================(
(
S9
economic science fiom which we can uiscovei the opeiations of
cause anu effect in economies. This is not to imply that economics
uoes not involve change, but that these changes occui within the
fiamewoik of fixities.
0ui nation's Founueis weie cognizant of this gieat ieality.
Theii knowleuge of these funuamental piinciples is eviuent in the
woiuing of oui Constitution. 0bseive, howevei, that in oui uay
seluom aie these tiuths evei uiscusseu in the places that mattei
most, such as oui homes, oui places of woiship anu places of
assembly. This stems piimaiily fiom the fact that they have nevei
been passeu uown to the next geneiation. 0ui chiluien anu
gianuchiluien aie not being taught these impoitant piinciples in
school. Consequently, it is not suipiising that we have manageu to
lose them oi that oui society is losing its way.
Bi. Paul Clevelanu, wiiting foi the B&1$'*2( &/( C$+"*.#(
!'.#$-$+,# in 1997, says:

Nuch of the failuie of the 0niteu States can be tiaceu
back to faulty expectations. That is, people have expecteu fai
moie fiom goveinment than can evei ieasonably be expecteu.
These expectations spieau with the piopagation of iomanticism
in the nineteenth centuiy. 0topian wiiteis became quite populai
anu influential. As a iesult, the iuea that a utopian society coulu
be achieveu became wiuely helu. Claience Caison iegaius people
pione to this vanity as those on a "flight fiom ieality."
"#$%&'!()*!+,-!
==========================================================(
(
6u
Neveitheless, having been captuieu by the notion that this is
possible, many people aie still tiying to legislate the way to
paiauise.
7

6(B#%1'#?(0'8&'(

Nen thioughout histoiy have lookeu upon the heavens anu
the eaith with awe anu wonuei. 0vei time, man has gaineu much
instiuction fiom them. Nen such as Keplei anu Newton, who gave
mathematical expiession to the motions of the heavenly bouies,
spuiieu men with new zeal to seek out the natuial laws in othei
aieas, incluuing the social anu the physical. In the late 17
th
anu 18
th

centuiies vaiious thinkeis began to uiscovei a natuial oiuei in
economics. Some thinkeis began to iealize that theie was a pattein
oi ihythm in maiket affaiis, that acteu inuepenuent anu often in
contiauiction of the uesiies of political iuleis. Auam Smith famously
gave expiession to this concept in 1776 in his book, D#*2.0( &/(
5*.+&',. In a famous passage, Smith explaineu that in the maiket
economy theie is a natuial haimony between a piouucei's self-
inteiest anu the well-being of society:

|The piouuceij geneially, inueeu, neithei intenus to piomote the
public inteiest, noi knows how much he is piomoting it. By
piefeiiing the suppoit of uomestic to that of foieign inuustiy, he
intenus only his own secuiity; anu by uiiecting that inuustiy in
"#$%&'!()*!+,-!
==========================================================(
(
61
such a mannei as its piouuce may be of the gieatest value, he
intenus only his own gain, anu he is in this, as in many othei
cases, leu by an invisible hanu to piomote an enu which was not
pait of his intention.
8

(
0ne veiy impoitant factoi which must be emphasizeu is that
the natuial oiuei foi an economy uoes not lenu itself to piecise
mathematical foimulations anu any attempts to uo so will fail. The
ieason foi this is because, unlike the heavenly bouies which aie
composeu of minuless mattei, economies woik thiough human
action involving countless uecisions anu choices of inuiviuuals. The
same thing can be saiu of othei aieas of social activity such as ethics.
It can also be saiu that economics uiffeis fiom the physical
sciences, such as chemistiy oi physics, in that economics contains
within it the element of man's 3$145%$6! %&/1*1$/78 This impoitant
uiffeience necessaiily takes in the stuuy of man's human natuie, the
enviionment in which humans act anu the ielationship between the
two. Foi this ieason, economics cannot be solely unueistoou within
the fiamewoik of mathematical foimulas, equations oi statistics.
Insteau, by using "ueuuctive" ieasoning the economist moves fiom
an alieauy establisheu position to one which follows logically fiom
it, but is not otheiwise known. Be uses "inuuctive" ieasoning when
something is uiscoveieu oi pioven by numeious instances.
0f supieme impoitance is the iuea of inuiviuual fieeuom in
economic activities. The concept of a natuial oiuei in economics
"#$%&'!()*!+,-!
==========================================================(
(
62
ieinfoices this iuea. Foi example, if the puisuit of self-inteiest
iesults in the economic well being of the inuiviuual anu society at
laige, then it stanus to ieason that the inuiviuual ought to be fiee to
puisue just that. Anu again, if theie is a natuial oiuei to the
economy, then it also stanus to ieason that it is not auvantageous foi
goveinment to continually inteivene in the economy.

C=+?1%-+.#'3(4+5-#?-,@(
(
The uisiegaiu foi the self-eviuent tiuths founu in economic
piinciples has hau a uiamatic effect on oui countiy's political
agenua. The public's geneial unueistanuing of the piopei iole of
goveinment has changeu fiom an institution that maintains the
peace, piotects piivate piopeity anu punishes offenueis, to that of
being the pioviuei anu uistiibutoi of goous anu seivices. In oiuei to
accomplish this, goveinment now sepaiates the fiuits of laboi fiom
the piouuceis. The savings anu the means of savings have been
taken away. uoveinment has also taken ovei the iesponsibility of
looking aftei the well being of people anu the people, having hau
theii inuepenuence eioueu, have yielueu up theii iesponsibility to
look aftei themselves. In this type of system politicians aie voteu
into office by piomises of a bettei uistiibution of wealth anu favois.
Theii special inteiest gioups aie iewaiueu accoiuingly.
"#$%&'!()*!+,-!
==========================================================(
(
6S
9"-,( -,( ,+5-#?-,@( #%( -%,( '++%,D 0f couise we woulu not
openly call it that heie in the 0niteu States. Socialism is unspoken
piincipally because it woulu be categoiically uefeateu at the polls,
but the type of system we now have cannot be calleu by any othei
name. To this, Piofessoi Clevelanu auus the following summation:

The imposition of welfaie polices in a nation is best unueistoou
in the context of socialism. In this countiy it woulu be the
evolutionaiy foim of socialism. That is, in an effoit to eliminate
piopeity iights, socialists begin by pioposing giauual policies of
change. The implementation of welfaie piogiams seives as a
useful beginning foi they unueimine piopeity iights. These
policies veil the foice of goveinment behinu the mask of
benevolence even though the thiust of them is the giauual
eiosion of piopeity iights anu the uevelopment of socialism.
0ften the pioposals aie willingly accepteu because theii stateu
enu is to alleviate the suffeiing of the pooi.
9

(
At its coie, Social Secuiity is the classic example of a
ieuistiibutionist plan, but it is only one of many welfaie piogiams in
the 0niteu States that have been in existence foi uecaues. These
welfaie piogiams exist not only heie at home, but also abioau. The
cost to pay foi all of them is astionomical! 9"&( /+=&'.@&.%E,(
;1'%"&'( -.%'1,-+.,( -.%+( +1'( "&#?%"( 5#'&( F-??( $+,&( #.(
&G%'#+'8-.#'3( 8'#-.( +.( ;&8&'#?( 5+;;&',( +=&'( %"&( .&G%( ;&F(
8&5#8&,H((
"#$%&'!()*!+,-!
==========================================================(
(
64
Nost mouein westein countiies have leaineu to leave
piopeity in piivate hanus in oiuei to fostei welfaie piogiams iathei
than to take complete contiol ovei all of it. Aftei the failuie of
socialism in Englanu anu the collapse of the 0.S.S.R., most
evolutionaiy socialists weie convinceu that goveinment owneiship
of the means of piouuction was neithei politically auvantageous noi
necessaiy. They coulu still plan the economy thiough goveinment
iegulation, taxation, monetaiy expansion anu cieuit manipulation.
This is exactly what all westein countiies have uone anu is the
situation heie in the 0niteu States.
The consequences of socialist tienus in policy making affect
so much moie than the economy, ceitainly oui money has been
uebaucheu, but it is the moial anu ethical ueteiioiation that has huit
us the most. Anu yet, as uiscusseu eailiei, the iuea behinu it all is
false anu cannot possibly go on foievei. It is a false notion that theie
aie suipluses of goous anu that society is maue up of abunuance.
Economic science cleaily teaches the opposite! We have wanueieu
fai fiom the tiuth. Reuistiibution only woiks so long as theie is
something to uistiibutea lot to uistiibute!
We enu with a quote fiom Nises:

An essential point in the social philosophy of
inteiventionism is the existence of an inexhaustible funu which
can be squeezeu foievei. The whole uoctiine of inteiventionism
"#$%&'!()*!+,-!
==========================================================(
(
6S
collapses when this fountain is uiaineu off. The Santa Claus
piinciple liquiuates itself.
1u
(
(

1
Ludwig von Mises, Human Action (Auburn, AL: The Ludwig von Mises Institute,
1998).
2
Murray Rothbard, Man, Economy, and State (Auburn, AL: The Ludwig von Mises
Institute, 2004), pp. 4-5, some emphasis removed.
3
Rothbard, Man, Economy, and State, p. 47.
4
5
Clarence B. Carson, Basic Economics (Phenix City, AL: American Textbook
Committee, 2003), p. 23.
6
Carson, Basic Economics, p. 21.
7
Paul Cleveland, Government: The Good, the Bad, and the Ugly, The Journal of
Private Enterprise, 1997, pp. 81-99.
8
Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations (1776),
Book IV, Chapter 2.
9
Cleveland, Government: The Good, the Bad, and the Ugly.
10
Mises, Human Action, p. 854.
!"#$%&'()*'+,-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!!"
"
67
Chapter 4!
Losing Our Spirit

The most efficient organization in the
world is not any group of people but a
single person. A normal person can
conceive a plan, figure out how to carry
it out, and communicate the orders to
do the task to his faculties instantly,
with minimum likelihood they will be
misinterpreted Moreover, an
individual who owns his own material,
has put up the investment for an
undertaking, and stands to gain
whatever profits arise from the
enterprise, must have the greatest
incentive to do the job well.
Clarence B. Carson
1

n a countiy such as ouis, with some Suu million
inhabitants, it is impoitant to iealize that not all people
piouuce uuiing theii entiie lifetime. Foi example, infants ceitainly
uo not piouuce. The elueily oi otheiwise incapacitateu, uo not
I
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
68
piouuce. We can say that the unemployeu, while they iemain
unemployeu, aie not piouuceis. Anu then theie is that laige
segment of society which uepenus entiiely on goveinment suppoit.
These people aie obviously not piouuceis eithei. But, although we
aie all not piouuceis, we aie all #$%&'()*&. No one knows this bettei
than the )%+*),*)%)'*.
Entiepieneuis aie those unique inuiviuuals who aie
constantly assessing human -.%+& anu foimulating iueas to meet
those wants. They pay special attention to the most uigent wants
anu ueteimine the best means anu uses of scaice iesouices to
satisfy them. They aie unique people in that theii unusual
peisonality, theii cieativity, theii use of imagination is not leaineu
noi can it be taught, but is iathei inheiently possesseu anu
cultivateu. Theii juugment of the facts of an unceitain futuie is a cut
above the iest of society. They act on theii stiong opinions of what
#$'/0" 1), many times against gieat ouus anu iisk! They aie always
on the aleit foi a means of making ,*$23+ in aieas wheie they can
eain moie than the going iate of 3%+)*)&+4 0ui woilu's supeiioi
stanuaiu of living is a uiiect iesult of what these entiepieneuis have
set in motion. These men anu women aie the tiue stimulus to an
economy. In fact, they aie the economy's .$/0'1.""2.
The term entrepreneur is derived from the French word which
means a person who organizes and manages a business undertaking,
assuming the risk for the sake of profit. More specifically, his role is
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
69
that of the individual who brings together the various means of
production to their final useful end. In essence he takes the elements of
production which are land, labor and capital and mixes them in such a
way that a product or service results. The entrepreneur can be a great
industrialist or he can be a farmer operating on a parcel of land.
One thing is certain: producing a product or service is not for the
faint of heart. The endeavor is filled with uncertainty, beginning first
with the simple fact that the product or service may not sell! The idea of
having to gauge wants and needs from infinite human desires is all
calculated guess work! The quantities, categories, styles, size, weight
an endless variety of considerations like these, can easily be
overestimated. Plus, undertaking production may be on borrowed money
or credit and interest rates may rise. What about competition? All of
these factors are uncertainties. Obviously, one prominent characteristic
of the entrepreneur is that of risk taker. Without question he is an
individual who operates one step away from total failure, a lifestyle not
for everyone in society. To the outsider the entrepreneur appears to be a
person of great independence with power to wield in an organization. In
reality the entrepreneur is at all times keenly aware of the perilous risks
he must take in making his decisions. As Rothbard explains:

The entrepreneur is not creating uncertainties for the fun of it. On the
contrary, he tries to reduce them as much as possible. The
uncertainties he confronts are already inherent in the market
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
7u
situation, indeed in the nature of human action; someone must deal
with them, and he is the most skilled or willing candidate.
2

'''''''''''''''''''''''''''''''''''''''''''''''''"
The Market

The entrepreneurs arena is the market place. Anywhere two or
more people meet to engage in buying and selling is a market.
Economists refer to the market as a concept, knowing that markets
exist everywhere in great varieties and numbers, with things common to
all. The varieties and kinds of products and services in a nation such as
ours are complex and extensive. It boggles the mind to gauge the
demand for such products and services against existing or non-existing
supplies.
And what about setting prices for all these goods and services?
Who or what determines price? Certainly, the cost of production will
play an important role in pricing, but since people acting in the market
tend to buy the highest quality goods at the lowest prices possible, cost
of production is always subordinated to supply and demand. In effect,
cost of production is irrelevant to the buyer.
Another factor to consider, is that all markets will invariably
have competition. A successful product or service will quickly have
many imitators. Competitors can run away with much needed sales! This
phenomenon is most clearly seen in fads, trends, and styles that can
create windfall profits for some producers while completely destroying
others. An entrepreneur enters this arena and carefully calculates the
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
71
pros and cons of his planned innovation. It is the action he takes that
starts the whole ball rolling. It is a most courageous undertaking. The
environment is filled with uncertainty. Yet, this is what he does and
society reaps the rewards.
All things being equal, the unhampered market has always been
seen by classical theorists as a mighty and efficient instrument of social
order. For example: with regards to prices, the market itself eventually
dictates the going price because a price in a free market is the amount
a willing seller will take and willing buyer will pay. In other words,
prices are arrived at by agreement between buyer and seller. Even the
simplest purchase involves an unspoken agreement. This market price is
the result of the interplay of a changing supply and demand because
these elements are dynamic. Nothing in the free market stands still for
long. And as far as competition goes, it and it alone is the stimulant to
market efficiency, both in price and quality. Competition keeps
producers from charging exorbitant prices. It is actually the friend of the
consumer. Therefore, in what can only be explained as a true marvel, the
free and unhampered market operates like an invisible hand, as Adam
Smith described it, or in Rothbards description:

[T]he free marketcreates a delicate and even awe-inspiring
mechanism of harmony, adjustment, and precision in allocating
productive resources, deciding upon prices, and gently but swiftly
guiding the economic system toward the greatest possible
satisfaction of the desires of all the consumers.
3

!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
72
"#$%&'()*+(&*)"
"
Every entrepreneur invests in a process of production because he
expects to make a profit; however, it is an error to think of the economy
in which he operates as being made up of only profits. In reality it is a
profit and loss economy. A loss occurs when an entrepreneur has made
poor judgments in estimating his future prices and sales. He understands
that a free market rewards its efficient entrepreneurs and penalizes its
inefficient ones. His goal is to be efficient; however, his biggest problem
is that profit and losses are intertwined with the going interest returns. It
is this rate of interest, especially when artificially manipulated, which
ultimately creates the greatest threat to his success. This process of
artificial manipulation is hidden. He does not see it coming. In effect he
is tricked! The results, of course, are always disastrousbusiness losses,
business failure or bankruptcy. For society at large the results are
massive unemployment, recessions, depressions and the dangerous
possibility of a complete collapse of the monetary system. As Austrian
economist Hans Sennholz writes:

Inflation and credit expansion always precipitates business
maladjustments and malinvestments that must later be liquidated.
The expansion artificially reduces and thus falsifies interest rates,
and thereby misguides businessmen in their investment decisions. In
the belief that declining rates indicate growing supplies of capital
savings, they embark upon new production projects. The creation of
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
7S
money gives rise to an economic boom. It causes prices to rise,
especially prices of capital goods used for business expansion. But
these prices constitute business costs. They soar until business is no
longer profitable, at which time the decline begins. In order to
prolong the boom, the monetary authorities may continue to inject
new money until finally frightened by the prospects of a runaway
inflation. The boom that was built on the quicksand of inflation then
comes to a sudden end.
4

"
,#-%*#$!./0+#*%/&!

It is difficult for entrepreneurs to put enough money aside to
invest in even a small business enterprise. In this century, entrepreneurs
have learned to organize in order to raise enough money to go into
business. Aside from borrowing, the most common way is partnering
with others who have saved money to put up for capital. However, the
greatest limitation to partnerships is that there is no shield against
creditors in case of business failure. The individual partners can be held
individually liable for all debts of the partnership. Consequently,
partnerships are most often very small enterprises. In fact most
businesses in the United States are small: The latest figures from the
U.S. Census Bureau list 25,409,525 businesses in the United States, of
which only 5,885,784 have one or more employees. All the others do not
report a payroll.
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
74
The most wiuely useu methou foi iaising money foi a
business is the #$*,$*.+3$%4 A coipoiation is an inuepenuent entity
cieateu by inuiviuualsan agieement iecognizeu by law.
Inteiestingly, coipoiations at one time weie instiuments of the
King. It was not until the miu 19
th
centuiy that coipoiations weie
fiist useu foi means of iaising capital. Initially, howevei,
coipoiations weie solely a piivilege of poweiful families oi
politically connecteu inuiviuuals.
Touay, the selling of stock foi puiposes of iaising capital is
commonplace. The coipoiation's gieatest attiaction is the opposite
of the paitneiship. The liability of the coipoiation's investois is
/3(3+)0 to the extent of the amount investeu. In othei woius, if the
coipoiation shoulu go bankiupt, the investois can just walk away
without any haim to theii ieputation oi peisonal pocketbook. A
stockholuei, if he is not an officei oi uiiectoi, may not even neeu to
concein himself with the business enteipiise oi its piouuction. Foi
this ieason many investois can anu uo own shaies of stock in
coipoiations.
We shoulu point out that because of the mannei in which
stock shaies aie owneu, theie is an oveily concentiateu emphasis
on piofitabilitythe "bottom line"above anything else. To the
stockholuei the uiviuenu pei shaie anu the piice each shaie will
biing in the maiket aie the main conceins. This fact is pioven
iepeateuly in the stock maiket.
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
7S
In auuition to selling stock shaies, coipoiations can also iaise
money thiough the issuance of uebt instiuments, such as bonus oi
uebentuies. These types of secuiities, as well as the shaies of stock,
can be tiansfeiieu at will.
0f piime impoitance to this uiscussion is the enoimous
giowth in the buying anu selling activity of these secuiities since the
coipoiation has become the uominant foice foi iaising money. In
mouein economies this activity has become one of the laigest foims
of concentiateu funus. Two othei foims of concentiateu funus aie
banks anu insuiance companies. Banks aie uepositoiies foi money
anu aie geneially unueistoou to be lenuing institutions, but theii
financial activities extenu beyonu these simple limits. A closei look
at banks anu how they opeiate will be examineu moie caiefully in
the next chaptei. What is impoitant to note heie is that banks aie
themselves coipoiations.
Insuiance companies may also be coipoiations, some aie
piivately owneu, some owneu by a laige numbei of stockholueis.
Nutual insuiance companies aie exclusively owneu by the policy
holueis. The point is that insuiance companies, like banks, take in
enoimous amounts of money. This money comes in the foim of
piemium payments. A poition of this money is not expecteu to be
paiu to beneficiaiies foi many yeais, theiefoie, the money is kept
investeu in shoit anu long teim investments. Consequently,
insuiance companies, like othei laige coipoiations, aie a majoi
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
76
souice of capital. We will also exploie insuiance companies in moie
uetail latei. But we begin to get a pictuie of the vastness anu
complexity of oui capitalistic system, the flow of money anu wheie
its aieas of concentiation can be founu.

12(!3*/45!"#05(*!

There is a strange phenomenon with regards to corporations,
securities and the stock market which merits discussion here: Americans
hold a belief that the stock market is the driving force behind
corporations and American industry. Many believe declining stock
prices on the New York Stock Exchange or NASDAQ and other
exchanges signifies that the entire national economy is declining, and
that rising stock prices indicate that prosperity is ahead. This is indeed a
strange reaction to the stock market. Most Americans do not feel that
way about other products and services when they go up or down in
price. Why should stocks be any different? Clearly it is the manner the
stock market news is reported by the media, however, the major culprit
is misinformation about the stock market and how it functions.
The New York Stock Exchange, the NASDAQ and the several
other stock exchanges in the United Sates, including those abroad, are
just that, exchanges. As Professor Carson notes, the entrepreneur would
more properly refer to it as the used stock market because that is all that
is offered for sale, used stock! New stock issues that are sold in return
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
77
for money are not offered on these types of exchanges. Actual wealth or
capital is transferred to the corporation at the time of the initial public
offering of the stock, or IPO. This is a one-time event. It represents the
true stock market for the corporation, occurring whenever IPOs are
offered to the public for sale. Some financial firms specialize in these
special securities, but the point here is that the stock exchanges, as in the
New York Stock Exchange or the NASDAQ, for all the daily trading
they do, provide no capital whatsoever for American industry.
Also, individuals who buy and sell stocks are frequently referred
to as investors. This too, can be confusing. We must not forget that
these individuals are only buying and trading shares. Although they may
be purchasing a return in dividends, their real motivation to buy a stock
is for the opportunity to sell at a profit when prices rise. In effect, they
are really speculators. They are primarily focusing on the exchange
value of the commodity. This is why purchasers of stocks only want bull
markets. On the stock exchanges, speculation is rewarded by the rising
price of a stock. When prices fall, all those who bet on the increase will
lose. It is this anticipatory element that defines speculation.
For example: On the famous Black Monday, October 19,
1987, the stock market was shocked by the loss of $500 billion in one
day. In reality this colossal amount of wealth simply vanished into thin
air because it existed only in the quoted price of the stocks on the stock
exchange. Factories and computers didnt disappear on Black Monday;
doctors and engineers didnt forget their skills. All that happened on
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
78
Black Monday was that the prices of many corporations shares of stock
plummeted.
Do not misunderstand; stock speculators do serve a social
purpose. By selling (or shorting) overvalued shares and buying
undervalued ones, speculators help correct mispriced stocks. It is
important for stocks to have the right market price, because the
stockholders are the actual owners of the corporation and are ultimately
responsible for its fate. With accurate share prices, these owners
understand just how socially valuable their property is, and will have the
incentive to exercise the appropriate amount of oversight.
5

However, important as stock speculation is, it is not an activity
for the average household, and certainly should not be confused with
old-fashioned saving. The typical American has been conditioned to
believe that investing in the stock market is the same thing as saving
for retirement. Americans have been lulled into a false sense of
security, in which investing in tech stocks is admittedly classified as
speculative and risky, while investing in the whole S&P 500 is
considered the epitome of caution. But even people with a diversified
portfolio can lose 40 percent in a single year, as recent events have
shown!
Additionally, we are pointing to the fact that stock trading can be
a highly emotionally charged activity. False signals are frequently sent
into the economy by either overvaluing or undervaluing particular
stocks. Naturally, when prices start to rise, trading tends to become
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
79
irrational. Predictably, people panic when prices fall. Much of the
liquidity crisis created during the Crash of 1929 was that the irrational
thinking created by skyrocketing prices made a lot of stock speculators
borrow on credit (margin), or from other lenders, in order to buy stocks.
Buying stocks on credit has the potential to achieve greater gains,
however, as prices plummeted, speculators who did not get out in time
scrambled for cash to meet their obligations. Of course the cash was
nowhere to be found and huge losses were incurred by many.
A similar situation occurred during the recent inflation of prices
in the housing market. Many borrowed from their home equity on home
prices that were overinflated in order to buy even more real estate. Great
losses were suffered by those who did not flip those purchases fast
enough before market prices on homes crashed.
Erratic movement in the stock market is prompted by other
outside forces which we know to be artificial bubbles in the economy,
caused by monetary policy. Austrian economists refer to them as boom
and bust business cycles. Nevertheless, one still wonders why people
speculate on stocks? What is the attraction? While it is true that some
professional traders have the ability to profit on prices going up or down
and can exit the market quickly, not everyone has this advantage.
Furthermore, it is still speculation. No one can predict with accuracy
each and every time. Many have discovered too late that speculation in
stocks can be an extremely risky endeavor especially if ones entire
lifes savings are vested in it.
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
8u
Unfortunately this has become a large problem for many middle
class Americans. Huge losses have been suffered by individuals who
unknowingly were driven into the stock market via their employment
benefits, disguised as their retirement savings. These good people, who
for the most part are living from paycheck to paycheck, are taking great
risks with what they believe is their retirement savings. Individual
retirement accounts, the 401(k), 403(b), and other government
sponsored programs, all have their underlying assets invested in the
stock market mostly through mutual funds. Furthermore, these allocated
funds are virtually untouchable till age 59! unless one is willing to
incur a 10% penalty, plus pay the federal income tax which has only
been deferred.
All this has presented an unpleasant dilemma for Americans and
their dreams for retirement. To put this in perspective, we should not
overlook the fact that the median income for a working couple in the
United States is only $47,500! That means that half of this nations
working couples make less than this! Only 2% of the entire nations
population makes an income larger than $355,000. This means that the
margin for financial planning error for virtually 98% of Americans is nil.
Any type of financial setback or losses in the market or anywhere else
for that matter can be financially catastrophic. Somehow the definition
of real savings has been obscured.
There is absolutely no way to retire from work without first
having stockpiled a substantial amount of real savings. For an average
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
81
annual retirement income of $60,000 to $100,000, this means a stockpile
of several million inflation-plagued dollars! It simply cannot be done by
the average citizen in todays economic environment. As it now stands,
most Americans live day to day buried in a mountain of debt and with an
ever rising cost of living. Most of that cost is taxes, not only direct taxes,
but indirect taxes caused by inflation. Americans know they need to
save and want to save, they simply cannot. Unless they can become fully
informed of the real source of their money problem, they will not be able
to solve this dilemma. Mises explains:

Everything that is done by a government against the
purchasing power of the monetary unit is, under present conditions,
done against the middle classes and the working classes of the
population. Only these people dont know it. And this is the
tragedy.
These people can only provide for their old age practically
by either entering into labor contracts that give them a pension for
their later age, or they can save a part of their income and invest it in
such a way that they can use in later years. These investments can
either be either simple savings deposits with banks, or they can be
life insurance policies or bonds...
6

There is a different position to consider when analyzing the middle class
employee to that of the business owner. Mises clarifies this distinction:

The man who owns an agricultural estate, the producer of
oil or foods, or the businessman who owns a factory is in a different
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
82
position. When the prices of the products that he is selling go up on
account of the inflation, he will not be hurt in the same way in which
other people are hurt by the inflation. The owner of common stock
will see that, by and large, most of this common stock is going up in
price to the same degree as the prices of commodities are going up
on account of the inflation.
But it is different for people with fixed incomes. The man,
who retired 25 years ago with a yearly pension, let us say of $3,000,
was by and large in a good situation or was believed to be in a good
situation. But this was at a time when prices were much lower than
they are today.
What I want to point out is that the greatest problem today
is precisely this, although the people dont realize it. The danger is
due to the fact that people consider inflation as something that hurts
other people. They realize very well that they too have to suffer
because the prices of the commodities they are buying go up
continually, but they dont realize fully that the greatest danger for
them is precisely the progress of inflation and the effect it will have
on the value of their savings.
We should not forget that over and above the
consequences of destroying a countrys monetary standard, there is
the danger that depriving the masses of their savings will make them
desperate.
7

!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
8S

In addition to this problem, is the fact that life has a way of
completely derailing the best and most disciplined savings plan. For
example, the fear of losing ones employment is a constant threat to
individuals these days, particularly during recessionary times. An
accident or illness that incapacitates the breadwinner for extended
periods of time can deplete savings and limit income. Since statistics
show that Americans can continue to pay living expenses for no more
than three months without income, bankruptcy is many times inevitable
under any one of these circumstances. The same is true in the case of
divorce or other form of lawsuit. What about the untimely death of the
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
84
bread winner? Yes, life, as we all know, is fragile and filled with
uncertainties. When these life events are coupled with severe money
problems, is there any wonder why Americans are forced to turn to the
government as the ultimate care giver?

Finally, the current housing crisis has added insult to injury. The
American home, one of the most sought after dreams and storehouse of
savings for all Americans, has been completely undermined. Americans
are reaching levels of complete exasperation, a sense of total defeat and
hopelessness.
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
8S
!
678)(!/9!*2(!,%*%:(&!

0nfoitunately, touay we aie living in a woilu of incieasing
economic illiteiacy, incieasing visible poveity anu incieasing visible
excess. The iich uo seem to be getting iichei, the pooi even pooiei.
Consequently, theie is a lot being saiu about 5*))04" It seems we
cannot entei into conveisation, pick up any soit of publication,
watch the news on television, oi check oui e-mails without the
mention of this one human chaiactei uefect anu its influence on oui
cuiient woilu ciisis. What actually lies behinu all of this iampant
coiiuption paiticulaily on the pait of the financial elite.
To appioach this question coiiectly, it's impoitant to note
that man has been oppiesseu by those who govein foi most of
histoiy. Slaveiy anu peasantiy have been the noim. Piofessoi
Claience Caison points out in his economic text that

the vast wealth of Louis XIv was mostly wiung fiom the pooi
peasants anu squanueieu on his piojects anu
mistiesses..|Bjaiuship anu suffeiing have been the common lot
of most men thioughout the ages. Bouis of woik have been long
anu often uniemitting foi |most peoplej thioughout histoiy. The
uispaiities between the wealthy anu the pooi have always been
veiy gieat.
8

!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
86
Also, we must not foiget that while man is ceitainly capable
of ieason anu can uo so much goou foi society, theie is anothei siue
to man's natuie that is uaik anu bent on his own uestiuction. Nan
pieys upon his kinu. Be commits all soits of ciime. Be can be
aggiessive anu uestiuctive. Be may cheat, tiespass, steal, anu
conspiie with otheis to uo gieat haim. Nan is also saiu to love
powei ovei otheis anu, if he attains it, may exeicise it in uictatoiial
fashion.
Foi this ieason man sets up the institution of goveinment not
only to piotect piivate piopeity, but in oiuei to piotect man fiom
man. When goveinment is acting in its piopei iole it allows
economic activity to take place. Since all economic activity involves
eithei the piouuction oi tiansfei of piopeity, goveinment shoulu
step in when piivate piopeity is tiespasseu upon, stolen, abuseu, oi
uestioyeu. It is neeueu to hanule uisputes, enfoice contiacts anu
othei similai uuties of piivate piopeity piotection, but what
happens when goveinment tuins on its people in the mannei we see
happening touay.
The funuamental pioblem with goveinment is that it is
monopolistic by natuie. The powei it has in its use of legal foice
makes keeping goveinment stiictly limiteu impossible. Excessive
tampeiing with money anu the maiket began uuiing Woilu Wai I,
anu incieaseu substantially uuiing the Roosevelt "New Beal" yeais.
0nce this happeneu all constiaints weie iemoveu. Touay money
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
87
inflation anu ueficit spenuing is uone with such impunity that the
national uebt has ieacheu staggeiing piopoitions! The affinity that
exists between powei anu wealth, a most feaiful combination, has
been unleasheu in the most impoveiishing way on oui society. The
iecent bank bailouts anu the nationalizing of much of Ameiican
inuustiy has eniicheu the politically connecteu at the expense of
eveiyone else, anu has only auueu to the common man's abuse. The
Ameiican citizen has been left viitually impiisoneu. Bis spiiit has
been ueeply wounueu anu many aie feeling they have ieacheu the
point of no ietuin.
!
12(!3/$8*%/&!
!
What if theie was a solution to this mauness. Woulu you
hesitate one minute in wanting to know what it is. 0f couise not! No
one woulu. This pioblem is so peivasive in natuie that a solution
also seems impossible anu yet, theie is a solution. It's calleu the
67$'%0" 8$%)9" 7$/'+3$%4: It is not new. It's actually been aiounu foi
centuiies. Austiian economists spoke anu wiote about it. What is
amazing is that a ievolution oi upiising is not iequiieu in oiuei to
change the insanity of the woilu aiounu us. It can be implementeu
iegaiuless of what goveinment anu the politically connecteu aie
uoing iight now. Theie is no neeu to picket the stieets, holu huge
iallies, oi stoim Washington uemanuing changes. Not a single shot
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
88
neeus to be fiieu. This solution's only iequiiement is the action of a
single peison acting in a mannei to help only himself, but in so
acting ultimately he helps all of society. It is the most natuial anu
innocent action a human being can uo, anu yet the iuea is so
poweiful that as it spieaus fiom one inuiviuual to anothei, a
massive movement silently uevelops anu gains velocity. 0nce it
spieaus to the masses, nothing will be able to pievail against it!
uoveinment anu uestiuctive monetaiy policy will be foiceu to
change. Bistoiy will be iecoiueu uiffeiently.
The Sounu Noney Solution's key action is in 6;*3<.+3=)0"
>.%?3%54:" Bow it specifically woiks will be explaineu in gieatei
uetail in Paits II anu III of this book. This authoi stiongly
aumonishes the ieauei not to jump aheau to examine those sections
until he has a fiim giasp of the quanuaiy that is being explaineu in
this section. In paiticulai he must unueistanu money anu banking
fiom the points of view being explaineu heie. This iequest is not
intenueu to intimiuate noi slow uown the ieauei, but iathei to uige
him to follow these instiuctions foi his ultimate benefit. The ieauei
will quickly iealize that most of the explanations in the next foui
chapteis aie easy to unueistanu with the use of a bit of puie
common sense. Bowevei, without this unueistanuing, the Sounu
Noney Solution cannot be fully giaspeu. Neeuless to say, olu iueas
anu incoiiect peiceptions will neeu to be set asiue. The ieauei will
neeu to auopt a completely new paiauigm. A thoiough examination
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
89
of the iemaining chapteis of this section will allow foi the necessaiy
shift in thinking iequiieu anu the ieauei will expeiience the full
impact of Paits II anu III. The motivation to act in the mannei
piesciibeu will be natuial.

1
Clarence B. Carson, Basic Economics (Phenix City, AL: American Textbook
Committee, 2003), p. 185.
2
Murray Rothbard, Man, Economy, and State (Auburn, AL: The Ludwig von Mises
3
4
Hans Sennholz, The Great Depression, reprinted from a Freeman article from
October 1969, posted June 24, 2009 at: http://mises.org/daily/3515. Accessed June 3,
2010.
5
See Robert P. Murphys The Social Function of Stock Speculators, November 22,
2006, at: http://mises.org/daily/2381. Accessed June 2, 2010.
6
Ludwig von Mises, Inflation Destroys Savings, excerpted from a speech given circa
1960s, posted May 18, 2010 at: http://mises.org/daily/4408. Accessed June 3, 2010.
7
Mises, Inflation Destroys Savings.
8
Carson, Basic Economics, p. 263.
!"#$%&'()*'+,$*$-'
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!
"#!
!
91
Chapter 5
Money

Money is such a routine part of everyday
living that its existence and acceptance
ordinarily are taken for granted. A user
may sense that money must come into
being either automatically as a result of
economic activity or as an outgrowth of
some government operation. But just
how this happens all too often remains a
mystery.
Federal Reserve Bank of Chicago
1

t is an eiioi to think that eveiybouy in society tiuly
unueistanus money, how it oiiginates, how it functions, oi
even the concept that it is simply a meuium of exchange. When we
take the time to seiiously consiuei the subject of money anu ask
ouiselves the same kinu of questions the young chilu askeu in the
opening chaptei of this book, we come full ciicle to iealize that
money is the common uenominatoi of viitually eveiything on this
planet. viitually eveiything is expiesseu within the teims of this one
system. Nost, if not all, of oui ielationships with othei entities anu
I
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
92
othei humans involve money. Even time is expiesseu in teims of
money. If the goal of this text is to help biing claiity to all of the
hiuuen aspects of the money pioblem, then we must stait with the
moie basic facts about money anu move along a uelibeiate line of
thought that eventually auuiesses oui concein. The iuea is to make
suie we infoim eveiyone, because eveiyone's full unueistanuing is
impoitant to oui cause.
A goou place to begin oui basic stuuy of money is by
physically examining it. It is tiue that in oui cuiient times money in
one sense has become invisible. 0ften moving electionically at the
speeu of light it uoes not even posses a physical bouy. Typically it is
most often seen as numbeis on a leugei on some account balance,
youi account oi theiis. Neveitheless, all foims of oui cuiient money
must conveit back to oui papei cuiiency anu coins. An economist
woulu iefei to oui money as #$%& money, electionic oi otheiwise.
0ui fiist queiy will be, "Why fiat money."

!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
9S

Fiist of all, the woiu #$%& is uefineu as a "'()*%+%&$,-" ./"
012+(3(" *%4" ,+" %" #,+3%*" %1&5,+$6%&$,-7" %" ),33%-'89" By fiat, the
supieme law of this lanu has ueclaieu this papei note to be *(:%*"
&(-'(+" #,+" %**" '(.&0" 21.*$)" %-'" 2+$;%&(8 Stuuy the small piint at the
top left hanu coinei of this familiai piece of gieen papei. Simply put,
this is officially oui meuium of exchange, the only money we can
use2(+$,'! We may use a check, online banking oi even cieuit
caius to pay foi things, but ultimately all payment tiansactions aie
uenominateu in iefeience to these papei uollais. To claiify fuithei,
if a cieuitoi owes you money anu you iefuse to accept this cuiiency
in payment, that cieuitoi's uebt to you, by law, is simply canceleu.
Notice also at the veiy top of oui uollai bill the woiuing
<('(+%*" =(0(+;(" >,&(8" Again, veiy simply, the note inuicates cleaily
that it was maue anu uistiibuteu by the Feueial Reseive, oui
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
94
countiy's cential bank. 0bviously, we know that this is piinteu
money because it is papei anu ink. We also ueteimine by
obseivation that it ceitainly appeais official. It is elaboiately
auoineu with authoiitative images that expiess the full faith anu
stiength of the 0.S. goveinment. Bowevei, we shall soon see that
theie is nothing #('(+%*"about it anu theie is no +(0(+;(8"
Now compaie the uollai bill on the pievious page with the
one on this page.

This uollai, which ciiculateu in 19S7, looks exactly like the uollai on
the pievious page except foi this one veiy impoitant uistinction. At
the veiy top we see that this uollai has wiitten acioss it ?@ABC="
DC=E@<@DFEC. We also ieau the following: GE5$0")(+&$#$(0"&5%&"&5(+("$0"
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
9S
,-" '(2,0$&" 4$&5" &5(" E+(%01+/" ,#" &5(" H-$&('" ?&%&(0" ,#" F3(+$)%7" ,-("
'()*$+"',**%+7"2%/%.*("&,"&5(".(%+(+",-"'(3%-'89"
That is quite a uistinction. In case the ieauei isn't suie, let us
be ciystal cleai: E5(+(" $0" -,&5$-:" .%)I$-:" ,1+" )1++(-&" )1++(-)/8 By
that we mean that its piecious metal conveitibility has been
iemoveu, giauually at fiist, but ovei time peimanently. This piocess
actually began when Piesiuent Fianklin B. Roosevelt, in one of his
fiist acts in office, ueclaieu as illegal the use of golu as money in
19SS. It was pionounceu a ciime foi any citizen to continue using
golu as money, a law that was stiictly enfoiceu by a stiff fine, even
impiisonment. Fuitheimoie, Piesiuent Roosevelt uemanueu that all
golu be tuineu ovei to the goveinment, to be stoieu anu lockeu in a
vault unuei aimeu militaiy piotection. The golu vault is known as
Foit Knox anu is locateu in the state of Kentucky.
0ui coins weie at one time maue of 97% puie silvei. Touay
they aie meiely tokens maue of cheap metal. When we say that oui
money has lost 9S% of it value since the eaily 19uus, we aie
speaking of its loss of puichasing powei, but also of the fact that it
has been un-linkeu fiom piecious metals+(%*"3,-(/8
0ne othei significant point neeus mentioning. The 0.S. once
owneu a laige shaie of all the golu in the woilu, but touay the
amount actually in 0.S. possession is unknown. No outsiue agency
has been alloweu insiue Foit Knox in many uecaues to auuit the golu
bullion helu theie. 0bviously none of this is goou news.
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
96
0nueistanuing how anu why we have wounu up in this situation is
of supieme impoitance to us touay. We will leain moie specifics
latei, but foi now these facts shoulu not be foigotten.

!"#$%&'"()*$")'"!+&$%,-./"0-$12"3)4&5-$2"6%/5)$2"

Theie weie two laige-scale expeiiments with fiat money in
oui countiy's eaily histoiy. Both times illustiateu the uangei of
giving politicians contiol of the piinting piess. The fiist episoue
occuiieu uuiing oui countiy's infancy. Buiing the Wai of
Inuepenuence, the uespeiate Continental Congiess began paying its
uebts in fiat money calleu D,-&$-(-&%*0. At one point, ueneial
Washington complaineu to Congiess that it took a wheelbaiiow of
Continentals in oiuei to buy bieau foi his staiving soluieis. People
woulu not ieauily accept Continentals as money, simply because
they knew it was not ieal money. (The ieauei may have heaiu the
phiase "not woith a Continental.") They knew it was papei fiat
money whose conveitibility to a piecious metal was questionable.
Inueeu this eaily uisastei with fiat money gieatly influenceu
the Founuing Fatheis. u. Euwaiu uiiffin uesciibes some of the
commentaiy at the Constitutional Convention:
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
97
0livei Ellswoith fiom Connecticut, who latei was to
become oui thiiu Chief }ustice of the Supieme Couit, saiu, "This
is a favoiable moment to shut anu bai the uooi against papei
money. The mischief of the vaiious expeiiments which have been
maue aie now fiesh in the public minu anu have exciteu the
uisgust of all the iespectable paits of Ameiica."
ueoige Nason fiom viiginia tolu the uelegates he hau a
"moital hatieu to papei money." Pieviously he hau wiitten to
ueoige Washington: "They may pass a law to issue papei money,
but twenty laws will not make the people ieceive it. Papei money
is founueu upon fiauu anu knaveiy."
}ames Wilson of Pennsylvania saiu: "It will have the most
salutaiy influence on the cieuit of the 0niteu States to iemove
the possibility of papei money."
}ohn Languon fiom New Bampshiie waineu that he
woulu iathei ieject the whole plan of feueiation than to giant the
new goveinment the iight to issue fiat money.
ueoige Reeu fiom Belawaie ueclaieu that a piovision in
the Constitution gianting the new goveinment the iight to issue
fiat money "woulu be as alaiming as the maik of the beast in
Revelation."
2

Neeuless to say, the oiiginal signeis of the Constitution uiu
-,& think they weie cieating a feueial goveinment that hau the iight
to give gieen pieces of papei the foice of legal tenuei. The clause
gianting Congiess the powei to "coin money" anu "iegulate the
value theieof" has been as heioically stiaineu (in oiuei to justify the
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
98
goveinment's uebasement of the uollai) as the othei mouein
misinteipietations of the obvious intentions of the signatoiies.
uiiffin explains:

In view of the fact that golu anu silvei coin was
specifically uefineu as the only kinu of money to be alloweu,
theie can be no uoubt of what was meant.To coin money meant
to mint piecious-metal coins. Peiiou.
The seconu half |of the clausej is equally cleai. Both in
the Constitution anu in the uiscussions among the uelegates, the
powei to iegulate the value of golu anu silvei coin was closely
tieu to the powei to ueteimine weights anu measuies. They aie,
in fact, one anu the same. To iegulate the value of coin is exactly
the same as to set the nationally accepteu value of a mile oi a
pounu oi a quait. It is to cieate a stanuaiu against which a thing
may be measuieu..
The intent, theiefoie, was simply foi Congiess to
ueteimine the exact weight of a piecious metal that woulu
constitute the national monetaiy unit.
S

To uiive home the point that the Founueis uiu not think the
new Constitution gave the feueial goveinment the powei to issue
fiat money, consiuei the following thoughts that ueoige Washington
wiote in 1789:
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
99
We may one uay become a gieat commeicial anu
flouiishing nation. But if in the puisuit of the means we shoulu
unfoitunately stumble again on unfunueu papei money oi any
similai species of fiauu, we shall assuieuly give a fatal stab to oui
national cieuit in its infancy.
4

Buiing Washington's fiist teim as piesiuent, his Secietaiy of
the Tieasuiy Alexanuei Bamilton pioposeu the cieation of a cential
bank (the Fiist Bank of the 0niteu States). This iaiseu the fieice iie
of Secietaiy of State Thomas }effeison, who ueclaieu: "A piivate
cential bank issuing the public cuiiency is a gieatei menace to the
libeities of the people than a stanuing aimy."
S
We see that the
Founuing Fatheis, weie they to view piesent-uay Ameiica, woulu be
shockeu on 3%-/ levels.
Bespite the awful expeiience with Continentals uuiing the
Wai foi Inuepenuence, both siues in the Civil Wai (oi what is also
known as the Wai Between the States) succumbeu to the temptation
to iely on unbackeu fiat money to pay theii expenses. The piice
inflation in the Confeueiate states was appalling, anu even in the
Noith the public became uisillusioneu with the iapiuly ueteiioiating
"uieenbacks" until they weie once again linkeu to piecious metals
aftei the wai.
Anytime sounu money, as in golu, ciiculates alongsiue papei
money not backeu by a piecious metal, the people tenu to hoaiu the
sounu money anu spenu the bau money. This phenomenon was fiist
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1uu
uiscoveieu in the 1Suus anu is known as uiesham's Law: GJ%'"
3,-(/" '+$;(0" ,1&" :,,'" 1-'(+" *(:%*" &(-'(+" *%4089 When the
goveinment foices meichants anu cieuitois to accept uebaseu
money as if it weie equivalent to the genuine aiticle, eveiyone
tiaues away the infeiioi veision. No one wants the papei money. No
one saves the papei money. The people will hoaiu the goou money
each anu eveiytime. This paitly explains FBR's confiscation of
citizens' holuings of golu in 19SS.
0nce again, oui nation is using a papei money not
ieueemable in piecious metals. Feueial Reseive Notes now ciiculate
in oui economy totally fiee fiom its main competitois, golu anu
silvei. It is officially legal tenuei anu it is the only money we can use.
Even moie notewoithy, touay all countiies in the woilu use fiat
money. Beie anu abioau we aie completely off the golu stanuaiu.
0niveisally it is all nothing moie than papei anu ink.

(7&"#$&55)4"8))9/"!:$&&+&45";<=="

Aftei Woilu Wai II, the 0niteu States emeigeu as a woilu
supeipowei. 0sing this poweiful influence the 0.S. foimulateu anu
uiove into acceptance a new global monetaiy system at the
confeience in Bietton Woous, New Bampshiie in 1944. In contiast
to the classical golu stanuaiu, in which eveiy nation's cuiiency was
conveitible by anyone into a specifieu weight of golu, the new
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1u1
system enshiineu the H8?8"',**%+"as the anchoi upon which all othei
fiat cuiiencies weie baseu. Rathei than stockpiling bais of golu in
theii vaults as ieseives, foieign cential banks weie encouiageu to
use 0.S. uollais as theii "ieseives."
0nuei the Bietton Woous agieement, the 0.S. uollai itself
was still backeu up by golu, at the official exchange iate of $SS an
ounce, thus pioviuing a fiim founuation to the entiie system.
Bowevei, unlike the piactice uuiing the classical golu stanuaiu, in
the new aiiangement only )(-&+%*" .%-I0 hau the iight to tuin in
theii papei uollais foi golu bullion. Ameiican citizens woulu nevei
again iegain the abilitystiippeu fiom them by FBRto tuin theii
uollais in foi golu. Thus one of the most potent checks on inflation
hau been iemoveu.
As stateu eailiei, the 0niteu States hau a huge stock of golu
ieseives aftei Woilu Wai II anu began puisuing a highly inflationaiy
couise much to the uismay of foieign countiies. As the uollai
weakeneu because of these monetaiy activities, golu staiteu flowing
out of the countiy in laige amounts as foieign goveinments casheu
in theii uollais foi golu. It ieacheu a ciisis point by 1968, anu in
1971 Piesiuent Richaiu Nixon took oui uollai totally off golu anu
ueclaieu the Bietton Woous agieement null anu voiu. At this point,
the 0.S. uollaianu by extension, the cuiiencies of othei woilu
poweiswas an asset unto itself, having no link to the piecious
metals. At this point, the only iestiaint on the piinting of new papei
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1u2
uollais was the uiscietion of Feueial Reseive officials. Theie weie
no foimal checks left on theii appetite foi inflation.
Nany people expecteu that the entiie inteinational monetaiy
system woulu collapse aftei the bieakup of Bietton Woous.
Suipiisingly it uiun't. Some histoiians speculate that 0.S. militaiy
might anu feais of an outbieak of Woilu Wai III kept othei
goveinments in check, continuing to use the 0.S. uollai as the
woilu's ieseive cuiiency even though they nevei woulu have
agieeu to the aiiangement oiiginally without the uollai's backing by
golu. In any event, the 0.S. expeiience of "stagflation" uuiing the
197us showeu that the tie to goluweak though it was unuei
Bietton Wooushau iestiaineu inflation. Aftei Nixon iemoveu the
last shackles, the 0.S. suffeieu fiom an oigy of uollai piinting.

(7&">&4&/%/")'"3)4&2"
"
Foi a complete peispective on money anu foi oui own
pieseivation, it is impoitant to know wheie money oiiginally came
fiom. Austiian economist Nuiiay Rothbaiu in seveial of his
excellent books (K5%&" L%0" M,;(+-3(-&" N,-(" &," O1+" P,-(/Q," E5("
D%0(" F:%$-0&" &5(" <('," E5(" P/0&(+/" ,#" J%-I$-:, anu his famous
economic tieatise7"P%-7"C),-,3/"%-'"?&%&(),"explains this impoitant
featuie of money in language that the laypeison can unueistanu. We
now give a summation of Rothbaiu's explanation.
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1uS
Fiist of all, money uiu not come into being by some soit of
agieement, oi social contiact. Noney comes into being fieely in the
maiket place by tiial anu eiioi. This happens as inuiviuuals begin to
facilitate the piocess of exchanging goous with one anothei. In the
uays of baiteiing (what economists iefei to as "uiiect exchange"),
pioblems aiose when people attempteu to exchange two uiffeient
commouities. Foi example, if you hau buttei to exchange foi beef,
but no one with beef wanteu youi buttei, then you obviously hau a
pioblem. This exchange pioblem, because it came up quite
fiequently, foiceu society to seaich foi a commouity to seive as a
&(32,+%+/" (R)5%-:(, oi what economists iefei to as an $-'$+()&"
(R)5%-:(8 0bviously, the commouity society ultimately selecteu foi
the inuiiect exchange hau to be highly maiketable. It may have been
eggs, milk oi bieau, but, whatevei it was, society eventually
employeu it as money.
0vei the couise of time the one meuium of exchange that
won ovei all othei foims of money has been golu. Why golu.
Because it has featuies no othei commouity has. Foi example, it is
,(*('(-)$. Imagine tiying to uiviue a uiamonu to pay foi something.
uolu, on the othei hanu, can be easily cut up into tiny pieces while
+(&%$-$-:" $&0" 2+,+%&%" ;%*1( so that money calculations can be maue.
By making golu in eithei bullion bais oi coins, it becomes veiy
."+/0-)$ anu veiy convenient to use.
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1u4
Theie is also the fact that fiom eailiest iecoiueu histoiy golu
has been valuable as jeweliy piincipally because of its uecoiative
beauty. In auuition to this, we must not foiget that golu is )(1(/$,&(#&
(/'& '2..)%. In oiuei to get moie of it, it has to be mineu fiom the
giounu at gieat expense. But that is not all. uolu is extiemely
,2+0-)$& anu non-peiishable. It can last foi centuiies. Anu finally,
golu is 3"1"4$#$"2' anu easily iecognizable8 It can be maue to
look exactly like anothei of its kinu, as in golu coins. Foi these
ieasons it is not suipiising that histoiically golu has been the money
of choice. No uoubt, golu is sounu money. Fiom a convenience
stanupoint, papei money can be useful but only so long as it is
ultimately linkeu to, oi payable upon uemanu foi, golu.

What is the right quantity of money?

As we well know, there has been an astronomical increase of the
money supply by the Federal Reserve Bank during the last four decades,
especially in 2008. The general public innately knows that all this new
money creation is not a good thing for society simply because the more
we have of something the less it is worth. Before pondering the question
of the best or the optimal amount of money, try asking these
questions: What should the optimum amount of canned peas be in
society? Or: What is the optimum amount of fresh turkeys? Or:
watermelons? Or: cattle? or whatever commodity comes to mind. The
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1uS
point is that the more consumable goods we have in society the better it
is for everyone. In fact, more goods in the market help bring down
prices and our standard of living goes up, because there is more to
consume and enjoy per capita. However, this is not the case with more
money. An increase of money provides no social benefit whatsoever.
"Why no social benefit." you ask. Because money cannot be
eaten oi consumeu. Noney, iemembei, is useu foi exchange
puiposes only. 0nce a commouity is in sufficient supply as money,
no fuithei incieases aie neeueu. Any quantity of money is optimal.
The moie mining of golu foi uses othei than money, such as jeweliy,
is peifectly fine, but moie golu as money is not neeueu. So while an
inciease in the total supply of cattle oi tea oi laptops is uefinitely
beneficial foi society, an inciease in money only uilutes its value;
people can't consume moie goous anu seivices just because theie is
moie money floating aiounu. To put it simplistically: If we magically
uoubleu the supply of cais, twice as many people woulu be able to
uiive. But if we magically uoubleu the supply of money, all that
woulu happen is piices woulu uouble (on aveiage). People might
feel iichei foi a little while, but they woulu iealize it was an illusion
once they saw piices soai.
A laige inciease in the money supplypaiticulaily when
occuiiing in oui mouein financial systemcauses uistoitions to the
entiie economy .(0$'(0 uiiving up piices. We will explain this
piocess in gieatei uetail latei in the book.
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1u6

Legalized Increases of Money

To put these points into peispective, imagine a fiee maiket
economy wheie golu is the money. In such a society one can acquiie
the golu in one of only thiee ways3$-$-:7" &+%'$-:7 oi as a :$#&. In
each one of these methous of acquiiing golu, the piinciple of piivate
piopeity is stiictly honoieu. Bowevei, let's suppose an inuiviuual
ueciues to take auvantage of golu's 5,3,:(-,10 featuie anu cieates
an enoimous amount of counteifeit golu coins foi himself. (Peihaps
he takes coins of a basei metal anu coats them with golu.) This act
will cieate a peimanent uestiuctive iippling effect thioughout
society! In auuition to its fiauuulent methou of acquiiing the golu
(counteifeiting), it unueimines the founuations of piivate piopeity.
The counteifeitei will also inciease the money supply substantially
when he spenus the money in the maiketplace.
With moie money in supply because of the counteifeiting, its
value will necessaiily ueciease theieby making goous anu seivices
cost moie. This, of couise, is piice inflation. It is veiy uestiuctive
because it impoveiishes the whole of society, except foi the
counteifeitei. The counteifeitei benefits immeuiately by getting the
money fiist, as opposeu to the latei iecipients of the money, oi those
who nevei get the new money at all. 0sually this tuins out to be the
aveiage haiu woiking citizen. These goou people winu up paying
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1u7
ueaily. They aie left to ueal with the incieaseu piices on all the
goous in the maiket place. Foi them the cost of living simply iises
yeai aftei yeai, anu no one can pioviue an explanation. They aie
totally unawaie of the counteifeitei. Foi this ieason, Austiian
economists have always saiu that the inflation piocess (the inciease
of the money supply), is a foim of inuiiect oi G$-;$0$.*(" &%R9 on
society.
Foitunately, piivate counteifeiting has ieally nevei been
much of a pioblem in mouein times. Counteifeiting caiiies stiff
penalties foi anyone who attempts it. Bowevei, when counteifeiting
is manuateu by goveinment, when it is legalizeu, we have a seiious
economic anu moial pioblem foi all of society. Bistoiically, theie
have been two majoi kinus of goveinment-sanctioneu
counteifeiting: (1) goveinment papei money anu (2) fiactional
ieseive banking. These two foims of money cieation aie piecisely
what we have touay, not only in oui 0niteu States, but woiluwiue.
We iecall Bastiat's quotation:

Theie is in all of us a stiong uisposition to believe that
anything lawful is also legitimate. This belief is so wiuespieau
that many peisons have eiioneously helu that things aie "just"
because law makes them so. Thus, in oiuei to make plunuei
appeai just anu sacieu to many consciences, it is only necessaiy
foi the law to ueciee anu sanction it.
6

"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
1u8

1
Federal Reserve Bank of Chicago, Modern Money Mechanics: A Workbook on Bank
Reserves and Deposit Expansion (1994), p. 1. Available at:
http://www.rayservers.com/images/ModernMoneyMechanics.pdf. Accessed June 3,
2010.
2
G. Edward Griffin, The Creature From Jekyll Island (Westlake Village, CA:
American Media, 2002), p. 315.
3
G. Edward Griffin, The Creature From Jekyll Island, pp. 317-318.
4
Quoted in Griffin, p. 323.
5
Quoted in Griffin, p. 329.
6
Frederic Bastiat, The Law (1850), available at: http://bastiat.org/en/the_law.html.
1u9
Chapter 6
Deposit Banking

The actual process of money
creation takes place primarily in
banks.[B]anks can build up
deposits by increasing loans and
investments...This unique attribute of
the banking business was discovered
many centuries ago. It started with
goldsmiths.
!"#"$%&'(")"$*"'+%,-'./'0123%4.
5
''
'
he major control [of changes in the quantity of
money] rests with the central bank. The actual
process of money creation takes place primarily in banks.
2
This
statement, made in a 1994 Federal Reserve publication, can be
immensely helpful in dealing with one of the more difficult hurdles in
this intellectual debate. This hurdle has to do with the fact that some of
us reading this book are in the banking profession, or have friends and
family who are bankers. If this happens to be the case, there will be a
natural rising of our defenses not only to protect ourselves, but those
close to us that make an honest living being bankers. This is quite
understandable. Nearly everybody can appreciate this reaction regardless
T'
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
11u
of his or her own profession. And most of us do have friends who are
bankers. We are also all aware of the criticism many times expressed
toward the legal professional, the medical doctor, the accountant, broker,
minister. No one is immune. Nevertheless, the main thing about this
statement made by the Federal Reserve is that it allows all of us,
regardless of profession or personal views, to confront the undeniable
fact it states: In our current financial system, money is ultimately created
and controlled by the Federal Reserve. It is a seat of power, set apart
from all other powers in society. It creates and controls what we use as
money, utilizing a system involving thousands of our commercial banks,
making this system unique.
However, what we must continually keep in mind is that banking
is a very old profession dating back centuries. Even the system we speak
of, the Federal Reserve System, was established almost 100 years ago.
All modern-day bankers, in fact, all citizens have been born into this
present system. Indeed, many bank professionals have probably never
even heard the type of analysis we present in this book. So we certainly
are not implying that the rank and file bank employee is consciously
participating in a sinister plot to defraud the general public.
At the same time, we must not be nave. As we demonstrate in
this book, the present financial system allows commercial banks to
literally create money out of thin air, for the benefit of their owners and
their major customers. This system did not fall out of the sky. It was
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
111
shaped and at times literally designed by the very people who stood to
profit from its creation.
The point of the present book is not to level accusations against
particular individuals. We are instead trying to alert the American public
to the fact that our current monetary and banking system rests on sand
(or more accurately, on paper). The primary purpose for studying the
path by which we arrived, is to demonstrate that it doesnt have to be
this way. Modern Americansincluding the vast majority of those who
currently work in the banking sectorhave little reason to suspect that
life would be possible without a central bank exercising complete
dominance over the nations money. For many people, the key to this
realization is learning that powerful groups benefited from morphing our
system into its present form, a form that would be unrecognizable to
Americans from the early days of the Republic.

The Mystery of Banking

The Federal Reserve and its banking system have always been
shrouded in mystery. In order to better understand this mystery it will
serve us well to continue to use a publication from the Federal Reserve
as our guide, in addition to Murray Rothbards historical account from
his book The Mystery of Banking.
We will begin our study with the following three selections from
a 1994 publication distributed by the Federal Reserve Bank of Chicago:
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
112

Money is such a routine part of everyday living that its existence and
acceptance ordinarily are taken for granted. A user may sense that
money must come into being either automatically as a result of
economic activity or as an outgrowth of some government operation.
But just how this happens all too often remains a mystery.

The major control [of changes in the quantity of money] rests with
the central bank. The actual process of money creation takes place
primarily in banks.[B]anks can build up deposits by increasing
loans and investments...This unique attribute of the banking business
was discovered many centuries ago. It started with goldsmiths.

[B]ankers discovered that they could make loans merely by giving
their promises to pay, or bank notes, to borrowers. In this way, banks
began to create money. More notes could be issued than the gold and
coin on hand because only a portion of the notes outstanding would
be presented for payment at any one time.Transaction deposits are
the modern counterpart of bank notes. It was a small step from
printing notes to making book entries crediting deposits of
borrowers, which the borrowers in turn could spend by writing
checks, thereby printing their own money.
3

We can all benefit by first acknowledging that the concept of
banking can be confusing. For example, one view of a bank is simply as
an institution that makes loans. By studying historical records we learn
that the earliest bankers were merchants who extended credit to their
customers and charged a fee for the delay of payment. This fee or
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
11S
interest was the price on time. This type of lending became a good
business practice where transactions of this sort multiplied and were
conducted outside in the market place with the merchants and their
customers sitting on bankasthe Italian word for benches, or banks.
One family in particular, in the 14
th
century, the Medici family, became
so successful at this type of business that they are regarded as the first
institutionalized bankers. But for our purposes, the important point is
that this type of banking was non-inflationary. In other words, the
business did not counterfeit or increase the money supply. It was simply
a legal and very profitable lending business.
Most people think of banks or bankers as businesspeople who
borrow money from one set of people and lend that money to another
group. These bankers charge an interest differential, or at least this is the
perception. This form of lending is known as loan banking. For our
purposes, the important distinction about loan banking is that it is non-
inflationary.
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
114

Theie is, howevei, anothei type of bank that has no
connection with loan banking as just uesciibeu. This type of bank
came about because it hau a piactical connection to money, ,.7
banking. It is this type of bank that we neeu to investigate moie
caiefully.
To begin with, golu coins anu bullion aie heavy to lug aiounu,
anu they can be lost oi stolen. Foi this ieason people began to
ueposit theii golu anu othei valuable items into waiehouses foi safe
keeping. These money waiehouses came to be known as #"8.)27'
9%,-) anu weie usually opeiateu by golusmiths. In most stoiage
waiehouses the uepositoi, when he uepositeu his golu, ieceiveu a
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
11S
papei #"8.)27' 723-"7 oi coupon. The ticket holuei coulu uemanu the
ietuin of his golu upon piesentation of the ticket anu woulu be
chaigeu a )7.$%4"'/"" foi the seivices pioviueu.

Since these weie actually stoiage facilities they woulu be no
uiffeient fiom a stoiage facility in oui uay anu time. When
uepositing oi stoiing an item, such as an antique chaii, an heiiloom
iug, a painting, oi any numbei of items in a stoiage facility, the
uepositoi always ieceives a ueposit ieceipt, a claim ticket to the
item he has in stoiage. The point is that the uepositoi is stoiing
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
116
these items foi safekeeping. They aie not being "lent" to the
waiehouseman. In othei woius, it woulu be incoiiect to say that the
waiehouseman was a "uebtoi" of the uepositoi oi that the uepositoi
was a "cieuitoi" of the waiehouseman. If the exact antique chaii is
not ietuineu upon piesentation of the stoiage ticket, the uepositoi
has eveiy iight to accuse the waiehouseman of theft. That is
because placing goous in a stoiage facility oi something similai to a
safety ueposit box is not a #"97'3.,7$%37 between the uepositoi anu
the stoiage facility. It is in fact a 9%2&:",7'3.,7$%37;'
Bowevei, some items placeu in stoiage aie of a special
natuie. They aie homogenous oi /<,429&"; This means that you
cannot tell these items apait. 0ne such example woulu be giain in a
giain elevatoi. But, theie is an item that is even moie fungible than
giain anu that item is money. All money, whethei it is golu oi
goveinment papei money, looks the same. uiain is useu to make
something euible, anu although it may be fungible foi a biief peiiou,
eventually the "olu" giain neeus to be iemoveu fiom the stoiage
facility. Noney, on the othei hanu, uoes not have to be iemoveu
fiom the waiehouse at all because it will nevei expiie oi peiish. This
element of money's homogenous natuie eventually openeu the uooi
foi embezzlement anu befoie long the temptation became too much
to iesist.
0vei time, this temptation eventually tuineu into the
counteifeiting of waiehouse ieceipts when it was iealizeu that
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
117
uepositois weie tiauing the waiehouse ieceipts as money. Rathei
than uemanuing the golu back each time they wanteu to make a
puichase, uepositois simply signeu ovei the waiehouse ieceipts.
This meant that the eaily ueposit bankeisthose who weie stoiing
golu as a seivice to theii customeisalways helu a ceitain amount
of unieueemeu money in theii vaults. In othei woius, theie was a
maigin to play with anu piofit, to be maue by using someone else's
money. As the Feueial Reseive Bank of Chicago puts it:

|Bjankeis uiscoveieu that they coulu make loans meiely by
giving theii piomises to pay, oi bank notes, to boiioweis. In this
way, banks began to cieate money. Noie notes coulu be issueu
than the golu anu coin on hanu because only a poition of the
notes outstanuing woulu be piesenteu foi payment at any one
time.
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
118
'
'

In Rothbaiu's view (shaieu by many, though not all, mouein
Austiian economists), honest waiehousing is uefineu by a
waiehouse ieceipt foi eveiy uepositeu item. This woulu be 5==>'
$")"$*"' ?%$"1.<)2,4;' 0n the othei hanu, if a waiehouseman issues
fake waiehouse ieceipts anu the golu stoieu in the waiehouse is
only a fiaction (oi something less than 1uu% of the ieceipts
ciiculating) then he coulu be saiu to be engageu in /$%372.,%&'$")"$*"'
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
119
?%$"1.<)2,4' which Rothbaiu ieasoneu was simply a sophisticateu
foim of fiauu.

This foim of embezzlement is highly inflationaiy anu moially
wiong. It victimizes all piivate piopeity owneis anu is a teiiible
ciime to society. Yet, these aie the tiue oiigins of ueposit banking
anu fiactional ieseive banking as we have them in oui mouein
times. 0vei the centuiies the waiehouse ieceipt became known as a
"bank note." Nuch latei, ueposits came to be known as "uemanu
ueposits." A tiansfei oiuei coulu be wiitten fiom the uemanu
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
12u
ueposit to anothei bank. This tiansfei oiuei became known as the
"check." Then, of couise, the "uemanu ueposit" became the
"checking account." We tuin once again to the Feu itself:'
'
Transaction deposits are the modern counterpart of bank notes. It was
a small step from printing notes to making book entries crediting
deposits of borrowers, which the borrowers in turn could spend by
writing checks, thereby printing their own money.

It would take many years of building a reputation of integrity
before a practice of counterfeiting warehouse receipts could actually be
done without being detected. Once the crime of counterfeiting has begun
there is the worry of being caught. The warehouseman could obviously
be accused of embezzlement and sent to jail. To prevent this from
happening it would be of utmost importance to hire attorneys and
financial experts to convince the courts that what the warehouseman was
doing was not a crime, but merely entrepreneurial activities. To make
this argument palatable, the courts would have to be convinced that the
deposits into the warehouse were not bailment contracts, but are actually
debt contracts.
At the time deposit banking was developing, bailment law had
not developed sufficiently to overcome the growth of deposit banking.
The British courts ruled in favor of deposit banking defining the money
deposit as a debt contract. These decisions were approved by American
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
121
courts and were ultimately adopted as law. In 1848 the House of Lords
ruled in the case of Foley v. Hill and Others:

The money placed in the custody of a banker is, to all intents and
purposes, the money of the banker, to do with as he pleases; he is
guilty of no breach of trust in employing it; he is not answerable to
the principal if he puts it into jeopardy, if he engages in hazardous
speculation; he is not bound to keep it or deal with it as the property
of his principal; but he is, of course, answerable for the amount,
because he has contracted.
4

This decision that we have to this day in the United States
completely overlooks the fact that in the case of a bank run where all
depositors demanded their money all at once, the banker could not
possibly live up to his contract. Furthermore, it also authorizes a banking
system structured on deceiving the public.

The Central Bank

In order to go a step further and obtain a full grasp of what we
have explained thus far, the reader must imagine being in the deposit
banking business. First of all, suppose you have been in business many
years in the community conducting an honest 100% reserve warehouse
business where all property was promptly returned to customers upon
presentation of their warehouse receipts. You have one million dollars in
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
122
gold on deposit in the warehouse, but now decide you are going to make
a killing in this business and counterfeit five million dollars more in
warehouse receipts. You will then have five times more in warehouse
receipts than gold on deposit. As long as these warehouse receipts (bank
notes) trade as gold among your loyal clientele you are safe and will
make a lot of money.

But what if all of your customers decided to demand their gold
all at the same time, in effect a run on your bank? This event would not
only expose your fraud, but would be unstoppable. It would certainly
bankrupt you, law or no law!
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
12S
Apart from the bank run, there is another powerful limit on your
counterfeiting scheme. What if one of your customers passed one of
your fake (i.e. non-backed) receipts to a non-bank customer, who in turn
presented it to another competing bank for redemption? The competing
bank would then present the ticket to you in the course of normal inter-
bank clearing operations. Consequently, redemption is a real problem
especially if that one fake warehouse receipt happens to be a two million
dollar receipt. Once again, your chicanery would have led to your ruin.

Only one force can overcome this limitan agreement!
Developing an agreement with one or two competing banks whereby
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
124
counterfeiting could be done together would be relatively easy to
accomplish. But in a society with thousands of banks it would not be
possible. To accomplish that feat, a central bank is needed.

Historically, the central bank has always had two major roles: (1)
To help finance the governments deficits, and (2) to form an alliance of
the private banks in a society in order to remove the two great market
limits of the bank run and redemption.
A significant fact is that the original central bank, the Bank of
England in the late 17
th
century, began as a crooked deal between a near
!"#$%&'()*+,&+-(
6666666666666666666666666666666666666666666666666666666666'
'
12S
bankrupt government and a corrupt group of financial promoters. Not
surprising since governments are always broke and short of money!
Over the centuries, other large nations eventually copied this
institution from England. Our United States was the last major nation to
establish a permanent central bank, adopting the Federal Reserve System
in 1913, which was explicitly modeled on the central banks that had
developed overseas. Our money and our society have never been the
same.

1
Federal Reserve Bank of Chicago, Modern Money Mechanics: A Workbook on Bank
Reserves and Deposit Expansion (1994), p. 3. Available at:
http://www.rayservers.com/images/ModernMoneyMechanics.pdf. Accessed June 3,
2010.
2
Modern Money Mechanics, p. 3.
3
Modern Money Mechanics, pp. 1 and 3.
4
Murray Rothbard, The Case Against the Fed (Auburn, AL: The Ludwig von Mises
!"#$%&'()*+,&+-(
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!"#$
$
127
!"#$%&'()(
*+,-#%./+(
!
!
"#$!%&'(!)*+,-./*&+0!&'*1*+.--2!.33-*$(!
4&-$-2! /&! /#$! 56.+/*/2! &,! 7&+$28! 9/!
7$.+/! /#./! /#$! :&-67$! &,! 7&+$2! %.4!
inflateu;! <-&%+! 63;! &:$'$=/$+($(8! 9/! *4!
+&/! 7$'$! 3$(.+/'2! /&! *+4*4/! /#./! /#$!
%&'(! 4#&6-(! <$! 64$(! &+-2! *+! */4!
&'*1*+.-!7$.+*+18!"&!64$!*/!/&!7$.+!).!
'*4$! *+! 3'*>$40! *4! /&! ($,-$>/! .//$+/*&+!
.%.2! ,'&7! /#$! '$.-! >.64$! &,! *+,-./*&+!
.+(!/#$!'$.-!>6'$!,&'!*/
?$+'2!?.@-*//
A
!
!
!
hat is inflation. This woiu, if iightly unueistoou,
woulu help lift the veil fiom the eyes of millions so
that the hiuuen paits of the money anu banking pioblem coulu
finally be ievealeu. This may sounu like an exaggeiation; howevei,
nothing else in this book coulu be saiu with moie tiuth than this.
Knowing the tiue uefinition of this teim anu how it comes about in
oui economy is ciucial to oui unueistanuing of oui money
pioblems. This is the enu which we have been moving towaiu anu
W
"#$%&'()#!
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB!
!
128
one of the piincipal goals of this book. Nisunueistanuing this woiu,
oi meiely assuming that it means iising piices, will keep us in the
uaik.
We must also aumit that inflation is not an easy concept to
unueistanu. 0ne of the most famous economists of the 2u
th
centuiy,
}ohn Naynaiu Keynes, stateu that only "one man in a million" coulu
giasp the piocess. 0bviously, theie is much moie to inflation than
what fiist meets the eye. It is to this unueistanuing that we uevote
this chaptei, befoie pioceeuing to fiactional ieseive banking in the
next anu final chaptei to this section.
To begin, }ohn Auam's famous quote will pioviue the basis
foi oui initial steps of uiscoveiy: )C--! /#$! 3$'3-$=*/*$4;! >&+,64*&+! .+(!
(*4/'$44! *+! C7$'*>.! .'*4$! ,'&7! /#$! (&%+'*1#/! *1+&'.+>$! &,! /#$! +./6'$!
&,!>&*+;!>'$(*/!.+(!>*'>6-./*&+80!
Nany of us aie familiai with this quote, but foi oui puiposes
heie it is ceitainly woith examining once moie. Though Auams uses
haish anu ciitical language, he points to the thiee things which we
shoulu all unueistanu unequivocally: 7&+$2;! >'$(*/! .+(! #&%! */!
>*'>6-./$4!*+!&6'!$>&+&728 !
We shoulu pay paiticulai attention to his mentioning of the
)3$'3-$=*/*$4;! >&+,64*&+! .+(! (*4/'$440 because consiueiing that this
statement was maue in 1829, we shoulu be able to easily see that
theie is nothing new unuei the sun. These seem to be the iuentical
emotions we aie uealing with touay. That is because inflation has
"#$%&'()#!
!
129
been plaguing the human iace foi a long time. Eveiy time it is
mysteiiously set in motion, it cieates uistiess among the people. We
coulu tiavel back in time five hunuieu yeais, a thousanu yeais oi
even two thousanu yeais anu see eviuence of the same thing. Eveiy
time we see it we also see the uestiuction it cieates.
Foi example, let us imagine the gieat Roman Empiie. In youi
minu's eye see the poweiful Caesai sitting on a thione oveilooking a
sea of tens of thousanu of heavily aimeu Roman soluieis all
equippeu with the finest weaponiy in the woilu. Can you feel the
powei, pomp anu ceiemony that imaginaiy visual cieates. If you
can pictuie the aimy consiuei foi a moment the cost to outfit such a
feaisome anu poweiful militaiy foice. Imagine having to feeu, clothe
anu aim such an aimy of men anu hoises. The cost woulu have been
astionomical.
Now think of Rome itself, the splenuoi of Rome, the lavish
aichitectuie, the watei anu iiiigation systems, the coliseums; we
have all seen pictuies of what Rome must have lookeu like.
Bieathtaking yes, but now think of the cost to maintain all of that.
We have to wonuei, "Bow uiu Caesai pay foi it all." The answei is
that Rome's poweiful aimy pioviueu much of the money iequiieu to
covei such a huge cost. The Roman Empiie actually stole much of its
wealth fiom its conqueieu teiiitoiies. In auuition to this, Caesai
collecteu /'*<6/$, not only fiom the victims of wai, but also fiom his
own citizens. These taxes weie heavy. Tiibute, as it tuins out, was
"#$%&'()#!
!
1Su
moie of a piotection fee, than an actual voluntaiy payment. The
thieat of foice was always useu in oiuei to collect it. Theie was one
othei thing that we shoulu mention about the wealth of Rome. Theie
was nevei enough money. Caesai hau an insatiable appetite anu no
amount of money woulu satisfy.
Typically, at the enu of each yeai's tax collection anu aftei all
the plunuei fiom conqueieu teiiitoiies hau been biought into
Rome, Caesai woulu iealize that he still hau a lot moie expenuituies
than golu. What is Caesai to uo. Be knows bettei than to ask foi
moie tax money. If goveinment taxes the people too much, a ievolt
is the iesult.
Insteau, Caesai comes up with a clevei scheme. Be oiueis his
ministeis of the tieasuiy to clip all of the euges of the golu coins in
his possession anu with the clippings makes moie golu coins. Now
he has moie golu coins anu he can meet his expenuituies. In taking
this action we shoulu immeuiately notice that Caesai has secietly
tampeieu with the value of the money. Be has uevalueu the money
by ieuucing the weight of each golu coin. Auuitionally, he has
incieaseu the money supply (measuieu in teims of coins) anu he
will be the fiist to benefit fiom this inciease.
0p to this point the ieauei may be thinking this is a faiiy tale
alteieu solely to be useu as an example. It is an example; howevei,
this is also uocumenteu histoiy (with some of the uetails being
simplifieu foi oui exposition). It actually happeneu. So we neeu to
"#$%&'()#!
!
1S1
continue with this stoiy to its enu in oiuei to see its application to
oui economy in 2u1u.
So now, Caesai is able to pay foi all of the iequiieu
expenuituies with the incieaseu money supply, plus peihaps a few
othei luxuiies foi himself. It follows then that the people waiting to
be paiu can now be compensateu anu the new money goes out into
the economy of Rome. Now let's say you aie a Roman meichant in
Rome's maiket place anu you sell fiesh fish at a piice of one golu
coin foi a fish. A Roman Centuiion, who has just been paiu by Caesai
with one of these new coins, makes a puichase at youi fish maiket.
Be pays you one golu coin foi the fish, but upon closei examination
of the coin, you immeuiately iealize that theie is something uiffeient
about it. You ieach into youi own pocket anu pull out one of youi
coins anu compaie it to his. Theie is a uiffeience! The next step in
the tiansaction shoulu be obvious. You quickly uemanu two golu
coins foi youi fish. It is the only iight anu faii thing to uo, since the
new coins have a lowei golu content. But you can also see how this
same type of tiansaction will be iepeateu countless times
thioughout the entiie Roman economy with this new money, anu
each time, piices will be incieaseu on all goous anu seivices. It was
Caesai's counteifeiting that causeu the inciease both in piices anu
in the supply of money. That is the main point to unueistanu.
This stoiy, unfoitunately, uoes not enu heie. Actually, the
following yeai Caesai is again faceu with the same pioblem. The loot
"#$%&'()#!
!
1S2
fiom all conqueieu lanus has come in anu so has the tiibute, but it is
not enough golu to pay foi eveiything. Caesai staits to pull the same
clipping of the coins tiick again, but he notices that the golu coins
have now all been notcheu with iiuges aiounu the euges. The people
have gotten wise to the tiick! They have put a maik on the money so
that any newly clippeu coin coulu easily be spotteu. (As a mattei of
histoiical infoimation, these notches, oi iings aiounu the euges of
coins aie known as '$$(*+1. Symbolically, oui own coins aie ieeueu
to exemplify oui goveinment's piotection against a counteifeitei
clipping oui coins.)
Not able to clip the coins again, Caesai uieams up yet anothei
scheme. This time he oiueis all the golu in his possession to be
melteu uown anu a base metal to be mixeu in with it. Fiom the
incieaseu mixtuie Caesai is now able to cieate even moie coins.
0nce again, this is anothei foim of uebasing the money in oiuei to
cieate moie of it. As befoie, the incieaseu money floous the maiket
place anu piices on eveiything inciease again. This counteifeiting
piactice continueu foi many yeais until the Roman coin containeu
less than one peicent of the tiue piecious metal. Consequently,
Roman money became totally woithless. The entiie monetaiy
system collapseu. In an attempt to aiiest the spiialing piices
which weie the inevitable iesult of the inflationthe Roman
authoiities enacteu stiict piice contiols. But stiippeu of the legal
ability to iaise the piices of theii piouucts in line with theii
"#$%&'()#!
!
1SS
escalating costs, meichants simply went out of business. The
population coulu no longei obtain the necessities of life anu fleu the
city foi the countiysiue, wheie they coulu tiy to live off the lanu. All
of these uisiuptions maue Rome vulneiable to foieign invaueis,
ones who hau pieviously been easily iepelleu. But ultimately it was
not baibaiian conqueiois who biought uown Rome. Bebasing the
monetaiy unit is actually what causeu the fall of the Roman Empiie.
2

Can all see the significance of this piece of histoiy. When the
value of the money is uelibeiately uiluteu you neeu moie of it to buy
what you neeu. Piices necessaiily iise eveiywheie. Isn't the stoiy
the same touay. This loss of value in the money supply is happening
not only with oui own uollai, but with all cuiiencies woiluwiue.
Piices aie also iising eveiywheie thioughout the woilu, as quoteu
in the local cuiiency. Incieasing the money supply, as you can see, is
not unique to Caesai. All goveinments have uone this in one way oi
anothei. It is inheient in the natuie of goveinment, not only to
contiol the money supply, but to tampei with it foi the benefit of the
goveinment fiist. It is legalizeu assault on piivate piopeity.
(
0/1#234(*+,-#%./+(

Fast foiwaiu to mouein times: In oiuei to unueistanu
inflation theie aie two things we must fully iecognize. Fiist, oui
goveinment has no money of its own although it has access to all of
"#$%&'()#!
!
1S4
it. uoveinment only spenus the money it has fiist taken fiom the
piivate sectoianu tiillions of uollais of it! Seconuly, oui
goveinment has enoimous expenuituies. uoveinment payioll alone
is astionomical. It is the laigest employei in the woilu with ovei
thiee million employees with moie than half of them aimeu to the
teeth with the finest weaponiy money can buy. Anu, what about the
piogiams it funus yeai aftei yeai, with new ones voteu in iegulaily.
Think of the cost. What about the cost of wai. It's monstious!
Wheie uoes the goveinment get all the money to pay foi all
of this. Well, fiom us of couise. We, the people of this countiy, pay
taxes. Bowevei, goveinment has gotten so big anu so expensive that
it now takes two salaiies in eveiy householu to make enus meet.
0ne coulu easily concluue that one membei's entiie income goes
just to pay foi the cost of goveinment. Yes, pay foi all of this with
oui taxes anu yes, it's by foice. If you uon't believe this, tiy not
paying them.
Accoiuing to the "official" numbeis, goveinments at all levels
in the 0niteu States spenu SS cents out of eveiy uollai that we woik
so haiu to eain, anu the ieal fiaction is much highei.
S
With
goveinment taking a goou #.-, of what we piouuce, it's no wonuei
we all hate to pay taxes. No one knows this bettei than the
goveinment. The goveinment has nevei foigotten that excessive
taxation will cause the people to ievolt. This is why so few
politicians evei pleuge to iaise $:$'2&+$D4! taxes. But, the
"#$%&'()#!
!
1SS
goveinment's unbalanceu buugets anu incieasing uebt tells us
cleaily that taxes aie not enough to pay foi the expenuituies, so how
in the woilu uoes goveinment continue to pay foi them.

0"&(5&1&'#-(6&4&'7&(824%&9(

Taxes aie obviously only one way foi goveinment to access
the necessaiy money. So wheie exactly uoes all the extia money
come fiom. This is wheie the Feueial Reseive System comes into
play. Cential banking in its cuiient incaination was establisheu in
"#$%&'()#!
!
1S6
the 0niteu States in 191S with papei cuiiency initially backeu by
piecious metals. (Not so coinciuently, the feueial income tax was
passeu into law that veiy same yeai.)
0ne of the initial uuties of the Feueial Reseive was to ienew
tiust anu confiuence in the nation's newly oiganizeu banking
system. The public peiceiveu the Feueial Reseive to be )/#$! -$+($'!
&,!-.4/!'$4&'/0 as a way to iescue banks who weie subject to a "iun"
anu weie in uangei of not being able to satisfy theii uepositois.
Thiough a clevei campaign fueleu (iionically) by some of the
wealthiest financieis themselves, the public was leu to believe that
the Feueial Reseive woulu eliminate financial ciises anu woulu
eliminate the influence of piivate inteiests on the nation's financial
system.
It is impoitant to mention that papei money linkeu to golu
limits a goveinment's ability to boiiow money. This is why uuiing
times of seveie ciisissuch as waigoveinments woulu often
ienege on theii obligations to ieueem cuiiency in golu (oi silvei).
Buiing Woilu Wai I, all the belligeients except the 0niteu States
explicitly abanuoneu the golu stanuaiu. They founu it too tempting
to pay foi the wai effoit by piinting new money, anu when the
inevitable uiain on theii golu ieseives began to manifest itself, they
simply violateu theii ieuemption pleuge. Aftei the wai, the majoi
countiies ietuineu (halfheaiteuly) to a vaiiant of the oiiginal golu
stanuaiu, but this makeshift aiiangement collapseu in the uieat
"#$%&'()#!
!
1S7
Bepiession of the 19Sus when goveinments once again wanteu to
spenu moie than theii citizens woulu toleiate thiough visible tax
payments. What the politicians coulu not uaie take uiiectly, they
took inuiiectly thiough the hiuuen tax of inflation.

:&2+&4.#+(;</+/9.<4(

In the miust of the uieat Bepiessionwhich the public
eiioneously blameu on a failuie of capitalism anu classical economic
theoiy}ohn Naynaiu Keynes, a biilliant Biitish economist,
publisheu a book in 19S6 that took the woilu of economics by
stoim. The timing coulu not have been bettei. This new theoiy, a
foim of "mouein" economics, pioclaimeu that business slumps weie
causeu by a lack of auequate "aggiegate uemanu" to ensuie full
employment. Loosely speaking, Keynes aigueu that a maiket
economy, if left to its own uevices, coulu get stuck foi yeais in a
situation wheie consumeis anu businesses weien't 43$+(*+1!$+&61#
to buy all that the economy was capable of piouucing. Consequently,
because of the excess capacity oi slack in the system, a laige fiaction
of the woikfoice wasn't neeueu anu consequently these people
iemaineu unemployeu.
Keynes' solution was suipiisingly simple, anu one that the
politicians enthusiastically embiaceu: Incieaseu goveinment ueficit
spenuing coulu boost aggiegate uemanu anu theieby eliminate the
"#$%&'()#!
!
1S8
gap between actual output anu potential output. In othei woius, the
goveinment coulu buy enough stuff in oiuei to justify the hiiing of
all the unemployeu.
In teims of conqueiing unemployment anu enuing a seveie
iecession, it uiun't even mattei %#./ the goveinment spent its
money on. In piinciple it coulu pay one million woikeis to uig holes
in the giounu, anu pay anothei million woikeis to fill the holes back
up. The point wasn't to caiefully husbanu society's scaice iesouices,
but iathei to boost incomes (by giving paychecks to the woikeis
uigging anu filling holes) so that /#$*' incieaseu spenuing in tuin
woulu fuithei stimulate the economy. To see that we aie not
pioviuing a caiicatuie of Keynes, let us quote him uiiectly on a
fanciful way to alleviate mass unemployment:

If the Tieasuiy weie to fill olu bottles with banknotes, buiy them
at suitable uepths in uisuseu coal mines which aie then filleu up
to the suiface with town iubbish, anu leave it to piivate
enteipiise on well-tiieu piinciples of laissez-faiie to uig the
notes up again.theie neeu be no moie unemployment anu with
the help of the iepeicussions, the ieal income of the community,
anu its capital wealth also, woulu piobably become a goou ueal
gieatei than it actually is.
4

!
The key insight of Keynesian economics is that one peison's
expenuituie cieates income foi someone else. (Peiveisely, this also
"#$%&'()#!
!
1S9
means that if someone 4.:$4 moie of his own income, his action
'$(6>$4 the income of somebouy else, giving iise to the Keynesian
attention to the so-calleu "paiauox of thiift" in which the community
impoveiishes itself by tiying to uo the iesponsible thing.) By taking
this tiuism anu aggiegating it acioss the entiie economy, Keynes
concluueu that total income equals total expenuituies. Combineu
with the equally plausible assumption that people spenu only a
fiaction of what they eain, the solution to a uepiession was cleai:
The goveinment neeueu to spenu enough extia money, in oiuei to
boost total national income to the point at which the total amount
spent by consumeis anu investeu by businesses, woulu geneiate
enough sales to put eveiyone to woik.
Whethei libeial oi "conseivative," oui financial piess touay
is thoioughly infuseu with the Keynesian minuset. Punuits on CNBC
anu Bloombeig fiet ovei "consumei confiuence" anu wiing theii
hanus whenevei people ueciue to save moie. The implication is that
if only we coulu have Chiistmas eveiy uay of the yeai, we woulu
nevei have iecessions. In the Keynesian view, the olu-fashioneu
viitue of thiiftof living below one's meansis positively haimful
uuiing a iecession.
Neeuless to say, Austiian economists have been the fieicest
ciitics of theii Keynesian iivals. In the Austiian view, ueficit
spenuing is the woist thing politicians can uo uuiing a seveie
iecession. In such a scenaiio, the goveinment takes an economy that
"#$%&'()#!
!
14u
is alieauy on its knees, anu auus a fuithei blow by siphoning moie
iesouices away fiom the piouuctive sectoi anu into the inefficient
political piocess. It is no suipiise, the Austiians point out, that those
iecessions chaiacteiizeu by the biggest uoses of Keynesian
"meuicine"notably the 19Sus anu oui cuiient ciisisaie also the
ones with the longest anu most lacklustei iecoveiies.
S

=&>%(
!
We still must piobe ueepei to unueistanu the exact
mechanism by which goveinment incieases its uebt, anu how this
ielates to inflation.
When the goveinment neeus moie money, the Tieasuiy
Bepaitment issues bonus into the open maiket. A bonu is a foim of
I00. Since the bonu is a uebt instiument, the piomise of the
goveinment is to pay the uebt to the bonuholuei sometime in the
futuie. Foi uebts of sufficient length, inteiest payments aie maue to
the bonuholuei peiiouically in auuition to the ietuin of piincipal at
the time of matuiity.
Anyone can buy the bonus issueu by the 0niteu States
goveinment. Institutions, inuiviuuals, anu even othei countiies
puichase the goveinment secuiities. Some of the biggest
institutional buyeis aie cential banks, notably incluuing the Feueial
Reseive. Keep in minu that the Feueial Reseive uoes not have a
"#$%&'()#!
!
141
savings funu of money somewheie with which to puichase the
goveinment's bonus, but it can anu uoes simply cieate the money
out of thin aii. Specifically, when the Feueial Reseive buys bonus
issueu by the 0niteu States goveinment,
6
the Feu simply wiites a
check on itself. At this stage in the explanation, you can think of it as
the Feu liteially piinting up ciisp new $1uu bills anu hanuing them
ovei to the goveinment, in exchange foi its I00s.
This piocess can be veiy mysteiious anu confusing, so let us
uesciibe it in uiffeient woius. Remembei: the 0.S. goveinment
wants to spenu money, moie money in fact than it collects in taxes.
So one auuitional avenue to iaise funus, is foi the goveinment to
issue an I00 (a bonu) to the Feueial Reseive. Foi example, the
goveinment might sell a new I00 in ietuin foi the Feu pioviuing $1
million in bianu new money. The goveinment can then go spenu the
$1 million on tanks, foou stamps, oi whatevei the politicians uesiie.
The Feu, foi its pait, now auus $1 million in new bonus to its
holuings of othei assets.
0nce we boil uown to the essence of the tiansaction, we see
the symbiotic ielationship between the Feueial Reseive anu the
Tieasuiy. Basically, the Tieasuiy issues papei ($</ to the Feu, which
issues papei 7&+$2 in exchange. At fiist glance, this complicateu
piocess beais little iesemblance to the simple chicaneiy by which
the Roman goveinment uebaseu its cuiiency.
"#$%&'()#!
!
142
Yet uig just a little ueepei. Although the Tieasuiy makes
inteiest payments to the Feu (which aftei all is holuing hunuieus of
billions of uollais woith of Tieasuiy I00s), the Feu tuins aiounu
anu 1*:$4! */4! $=>$44! $.'+*+14! '*1#/! <.>E! /&! /#$! "'$.46'2F Noieovei,
the geneial tienu is foi the Feu to amass a giowing stockpile of
goveinment uebt; the Tieasuiy knows that it will nevei have to pay
off the piincipal on its loans, because the Feu will continually ioll
them ovei as they matuie. In othei woius, even though it 4$$74 as if
the Tieasuiy is playing by the same iules as eveiyone else, anu must
make inteiest payments anu piincipal payments when it boiiows
money, in piactice the Feu lets the goveinment boiiow new money
with no stiings attacheu!
In the gianu scheme, then, the feueial goveinment anu
Feueial Reseive employ the same basic mechanism useu by Caesai:
In auuition to what the goveinment spenus thiough uiiect taxation
anu boiiowing fiom people in the piivate sectoi, the goveinment
also finances some of its puichases thiough the cieation of new
money (supplieu by the Feu). The piocess is not as nakeu as
Caesai's methous, but the unueilying economics aie essentially the
same.
7

0f couise, ieal iesouices aie consumeu by the goveinment
when it spenus this new money cieateu by the Feu. The goveinment
ieally (&$4 obtain bombeis anu ieally (&$4 finance welfaie
payments with its spenuing. So what's the catch. Bow can the
"#$%&'()#!
!
14S
goveinment obtain all these goouies meiely by having the Feu piint
up gieen pieces of papei.
The answei is the same now as it was uuiing the Roman
Empiie. All holueis of uollai bills ultimately pay the cost thiough the
hiuuen tax of iising piices. In othei woius, in auuition to theii uiiect
tax payments anu whatevei money they uiiectly lenu to the
goveinment by buying Tieasuiy bonus, the public .-4& pays in the
foim of the iising cost of living.
Keynesian economics pioviues the intellectual justification
foi this massive tiansfei of wealth fiom the public to the
goveinment. 0nce we unueistanu the basic mechanics of the
opeiation, we can now unueistanu why politicians aie so ieluctant
to cut spenuing anu balance the buuget. 0nlike a piivate householu
oi coipoiation, theie is no uangei of insolvency foi the goveinment,
so long as it can iely on the Feu to cieate new uollai bills. 0f couise,
gieatei inflation of the money supply will leau to iising piices anu
soaiing inteiest iates, anu so the Feu must exeicise 4&7$! iestiaint.
Nonetheless the oveiall tienu is cleai: The goveinment is making no
ieal effoit to pay off any of the mounting uebt (bonus). Remembei
that unuei Keynesian economics, it uoes not neeu to. Cuiiently the
official uebt level is some thiiteen tiillion uollais, anu that figuie
uoesn't incluue the total obligations of the goveinment uue to
Neuicaie anu othei commitments.
"#$%&'()#!
!
144

0nce we unueistanu the piocess of inflation, we can see how
absuiu it is when Feueial Reseive officials solemnly pleuge to ,*1#/!
inflation. It is a bit like aisonists piomising to uo theii pait in
combating foiest fiies. In the context we see a haimful effect of the
change in uefinitions, when the teim *+,-./*&+ useu to mean an
inciease in the supply of money oi cieuit, wheieas now most people
use *+,-./*&+! to mean iising piices. Eveiy time the Feueial Reseive
piints new money, it is inflating the money supply, theieby uiluting
"#$%&'()#!
!
14S
its value. The tiuth is that high piices aie the effect, oi the iesult of
inflation.
Beyonu the cuise of constantly iising piicesoi what is the
same thing, a constant eiosion of the value of the uollaiinflation
via the Feueial Reseive .-4& causes the boom-bust cycle, as
explaineu by Austiian economists. But we fiist neeu to unueistanu
fiactional ieseive banking, befoie exploiing this piece of the puzzle.

"#$%&'()#!
!
146

1
Henry Hazlitt, What You Should Know About Inflation (New York: D. Van Nostrand
Company, Inc., 1965), p. 2.
2
1998), pp. 761-763.
3
See Robert P. Murphy, The Costs of Government, at:
http://www.econlib.org/library/Columns/y2010/Murphygovernmentcosts.html.
Accessed May 31, 2010. Government statisticians count government expenditures as
part of Gross Domestic Product, and so the ratio of government spending to the size of
the economy is artificially deflated. But once we recognize that many of the
governments services arent really worth what the politicians spend on them, the
true fraction of real economic output seized by the government becomes much larger.
4
The Keynes quotation is listed in a Paul Krugman blog post, Bush is right about
something, February 19, 2008, at:
http://krugman.blogs.nytimes.com/2008/02/19/bush-is-right-about-something/.
5
For a full comparison of the Austrian and Keynesian theories, and their ability to
explain historical episodes, see Robert P. Murphys The Politically Incorrect Guide to
the Great Depression and the New Deal (Washington, D.C.: Regnery, 2009).
6
In practice, the Federal Reserve doesnt directly buy new bonds auctioned by the
Treasury. Instead, private dealers buy the new bonds, and then resell them to the Fed.
7
For a fuller description of this process, see Robert P. Murphy, The Fed as Giant
Counterfeiter, at: http://mises.org/daily/4029. Accessed May 31, 2010.
147
!"#$%&'()(
*'#+%,-.#/(0&1&'2&(3#.4,.5(
!
!
"#$%$! &'&! (#$! )*+$,! -*)$! .%*)/! 0(!
-1)$21+&!(#'3!'3!(#$!)*3(!')4*%(1+(!
3'+56$! (#'+5! (*! 7+*8! 19*:(! )*&$%+!
91+7'+52'(! -1)$! *:(! *.! (#'+! 1'%;!
<*))$%-'16! 91+732(#1(! '3=!
.%1-('*+16! %$3$%>$! 91+732-%$1($!
)*+$,!*:(!*.!(#'+!1'%;!
2?:%%1,!@;!A*(#91%&
B
!
!
!
t's easy to imagine a countiy awash in fiat papei cuiiency
flowing fiom the Feu's piinting piesses, but we all know
that papei cuiiency in oui mouein woilu is uisappeaiing. In oui
high tech enviionment money now mostly flows electionically. The
conuuit foi mouein uay inflation is not papei cuiiency, it's -%$&'(!
$C41+3'*+.
To unueistanu how the Feueial Reseive expanus oi contiacts
the money supply using cieuit, we neeu an oveiview on the meaning
anu woikings of two functions of mouein banking. In may be helpful
to see them as the oiiginating functions of the piocess. 0ne is the
I
"#$%&'()$*!+,-,#.,!/$)0')1!
DDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDD!
!
148
.$&$%16! .:+&3! %1($ anu the othei is the &'3-*:+(! %1($, both of which
aie contiolleu by the Feueial Reseive.
All commeicial banks which aie a pait of the Feueial
Reseive's Cential Banking System must keep a ceitain amount of
%$3$%>$3 to back up customei ueposits. The Feueial Reseive contiols
this limit. Piesently, the ieseive limit is appioximately 1u% on
aveiage (the iate being uiffeient foi banks of uiffeient sizes). Foi
example, if a bank's customeis collectively holu $1 million in
ueposits, then the bank must itself have $1uu,uuu in ieseives. The
ieseives consist of eithei cuiiency in the vault, *%!as the bank's own
checking account with the Feueial Reseive itself. To continue oui
example, the bank might have $2S,uuu in gieen pieces of papei in its
vaults, available foi immeuiate customei withuiawals, anu it might
have $7S,uuu listeu as the balance of its account with the Feu.
Fiom time to time, the vagaiies of the banking business leau
some banks to have excess ieseives, anu otheis to have ueficit
ieseives. Banks will boiiow fiom each othei in oiuei to make up
theii ueficits anu iemain in goou stanuing with the Feu. The maiket
foi oveinight loans of ieseives is calleu the feueial funus maiket,
anu the inteiest iate (expiesseu as an annual peicentage) is the "feu
funus iate." When we heai in the news that the Feueial Reseive has
incieaseu oi loweieu "inteiest iates," what they have actually uone
is set a "taiget" inteiest iate foi banks to chaige each othei foi these
oveinight loans.
"#$%&'()$*!+,-,#.,!/$)0')1!
!
149
The Feueial Reseive uoes not &'%$-(6, set the feu funus iate,
but insteau inuiiectly influences it by eithei auuing oi iemoving
ieseives fiom the system. If the actual iate that banks chaige foi
loans is highei than the uesiieu taiget iate, then the Feu buys assets
anu auus ieseives to the system; the influx of new ieseives makes it
easiei foi banks to meet theii ieseive iequiiements, anu so the
actual feu funus iate falls towaiu the uesiieu taiget. 0n the othei
hanu, if the actual feu funus iate is lowei than the taiget, the Feu can
sell assets off its balance sheet, theieby uiaining ieseives fiom the
system anu making banks sciamble to meet theii ieseive
iequiiements. In this seconu scenaiio, the Feu incieases the banks'
uemanu foi ieseives, anu theieby the Feu inuiiectly causes the feu
funus iate to inciease (which is what the Feu wanteu).
In auuition to inuiiectly contiolling the feu funus iate, the
Feu uiiectly sets the &'3-*:+(!%1($, which is the inteiest iate that the
Feu chaiges on loans it uiiectly makes to commeicial banks. To
iepeat, in the moie typical tiansaction, a bank neeuing ieseives (in
oiuei to satisfy its legal ieseive iequiiement) will seek the funus
fiom othei banks. But it can also go hat in hanu to the Feu itself,
boiiowing fiom the "uiscount winuow." In oiuei to uiscouiage this
activityanu especially to pievent an aibitiage situation in which a
bank coulu boiiow fiom the Feu anu lenu the ieseives out to othei
banksthe Feu usually sets its uiscount iate slightly highei than the
taiget foi the feu funus iate.
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1Su

Although the Feueial Reseive has been making uiiect loans
to banks in an extiaoiuinaiy mannei uuiing the cuiient ciisis,
histoiically the Feu influenceu the maiket '+&'%$-(6, by affecting the
total amount of ieseives in the system. This occuis thiough *4$+!
)1%7$(! *4$%1('*+3, in which the Feueial Reseive buys anu sells
assets. In pievious chapteis we have uiscusseu some of the
mechanics, but now we will complete oui sketch.
To begin, suppose that the Feueial Reseive buys $1 million
woith of goveinment bonus fiom a piivate bonu uealei. The Feu
pays foi the bonus by wiiting a check upon the Feu itself. The bonu
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1S1
uealei ueposits the check at his local bank, anu natuially his
checking account is cieuiteu with $1 million.
Fiom the bank's point of view, its liabilities have incieaseu by
$1 millionone of its customeis now has $1 million moie in his
checking account. But the bank's assets have gone up by the same
amount, because the bank takes the check anu cleais it with the Feu.
The bank has a "checking account" as it weie with the Feu itself, anu
(#1( account has now gone up by $1 million as well.
At fiist glance, it might seem as if the commeicial bank is
unaffecteu by the Feu's puichase of the bonus. Aftei all, the bank's
liabilities have gone up by $1 million, anu its assets have gone up by
the same amount. Anu inueeu, in a 1uu% ieseive banking system,
things 8*:6&! stop theie. The bank woulu meiely be a miuuleman
between the Feu anu the piivate bonu uealei.
Bowevei, things get much moie complicateu when the
commeicial banks aie only iequiieu to holu 1u% in ieseives. In this
fiactional ieseive enviionment, when the bonu uealei ueposits $1
million in new ieseives into the system, this tiansaction now allows
the commeicial banks to -%$1($!EF!)'66'*+!'+!1&&'('*+16!6*1+3.
This can be a veiy confusing fact, so let us iestate exactly
what happeneu: The Feueial Reseive appioacheu a piivate bonu
uealei, anu wiote him a check foi $1 million wiitten on "the Feueial
Reseive." This million uollais was cieateu out of thin aii; by
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1S2
uefinition, the Feu's checks cleaiit is impossible foi the Feu to
bounce a check!
So alieauy, even at step one, theie is a new $1 million in
money (in electionic foim) in the economy. But when the bonu
uealei ueposits his check into the commeicial banking system, look
at what happens: The total checking account balances of the
commeicial banks inciease by $1 million (the checking account of
the bonu uealei himself). But at the same time, theii ieseives (on
ueposit with the Feu) have gone up by $1 million as well.
We know that banks aie only iequiieu to set asiue 1u% of
theii customei checking account balances as ieseives. Theiefoie,
the banks can have an outstanuing total of $1u million in balances,
being backeu up by the (new) $1 million in ieseives. Anu since the
bonu uealei has only "soakeu up" $1 million of that total, the
commeicial banks aie legally entitleu to cieate an 1&&'('*+16 $9
million in new loans.
Bow exactly uo they uo this. In the same way that the Feu
itself uoes itthey cieate money out of thin aii, just as Rothbaiu
claimeu in oui opening quotation foi this chaptei. Specifically, when
a commeicial bank has "excess ieseives"meaning that it has moie
than 1u% in ieseives, backing up its total customei balancesit is
alloweu to simply cieuit a loan applicant's checking account with
extia numbeis! Foi example, if a couple applies foi a $2uu,uuu
moitgage, the commeicial bank is legally able to simply open up a
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1SS
new account anu type in "$2uu,uuu" as the balance, with which the
couple can then buy theii uieam house. Not too shabby, is it.
To ieview: When the Feu buys goveinment bonus woith $1
million, it wiites a check on itself foi the amount of the puichase.
The peison selling the bonus then takes the check anu (of couise)
ueposits it with a commeicial bank. The commeicial banking system
at this point has an auuitional $1 million in ieseives (which
iemembei incluue not just physical cuiiency in the vault, but also a
bank's ueposits with the Feu itself). Because banks aie only subject
to a 1u% ieseive iequiiement, the inciease of $1 million in ieseives
means that the banks aie now legally alloweu to expanu theii
customeis' total checkbook balances by $1u million. The peison
who solu the bonus to the Feu alieauy accounts foi $1 million of
these new checkbook balances. That means the banks aie still fiee
to lenu out an auuitional $9 million to theii customeis, anu in a veiy
ieal sense this new money is cieateu out of thin aii.
When all is saiu anu uone, the people in this hypothetical
community aie now walking aiounu with $1u million moie money
in theii possession, anu spenu it on goous anu seivices. This
inflation of the money supply will push up piices.

"#$%&'()$*!+,-,#.,!/$)0')1!
!
1S4

We have one final wiinkle to auu to oui explanation of cieuit
inflation. In oui stoiy above, we saiu that when the Feu injects $1
million in new ieseives by puichasing assets, that the commeicial
banks iesponu by cieating an auuitional $9 million in fuithei loans.
This is tiue. Bowevei, it is +*( tiue that (#$!>$%,!.'%3(!91+7 to ieceive
the initial $1 million check fiom the Feu, is theiefoie going to lenu
out $9 million in new loans to its own customeis.
To see why, let's walk thiough the following scenaiio:
Assume commeicial bank #A has a customei who ieceives a $1
million payment fiom the Feu (peihaps foi bonus) anu then
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1SS
ueposits the check with bank #A. Because its ieseives with the Feu
have just incieaseu by $1 million, the 1u% ieseive iequiiement iule
allows bank #A to make a loan to Neiiill Lynch in the amount of $9
million uollais. To caiiy this out, bank #A simply changes the
numbeis in Neiiill Lynch's checking account anu Neiiill Lynch is
authoiizeu to spenu the money. It's ciitical to iealize that this $9
million that was cieuiteu to Neiiill Lynch's account uiun't "come
fiom" somewheie; bank #A simply incieaseu the numbei showing
Neiiill Lynch's balance by $9 million.
To continue oui stoiy, suppose Neiiill Lynch ueciues to
puichase fiom the XYZ Fuinituie Stoie, $9 million in fuinituie to
ievamp all of its executive offices nationwiue. It wiites a check fiom
its account at commeicial bank #A maue out to the XYZ Fuinituie
Company. XYZ Company ueposits this check at its bank, commeicial
bank #B. What will happen when commeicial bank #B piesents the
$9 million check to commeicial bank #A foi ieuemption. Remembei
that commeicial bank #A only has $1 million in ieseives.
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1S6

The answei is that commeicial bank #A will have a ieseive
ueficit of $8,1uu,uuu. Realize that its total customei ueposits aie
now $1 million highei than they weie oiiginallybecause we
assume the bonu uealei hasn't spent any of his new checking
account balance, wheieas Neiiill Lynch has emptieu out its new
accountwhile the bank's ieseives aie $8 million smallei than they
weie befoie the whole piocess got staiteu. Bence, if bank #A
oiiginally hau just enough ieseives to covei its total customei
checking account balances, it woulu now be $8,1uu,uuu in the hole.
G#'3 is why a commeicial bank woulu be foolish to loan out laige
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1S7
multiples of an initial injection of new ueposits, in one fell swoop.
Customeis who take out loans aie likely to spenu the new checking
account balances, anu inteibank cleaiing opeiations will soon move
the excess ieseives to othei banks.
Bowevei, in teims of (#$! 91+7'+5! 3,3($)! 13! 1! 8#*6$, the
excess ieseives can ultimately become iequiieu ieseives as each
bank sequentially cieates moie anu moie new loans. The )*+$,!
):6('46'$% is achieveu by a combination of banks thioughout the
cential banking system. Economics textbooks simplify the piocess
by supposing that each bank follows a lenuing foimula which is (1
Ninus the Ninimum Reseive Requiiement) = 9u% on each new
uollai uepositeu. In oui example, the maximum loan amount maue
to Neiiill Lynch in the fiist iounu woulu be $9uu,uuu, not $9
million. In this way, commeicial bank #A is still compliant with the
1u peicent ieseive iequiiement, even if Neiiill Lynch spenus all of
its new loans anu othei banks immeuiately uemanu ieuemption.
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1S8

0nce commeicial bank #A honois the ieuemption fiom
commeicial bank #B, this bank is out of the money multipliei loop
even though Neiiill Lynch still has a loan obligation with it. But now
commeicial bank #B can lenu out 9u% on its ueposit of $9uu,uuu.
This woulu be loans equaling $81u,uuu. If on this chait we hau
anothei bank, commeicial bank #C, this bank woulu be able to lenu
out 9u% on its ueposits of $81u,uuu. This woulu be loans equaling
$729,uuu.
"#$%&'()$*!+,-,#.,!/$)0')1!
!
1S9
What we aie uiiving at is that it is the total of banks in the
aggiegate that expanu the money supply. With each "iounu" as it
weie, anothei bank in the chain contiibutes a smallei inciement of a
new loan into the system. In oui example, if Neiiill Lynch gets a
$9uu,uuu loan fiom commeicial bank #A anu buys fuinituie with it,
XYZ Company will then ueposit the $9uu,uuu at commeicial bank
#B. Yet this new ueposit is veiy similai to the bonu uealei's oiiginal
ueposit of $1 million, except that it is 1u peicent smallei. So the
piocess continues foi commeicial bank #B, just as it uiu foi bank
#A, except all the numbeis in "iounu 2" aie 1u% lowei than they
weie in "iounu 1." The piocess can continue foi many iounus, with
each subsequent bank making a new loan that is 1u% smallei than
the pievious bank's loan.
By simply auuing the expansion of loans foi the fiist thiee
banks, A, B anu C, the total is alieauy neaiing $2.S million. In the
limit, the oiiginal $1 million injecteu by the Feu's puichase of bonus
woulu ultimately cascaue into the cieation of anothei $9 million in
new loans anu spenuing in the economy.
At this point, the scales may be falling fiom the eyes of the
ieauei. Fiactional ieseive banking anu its woikings aie finally being
unueistoou. The uestiuctive iamifications foi oui society anu oui
woilu aie staggeiing. You the ieauei may be having youi fiist
moment of claiity on the subject of inflation. We all face imminent
uangei. If we aie to have any hope of stopping inflation anu its
"#$%&'()$*!+,-,#.,!/$)0')1!
!
16u
uestiuction, this piece of the mysteiious money puzzle cannot be
kept to oneself; it must be uncoveieu anu exposeu to the geneial
public as soon as possible. If you aie now asking "Bow.", ieau Paits
II anu III of this book foi the veiy best solution.
The thieat of uouble-uigit piice inflation is veiy ieal. The
collapse of oui entiie monetaiy system is possible. The tiiggei has
alieauy been pulleu. The banks at this veiy moment aie sitting on
moie ieseives than they have evei hau in the histoiy of banking in
the 0niteu States! They have excess ieseives in unpieceuenteu
amounts! This giaph, taken uiiectly fiom the Feueial Reseive's
website, shows the teiiible stoiy. Although millions of people have
now seen it, veiy few can unueistanu its iamifications without fiist
having the knowleuge of the function of fiactional ieseive banking.
You can now see it in its piopei light. This is inueeu a teiiible
situation.
"#$%&'()$*!+,-,#.,!/$)0')1!
!
161

This chait is staitling. Notice that the timeline goes back to
192S; nothing even iemotely close to oui cuiient situation has evei
occuiieu, even uuiing the uepths of the uieat Bepiession. Notice
that the line shoots stiaight up the chait all in one yeai! The Feu, as
shown by the veitical line maiking excess ieseives, has alloweu its
balance sheet to exploue (by puichasing assets thiough open
maiket opeiations) uuiing the last two yeais. Its balance sheet was
$92u billion in Becembei of 2uu7. In just one yeai it jumpeu to $2.S
"#$%&'()$*!+,-,#.,!/$)0')1!
!
162
tiillion by Becembei 2uu8.
2
This means that banks aie sitting with
huge excess ieseives iight now!
Let us spell out the potential implications. As of this wiiting
(spiing 2u1u), excess ieseives have exceeueu $1 tiillion.
S
0sing the
iough 1u% ieseive iatio, that means commeicial banks in the
0niteu States have the legal ability to cieate an auuitional EBH!
(%'66'*+!in new loans. Bow much is this. Consiuei that iight now the
total amount of physical cuiiency anu checkbook ueposits helu by
the public (what is known as "N1") is a meie $1.7 tiillion.
4

Thus, if the commeicial banks began cieating new loans
pyiamiueu on top of the massive ieseives that the Feu has pumpeu
into the system since the ciisis stiuck in the fall of 2uu8, they woulu
have the ability to cause the entiie money supply helu by the public
to go up 9,!1!.1-(*%!*.!.'>$. What uoes this mean. Well, if we assume
that all piices woulu iesponu mechanically to the inciease, it woulu
mean gasoline piiceu at $1S pei gallon. But of couise, in such a
situation people woulu panic anu flee the uollai, making the piice
inflation even woise.
We uo not wish to cause the ieauei unuue alaim. We aie not
necessaiily 4%$&'-('+5 that gasoline piices will soon hit $1S. Foi one
thing, the commeicial banks aie cleaily not eagei to cieate new
loans anytime soon, because theii balance sheets might take fuithei
hits as they continue to wiite off bau loans alieauy on theii books. It
is also possible that Feu chaii Ben Beinanke coulu ieveise couise
"#$%&'()$*!+,-,#.,!/$)0')1!
!
16S
anu begin uiaining the excess ieseives out of the system, befoie the
inflation genie gets out of the bottle.
Regaiuless of which couise histoiy ultimately takes, you the
ieauei have now seen oui quanuaiy. Anu it is monstious.

1
Murray Rothbard, The Mystery of Banking (Auburn, AL: The Ludwig von Mises
2
For an excellent analysis of the changing composition of the Feds balance sheet over
time, see Catherine Rampells NYT blog post, Fed Balance Sheet Expansion: Some
Takeaways, May 7, 2009, at: http://economix.blogs.nytimes.com/2009/05/07/fed-
balance-sheet-expansion-some-takeaways/. Accessed June 3, 2010.
3
The reason we have posted a slightly outdated chartin which the excess reserves
had not yet topped $800 billionis that the St. Louis Fed truncated its data history
soon after the chart in the text was captured. Consequently, if one tries to generate the
most recent chart of excess reserves, it will only go back to the 1959, rather than our
chart which goes back to the 1920s.
4
The St. Louis Federal Reserve lists these statistics at:
http://research.stlouisfed.org/fred2/data/M1NS.txt. Accessed June 3, 2010.
!"#$%&'(#)*+,-,".,*/#(0&(1*
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!
"#$!
!
!"#$
!"#$%&&%
'()%*+,-.%/+-)0%*+1,$2+-%
$
$
!"#$%&'#!#()#*%+,#-.'#/'0)#1.%",%&234#5)#,+67.66),#'0)#8)")&%*#
)7-"-9+7#:&-;*)9#7%.6),#;2#67%&7+'2<#%6#()**#%6#'0)#6:)7+=+7#)7-"-9+7#
:&-;*)9#7%.6),#;2#8->)&"9)"'#=+%'#9-")2#%",#7)"'&%*#;%"?+"83#
!"#'0+6#6)7'+-"<#$%&'#!!<#()#)@:*%+"#'0)#A-.",#B-")2#A-*.'+-"3#!'#
+6#+"'+9%')*2#'+),#'-#'0)#)7-"-9+7#%"%*26+6#-=#'0)#C.6'&+%"#A70--*3#D"7)#
2-.#.",)&6'%",#'0)#;%6+7#9)70%"+76#-=#%#9%&?)'#)7-"-92<#2-.#(+**#6))#
0-(# '0)# =%9+*+%&# +"6'+'.'+-"6# -=# 9-")2<# ;%"?+"8<# %",# +"6.&%"7)# %**-(#
+",+>+,.%*6# '-# :)%7)=.**2# 7--:)&%')# '-# 8&%::*)# (+'0# '0)# :&-;*)9# -=#
67%&7+'23#
E"=-&'."%')*2<#'0)&)#%&)#:-()&=.*#=-&7)6#%'#(-&?#'-#,+6&.:'#'0)#
"%'.&%*# ,)>)*-:9)"'# -=# '0)6)# 9%&?)'F;%6),<# >-*."'%&2# &)*%'+-"60+:63#
G0)# 6'.,)"'# -=# 0+6'-&2# ?"-(6# %**# '--# ()**# '0%'# '0)# &+70# %",# :-()&=.*#
'.&"#'-#8->)&"9)"'#=-&#6:)7+%*#:&+>+*)8)6#%",#0%",-.'6<#%",#6%;-'%8)#
'0)#:)%7)=.*#-:)&%'+-"#-=#'0)#9%&?)'#)7-"-923#
!"# '0+6# 6)7'+-"# ()# (+**# )@:*%+"# '0%'# 8->)&"9)"'# +"')&=)&)"7)#
(+'0# '0)# 9%&?)'# )7-"-92# *)%,6# '-# '0)# =+"%"7+%*# 7&+6)6# '0%'# 6))9# '-#
+")@:*+7%;*2#:*%8.)#-.&#7-."'&23#H-"'&%&2#'-#:-:.*%&#;)*+)=<#+'#(%6#"-'#
*%+66)IF=%+&)# 7%:+'%*+69# '0%'# 7%.6),# '0)# 0-.6+"8# ;.;;*)# %",# 7&%60# -=#
'0)#JKKK6<#"-&#,+,#+'#7%.6)#'0)#8&)%'#6'-7?#9%&?)'#7&%60#-=#LMJM3##
!"#$%&'()*%+,-./%0,.*1%+,2-$3,.%
NNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNN#
#
!""$
O)+'0)&# P)-&8)# 53# Q.60# "-&# )>)"# R)&;)&'# R-->)&# ()&)# =&))F
9%&?)'# +,)-*-8.)6S# -"# '0)# 7-"'&%&2<# '0)2# ()&)# Q+8# P->)&"9)"'# 9)"#
(0-#)@:%",),#'0)#67%*)#-=#'0)#=),)&%*#8->)&"9)"'#-"#'0)+&#&)6:)7'+>)#
(%'70)63#
!"# -&,)&# '-# .",)&6'%",# '0)# A-.",# B-")2# A-*.'+-"<# 2-.# 9.6'#
=+&6'# .",)&6'%",# 0-(# 9-")2# %",# ;%"?+"8# (-.*,# (-&?# +"# %# 8)".+")*2#
=&))# 9%&?)'# )">+&-"9)"'<# (+'0-.'# 8->)&"9)"'# -;6'%7*)6# '-#
7-9:)'+'+-"# -&# ;%+*-.'6# =-&# :-*+'+7%**2# 7-"")7'),# +"')&)6'63# G0)"# 2-.#
(+**#.",)&6'%",#0-(#-.&#:&)6)"'<#:)&>)&'),#626')9#7%.6)6#%**#-=#'0)#+**6#
'0%'# %&)# '2:+7%**2# ;*%9),# -"# /7%:+'%*+6934# T-.# (+**# '0)"# .",)&6'%",#
'0)# ")7)66+'2# -=# '0)# A-.",# B-")2# A-*.'+-"U'0%'# '0)# -"*2# (%2# '-#
:)&9%")"'*2# )*+9+"%')# =+"%"7+%*# 7&+6)6<# %",# '0)# %**F'--F=%9+*+%&#
;--9V;.6'# 727*)<# +6# '-# 8)'# '0)# 8->)&"9)"'# -.'# -=# '0)# ;.6+")66# -=#
:&+"'+"8#9-")2#%",#:&-::+"8#.:#=%+*),#;%"?63#
$
$
167
!"#$%&'()(
*"&(+,-&(,.(/,01#-(234%1%5%1,34(

!"#$%&'()*+%&#"$(#,-.-/-0+*-"%1#"%'#2$)*#
+33(',-+*'# *4+*# *4'# '5*'%&'&# "(&'(#
(')$/*'&# %"*# 6("2# 4$2+%# &')-7%# "(#
-%*'%*-"%# 8$*# )3"%*+%'"$)/9:# -*# +(")'#
6("2# $%-%*'%*-"%+//9# ,"%6"(2-%7# *"#
,'(*+-%# *(+&-*-"%+/# +%&# /+(7'/9# moial#
3(+,*-,');#
<=(-'&(-,4#>+9'?
@
#

ocial -%)*-*$*-"%) aie ielationships anu behavioial
piactices that allow humans to bettei cope with the
pioblems of life in this woilu. At the most geneial level, institutions
can incluue staples of society such as the family anu the moial coue,
but institutions can also incluue faiily tiivial examples such as the
piactice of tipping oi giving gifts on biithuays.
Institutions pioviue a fiamewoik of continuity anu
pieuictability that allows people to moie accuiately plan theii
activities. In paiticulai, institutions help us inteiact with each othei
by imposing a sense of stability anu oiuei onto the initially chaotic
jumble of life. We all unueistanu that paients anu teacheis neeu to
S
!"#$%&'#$&($)&*+,'$-./0+010+&./$
AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA#
#
168
pioviue a "ioutine" foi young chiluien, but iionically we auults neeu
ioutines ouiselves foi mouein civilization to be possible. We go
thiough oui ioutines of going to woik, buying items fiom the stoie,
going home to live with oui family membeis (oi ioommates), anu of
couise we uiiectly communicate with each othei with the institution
of languagecomplete with its iules of giammai anu uefinitions
that eveiyone in the community shaies.

*"&(6#%#-(!,30&1%(

0ne of the scouiges of the 2u
th
centuiy was the aiiogant
belief by many intellectuals that they coulu oveituin the inheiiteu
social oiuei anu iemake society fiom sciatch. In theii view, if the
existing customs anu social piactices coulun't be justifieu on a
puiely "iationalist" basis, then they weie obviously obsolete anu
shoulu be jettisoneu in favoi of new, "scientific" piinciples.
We have put these teims in quotation maiks because in
ieality, it was incieuibly -((+*-"%+/ to tiy to ievamp society fiom
sciatch, anu it was veiy $%),-'%*-6-, to tiy to substitute the time-
testeu tiauitions with new piactices uieameu up by iuealistic
ievolutionaiies. Fiieuiich Bayek, one of the most celebiateu
Austiian economists anu winnei of the 1974 Nobel Piize, teimeu
this hubiis *4'#6+*+/#,"%,'-*. In his book !4'#=+*+/#B"%,'-*:#!4'#C(("()#
"6#D",-+/-)2, Bayek wiites:
!"#$%&'#$&($)&*+,'$-./0+010+&./$
#
169

|The socialistsj assume that, since people hau been able to
7'%'(+*' some system of iules |in societyj cooiuinating theii
effoits, they must also be able to &')-7% an even bettei anu moie
giatifying system. But if humankinu owes its veiy existence to
one paiticulai iule-guiueu foim of conuuct of pioven
effectiveness, it simply uoes not have the option of choosing
anothei meiely foi the sake of the appaient pleasantness of its
immeuiately visible effects. The uispute between the maiket
oiuei anu socialism is no less than a mattei of suivival. To follow
socialist moiality woulu uestioy much of piesent humankinu anu
impoveiish much of the iest.
2

The tiagic mistake of the socialist iefoimeis of the 2u
th

centuiy was in thinking that they coulu ietain the bounty of fiee-
maiket capitalism, while coiiecting its allegeu faults such as
inequalities in wealth oi peiious of high unemployment. But by
oveituining the tiauitional iules of piopeity iights, the socialists uiu
not cieate a utopia. Insteau they unwittingly paveu the way foi the
most muiueious iegimes in human histoiy, whethei on the "left"
(Stalinist Russia anu Naoist China) oi the "iight" (Bitlei's ueimany,
wheie the Nazi Paity was the National D",-+/-)*#Paity).

!"#$%&'#$&($)&*+,'$-./0+010+&./$
#
17u
*"&( +&45-%4( ,.( 758#3( 90%1,3:( ;5%( <,%( ,.( 758#3(
=&41>3(

0ne of Bayek' majoi insights was that the fatal conceit of the
socialist intellectuals leu them to believe that simply because a
social institution was ,('+*'& by humans, that it was theiefoie
&')-7%'& by them anu coulu, in piinciple, be ('&')-7%'& as a new anu
impioveu institution. Especially befoie witnessing the hoiiois of
totalitaiianism, many "goou men" believeu that a bettei woilu coulu
be cieateu if only the smaitest, most humane men put theii heaus
togethei anu ciafteu a bettei plan foi society. Insteau of the anaichic
maiket system, in which goous anu seivices weie piouuceu on the
basis of piofit, the socialists wanteu the State to oiganize all
piouuction in the seivice of 3'"3/'. It was simply the ieincaination
of Plato's vision of iule by the philosophei kings.
Besiues theii nave tiust in those who woulu seize powei in a
socialist State, the intellectuals committeu a basic mistake in theii
analysis. As Bayek iepeateuly aigueu, these intellectuals oveilookeu
the capacity of social institutions to tap the &-)3'()'&# ?%"E/'&7' of
the entiie community. So iathei than ielying on a few of the
"smaitest guys in the ioom" to uesign a new society fiom the top-
uown, the inheiiteu social institutions effectively soliciteu input
fiom '.'(9"%', both biilliant anu uull. The combineu knowleuge anu
expeiience of the entiie community was always bettei than that of
!"#$%&'#$&($)&*+,'$-./0+010+&./$
#
171
any small sample of inuiviuuals, even if those inuiviuuals weie the
best anu the biightest.
It was unueistanuable that the socialist iefoimeis
oveilookeu this key insight; it took a scholai of Bayek's biilliance to
flesh out the point uuiing his long caieei. Bayek uevoteu aiticles
anu books to the stuuy of )3"%*+%'"$)# "(&'(), iefeiiing to self-
oiganizing systems that exhibiteu pieuictable patteins, even though
nobouy uelibeiately set about to ,('+*' such an oiueily pattein.
Boiiowing a phiase fiom the Scottish moial philosophei Auam
Feiguson, Bayek saiu that in a social context, spontaneous oiueis
weie "the piouuct of human action, but not of human uesign."
What uiu Bayek mean by this ouu phiase. Be was
unueiscoiing the ciucial fact that some of oui most impoitant
institutionsincluuing spoken language, oui iules of moiality, anu
the maiket economy itselfaie obviously not "natuial" cieations,
but insteau aie cleaily the iesult of human beings. 0n the othei
hanu, we can't scoui the histoiy books to finu out which wise king,
oi gioup of scholais, -%.'%*'& the English language, oi iules of
moiality, oi the opeiation of the capitalist system. The eailiest
economists saw the hanu of uou behinu these oiueily outcomes, but
both theist anu skeptical wiiteis unueistoou that human beings on
theii own uiu not uesign such institutions.
Befoie tackling the moie complex spontaneous oiuei of the
mouein maiket economy, let's stait with a simple example: a path
!"#$%&'#$&($)&*+,'$-./0+010+&./$
#
172
thiough a foiest. When a newcomei begins a hike in the foiest, he
will likely take the path of least iesistance, meaning he will follow
the well-woin tiail that otheis have alieauy cieateu. Now this path
oi tiail is cleaily the iesult of human action; the bianches weie not
iemoveu by beaveis, anu the foliage on the giounu was not eaten
away by cows. Even so, we uon't neeu to assume that the fiist
human to stumble into the viigin woous, uelibeiately set out to
cieate a path to seive subsequent tiaveleis.
0n the contiaiy, it's almost ceitainly the case that the fiist
peison to wanuei into the foiest pickeu his way thiough it, looking
foi the most auvantageous ioute. Be obviously woulu walk aiounu
laige tiees, woulu avoiu piickly bushes, anu woulun't walk into a
ueep iivei. But what the pioneei woulu be uoing, quite unwittingly,
was make it easiei foi the %'5* peison to follow in his footsteps.
Peihaps he woulu caiiy a machete anu hack away the bianches as
he stumbleu along this maiuen voyage; this woulu make it much
easiei foi the next peison to take the same ioute.
uiauually, ovei the uecaues, anu especially if hunuieus of
people hau to walk thiough this paiticulai foiest, a "goou" ioute
woulu be uiscoveieu. Its excellence woulu be enhanceu eveiy time
anothei peison walkeu along it, foi each such passage woulu stamp
uown any weeus attempting to giow in the uiit tiail, anu woulu
snap any small bianches that hau ventuieu into the coiiiuoi.
!"#$%&'#$&($)&*+,'$-./0+010+&./$
#
17S
This hypothetical path thiough the foiest woulu thus cleaily
be the iesult of human action, anu yet not of human uesign. All of the
hikeis ,"//',*-.'/9 contiibuteu to its cieation, ovei the couise of
uecaues, even though each inuiviuual hikei was acting in his own
inteiest anu in fact piobably hau no iuea he was assisting all
subsequent hikeis.
Now it's tiue, the path might not be "optimal" fiom the
viewpoint of a paik iangei who conuucts a helicoptei suivey of the
entiie foiest. The iangei might lament the fact that the path goes a
ceitain way, iathei than anothei. Even so, *+?-%7# *4'# E"(/&# +)# -*# -),
the iangei iealizes that it woulu be too confusing to tiy to "fix" the
path. It woulu take a lot of manpowei (with machetes anu axes) to
cleai the "bettei" path, anu then the iangei woulu have to set up
fences oi othei obstacles to inuuce people to stop using the oiiginal,
convenient path.
0ui simple example of a path thiough a foiest is a goou
metaphoi foi the Austiians' insights on the institutions of a maiket
economy. We will outline some of the most impoitant ones in the
following chapteis. But it is impoitant to keep in minu that even
though we will uiscuss the iole oi "function" of each institution, anu
how it helps humans ueal with the economic pioblem of scaicity,
that even so these institutions weie not consciously inventeu by any
human being.

!"#$%&'#$&($)&*+,'$-./0+010+&./$
#
174

1
Friedrich A. Hayek (ed. W. W. Bartley III), The Fatal Conceit: The Errors of
Socialism (Chicago: The University of Chicago Press, 1988), p. 6.
2
Hayek, The Fatal Conceit, p. 7.
17S
!"#$%&'()*(
+',-#%&(+'.$&'%/(

!"#$%"&'( )#%*( +#&( %,-*&( .%/01*%( &2%"%(
0"%( 304*5( .1&( 304*( %,-*&( .%/01*%( &2%"%(
-*($"#$%"&'6(
78"%)%"-/(90*&-0&
:
(

ne of the most funuamental social institutions is $"-;0&%(
$"#$%"&'. In a capitalist system, all pieces of tangible
wealth, incluuing not just consumei goous (Tvs, computeis, spoits
cais, pizzas) but also capital goous (tiactois anu uiill piesses) anu
natuial iesouices, aie owneu by piivate inuiviuuals. Sometimes
laige assets such as a majoi coipoiation aie owneu by a gioup of
inuiviuuals, but even heie theie aie uefinite owneiship claims of
each peison to a specific poition of the total asset.
Bistoiians anu anthiopologists can uebate the uiffeient
systems of piopeity law in vaiious cultuies fiom uiffeient eias anu
uiffeient iegions of the woilu. Bowevei, in teims of economic
analysis, the function of piivate piopeity iights is stiaightfoiwaiu:
Because this woilu is plagueu by scaicitytheie aie unlimiteu
human uesiies but only limiteu iesouices to satisfy themtheie is a
natuial /#+<3-/& ovei the use of these iesouices. It is the social
0
!"#$%&'(!")*'"&+(
==========================================================(
(
176
function of piopeity iights to be the "tie bieakei" as it weie,
whenevei conflict aiises. Austiian economist Bans Boppe explains:

Foi a concept of piopeity to aiise, theie must be a scaicity of
goous. Shoulu theie be no scaicity, anu shoulu all goous be so-
calleu "fiee goous" whose use by any one peison foi any one
puipose woulu not in any way excluue (oi inteifeie with oi
iestiict) its use by any othei peison oi foi any othei puipose,
then theie woulu be no neeu foi piopeity. If, let us say, uue to
some paiauisiac supeiabunuance of bananas, my piesent
consumption of bananas uoes not in any way ieuuce my own
futuie supply (possible consumption) of bananas, noi the
piesent oi the futuie supply of bananas foi any othei peison,
then the assignment of piopeity iights, heie with iespect to
bananas, woulu be supeifluous. To uevelop the concept of
piopeity, it is necessaiy foi goous to be scaice, so that conflicts
ovei the use of these goous can possibly aiise. It is the function of
piopeity iights to avoiu such possible clashes ovei the use of
scaice iesouices by assigning iights of exclusive owneiship.
Piopeity is thus a noimative concept: a concept uesigneu to
make a conflict-fiee inteiaction possible by stipulating mutually
binuing iules of conuuct (noims) iegaiuing scaice iesouices.
2

To iepeat, we aie not heie talking about *$%/-<-/()-*&"-.1&-#+*(
of piopeity iights. It may veiy well be that oui cuiient legal system
has given its enuoisement of "piopeity iights" that aie in fact the
!"#$%&'(!")*'"&+(
==========================================================(
(
177
iesult of histoiical injustices. We aie not uefenuing (noi attacking)
the cuiient assignment of piopeity iights.
What we 0"%( saying is that piivate piopeity itself is an
inuispensable institution, without which mouein civilization woulu
be impossible. Inueeu it is such a beuiock of society that one of the
Ten Commanuments ("Thou shalt not steal.") piesupposes the
existence of piopeity iights.

1
Frederic Bastiat, Property and Law (1848), at:
http://bastiat.org/en/property_law.html. Accessed June 4, 2010.
2
Hans Hoppe, A Theory of Socialism and Capitalism (U.S.A.: Kluwer Academic
Publishers, 1990), p. 18. Available at: http://mises.org/books/Socialismcapitalism.pdf.
Accessed May 25, 2010.
!"#$%&'(!")*'"&+(
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!
"#$!
!
179
!"#$%&'())(
*'#+&(

!"#$%&'( "#( )( #$&*++,-( .-$/--0( $/%(
1&"02"1,-#3( $4-( 1-)2-5*,( 1&"02"1,-3(
/4"24( )67)02-#( $4-( 6-7-,%18-0$( %5(
$&)6-3( )06( $4-( 8","$)&"#$9"81-&"),"#$(
1&"02"1,-3( /4"24( "0$-&1&-$#( 4*8)0(
#%2"-$'( 0%$( )#( )( 5&"-06,'( 6"7"#"%0( %5(
,).%*&(.*$()#($4-(5%&2".,-(&-1&-##"%0(%5(
#%8-(%5("$#(8-8.-&#(.'(%$4-&#:(
;<*6/"+(7%0(="#-#
>
(

lthough we take it foi gianteu, the piactice of voluntaiy
$&)6- unueipins oui entiie economic system. A system
of shaieu beliefs about piivate piopeity iights minimizes conflicts
anu allows humans to live in peace with each othei. But if eveiyone
weie stuck with whatevei collection of piopeity he helu &"+4$()$($4"#(
8%8-0$anu uiun't have the ability to swap with othei people
things woulu be pietty bleak, even foi the people who staiteu out
with a lot of "stuff."
The benefits of tiaue aie so obvious that we see them even in
the ineiactions of chiluien. At lunch one uay }immy uiscoveis that
A
!"#$%&
??????????????????????????????????????????????????????????(
(
18u
his mothei has packeu him a bologna sanuwich, even though he
much piefeis peanut buttei. At the same time, Sally opens hei lunch
box to finu a peanut buttei sanuwich, even though she has hau the
same thing thiee uays stiaight. The two chiluien complain alouu of
theii miseiable pieuicaments, anu quickly iealize that they can
stiike a mutually auvantageous ueal. }immy tiansfeis his piopeity
(the bologna sanuwich) to Sally, who in tuin tiansfeis hei piopeity
(the peanut buttei sanuwich) to }immy. Both chiluien come out
aheau, oi at least they expect to.
Believe it oi not, economic science wasn't able to auequately
explain even such a basic tiansaction until the late 18uus. Befoie
then, thinkeis as august as Aiistotle hau been plagueu by the faulty
notion that goous anu seivices possesseu intiinsic, "objective" value.
In that fiamewoik, a maiket exchange was only just if people tiaueu
goous that weie of -@*), valueotheiwise one peison woulu be
iipping off the othei.
But as oui simple sanuwich example shows, -2%0%8"2(7),*-("#(
"0($4-(-'-(%5($4-(.-4%,6-&. To use mouein jaigon, economists say that
value is #*.A-2$"7-. That is why it's possible foi .%$4(chiluien to walk
away fiom theii tiaue, feeling as if they got the bettei enu of the
ueal. That's not a contiauiction: Both chiluien ieally uiu benefit;
each chilu can tiuthfully say that he oi she gave up a sanuwich of
lessei value, anu acquiieu a sanuwich of gieatei value.
!"#$%&
??????????????????????????????????????????????????????????(
(
181
Notice that this type of statement only woiks because
economic value is subjective. Foi example, it woulu be impossible
foi each chilu to walk away with the 4-)7"-& sanuwich, oi the
sanuwich with moie caloiies, because weight anu caloiic content
aie objective piopeities of physical objects. But the amount of
happiness oi satisfaction that a peison gets fiom a paiticulai item, is
a #*.A-2$"7- piopeity, anu one that vaiies fiom peison to peison. So
theie is no contiauiction in each peison thinking he oi she benefiteu
fiom the exchange. Tiaue is a 1%#"$"7-9#*8 game, meaning that one
peison's gain uoesn't tianslate into someone else's loss.
To avoiu confusion, we shoulu claiify that we aie talking heie
about -2%0%8"2( 7),*-( )#( 1-&2-"7-6( .'( -)24( "06"7"6*),( 2%0#*8-&. To
say "value is subjective" is not to auopt a position of ethical nihilism
oi moial ielativism. A paient can still think that it's bau foi hei chilu
to smoke cigaiettes. Even so, if an economist is tiying to explain why
cigaiette piices aie so high, pait of the explanation obviously ielies
on the unueniable fact that many people -0A%' smoking.

1
Ludwig von Mises, Socialism (Indianapolis: Liberty Fund, 1981), p. 268.
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!"#$
$
18S
!"#$%&'()*(
+,-&.(

!"#$%&'(&#")&*#&'#+$#)'"#&",&)-$&()*)$.&/)&
'(& #")& )-$& 01"234)& ",& *& 5$6'(5*)'+$& *4).&
7+$#& )-$& (*#4)'"#& ",& 0"5')'4*5& *3)-"1')%&
'(&#")&#$4$((*1%&,"1&')(&$8'()$#4$.&9$1)*'#&
4"::"2')'$(& 4*:$& )"& ;$& :"#$%& <3')$&
#*)31*55%=& *(& )-$& 1$(35)& ",& $4"#":'4&
1$5*)'"#(-'0(& )-*)& >$1$& <3')$&
'#2$0$#2$#)&",&)-$&0">$1&",&)-$&()*)$.&
?9*15&!$#6$1
@
&

he institutions of piivate piopeity anu voluntaiy tiaue
allow humans to catapult into a much highei stanuaiu
of living than woulu be possible without them. Even so, theie aie
seiious limitations on 2'1$4)& exchange, oi what is sometimes calleu
;*1)$1.
In a puie baitei economy, wheie people only tiaue goous
anu seivices that they plan on using peisonally, theie woulu be little
scope foi specialization oi foi business enteipiises. Foi example,
nobouy coulu affoiu to become a uentist, because anytime he was
hungiy, he woulu have to finu someone in the community at that
T
!"#$%&
AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA&
&
184
veiy moment who hau extia foou *#2 a toothache. Anu it woulu be
even moie impiactical foi laige-scale houses to be built, because
what aie the chances that a couple woulu happen to have a stockpile
of enough foou, clothes, anu othei goouies to exchange with all of
the woikeis, lumbei owneis, glazieis, anu biickmakeis necessaiy to
builu a house.
In shoit, although uiiect exchange allows foi a ieuistiibution
of existing piopeity titles in a way that makes eveiy paiticipant
bettei off, it still uoesn't allow people to specialize in paiticulai
occupations, anu it uoesn't fostei laige-scale piouuction. These
hallmaiks of economic piogiess can only occui with '#2'1$4)&
exchange anu ultimately the emeigence of money.

/",(0-1&-%&2(+,-&.3(

Cail Nengei was the founuei of the Austiian School, which
officially began with his 1871 tieatise on the B1'#4'05$(&",&74"#":'4(.
Be maue many contiibutions to economic theoiy, incluuing the fiist
satisfactoiy explanation of the oiigin of money.
Nost people piobably fall into the tiap that Bayek waineu
about, anu assume that since money is obviously a "piouuct of
human action," that theiefoie someone oi some gioup must have
uelibeiately '#+$#)$2 money. But if we think about it, that
explanation is absuiu. Foi one thing, theie is no histoiical iecoiu of
!"#$%&
&
18S
a wise king waking up one uay anu commanuing his subjects to
abanuon baitei in favoi of a moie efficient system.
Yet even if such a iulei 2'2& (implausibly) uieam up the iuea
of money, anu iecognize its auvantages ovei baitei, he still woulu
have pioblems implementing his new scheme. Pictuie the wise king
collecting a bunch of sea shells anu telling his subjects, "Fiom now
on, when you want to tiaue away youi suiplus goous, I uon't want
you to accept goous that you actually value in exchange foi them.
Insteau, I want you to accept these useless sea shells when you sell
youi hoises, pigs, anu laboi to otheis in the kinguom. But uon't
woiiy that you aie getting cheateu; I will foice $+$1%"#$& $5($ to uo
the same, when it's youi tuin to buy goous with these useless sea
shells."
Alieauy the plot is too fai-fetcheu to be believeu. Anu yet it
gets woise. Even if the king hau manageu to push thiough the above
schemepeihaps unuei thieat of seveie punishmentthe subjects
in his kinguom woulun't know how to 01'4$ theii vaiious objects in
teims of the new "money." Foi example, on the fiist uay of the
pioclamation, suppose a faimei hau planneu on tiauing away thiee
pigs foi anothei faimei's hoise. Now the king comes along anu
oiueis him to fiist sell his pigs in exchange foi sea shells, which he
will then use to buy a hoise. Cleaily then, he will neeu to know how
many sea shells a hoise costs, befoie setting the "sea shell piice" on
his pigs. But he can't just look at the asking piice (in teims of sea
!"#$%&
&
186
shells) fiom the hoise-sellei, because that guy is in the same
pieuicament!
So we see that theie aie seiious flaws with the typical view
that money must have been uesigneu by somebouy in the uistant
past. 0n the othei hanu, we know that money is obviously a -3:*#
phenomenon. So how exactly uiu it aiise.

4"&(56'%"(,7(0-26'&8%(9:8"#-;&

Nengei pioviues the compelling solution. Initially, even in a
state of baitei, some goous weie moie "saleable" oi (what we woulu
now call) 5'<3'2 than otheis. Foi example, a peison who wanteu to
acquiie a hoise, anu hau pigs to tiaue foi them, woulu be in a much
bettei position than a peison who wanteu a hoise but hau a fancy
telescope to offei. The uiffeience woulun't be that the pigs weie
moie +*53*;5$ than the telescope; in fact, uepenuing on how
sophisticateu it was, the telescope might be fai moie valuable.
Bowevei, because ielatively few people can use a fancy telescope
wheieas plenty of people coulu finu a uiiect use foi pigsthe
telescope woulu be veiy '55'<3'2. (To take a moie familiai example, it
is much easiei to sell a coipoiate bonu than it is to sell a house, even
though a house might have a much highei maiket piice than a given
bonu. That's why we say the bonu is fai moie 5'<3'2 an asset than
the house.)
!"#$%&
&
187
Nengei explaineu what happens next. In an oiiginal state of
baitei, people who aie stuck with ielatively illiquiu goous aie
willing to tiaue them away foi moie liquiu assets, even if they uon't
intenu on using those items peisonally. Foi example, oui
hypothetical man who wants a hoise, but only has a telescope to
offei in tiaue, piobably won't finu someone else at that exact
moment who (a) has a hoise anu (b) wants a telescope. Bowevei,
suppose the man iuns into a peison who 2"$( want his telescope,
anu can offei (say) seven sheep in exchange. Even though oui man
may have no use foi sheep at the moment, he still might agiee to the
tiaue, because he knows he's much moie likely to get his hoise if he
comes to the baigaining table with seven sheep, iathei than his
oiiginal telescope.
Anu thus the piactice of '#2'1$4)& $84-*#6$ was boin. In an
inuiiect exchange, a peison tiaues away his valuable goous oi
seivices, anu ieceives something that he uoesn't peisonally uesiie.
Bowevei, the ieason he agiees to the tiaue is that the object he
acquiies is moie :*1C$)*;5$ (oi liquiu) than the one he gave up. It
puts him in a bettei position to attain his ultimate objective, even
though the inuiiect exchange itself uoesn't make him bettei off.
In the jaigon of economics, goous that aie accepteu in tiaue
with the intention of being tiaueu away in the futuie, aie calleu
:$2'*& ",& $84-*#6$. }ust as aii oi watei can be a :$2'3: thiough
which sounu waves tiavel, so too can goous (such as the seven
!"#$%&
&
188
sheep in oui example) be a :$2'3: thiough which an inuiiect
exchange is facilitateu.
With the piactice of inuiiect exchange, a community can
giow fai moie piospeious than if it ielieu on puie baitei. Foi one
thing, theie aie many moie positive-sum voluntaiy tiaues that can
occui, when tiaueis begin looking two anu thiee moves aheau,
iathei than limiting themselves to one-shot tiansactions. But moie
funuamentally, the piactice of inuiiect exchange allows foi much
ueepei maikets in the most liquiu goous, anu so gives an incentive
foi at least some people to begin specializing in the piouuction of
those goous. In oui example, as moie people begin accepting sheep
foi theii use as a meuium of exchange (iathei than just foi theii
uiiect puiposes), it makes it moie luciative to iaise sheep.

4"&(9<&';&-8&(,7(+,-&.(

We now come to the final step of Nengei's explanation. 0vei
time, those goous that weie initially the most maiketable, got an
auueu boost once people began using them in inuiiect exchanges. In
othei woius, theie was a snowball effect: goous that weie initially
accepteu by, say, ten peicent of the meichants, woulu soon be
accepteu by twenty peicent, because the meichants woulu iealize
these goous weie veiy liquiu. The piocess continueu, until the point
at which one of the goous became 3#'+$1(*55%& *44$0)$2 by eveiyone
!"#$%&
&
189
in the community in tiaue. At that point, :"#$% hau emeigeu
spontaneously on the maiket.
Aftei all, that's what money is: It is a paiticulai goou foi
which people aie always willing to sell theii own waies in exchange;
it is the most liquiu of all assets. No one evei hesitates to sell his
items in exchange foi money (so long as the piice is iight), because
he knows he will have no pioblem getting othei people uown the
ioau to accept the money when -$ wants to buy things.
It is useful to step back anu ponuei Nengei's scientific
accomplishment. Be has given us a coheient stoiy, explaining the
emeigence of money in a stiaightfoiwaiu mannei fiom an initial
state of baitei. }ust as in oui stoiy of the emeigence of a tiail
thiough a foiest, heie too we uiu not assume that meichants
consciously intenueu to "cieate money" foi theii uescenuants.
Insteau, we showeu how each inuiviuual, acting in his immeuiate
inteiest, nonetheless paiticipateu in the cieation of a social
institution of tiemenuous impoitance.

1
Carl Menger, Principles of Economics (Grove City, PA: Libertarian Press, Inc.,
1994), pp. 261-262.
!"#$%&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!
"#$!
!
191
!"#$%&'()*(
+',-&./(+'01,%./(#23(+4#22,25(

!" #$%&'$(%')" *+,,&%-" ,%./" '" 0.01
#$%&'$(%')" 2%&(+-&34" #&('$-&" 5&" +-"
6.%7+08" +0" '" ,+&3*" +0" 65+(5" +)" +-"
+/2.--+#3&" )." '22%'+-&" )5&" %&-$3)" .," '"
/'09-"&,,.%)"+0")&%/-".,"/.0&4:"
;<$*6+8"=.0">+-&-
?
"
"

nce a maiket uevelops the use of money, entiie new
vistas open up foi economic uevelopment. Because the
money commouity exists on one siue of eveiy tiansaction,
meichants anu consumeis can quickly giasp the ielative scaicity of
vaiious goous anu seivices. In othei woius, the use of money allows
people to ieuuce economic opeiations uown to a common
uenominatoi.
As in so many othei aieas, Bayek was one of the few
economists to giasp the significance of this fact. Bayek vieweu the
piice system in a maiket economy as a type of communication
netwoik, in which people "on the giounu" in one aiea tiansmitteu
ielevant infoimation to eveiyone else thiough theii buying anu
selling uecisions. In a famous 194S jouinal aiticle Bayek wiote:

0
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
192
We must look at the piice system as such a mechanism foi
communicating infoimation if we want to unueistanu its ieal
function..The most significant fact about this system is the
economy of knowleuge with which it opeiates, oi how little the
inuiviuual paiticipants neeu to know in oiuei to be able to take
the iight action. In abbieviateu foim, by a kinu of symbol, only
the most essential infoimation is passeu on anu passeu on only
to those conceineu. It is moie than a metaphoi to uesciibe the
piice system as a kinu of machineiy foi iegisteiing change, oi a
system of telecommunications which enables inuiviuual
piouuceis to watch meiely the movement of a few pointeis, as an
engineei might watch the hanus of a few uials, in oiuei to aujust
theii activities to changes of which they may nevei know moie
than is ieflecteu in the piice movement.

But I feai that |economists'j theoietical habits of appioaching the
pioblem with the assumption of moie oi less peifect knowleuge
on the pait of almost eveiyone has maue us somewhat blinu to
the tiue function of the piice mechanism.The maivel is that in a
case like that of a scaicity of one iaw mateiial, without an oiuei
being issueu, without moie than peihaps a hanuful of people
knowing the cause, tens of thousanus of people whose iuentity
coulu not be asceitaineu by months of investigation, aie maue to
use the mateiial oi its piouucts moie spaiingly; +:&:A they move in
the iight uiiection..

I have uelibeiately useu the woiu "maivel" to shock the ieauei
out of the complacency with which we often take the woiking of
this mechanism foi gianteu. I am convinceu that if it weie the
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
19S
iesult of uelibeiate human uesign, anu if the people guiueu by
the piice changes unueistoou that theii uecisions have
significance fai beyonu theii immeuiate aim, this mechanism
woulu have been acclaimeu as one of the gieatest tiiumphs of the
human minu.
2

We aie now beginning to see how social institutions help
humans cope with the all-peivauing pioblem of scaicity. The ieason
it took scholais of the calibei of Fiieuiich Bayek to unueistanu the
tiue function (anu hence impoitance) of piivate piopeity anu
maiket piices, is that these inuispensable tools weie not *&-+80&* by
anyone. Since no single peison inventeu money, many intellectuals
take its seivices foi gianteu anu inueeu imagine a utopia which
abolishes money altogethei. In this context, Luuwig von Nises'
famous ciitique of socialism is an excellent illustiation of the fatal
conceit.

6,.&.( 02( 7-0208,-( !#4-94#%,02:( ;"&( <923#8&2%#4(
+'0=4&8(>,%"(?0-,#4,.8(

In the chionology of Austiian economists, Nises actually
pieuates Bayek. Inueeu, Bayek cieuits Nises' 1922 book B.(+'3+-/
with conveiting C'4&7 fiom being a socialist! In a Foiewoiu
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
194
(wiitten in 1978) to the book, Bayek explains how he came to know
Nises, anu the effect he hau:

When B.(+'3+-/" fiist appeaieu in 1922, its impact was
piofounu. It giauually but funuamentally alteieu the outlook of
many of the young iuealists ietuining to theii univeisity stuuies
aftei Woilu Wai I. I know, foi I was one of them.
We felt that the civilization in which we hau giown up
hau collapseu. We weie ueteimineu to builu a bettei woilu, anu
it was this uesiie to ieconstiuct society that leu many of us to the
stuuy of economics. Socialism piomiseu to fulfill oui hopes foi a
moie iational, moie just woilu. Anu then came this book. 0ui
hopes weie uasheu. B.(+'3+-/ tolu us that we hau been looking
foi impiovement in the wiong uiiection.
A numbei of my contempoiaiies, who latei became well
known but who weie then unknown to each othei, went thiough
the same expeiience: Wilhelm Ropke in ueimany anu Lionel
Robbins in Englanu aie but two examples. None of us hau
initially been Nises' pupils. I hau come to know him while
woiking foi a tempoiaiy Austiian goveinment office which was
entiusteu with the implementation of ceitain clauses of the
Tieaty of veisailles. Be was my supeiioi, the uiiectoi of the
uepaitment.
Nises was then best known as a fightei against inflation.
Be hau gaineu the eai of the goveinment anu.was immensely
busy uiging the goveinment to take the only path by which a
complete collapse of the cuiiency coulu still be pieventeu.
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
19S
(Buiing the fiist eight months I seiveu unuei him, my nominal
salaiy iose to two hunuieu times the initial amount.)
.B.(+'3+-/"shockeu oui geneiation, anu only slowly anu
painfully uiu we become peisuaueu of its cential thesis.
S

What was Nises' "cential thesis" conceining socialism, that
hau so shockeu Bayek anu his peeis. In a nutshell, Nises aigueu
that the socialist planneis woulu finu it impossible to iationally
allocate society's scaice iesouices. Even if they hau the best
intentions, anu even if they hau at theii fingeitips all of the ielevant
knowleuge fiom vaiious expeits, Nises aigueu that the socialist
planneis woulu have no way of ueteimining whethei theii plans foi
inuustiy weie a goou iuea, oi whethei an alteinative set of
instiuctions woulu be bettei.
The maiket economy solves this pioblem thiough the piofit-
anu-loss test. In a capitalist society, eveiy scaice iesouice
incluuing capital goous such as tiactois anu factoiiesis subject to
piivate owneiship. This allows the foimation of maiket piices foi
eveiy unit of eveiy iesouice. When an entiepieneui in a maiket
economy wants to know if he is iunning a successful business, he
has a simple anu objective ciiteiion: Be can see if the ievenues fiom
his customeis aie gieatei than his expenses. If they'ie not, that
means the entiepieneui is losing money, anu in a maiket economy
an unpiofitable opeiation is soon shut uown.
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
196
Now the socialists lookeu upon this piactice with scoin. Aftei
all, money isn't eveiything! Who is to say that a paiticulai fiim
making uiapeis, foi example, shoulun't continue tuining scaice
iesouices into moie boxes of uiapeis, even past the point of
piofitability, in oiuei to help stiuggling motheis with infants. The
socialists thought the accountant's "bottom line" was an aibitiaiy
quiik of a maiket economy, anu that it uiun't coiiesponu to
anything "ieal" that woulu exist in a socialist woilu.
Yet Nises uemonstiateu that the socialists weie simply
wiong. Although theie aie limits to the guiuance given by monetaiy
accounting, Nises pointeu out that it gives people -./& guiuance.
Think about it: When a paiticulai enteipiise is unpiofitable, it
means that the ownei is spenuing moie money on inputs than his
customeis aie willing to spenu on the outputs. Loosely speaking, we
can say that the ownei is uestioying wealth, because he is
tiansfoiming iesouices of a high maiket value into finisheu
piouucts of a lowei value.
Nises explaineu that the maiket piices of the "means of
piouuction" weie not aibitiaiy, but insteau ieflecteu theii ielative
scaicities. Foi example, a pounu of coppei (as of this wiiting)
fetches a highei maiket piice than a pounu of aluminum. This isn't
some iiielevant factoiu of capitalist countiies, but insteau iefeis to a
genuine ielationship between the uifficulty in piouucing coppei vs.
aluminum, compaieu to the uses people have of the two uiffeient
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
197
mateiials. The ieason entiepieneuis can ',,.%* to pay so much moie
foi a pounu of coppei, is that theie aie some piouucts that can be
maue with coppei anu not aluminum, anu consumeis aie willing to
2'4 foi these piouucts.
In Nises' view, the entiepieneui in a maiket economy acts as
a "manuataiy of the consumei," meaning that he acts as the
consumei's agent oi iepiesentative. Aimeu with a knowleuge of
how much money consumeis will spenu on vaiious goous anu
seivices, the entiepieneuis entei the maikets foi iaw mateiials,
laboi, anu othei iesouices anu engage in a biuuing wai with each
othei. A high piice foi a pounu of coppei, compaieu to a low piice
foi a pounu of aluminum, is the maiket's way of signaling that
coppei is moie impoitant foi pleasing consumeis, anu that
entiepieneuis shoulu exeicise moie caie when using it in theii
opeiations.
It is this fiamewoik that leu Nises to tiumpet the notion of
"consumei soveieignty," which claims that the ieal powei in a
capitalist system uoes 0.) lie with the capitalists, as the Naixists
believeu:

The capitalists, the enteipiiseis, anu the faimeis aie
instiumental in the conuuct of economic affaiis. They aie at the
helm anu steei the ship. But they aie not fiee to shape its couise.
They aie not supieme, they aie steeismen only, bounu to obey
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
198
unconuitionally the captain's oiueis. The captain is the
consumei.
4

Nises went on to say that not only was the consumei the one
in chaige, but that he was a ,+(73&"commanuei at that:

The ieal bosses |unuei capitalismj aie the consumeis. They, by
theii buying anu by theii abstention fiom buying, ueciue who
shoulu own the capital anu iun the plants. They ueteimine what
shoulu be piouuceu anu in what quantity anu quality. Theii
attituues iesult eithei in piofit oi in loss foi the enteipiisei. They
make pooi men iich anu iich men pooi. They aie no easy bosses.
They aie full of whims anu fancies, changeable anu
unpieuictable. They uo not caie a whit foi past meiit. As soon as
something is offeieu to them that they like bettei oi is cheapei,
they ueseit theii olu puiveyois.
S

Now that we unueistanu Nises' conception of the piofit-anu-
loss system, anu how it leaus entiepieneuis in a capitalist economy
to catei to the uesiies of the public, we can giasp his ciitique of
socialism. In a socialist society, the State nationalizes all of the
"means of piouuction," incluuing the capital goous anu natuial
iesouices such as faimlanu anu coal mines.
Because the State is the sole ownei of the means of
piouuction, theie can be no maiket piices foi them. Yet this means
theie can be no monetaiy calculation, anu consequently no way of
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
199
ueteimining whethei the iesouices being useu up in a paiticulai
opeiation coulu be bettei ueployeu elsewheie in the system.
Foi example, the socialist planneis might oiuei a gioup of
comiaues to take a ceitain amount of iubbei, steel, electiicity, anu
so foith, in oiuei to piouuce Suu automobiles. Aftei the fact, theie is
simply no way foi the planneis to know whethei the output was
"woith it." So long as the cais weie suitably engineeieu, the
planneis woulu know that the subjects weie bettei off with the cais
than without them; in othei woius, the cais woulu be valuable. But
the tiue question was whethei the cais woulu be moie valuable
)5'0" .)5&%" 2.)&0)+'3" 8..*-" )5')" (.$3*" 5'=&" #&&0" 2%.*$(&*" 6+)5" )5&"
%&-.$%(&-")5')"6&%&"$-&*"$2"65+3&"/'7+08")5&"('%-.
Thus we see the funuamental pioblem with socialism. Befoie
Nises, the uebate ovei the "planneu economy" hau centeieu on
incentives. To wit, in a system that followeu the communist
piinciple, "Fiom each accoiuing to his ability, to each accoiuing to
his neeus," woulu the woikeis actually push themselves as haiu as
they uo unuei capitalism. In othei woius, if the State took all the
piouuction anu thiew it into one giant pie, to be uistiibuteu in a way
that uiun't uepenu on each peison's contiibution, then woulun't the
oveiall pie shiink.
Compelling though this objection may have been, the socialist
theoiists claimeu that the gieeu anu self-centeieuness of the
aveiage man was uue to his giowing up in a capitalist system. 0nce
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
2uu
socialism hau swept the woilu, they claimeu, a new "Socialist Nan"
woulu emeige who enjoyeu piouucing foi his stiangeis as much as
foi his own family.
In this context, we see how poweiful Nises' ciitique was.
Nises conceues foi the sake of aigument that eveiy woikei anu
factoiy managei faithfully obeys the oiueis of the cential planneis.
Be also conceues foi the sake of aigument that the planneis have all
the ielevant technical anu piactical knowleuge in eveiy single
inuustiy in the economy. Even so, because they lack maiket piices,
the socialist planneis have no means of feeuback, no means of
ueteimining whethei theii gianu plans aie using iesouices
efficiently. As Nises summaiizes in his gianu tieatise C$/'0"!()+.0:

The paiauox of "planning" is that it cannot plan, because
of the absence of economic calculation. What is calleu a planneu
economy is no economy at all. It is just a system of gioping about
in the uaik. Theie is no question of a iational choice of means foi
the best possible attainment of the ultimate enus sought. What is
calleu conscious planning is piecisely the elimination of
conscious puiposive action.
6

Noie than any othei school of economists, the Austiians
iecognize the social function of maiket piices anu piofit-anu-loss
calculations. Bespite its flaws, the capitalist societyin which
piivate inuiviuuals buy anu sell the means of piouuction in an open
!"#$%&'(!")*#+&'(,-.(!/,--#-0(
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@"
"
2u1
maiketis the only one that can possibly yielu an efficient use of
scaice iesouices. 0f couise entiepieneuis in a maiket economy
make mistakes all the time. But the ciucial point is that theii
mistakes aie %&8+-)&%&*"'-"-$(5 by the suffeiing of losses. Theie is no
such feeuback in a socialist system of outiight cential planning, anu
thus no mechanism to biing the planneis' uecisions into alignment
with the evei changing conuitions of piouuction anu the tastes of
the consumeis.

1
Ludwig von Mises, Bureaucracy, p. 53, available at:
http://mises.org/etexts/mises/bureaucracy/section1.asp. Accessed June 4, 2010.
2
Friedrich A. Hayek, The Use of Knowledge in Society (1945), American Economic
Review, XXXV, No. 4, pp. 519-530, available at:
http://www.econlib.org/library/Essays/hykKnw1.html. Accessed June 4, 2010.
3
Hayek, Foreword to Ludwig von Mises, Socialism (Indianapolis: Liberty Fund,
1981), pp. xix and xxi.
4
Mises, Bureaucracy, p. 226.
5
Mises, Bureaucracy, p. 227.
6
Mises, Human Action (Auburn, AL: The Ludwig von Mises Institute, 1998), p. 696.
!"#$%&'(!")*#+&(,-.(!/,--#-0(
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!"!#
#
2uS
!"#$%&'()*(
+#,-.,/(

!"#$#% &'(% )*% $#'(*)% &"'+#,#$% +*%
'-').*)% +"#% /$0)10/2#% *3% 3$##%
#)+#$/$0(#%0)%+"#%30#2.%*3%-')40)56%
789.&05%,*)%:0(#(
;
%

hus fai in oui suivey we have examineu the
spontaneous uevelopment anu social puipose of
institutions that aie quite familiai in a maiket economy, incluuing
piivate piopeity, money, piices, anu piofits. If these weie the only
tools that humans hau uevelopeu in the stiuggle against scaicity, it
woulu be enough to fostei mouein civilization as we know it. But
the maiket has impioveu upon the "state of natuie" thiough the
uevelopment of othei institutions as well, filling yet moie niches to
make mouein life moie piouuctive anu comfoitable. 0ne such
institution is -')40)5.

0(12'34(1.%"25%(+#,-.,/(

To appieciate the impoitance of banking, we can imagine a
T
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
2u4
maiket economy that lackeu this institution. As we have
seen, so long as inuiviuuals have piivate piopeity iights, they
giauually will uevelop a maiket-baseu commouity money, which
histoiically has been golu oi silvei as woiluwiue tiaue uevelopeu.
0nce people begin using money in theii tiaues, they can peifoim
economic calculations of piofit anu loss anu gain all the auvantages
that Nises anu Bayek stuuieu.
Bowevei, without banks theie woulu be inconveniences anu
misseu oppoitunities. Foi example, wealthy inuiviuuals who hau
acquiieu laige foitunes woulu feel veiy anxious about stoiing
stockpiles of golu anu silvei in theii homes, foi feai of fiie oi
buiglaiy. Anu when making veiy laige puichases, meichants woulu
have to aiiange foi vehicles to tianspoit the haul of golu bais at the
moment of sale. These iisks anu inconveniences woulu stifle the
accumulation of wealth anu the consummation of what otheiwise
woulu be mutually auvantageous ueals.
Without banks, laige-scale cieuit tiansactions woulu also be
much moie uifficult. Foi example, a young couple might want to buy
a new house, anu they woulu be willing to eaimaik a poition of theii
futuie paychecks if only they coulu move into theii home
immeuiately. 0n the othei hanu, uozens of oluei people in the same
community might have laige accumulations of money that they
wanteu to uevote to theii ietiiement, anu possibly "put it to woik"
in the meantime.
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
2uS
Cleaily theie is a way to link up the young couple with theii
oluei neighbois, so that eveiyone comes out aheau. The solution of
couise is foi the oluei inuiviuuals to lenu theii suiplus money to the
couple, who then buy theii uesiieu house. Then, ovei the next few
uecaues the couple tiansfeis a poition of theii paychecks eveiy
month to paying back theii lenueis at inteiest. This is a win-win
scenaiio, in which the couple "pays moie" foi theii house, but is
happy to uo so because they can move in iight away, anu wheie the
oluei inuiviuuals uefei the use of theii saveu funus, but aie happy to
uo so because they enu up iecouping moie than the oiiginal
piincipal.
Alas, theie is a majoi obstacle to oui fanciful stoiy: In the ieal
woilu, a young couple piobably coulun't obtain financing foi a new
house, simply by hitting up a few uozen of theii neighbois foi laige
loans. The ieason is that placing theii entiie savings in the hanus of
one couple's ieal estate puichase woulu be too $0(4= foi the oluei
neighbois. Foi example, if the young husbanu lost his job anu
uefaulteu on his monthly iepayments, then the neighbois who hau
lent him theii life savings coulu be wipeu out, oi at the veiy best
they woulu collectively be stuck with a house that might be uifficult
to sell. 0nuei these conuitions, it is cleai that the iisk of uefault
woulu make it much haiuei foi potential boiioweis anu lenueis to
connect with each othei anu make win-win exchanges of piesent
money against futuie cash flows.
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
2u6

6"&(672(85,9%.2,:(2;(+#,-.,/(

The institution of banking auuiesses the two pioblems
uiscusseu in the above section. It solves them thiough two uistinct
functions: the piovision of checking accounts (associateu with
uemanu ueposits), anu the piovision of savings accounts (associateu
with time ueposits).
In the case of a checking account with 1uu% ieseives, the
bank acts simply as a &'$#"*9(# of the customei's money. If the
community useu piecious metals as theii money, then a customei
might ueposit, say, ten ounces of golu at the bank, which woulu be
placeu safely in the vault. In ietuin, the customei might get notes
issueu by the bank, allowing the beaiei to ieueem ten ounces of golu
when piesenteu at any of the bank's bianches. In mouein times,
banks uo not issue banknotes so much as they pioviue customeis
with checkbooks anu uebit caius. The piinciple is the same,
howevei: So long as the bank has a soliu ieputation, meichants
know that they can safely accept a check wiitten on the bank,
because the bank will ieueem it foi the stipulateu amount of
physical golu upon iequest.
If all the banks kept 1uu% of theii customeis' checking
account ueposits safely in the vault, then the total money supply in
the community woulu be unaffecteu by the banks' activities. All that
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
2u7
woulu happen is that a poition of the money commouity (such as
golu) woulu move out of the home safes anu pockets of the people in
the community, anu woulu be stoieu insiue the bank vault. The
customeis woulu still have use of theii money, howevei, because of
the banknotes, checkbooks, anuoi uebit caius pioviueu by the
bank. But the bankeis woulu have no effect on the geneial level of
piices, because they woulun't be influencing the total '>*9)+% of
money in the economy. Insteau, they woulu simply be giving theii
customeis a moie convenient way to (+*$# theii money.
(In oui piesent woilu, banks uo )*+ opeiate in this fashion,
because they only keep a 3$'1+0*) of theii customeis' checking
account ueposits in the vault. This piactice is calleu 3$'1+0*)'2%
$#(#$,#% -')40)5 anu is the souice of the maiket economy's peiiouic
boom-bust cycles. We will explain this in a latei chaptei, but it's fiist
necessaiy to unueistanu the basic opeiations of banking in its puie
foim.)
In auuition to pioviuing waiehouse seivices foi customeis
wishing to open checking accounts, banks can also act as cieuit
inteimeuiaiies, seiving as "miuulemen" linking up boiioweis with
saveis. In this opeiation, the bank offeis an inteiest iate to boiiow
money fiom people in the community who have suiplus money they
wish to lenu. Then the bank ielies on its expeit staff to inteiview
potential boiioweis in the community anu assign them a highei
inteiest iate, baseu on the iiskiness of the loan.
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
2u8
So long as the bank uoes its job piopeily, it eains a highei
aveiage ietuin on the funus it lenus than it pays to the inuiviuual
lenueis who have entiusteu theii savings with the bank. This spieau
constitutes the bank's income, in its capacity as a cieuit
inteimeuiaiy. But the people uepositing theii savings with the bank
aie happy with the aiiangement, because it is much safei lenuing to
the bank than to an inuiviuual moitgage applicant. Although some
people will still lose theii jobs anu uefault on theii moitgage
payments, a well-manageu bank will have enough moitgages in
place that these pieuictable losses can be absoibeu anu shaieu by
eveiyone. The existence of the bank thus facilitates the movement of
money fiom lenueis into the hanus of boiioweis, anu vice veisa as
(most of) the boiioweis pay off theii loans.

6"&(+2,4(<#'-&%(

In auuition to banks, anothei majoi institution foi linking
boiioweis with lenueis is the -*).% >'$4#+. Although oui
hypothetical couple woulu not have the ieputation anu
cieuitwoithiness to appeal uiiectly to lenueis, majoi oiganizations
such as coipoiations anu goveinments 1') obtain funus fiom those
who oiiginally saveu them.
Specifically, the coipoiation (oi othei entity) issues a bonu,
which is a legally binuing I00 entitling the buyei to a specifieu
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
2u9
stieam of cash payments. In exchange foi selling this asset, the
coipoiation obtains money immeuiately. Because the sale piice of
the bonu is lowei than the sum total of all futuie cash payments, the
lenuei (i.e. the buyei of the bonu) will enu up eaining 0)+#$#(+ on the
loan. Foi example, if a one-yeai bonu piomises to pay the beaiei
$1,uuu anu sells foi $9Su when it is fiist issueu, the yielu (inteiest
iate) on the bonu is ($Su $9Su) - S.S peicent.

6"&(=23&(2;(>,%&'&:%(=#%&:

In the Austiian view, inteiest iates aie a special type of piice
that communicate infoimation about the ielative impatience of the
community. When people have satisfieu theii piesent uesiies anu
want to uevote theii income to the futuie, they save moie. This
incieases the amount of funus available to the bank foi lenuing, anu
pushes uown inteiest iates. At the lowei inteiest iates,
entiepieneuis finu it cheapei to finance long-teim piojects, anu so
they boiiow moie anu expanu theii opeiations.
To unueistanu exactly what happens in a maiket economy
when the community ueciues to save moie, we neeu to look at the
physical siue as well as the financial. If a laige numbei of people
ueciue to save moie out of theii cuiient income, it means that they
19+%-'14%+"#0$%(/#).0)5 on goouies in the piesent. Foi example, they
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
21u
might go out to uinnei less fiequently, attenu fewei movies, buy
fewei plasma scieen Tvs, anu so on.
These spenuing uecisions, of couise, ieuuce the business foi
iestauiants, movie theateis, anu electionics stoies. Consequently
the iestauiants have to lay off waiteis anu cooks, anu buy less foou.
The movie theatei owneis have to lay off woikeis as well, anu
peihaps postpone the constiuction of a new multiplex aiena. The
manufactuieis of plasma scieen Tvs will of couise neeu to scale
back piouuction at theii factoiies, laying off woikeis anu ieuucing
theii puichases of iaw mateiials.
Although some schools of thought, such as the Keynesian,
woulu view the uiop in consumei spenuing as a uisastei which
woulu cieate iipples of giowing unemployment, the Austiians aigue
that a healthy maiket economy iesponus to changes in piefeiences
in an efficient mannei. If most people cut back theii spenuing on
iestauiants, movies, anu Tvs, it woulu be to builu up theii ability to
spenu 0)%+"#%39+9$#. The fieeu-up woikeis anu othei iesouices fiom
the iestauiants, movie theateis, anu Tv factoiies woulun't uisappeai
fiom the face of the eaith; insteau, they woulu be absoibeu into
othei sectois that weie expanuing. In paiticulai, the lowei inteiest
iates (fueleu by the new savings) woulu allow othei businesses to
finance giowth in theii opeiations, anu they woulu hiie the
unemployeu woikeis anu spaie mateiials.
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
211
In the Austiian view, inteiest iates seive to iegulate the
maiket economy's focus on piesent veisus futuie piouuction. If
most people aie ielatively impatientmeaning they want to spenu
theii income on enjoyments in the neai futuiethen savings will be
low, anu inteiest iates will be high. This will penalize long-teim
business piojects, because entiepieneuis will finu the "cost of
capital" too high foi piojects that iequiie many yeais of inputs
befoie they yielu theii iesults.
0n the othei hanu, if most people in the community aie
ielatively patientmeaning they aie willing to uefei theii spenuing
to the uistant futuie, so long as they eain a piemium foi uoing so
then savings will be high, anu inteiest iates will be low. The cheap
cost of capital will encouiage entiepieneuis to go to the bank to
finance long-teim piojects that have a high payoff but take many
yeais to complete.
In eithei scenaiio, maiket piices (in the foim of inteiest
iates) guiue entiepieneuis to ueploy scaice iesouices in ways that
best suit the uesiies of the consumeis. It is Nises' geneial
obseivation about consumeis steeiing piouuction, applieu to the
special case of piouucing consumei goous (fancy uinneis, plasma
scieen Tvs) veisus capital goous (tiactois, uiill piesses).
If the people in a community aie willing to uefei
consumption, it fiees up physical iesouices to piouuce moie capital
goous. This makes woikeis moie piouuctive, because they now can
!"#$%#&'
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<%
%
212
use bettei machines anu equipment. In the long iun, a community
that saves a laige fiaction of its income will enjoy a highei stanuaiu
of living than a community of spenuthiifts. Because the piouigal
spenueis save so little out of theii income, the iesult is an economy
geaieu towaiu the piouuction of immeuiate consumei goous.
Consequently, this economy will not uevelop tools anu othei
supplements to inciease the output of its woikeis ovei time.

1
1998), p. 440.
21S
!"#$%&'()*(
+,-.'#,/&(

!" #$%" &'(" )*" +(,-./" 0(" 1,(2)/." (+" ')*"
(&%"$--(3%0"+(,"')*"(4/"$5."#3*0"*$2."$"
1$,0" (+" ')*" )%-(#." (," 0$6." (30" $%"
)%*3,$%-." 1(4)-788893-'" $" #$%" )*" #(,."
4)6.47" 0(" 5.0" $%" )/.$" (+" 0'." .-(%(#)-"
1,(:4.#*" (+" ')*" -(3%0,7" 0'$%" $" #$%"
&'(#" $" 1.%*)(%" *-'.#." *..#)%547"
,.4).2.*"(+"$44"&(,,).*8"
;<3/&)5"2(%"=)*.*
>
"
"

e have seen that a fiee maiket economy, in which
inuiviuuals tiaue theii piopeity in oiuei to impiove
theii ciicumstances, fosteis the uevelopment of social institutions
that enhance humans' ability to use theii laboi anu the gifts of
natuie in the most piouuctive way. In paiticulai, the uevelopment of
money anu banking allows inuiviuuals to make iational financial
goals foi theii entiie lifetimes. Contiaiy to the claims of the
socialists, in a sophisticateu capitalist society each householu
engages in 5.%3)%. "economic planning."
W
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
214
Bowevei, theie is still one majoi issue that we haven't
uiscusseu. In oui woilu, inuiviuuals aie subject to unlikely but
catastiophic ,)*6*. Foi example, someone coulu be quite iesponsible,
putting asiue a laige poition of his paycheck eveiy month into a
savings account with the bank. Yet thiough no fault of his own, his
house might buin uown while he is away on vacation. Even woise,
the man coulu suuuenly uiop ueau of a heait attack, leaving his
wiuow with a moitgage payment anu an inauequate bank balance.

0"&(1.,/%23,(34(5.'&(+,-.'#,/&

To help inuiviuuals cope with the numeious iisks they face,
maikets have uevelopeu the institution of insuiance. The customeis
of an insuiance company pool theii fate, in a sense, in oiuei to
aveiage out theii collective outcome. Foi example, suppose that out
of a population of one thousanu homeowneis, fiie will uestioy one
of theii houses in any given yeai, causing $2uu,uuu woith of
uamage. In teims of mathematical expectation, theiefoie, each
membei of this gioup will likely suffei $2uu woith of fiie uamage on
aveiage pei yeai.
But of couise, in ieality things play out much uiffeiently. In a
typical yeai, 999 of the homeowneis will suffei no loss at all,
wheieas one membei of the gioup will be uevastateu. By puichasing
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
21S
a house (insteau of ienting), the inuiviuuals in this gioup aie in a
sense subjecting themselves to a uangeious gamble.
A company pioviuing fiie insuiance can impiove the
situation gieatly. By chaiging each householu an annual piemium of
$2uS, the company can piomise to inuemnify a homeownei when
his oi hei house buins uown. Notice that this aiiangement is yet
anothei example of a positive-sum, win-win exchange in the maiket:
The insuiei benefits fiom eaining $S,uuu (ovei anu above the
uamage claims) in a typical yeai, while the homeowneis benefit
fiom conveiting theii small chance of a catastiophic $2uu,uuu loss
into the much moie acceptable ceitainty of losing $2uS in piemium
payments eveiy yeai. (Natuially we aie leaving out many of the
complications of the ieal-life insuiance inuustiy, in oiuei to focus on
its economic essence.)
People often uesciibe insuiance as a foim of gambling,
saying, "When you take out fiie insuiance, you'ie betting that youi
house will buin uown while the company takes the opposite
position." This common view has things exactly backwaius. If
anything, taking out insuiance is the (11(*)0. of gambling. When you
gamble, you typically pay a small amount of money (such as buying
a lotto ticket) to gain exposuie to a small piobability of winning a
laige amount of money. In contiast, when you take out insuiance,
you pay a small amount of money (the piemium) in oiuei to
.4)#)%$0." youi exposuie to a small piobability of 4(*)%5 a laige
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
216
amount of money (oi suffeiing some othei uisastei). uambling
makes youi financial futuie 4.**" ceitain, wheieas insuiance makes
youi financial futuie #(,. ceitain.
In the case of ueath, the puie foim of insuiance is 0.,#" 4)+..
When an inuiviuual buys a teim life insuiance contiact, he pays a
contiactual stieam of piemiums while the insuiei agiees to pay a
ceitain amount of money (the "ueath benefit") to a nameu
beneficiaiy, *(" 4(%5" $*" 0'." /.$0'" (--3,*" )%" $" *0)134$0./" 0)#." +,$#.. If
the inuiviuual suivives thioughout the peiiou of the oiiginal teim
life contiact, then he gets no payment fiom the insuiei. It is
analogous to a homeownei who pays fiie insuiance piemiums anu
nevei has a fiie.

5.'&( +,-.'#,/&( 56.-( 7#82,9-( :&"2/6&;( 5&'<#,&,%( =24&(
+,-.'#,/&(

In auuition to teim policies, the maiket has uevelopeu
anothei foim of life insuiance. With a 1.,#$%.%0" 4)+." )%*3,$%-."
1(4)-7, the inuiviuual once again agiees to make peiiouic piemium
payments. In exchange, the insuiei piomises to pay a monetaiy
benefit unuei two scenaiios: It will pay the nameu beneficiaiy a
ueath benefit, in the event that the insuieu uies befoie a ceitain age,
(," the insuiei will pay the ownei of the policy (the one making the
piemium payments) if he suivives beyonu a cutoff age (such as 1uu
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
217
oi 121 yeais). A 1.,#$%.%0" life insuiance policy is so nameu,
because it uoes not expiie as uoes a teim life policy. The plain
vanilla veision of peimanent life insuiance is calleu a &'(4." 4)+."
policy, again because it pioviues an inuiviuual with insuiance foi his
whole life, iathei than just a poition of it.
With peimanent life, the insuiei knows that it will have to
pay out soonei oi latei on eveiy policy (so long as the policyholuei
stays cuiient with his piemium payments). Because of this, the
piemiums aie highei on a peimanent policy than foi a compaiable
teim policy. (Note that the vast majoiity of teim policies expiie
without a claim against the insuiei.)
0n the othei hanu, the highei piemiums of a peimanent
policy aie compensateu by the giowing "cash value" of the policy.
Foi example, if an insuiei pioviues a stanuaiu whole life policy that
matuies at age 121 anu caiiies a ueath benefit of $1 million, then
the insuiei must conuuct its opeiations so that the peiiouic
piemium payments aie investeu in oiuei to acquiie a value of at
least $1 million by the time the insuieu tuins 121. (In piactice the
insuiei will have to uo moie than this, because theie is always the
iisk that the insuieu will uie :.+(,. age 121 anu iequiie the $1
million payment eailiei.)
The natuie of a whole life policy is such that aftei each
piemium payment, the suiviving policyholuei moves that much
closei to the $1 million payment (eithei thiough ueath oi attaining
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
218
age 121). In a sense, the insuiance company is simply oveiseeing
the policyholuei's piemium payments, to ensuie that they giow to
the iequiieu amount in the stipulateu time fiame. Because of this
aiiangement, as an auueu featuie foi theii customeis, whole life
insuiance companies allow policyholueis to suiienuei theii policies
at any time by stopping payment of piemium, anu getting a lump
sum payment of the "cash suiienuei value" at that point. In the
oiiginal contiact, the insuiei pioviues a list of guaianteeu cash
values at vaiious yeais into the life of the policy.
To compaie teim life insuiance with peimanent life
insuiance, an analogy fiom ieal estate is apt. Someone ienting a
house typically pays a lowei amount pei month to the lanuloiu, than
the amount he woulu have to pay to the bank hau he taken out a
moitgage to buy the same house. Bowevei, the homebuyei is
compensateu foi his highei monthly payments by the fact that ovei
time he builus .@3)07 in the house. Aftei the moitgage is fully paiu
off, the peison owns the house outiight, having a valuable asset in
his possession. In contiast, the ientei enjoys lowei monthly
payments to achieve the same flow of "housing seivices," but he is
not investing in his long-teim wealth. No mattei how long he makes
his monthly iental payments, he has nothing to show foi it besiues
the tempoiaiy ioof ovei his heau.
Theie is a similai tiaueoff in the case of life insuiance. The
peison buying a teim policy enjoys the same amount of puie
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
219
insuiance coveiage foi lowei monthly piemiums. Bowevei, the
moment he stops making the piemium payments, he has nothing to
show foi his faithful histoiy. In contiast, the ownei of a peimanent
life insuiance policy (such as whole life) aumitteuly pays a highei
monthly piemium foi the same ueath benefit, but ovei time he
builus up equity in the policy. If he lives long enough, he eventually
"pays off the insuiance company" anu owns the face value of the
policy outiight, having a veiy valuable asset (such as $1 million oi
moie) in his possession.

0"&(>.-%'2#,(5&'-$&/%28&(3,(+,-.'#,/&

Because the Austiian economists stiess the impoitance of
saving anu capital accumulation in economic uevelopment, it is only
natuial that they have an affinity foi the institution of insuiance.
}ess Bueita ue Soto, aiguably the woilu's leauing scholai on
Austiian business cycle theoiy, wiites:

The social significance of life insuiance companies sets
them apait fiom othei tiue financial inteimeuiaiies. In fact the
contiacts offeieu by these institutions make it possible foi bioau
layeis of society to unueitake a genuine, uisciplineu effoit to
save foi the long teim. Inueeu life insuiance pioviues the peifect
way to save, since it is the only methou which guaiantees,
piecisely at those moments when householus expeiience the
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
22u
gieatest neeu (in othei woius, in the case of ueath, uisability, oi
ietiiement), the immeuiate availability of a laige sum of money
which, by othei saving methous, coulu only be accumulateu
following a veiy piolongeu peiiou of time. With the payment of
the fiist piemium, the policyholuei's beneficiaiies acquiie the
iight to ieceive, in the event of this peison's ueath, foi instance, a
substantial amount of money which woulu have taken the
policyholuei many yeais to save via othei methous.
.|Wje coulu concluue that life insuiance companies aie
the quintessential "tiue financial inteimeuiaiies," because theii
activity consists piecisely of encouiaging long-teim saving in
families anu channeling saveu funus into veiy secuie long-teim
investments (mainly blue-chip bonus anu ieal estate).
2

In a footnote to the above uesciiption, ue Soto explains that
he is not alone in his conclusion:

Austiian economists have always iecognizeu the majoi
iole life insuiance plays in facilitating voluntaiy saving among
bioau sections of society. Thus Richaiu von Stiigl makes explicit
iefeience to the "life insuiance business, which is of such
extiaoiuinaiy impoitance in capital foimation."..|Ijn his classic
aiticle on saving, F.A. Bayek iefeis to life insuiance anu the
puichase of a home as two of the most impoitant souices of
voluntaiy saving.
S

!"#$%&"'()
??????????????????????????????????????????????????????????"
"
221
The viitues of insuiance go beyonu the encouiagement of
thiift anu capital accumulation. By its veiy natuie, insuiance of all
kinus pioviues maiket incentives foi inuiviuuals to engage in safei
behavioi. Foi example, piopeity insuiance contiacts might offei
lowei piemiums foi homeowneis who install smoke alaims, fiie
extinguisheis, ueaubolts, oi an alaim system. Cai insuiance
piemiums can be much highei foi uiiveis who have been in multiple
cai acciuents (especially at fault) anu especially if they have been
convicteu of B0Is. Peihaps the most obvious example of the
"feeuback" fiom maiket piices on lifestyle choices occuis in the case
of life insuiance policies, in which the penalty foi smoking is quite
staik anu objective. Inueeu, }eff Tuckei (euitoiial vice piesiuent of
the Luuwig von Nises Institute) once explaineu that all the
hanuwiinging Public Seivice Announcements anu tut-tutting fiom
the Nanny State coulun't get him to give up his beloveu chewing
tobacco. But as a maiiieu man applying foi life insuiance, }eff finally
quit in oiuei to qualify foi lowei piemiums.
In fact, some Austiians go so fai as to envision insuiance
companies filling the voiu foi ciucial public seivices in the event of a
laige iollback of the scope of goveinment. Foi example, one of the
authois of the piesent book has offeieu a pioposal to impiove
aiiline safety by shutting uown the FAA (which peiveisely gets #(,."
+3%/)%5 whenevei a plane ciashes!) anu allowing insuiance
companies to peifoim this impoitant function. If a stanuaiu
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
222
component of aiiline tickets weie an insuiance policy payable in the
event of a plane ciash, the insuiei (with millions of uollais on the
line) woulu have the coiiect incentives to inspect the planes,
ianuomly test pilots foi uiug use, anu so on.
4

A few Austiian economists have pusheu this piivatization
logic to the extieme, in an attempt to solve the vexing pioblems of
an unaccountable police monopoly anu innei-city ciime. Nuiiay
Rothbaiu explains:

|Ajs goveinment police have become incieasingly
inefficient, consumeis have been tuining moie anu moie to
piivate foims of piotection..Theie aie.piivate guaius,
insuiance companies, piivate uetectives, anu such incieasingly
sophisticateu equipment as safes, locks, anu closeu-ciicuit Tv
anu buiglai alaims..
Eveiy ieauei of uetective fiction knows that piivate
insuiance uetectives aie fai moie efficient than the police in
iecoveiing stolen piopeity. Not only is the insuiance company
impelleu by economics to seive the consumeianu theieby tiy
to avoiu paying benefitsbut the majoi focus of the insuiance
company is veiy uiffeient fiom that of the police. The police,
stanuing as they uo foi a mythical "society," aie piimaiily
inteiesteu in catching anu punishing the ciiminal; iestoiing the
stolen loot to the victim is stiictly seconuaiy. To the insuiance
company anu its uetectives, on the othei hanu, the piime concein
is iecoveiy of the loot, anu appiehension anu punishment of the
ciiminal is seconuaiy to the piime puipose of aiuing the victim of
!"#$%&"'()
??????????????????????????????????????????????????????????"
"
22S
ciime. Beie we see again the uiffeience between a piivate fiim
impelleu to seive the customei-victim of ciime anu the public
police, which is unuei no such economic compulsion.
S

Foi many ieasons, Austiian economists have histoiically hau
an affinity foi insuiance companies. This is not suipiising, since
insuiance is a maiket-baseu institution that allows inuiviuuals to
entei mutually auvantageous contiacts, in oiuei to minimize the
impact of iisk that they woulu otheiwise have to beai. As with othei
elements of a competitive maiket, theie is a natuial feeuback
mechanism: If insuieis uo not pay out legitimate claims, oi if they
chaige piemiums fai in excess of the actuaiial anu othei
auministiative expenses, they will be penalizeu by losing customeis
to iival fiims.
In light of this long-stanuing affinity, it shoulu not be
suipiising that insuiance can play such an impoitant iole in
implementing the Sounu Noney Solution, as will be explaineu fully
in Pait III.

1
Ludwig von Mises, Planning for Freedom, p. 92.
2
Jess Huerta de Soto, Money, Bank Credit, and Economic Cycles (Auburn, AL: The
Ludwig von Mises Institute, 2009), p. 586.
3
Huerta de Soto, footnote 104, pp. 586-587.
4
See for example Robert P. Murphy, The Source of Air-Travel Insecurity,
November 26, 2001, at: http://mises.org/daily/836. Accessed June 1, 2010.
5
Murray Rothbard, For a New Liberty (San Francisco: Fox & Wilkes, 1994), pp. 217-
218.
!"#$%&"'()
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!!"#
#
22S
!"#$%&'()*(
+,-&'./&.%(012%,'%1,.2(

!"#$#%&$#' (&)"*(+' *,' -&$#' *-.&$)/()'
)&0/1' )"/(' )&' #(2*+")#(' .342*5' &.*(*&('
/4&3)' )"#' 4/,*5' 0*%%#$#(5#,' 4#)6##('
+#(3*(#' 7*4#$/2*,-8' 6"*5"' /09&5/)#,'
)"#' %$##' -/$:#)' #5&(&-18' /(0' )"#'
9/$*&3,' *()#$9#()*&(*,)' ./$)*#,' 6"*5"'
/$#' /09&5/)*(+' +&9#$(-#()'
*()#$%#$#(5#;'
<7306*+'9&('=*,#,
>
'

he pieceuing chapteis in this section have uesciibeu the
basic functioning of a maiket economy. We have seen
how fiee inuiviuuals, acting only to impiove theii own lives anu that
of theii immeuiate families anu fiienus, nonetheless aie leu "as if by
an Invisible Banu" to uevelop institutions such as money, banking,
anu insuiance that make mouein civilization possible.
0nfoitunately, along the way the ieauei unuoubteuly
iecognizeu that something wasn't quite iight. Although the
uesciiption of a maiket economy is familiai, it uoesn't captuie what
$#/221 happens in oui woilu. In paiticulai, banking uoes not opeiate
along the lines sketcheu out in Chaptei 14.
T
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
226
The Austiians explain this uisciepancy by pointing to laige-
scale +&9#$(-#()' *()#$9#()*&(. In eveiy nation touay, even the
ostensibly "capitalist" 0niteu States, the goveinment systematically
iegulates, taxes, spenus, anu otheiwise uistoits the opeiation of the
maiket economy.
The Austiian ciitique of goveinment inteivention points out
a tiagic iiony: In case aftei case, the allegeu puipose of a new
goveinment iegulation oi piogiam is to fix a "maiket failuie" that is
actually causeu by a .$*&$'goveinment inteivention! In othei woius,
the social ills that aie typically blameu on "uniestiaineu capitalism"
aie in fact the piouuct of goveinment effoits to hinuei capitalism.
Foi example, the vexing pioblem of high unemployment in ceitain
uemogiaphics is causeu by minimum wage laws, (&)' by ciuel
employeis pei se.
Theie aie many Austiian books anu aiticles uealing with
these issues.
2
Foi oui puiposes, we will focus on just one: Bow
goveinment inteifeience with the institutions of money anu
banking uilutes the cuiiency anu spawns the boom-bust cycle.

3#'4&%56#2&7( !,//,71%8( 3,.&8( 9&'2:2( +,-&'./&.%(
;1#%(3,.&8

The most obvious uisciepancy between oui cuiient woilu,
anu the maiket economy sketcheu in eailiei chapteis, is that people
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
227
nowauays uo not use golu oi silvei as money. Insteau, they use
pieces of papei issueu by goveinments. When the monetaiy unit
was itself an actual commouity, its puichasing powei helu its value
ovei time; a golu ounce in 181u geneially bought the same amount
of goous as a golu ounce in 191u. In contiast, with goveinment
papei, the puichasing powei of money constantly fallsfoi
example, the 0.S. uollai has lost about 9S peicent of its value since
the Feueial Reseive was establisheu in late 191S. So peivasive is
goveinment inflation, that people in oui age take it foi gianteu that
piices inexoiably iise yeai aftei yeai, as if this weie a fact of natuie.
In the woist cases, such as Weimai ueimany oi mouein-uay
Zimbabwe, goveinment piinting piesses have causeu hypeiinflation
anu liteially uestioyeu the cuiiency.
Bow uiu this tiansfoimation occui. Why woulu people
abanuon the commouity money that emeigeu spontaneously out of
theii maiket tiansactions, in favoi of papei money issueu by
goveinments with all theii attenuant uangeis.
The piocess was not voluntaiy. As Nises states with
chaiacteiistic fiankness:

The golu stanuaiu uiu not collapse. uoveinments abolisheu it in
oiuei to pave the way foi inflation. The whole giim appaiatus of
oppiession anu coeicion, policemen, customs guaius, penal
couits, piisons, in some countiies even executioneis, hau to be
put into action in oiuei to uestioy the golu stanuaiu.
S

!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
228

The geneial pattein was that goveinments woulu
inciementally iegulate the issuance of banknotes, until the point at
which only one note ciiculateu in the countiy which was the official
ieuemption claim on the genuine commouity money (golu anuoi
silvei). Then, once the public hau become habituateu to buying anu
selling using the goveinment-uesignateu papei notes, theii
ieueemability woulu be suspenueu. At fiist, the suspension woulu
only be tempoiaiy, uuiing wais oi othei ciises. But since Richaiu
Nixon foimally closeu the golu winuow in 1971, all of the majoi
cuiiencies of the woilu have been puie %*/)'53$$#(5*#,, meaning that
they aie backeu up by absolutely nothing.
0nce the goveinments of the woilu weie fiee of the fetteis of
the golu stanuaiu, they piinteu new money with ieckless abanuon.
Look at the chait of the Consumei Piice Inuex, noting the
acceleiation in piice inflation aftei the uollai's tie to golu was fully
seveieu in 1971:
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
229

Although the peifoimance of the 0.S. cential bank has been
abysmal compaieu to a genuine maiket-baseu monetaiy system, the
Ameiican expeiience has actually been a ielative success stoiy,
compaieu to some othei cential banks. The uouble-uigit piice
inflation of the late 197us was ceitainly painful (anu completely
unnecessaiy), but things coulu be woise: Accoiuing to the Cato
Institute's Senioi Fellow Steve Banke's calculations, in Novembei
2uu8 Zimbabwe achieveu a -&()"21' inflation iate of 79.6 4*22*&(
peicent. In this inconceivable enviionment, piices in Zimbabwe
uoubleu eveiy 2S houis!
4
Whatevei shoitcomings may plague a
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2Su
maiket-baseu commouity money, they aie nothing compaieu to the
uangeis of goveinment papei money.

;'#<%1,.#=(>&2&'-&(6#.41.?

Eailiei we uiscusseu banking in the context of 1uu% ieseive
checking accounts. In this aiiangement, an inuiviuual uses a bank
simply to change the %&$- of his money. Rathei than lugging aiounu
hunuieus of pounus of golu, foi example, the inuiviuual woulu place
it on ueposit with a ieputable oiganization who hau a stiong safe
anu coulu issue eithei banknotes oi a checkbook to allow the
inuiviuual to spenu his money in the community.
Bistoiically, golusmiths weie among the fiist bankeis.
Because they hau golu on hanu anyway foi theii business, it was
only natuial that golusmiths woulu tiy to benefit fiom economies of
scale by offeiing to waiehouse the golu helu by otheis in the aiea.
0vei time, the golusmiths noticeu something veiy
inteiesting: 0n any given uay, most of theii customeis' golu ueposits
sat iuly in the vault. Although the customeis hau the legal ability to
claim theii ueposits at any time anu ietiieve theii golu, in piactice
most of them uiu not uo so. When someone useu a banknote (issueu
by a golusmith) to buy something fiom a local meichant, veiy often
the meichant woulu simply hang on to the note anu spenu it himself,
iathei than tuining it in foi ieuemption. 0nce meichants in the
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S1
community leaineu that a paiticulai golusmith coulu be tiusteu to
ieueem his notes, theie was little ieason to tiavel to the golusmith's
place of business anu iemove the clunky hunks of yellow metal. It
was fai moie convenient to simply holu the banknotes as they
tiickleu in fiom customeis, to be spent by the meichant latei on.
In this enviionment, it is not haiu to guess what the wily
golusmiths uiu. They began gianting loans of banknotes *('#@5#,, of
the golu stoieu in theii vaults. Foi example, if a paiticulai golusmith
hau 1,uuu ounces of his customeis' ueposits stoieu in the vault
anu hau alieauy issueu 1,uuu banknotes which in essence weie
claim tickets on each ouncethe golusmith might in auuition hanu
out 1uu auuitional banknotes, which weie iuentical to the notes he
hau given to the oiiginal customeis when they uepositeu theii
physical golu. The ieason this benefiteu the golusmith is that he
might sign a contiact in which the boiiowei agieeu that he woulu
pay back 11u banknotes in one yeai's time. Thus, as long as the
boiiowei uiun't uefault on the loan, the golusmith woulu have
eaineu 1u golu ounces' woith of inteiest income uuiing the couise
of the yeai, without having put up any of his own money in the
piocess.
Nany wiiteis have uesciibeu fiactional ieseive banking as a
foim of counteifeiting, because the bankei in a sense cieates new
money out of thin aii. In oui example above, the community woulu
have 1,uuu banknotes ciiculating which weie meiely claims against
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S2
the 1,uuu golu ounces sitting in the golusmith's vault, but on top of
that theie woulu be an /00*)*&(/2' 1uu notes ciiculating aftei the
new loan hau been gianteu. The meichants in the community woulu
not be able to uistinguish the one note fiom the othei, anu thus
piices (quoteu in golu ounces) in the community woulu iise, just as
if mineis hau uiscoveieu anothei 1uu ounces of physical golu. In the
gianu scheme, the golusmith's piactice of fiactional ieseive banking
woulu shift puichasing powei fiom eveiyone else in the community
(stuck with theii oiiginal amounts of physical golu anuoi
banknotes) into his own hanus, as his own income incieaseu in
piopoition to the iise in piices that his excessive note issue causeu.
It is absolutely essential foi the ieauei to unueistanu the
"magic" of fiactional ieseive banking, anu so we will leave oui
histoiical naiiative involving golu ounces anu banknotes, anu
illustiate the piocess in a mouein context with 0.S. uollais. Suppose
a teenagei, Bill, is iummaging in the attic anu finus $1,uuu in an olu
chest. Bill is ecstatic anu iuns to his bank, wheie he opens a
checking account anu ueposits the gieen pieces of papei.
0nuei a 1uu% ieseive system, this woulu be the enu of the
stoiy. Bill's cuiiency holuings woulu fall by $1,uuu, while his
checkbook balance woulu iise by $1,uuu. The act of uepositing the
money in the bank woulun't affect the total amount of money in the
economy.
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2SS
Bowevei, in oui cuiient system, Bill's bank woulu see a new
piofit oppoitunity. Aftei the bank put the $1,uuu in cuiiency into its
vault, its ieseives woulu be that much highei, while its outstanuing
ueposit liabilities woulu have iisen by $1,uuu as well (in the foim of
Bill's new checking account). But since banks in the 0niteu States
aie subject only to a ieseive iequiiement of (appioximately) ten
peicent, the bank woulu have #@5#,,' $#,#$9#, of $9uu. If it founu a
suitable boiiowei, the bank woulu have the legal ability to giant a
new loan foi this amount. Suppose the bank founu such a boiiowei,
Sally, anu chaigeu hei S peicent inteiest foi a 12-month loan.
Assuming she paiu off the loan in a timely mannei, heie is what the
bank's balance sheet woulu look like at vaiious stages in the
piocess:

( @A(6#.4B2(6#=#.<&(C"&&%(DE%&'(61==8B2(0&$,21%
Assets Liabilities + Shaieholuei's
Equity
$1,uuu in vault cash $1,uuu (Billy's checking
account balance

!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S4
@@A(6#.4B2(6#=#.<&(C"&&%(DE%&'(F,#.(+'#.%&7(%,(C#==8(
Assets Liabilities + Shaieholuei's Equity
$1,uuu in vault cash
$9uu loan to Sally at S% foi
12 months
$1,uuu (Billy's checking account
balance)
$9uu (Sally's new checking
account)

@@@A(6#.4B2(6#=#.<&(C"&&%(DE%&'(C#==8(C$&.72(G&'(F,#.(,.(
6:21.&22(C:$$=1&2(
Assets Liabilities + Shaieholuei's Equity
$1uu in vault cash
12 months
$1,uuu (Billy's checking account
balance)
$u (Sally's checking account
balance)

!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2SS

@9A(6#.4B2(6#=#.<&(C"&&%(DE%&'(C#==8(C&==2(G&'(H',7:<%2(E,'(
I)JKKK(!#2"(
#.7(0&$,21%2(%"&(H',<&&72(1.(G&'(D<<,:.%(
Equity
$1,1uu in vault cash
12 months
$1,uuu (Billy's checking
account balance)
$1,uuu (Sally's checking
account balance)

9A(6#.4B2(6#=#.<&(C"&&%(DE%&'(C#==8(H#82(LEE(G&'(F,#.(H=:2(
@.%&'&2%(
Equity
$1,1uu in vault cash

$1,uuu (Billy's checking
account balance)
$SS (Sally's checking account
balance)
$4S in bank shaieholuei
equity

!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S6
M,%&( E,'( $:'12%2N In the tables above, technically with the passage of time, the
maiket value of the loan to Sally woulu inciease fiom its initial $9uu. As the loan
matuieu, its appieciation woulu be matcheu by an equal giowth in the
shaieholuei's equity on the iight siue of the balance sheet. (In othei woius, the
shaieholuei equity woulu giauually inciease to $4S ovei the couise of the yeai; it
woulun't suuuenly jump fiom $u to $4S when Sally paiu off the loan.) But we have
neglecteu this complication to keep the above example as simple as possible.

As oui hypothetical example makes cleai, with the powei of
fiactional ieseive banking, bankeis can appaiently eain income out
of nothing! So long as Billy leaves his money in the bank, anu so long
as Sally is able to eain enough ievenues fiom hei business to avoiu
uefaulting on hei loan, the bank's shaieholueis enu up with $4S of
the community's cash, fiee anu cleai.
Notice that in oiuei foi this mysteiious piocess to unfolu, the
bank liteially cieateu $9uu in new money in the community when it
auvanceu the loan to Sally, anu then snuffeu it out of existence when
she paiu off hei uebt. It is because of these stiange machinations
that many ciitics of oui piesent financial fiamewoik iefei to it as
"uebt-baseu money."
Foi the newcomei, the mystical quality of fiactional ieseive
banking is at fiist haiu to giasp. u. Euwaiu uiiffin ielates a
humoious anecuote of a politician leaining the tiuth:

!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S7
Naiiinei Eccles was the uoveinoi of the Feueial
Reseive System in 1941. 0n Septembei Su of that yeai, Eccles
was askeu to give testimony befoie the Bouse Committee on
Banking anu Cuiiency. The puipose of the heaiing was to obtain
infoimation iegaiuing the iole of the Feueial Reseive in cieating
conuitions that leu to the uepiession of the 19Sus. Congiessman
Wiight Patman, who was Chaiiman of that committee, askeu how
the Feu got the money to puichase two billion uollais woith of
goveinment bonus in 19SS. This is the exchange that followeu.

ECCLES: We cieateu it.
PATNAN: 0ut of what.
ECCLES: 0ut of the iight to issue cieuit money.
PATNAN: Anu theie is nothing behinu it, is theie, except
oui goveinment's cieuit.
ECCLES: That is what oui money system is. If theie weie
no uebts in oui money system, theie woulun't be any money.
S

Along the same lines, Robeit Bemphill, Cieuit Nanagei of the
Feueial Reseive Bank in Atlanta, wiote in 19S6:

If all the bank loans weie paiu, no one coulu have a bank
ueposit, anu theie woulu not be a uollai of coin oi cuiiency in
ciiculation. This is a staggeiing thought. We aie completely
uepenuent on the commeicial banks. Someone has to boiiow
eveiy uollai we have in ciiculation, cash, oi cieuit. If the banks
cieate ample synthetic money we aie piospeious; if not, we
staive. We aie absolutely without a peimanent money system.
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S8
When one gets a complete giasp of the pictuie, the tiagic
absuiuity of oui hopeless situation is almost incieuiblebut
theie it is.
6

It is uebatable whethei things aie A3*)# as uiamatic as Eccles
anu Bemphill claim. Stiictly speaking, the commeicial banks only
cieate "uebt-baseu money" when they pyiamiu new loans on top of
existing ieseives. But the ieseives themselveswhethei in the foim
of actual cuiiency oi cieuits with the Feueial Reseiveuo not
constitute a uebt claim on any citizen oi commeicial bank. In oui
example above, the $1,uuu in cuiiency that Billy uiscoveieu was a
puie asset, as fai as he was conceineu. (In contiast, the $9uu in
auuitional money coulu only be biought into existence when Sally
incuiieu a $9uu uebt to the commeicial bank, anu that same $9uu
uisappeaieu fiom the money supply when Sally paiu hei uebt off.)
Yet even heie, theie is a uefinite sense in which bank
ieseives themselves aie a foim of uebt, as opposeu to a genuine anu
unfetteieu asset as golu coins woulu be in a commouity-baseu
system. This is so foi two ieasons. Fiist, the Feueial Reseive
typically cieates new ieseives by buying +&9#$(-#()' 0#4). In a
sense, the 0.S. Tieasuiy is in the position of Sally, anu when it is
(inuiiectly) gianteu a new loan fiom the Feu, the total amount of
ieseives in the banking system incieases, thiough what the
textbooks uesciibe as an "open maiket opeiation."
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S9
Seconu, the papei cuiiency in youi puise oi wallet is a
liability of the Feueial Reseive, legally speaking. Aftei all, these
gieen pieces of papei have "Feueial Reseive Note" wiitten on them.
This is an accounting fiction, of couise, a thiowback to the uays
when the notes weie simply claims to actual golu oi silvei. It's
haiuly a liability to have billions of uollais in "claims" against the
Feueial Reseive floating aiounu, when they aie claims to nothing. (If
you tiieu to piesent a $2u bill foi ieuemption at a Feueial Reseive
office, you woulu be able to get two $1u bills, oi foui $S bills, but
ceitainly no othei type of asset.)
In any event, theie is a laige uegiee of tiuth in the claim that
oui fiat money, fiactional ieseive banking system, is one in which
uebt is inteitwineu with money. This system featuies the utteily
peiveise piopeities that massive incieases in inuebteuness give iise
to a euphoiic boom (as the money supply giows), while peiious of
fiugality anu uebt payment coinciue with peiious of uepiession (as
the money supply contiacts). This is not a featuie of the maiket
economy, but insteau a iesult of goveinment inteivention in the
monetaiy anu banking aienas.

!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
24u
G,O(+,-&'./&.%(P.<,:'#?&2(;'#<%1,.#=((
>&2&'-&(6#.41.?

The stanuaiu justification foi "cential banking"in which
the cential goveinment heavily iegulates the banking sectoi, anu
inueeu uesignates a supieme bank to which all otheis aie
suboiuinateis that wilucat, uniegulateu banking woulu leau to
iampant inflation. Inueeu, oui uesciiption of the golusmiths woulu
leau many ieaueis to concluue that fiee enteipiise anu open entiy,
while they might be goou iueas in haii salons anu cai uealeiships,
woulu be uisastious in the banking inuustiy.
The opposite is tiue. In a puie maiket economy, theie aie
stiong 5"#5:, against fiactional ieseive banking, which pievent any
one bank fiom issuing an excessive numbei of unbackeu notes (oi of
gianting a laige fiaction of new loans on the basis of othei
customeis' ueposits). Suppose we stait in an initial position of
equilibiium, wheie all the golusmiths have "cheateu" to an equal
extent, such that only 9u% of any golusmith's ciiculating banknotes
actually have golu ieseives backing them up in the vault. So long as
the vaiious golusmiths' customeis aie content to keep theii golu on
ueposit, eveiything is fine: 0n aveiage, the golusmiths' customeis'
checking tiansactions offset each othei, so that theie is no net
movement of golu fiom one smith's vault to anothei.
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
241
This equilibiium will be uistuibeu if one of the golusmiths
becomes moie aggiessive, piinting up new banknotes anu lenuing
them into the community. Because of this new issuance, suppose
only 7S% of this golusmith's notes aie now backeu up by physical
golu in the vault. The shoit-teim benefit, of couise, is that the
golusmith now has a laigei loan poitfolio, anu ieaps moie inteiest
income than unuei his moie conseivative policy.
The success will be fleeting, howevei. Because of the ielative
inciease in the amount of banknotes useu by the aggiessive
golusmith's clientele, his clients will tenu to spenu moie when
buying things fiom othei membeis of the community, than the
clients of othei golusmiths will spenu on the goous offeieu by the
fiist gioup. In othei woius, the clientele of the aggiessive golusmith
will iun a "tiaue ueficit" with the clients of the moie conseivative
golusmiths.
What this means is that eventually, the conseivative
golusmiths will accumulate an excess of banknotes issueu by the
aggiessive golusmith, as theii clients ueposit these notes into theii
own accounts. Buiing peiiouic cleaiinghouse opeiations, the
aggiessive golusmith will finu that he consistently has net
ieuemption claims fiom his competitois. Bis stockpiles of golu will
eventually be uiaineu away into theii vaults, as they continually
piesent him with moie of his own banknotes foi ieuemption, than
he in tuin can piesent to them.
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
242
Thus we see that a fiee maiket in banking contains automatic
stabilizeis, a built-in feeuback mechanism that penalizes fiactional
ieseive banking. If one bank becomes moie aggiessive than its
peeis, its newly issueu loans will quickly come home to ioost as the
new money finus its way into the hanus of iival bankeis.
Fuitheimoie, in a fiee maiket with open entiy, the banks can't even
agiee to foim a caitel anu expanu ,*-32)/(#&3,21, because this
woulu pioviue an incentive foi a new stait-up fiim to begin banking
with a highei ieseive iatio than the iest of the inuustiy. This new
bank woulu then giauually uiain away the golu ieseives of the olu
establishment, foicing them to abanuon theii aggiessive lenuing anu
iaise theii ieseive iatios.
But if a fiee maiket in banking woulu have built-in incentives
foi 1uu% ieseives, why uo we not see this in piactice. The answei
is +&9#$(-#()'*()#$9#()*&(. Contiaiy to the official justifications, the
puipose of goveinment bank iegulation has been to caitelize the
inuustiy anu #2*-*(/)#' the maiket biakes on fiactional ieseive
piactices. The entiie soiuiu histoiy is beyonu the scope of this book,
but we will quote Nuiiay Rothbaiu's summaiy of the piocess as it
was pioneeieu in uieat Biitain:

The institution of Cential Banking easeu the fiee-maiket
iestiictions on fiactional ieseive banking in seveial ways. In the
fiist place, by the miu-nineteenth centuiy a "tiauition" was
ciaftily cieateu that the Cential Bank must always act as a
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
24S
"lenuei of last iesoit" to bail out the banks shoulu the bulk of
them get into tiouble. The Cential Bank hau the might, the law,
anu the piestige of the State behinu it; it was the uepositoiy of
the State's accounts; anu it hau the implicit piomise that the
State iegaius the Cential Bank as "too big to fail."..Backeu by the
Cential Bank anu beyonu it by the State itself, then, public
confiuence in the banking system was aitificially bolsteieu, anu
iuns on the banking system became fai less likely.
.
The Peel Act |of 1844j system insuieu that the Cential
Bank coulu act as a caitelizing uevice, anu in paiticulai to make
suie that the seveie fiee-maiket limits on the expansion &%' /(1'
&(#' 4/(: coulu be ciicumventeu..|Sjince the whole point of
fiactional-ieseive banking is (&) to have sufficient money to
ieueem the ieceipts, |an aggiessive bankj woulu quickly go
unuei |in a fiee maiketj. But if a Cential Bank enjoys the
monopoly of bank notes, anu the commeicial banks all pyiamiu
expansion of theii uemanu ueposits on top of theii "ieseives," oi
checking accounts at the Cential Bank, then all the Bank neeu uo
to assuie successful caitelization is to expanu piopoitionately
thioughout the countiy, so that all competing banks inciease
theii ieseives, anu can expanu togethei at the same iate.
7

As in so many othei aieas, in the fielus of money anu
banking, goveinment inteivention achieves the exact &..&,*)# of its
stateu puipose. Feueial Reseive officials solemnly ueclaie that they
will fight inflation to piotect the uollai, anu yet it is theii conscious
uecision to 5$#/)#' -&$#' 0&22/$, that eioues puichasing powei fai
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
244
moie than occuiieu befoie the Feu's existence. Inteiventionists
assuie us that a fiee maiket in banking woulu leau to ieckless
lenuing anu wiuespieau instability; yet this peifectly uesciibes the
system we have unuei the "piotection" of the cential bank.
Peihaps woist of all, goveinment meuuling with inteiest
iates causes the boom-bust cycle that plagues mouein economies.
Auuing insult to injuiy, fuithei goveinment effoits to "pioviue a soft
lanuing" only seive to intensify anu piolong the iecoveiy. If we
know what to look foi, the pattein is obvious in both the uieat
Bepiession anu in oui cuiient ciisis.

;'#<%1,.#=(>&2&'-&(6#.41.?(!#:2&2(%"&(6:21.&22(!8<=&

Nany economists, even those who geneially aumiie the fiee
maiket, believe that the boom-bust cycle is a natuial featuie of
capitalism. Foi whatevei ieason, theie aie peiious of iapiu giowth
anu low unemployment, followeu by peiious of sluggishness anu
high unemployment. It seems that these cycles aie a natuial featuie
of maiket economies, with the goveinment's iole (if any) being to
smooth out these peiiouic ups-anu-uowns.
The Austiian economists uisagiee. Accoiuing to the business
cycle theoiy uevelopeu by Nises anu iefineu by Bayekthe lattei
winning his Nobel foi this woikit is goveinment inteifeience with
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
24S
the banking system that uistuibs the unueilying tienu of noimal,
sustainable economic giowth.
Specifically, what happens is this: It is veiy politically
populai to push uown inteiest iates below theii maiket levels. The
cential bank (the Feueial Reseive in the 0.S.) buys assets such as
goveinment bonus anu injects new ieseives into the banking
system. Because iegulations only insist on fiactional (insteau of
1uu%) ieseives, the commeicial banks can then auvance new loans
to theii customeis, which aie "pyiamiueu" on top of the influx of
new ieseives. (The piocess is analogous to oui uiscussion above,
except that the initial ueposit comes not fiom the uiscoveiy of
$1,uuu in cuiiency, but fiom the cential bank's puichase of assets
by wiiting a check uiawn on the Feu itself.) In oiuei to move the
new loans, the commeicial banks lowei the iate of inteiest they
chaige.
In the Austiian view, the inteiest iate is a veiy impoitant
maiket piice, which seives to iegulate the steeiing of iesouices into
consumption goous veisus capital goous. When the inteiest iate is
veiy high, it penalizes entiepieneuis fiom staiting long piouuction
piocesses, because they can't affoiu to have theii capital "tieu up"
foi yeais in a ventuie. 0n the othei hanu, if inteiest iates fall, then
ceitain long-teim piojects may suuuenly become piofitable, even
though they weie not goou investments at the highei inteiest iate.
Foi example, to builu a skysciapei might iequiie yeais of upfiont
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
246
investment, befoie the builuing can be ienteu out to eain ievenues.
The same piojecteu flow of expenses anu income coulu have a
positive oi negative piesent value, uepenuing on the inteiest iate.
The lowei the inteiest iate useu to "uiscount" futuie cash flows, the
moie piofitable the pioject woulu become.
Accoiuing to the Austiians, when the cential bank aitificially
loweis the inteiest iate, this senus a false signal to entiepieneuis.
They begin long-teim piojects, just as they woulu if people hau
actually incieaseu theii savings (which /2,& woulu push uown
inteiest iates). Foi a while, things appeai piospeious. The
entiepieneuis who get the new loans can expanu theii opeiations,
hiie woikeis, anu buy supplies fiom othei businesses. Theie is a
geneial feeling of euphoiia. The 4&&- ensues.
0nfoitunately, the boom is illusoiy. The cential bank uiun't
actually inciease the amount of ieal savings in the economy, just by
piinting up money anu giving it to bonu uealeis (who in tuin
uepositeu the new money in theii own commeicial banks). The
falling inteiest iate is giving the wiong message about the tiue
amount of savings available foi businesses to boiiow. It is not
physically possible foi businesses to expanu in some sectois,
without coiiesponuing contiactions in othei sectois. Anu yet,
uuiing the boom peiiou, #9#$1 sectoi seems to be uoing well. The
ianks of the unemployeu shiink, because businesses in geneial aie
hiiing, while veiy few aie laying off woikeis.
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
247
Because it is built on sanu, the boom must eventually enu
anu the soonei the bettei. When the cential bank eases back on its
injections of new ieseives, inteiest iates begin iising to theii tiue
maiket level. At this stage, many business owneis aie caught flat-
footeu. As inteiest iates iise, anu as the new money pushes iesouice
piices highei, many owneis iealize that they have bitten off moie
than they can chew. Theii opeiations aie no longei piofitable, anu
they aujust to the new ieality. Some meiely scale back opeiations,
but otheis iealize that the best thing to uo is shut uown
immeuiately, lay off all woikeis, anu liquiuate whatevei assets they
own. This is the 43,) phase.
Iionically, the Austiians view the boom peiiou as bau, while
the bust is goou. Buiing the boom peiiou, iesouices aie being
-/2*(9#,)#0. The longei the boom peisists, the fuithei the capital
stiuctuie of the economy stiays fiom wheie it ieally shoulu be.
(This is because the cential bank is not allowing the inteiest iate to
communicate the coiiect infoimation.) When the cential bank
finally ielents anu lets the inteiest iate "tell the tiuth" once again,
businesses aujust to the giim ieality. It's tiue, the bust peiiou isn't
pleasant, but it is necessaiy to cleanse the economy of the
malinvestments fiom the boom peiiou. A populai analogy compaies
the boom to a uiinking binge, anu the bust to a hangovei.
Thus we see that goveinment inteiventionin the foim of
cential banks which oiganize caitels in the inuustiy anu fostei
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
248
fiactional ieseive bankingis the souice of the boom-bust cycle. In
a fiee maiket, wheie the inteiest iate ieflecteu the genuine amount
of savings maue possible by people living below theii means (i.e.
consuming less than theii incomes), business expansion woulu be
sustainable. Theie woulu be no massive swings up anu then ciashes
uown. It's tiue, in any given yeai some business woulu always fail,
but theie woulun't be peiious of ,1,)#-/)*5 failuie sweeping acioss
the entiie economy.

PQ$=#1.1.?(%"&(+'&#%(0&$'&221,.

Accoiuing to the stanuaiu line most ieaueis piobably
leaineu in giaue school, the uieat Bepiession of the 19Sus was the
fault of the uniegulateu, wilucat fiee maiket. Back in those
unenlighteneu timesso the official stoiy goesthe 0niteu States
anu othei auvanceu economies hau a ielatively puie capitalist
system. When uniegulateu speculatois ciasheu the stock maiket in
1929, Piesiuent Beibeit Boovei sat back anu uiu nothing to aveit
uisastei. Clinging to his antiquateu beliefs in small goveinment,
Boovei watcheu as the nation plungeu into uepiession. It took the
bolu inteiventionist Fianklin B. Roosevelt to expanu the size of the
feueial goveinment anu iescue the economy fiom the slump causeu
by puie capitalism.
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
249
Eveiy element in this official stoiy is a myth. This is not the
place foi a full iefutation; one of the piesent authois has wiitten a
book on the subject.
8
Foi oui puiposes, we will offei a few
obseivations.
Fiist, on the face of it this official explanation makes no
sense. The ciash of 1929 wasn't the fiist financial panic in 0.S.
histoiy. Anu howevei laissez-faiie the 0.S. goveinment was in the
eaily 19Sus, it ceitainly was /)'2#/,) as laissez-faiie uuiing the piioi
financial ciises. So to explain the uieat Bepiession as uue to
uniegulateu capitalism, is a bit like blaming a paiticulaily awful
plane ciash on giavity.
Yet in the seconu place, the piemise itself is wiong. Beibeit
Boovei was (&) a laissez-faiie manfai fiom it! In iesponse to the
1929 ciash, Boovei calleu all the big business leaueis to Washington
anu insisteu that they not cut wage iates as a means of coping with
the ciisis. This ensuieu that laboi became aitificially moie
expensive as the yeais uiaggeu on, as othei piices plummeteu but
businesses weie ieluctant to cut pay. It's not suipiising then that
unemployment soaieu to 2S peicent, when Boovei's high-wage
policies uiove up the (ielative) piice of employing woikeis.
Believe it oi not, Boovei implementeu what coulu be faiily
calleu a New Beal-lite uuiing his single teim in office. In the two
yeais following the stock maiket ciash, feueial spenuing iose 42
peicent. Boovei inheiiteu a peifect stiing of feueial buuget
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2Su
suipluses unuei his pieuecessoi Calvin Cooliuge, anu yet in
Boovei's last buuget yeai the feueial ueficit was a whopping 4.S
peicent of uBP. (Foi compaiison, uuiing ueoige W. Bush's fiist
teimin which he "staiteu a wai anu cut taxes on the iich"the
feueial buuget ueficit peakeu at S.6 peicent of uBP.) Boovei also
uiastically incieaseu the tax buiuen, with the top income tax iate
going fiom 2S peicent in 19S1 to BC'.#$5#()'&(#'1#/$'2/)#$. Anu in a
move that sounus veiy Roosevelt-ish, Boovei oveisaw the cieation
of the Reconstiuction Finance Coipoiation (RFC) to bail out
tioubleu financial institutions, which uisbuiseu some $1.S billion in
19S2 alone. (Anu iemembei, in 19S2 a billion uollais ieally meant
something!)
9

As we see, the actions of the Boovei Auministiation haiuly
justify his ieputation as a colu-blooueu uogmatist. Iionically, Boovei
himself uenieu such a uesciiption, so it is veiy cuiious that the
official myth peisists. In his memoiis heie is what Boovei has to say
on this peiiou:

With the 0ctobei-Novembei |1929j stock-maiket ciash the
piimaiy question at once aiose as to whethei the Piesiuent anu
the Feueial goveinment shoulu unueitake to mitigate anu
iemeuy the evils stemming fiom it. No Piesiuent befoie hau evei
believeu theie was a goveinmental iesponsibility in such cases.
No mattei what the uiging on pievious occasions, Piesiuents
steaufastly hau maintaineu that the Feueial goveinment was
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S1
apait fiom such eiuptions; they hau always been left to blow
themselves out. Piesiuents van Buien, uiant, Clevelanu, anu
Theouoie Roosevelt hau all iemaineu aloof.
Because of this lack of goveinmental expeiience,
theiefoie, we hau to pioneei a new fielu. As a mattei of fact theie
was little economic knowleuge to guiue us.
1u

In his acceptance speech foi the 19S2 Republican
piesiuential nomination, Boovei lookeu back on the
accomplishments of his fiist teim anu piouuly ueclaieu:

|Wje might have uone nothing. That woulu have been uttei iuin.
Insteau, we met the situation with pioposals to piivate business
anu to Congiess of the most gigantic piogiam of economic
uefense anu counteiattack evei evolveu in the histoiy of the
Republic. We put it into action.
11

So theie you have it: Both the statistics anu Boovei's own
statements show that his was the most *()#$9#()*&(*,)
auministiation in 0.S. histoiy, at least in teims of uealing with a
financial ciash. Since this "meuicine" fiom Washington went hanu-
in-hanu with the woist economic collapse in 0.S. histoiy, 0ccam's
Razoi (as well as Austiian economic theoiy) suggests that the
Boovei meuicine was in fact poison. Rathei than uepaiting fiom the
laissez-faiie policies of his pieuecessois, Boovei shoulu have
followeu theii example anu let the maiket aujust to the ciisis.
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S2
Theie is moie to the stoiy, howevei. The stock maiket ciash
of 1929 itself was not uue to the "fiee maiket." In fact, the Feueial
Reseive in 1927 consciously cut inteiest iates anu fueleu 0.S.
inflation, in oiuei to assist the Bank of Englanu. This easy-money
policy by the Ameiican cential bank fueleu the stock maiket boom
of the late 192us, which then came ciashing uown in 1929 when the
Feu began applying the biakes.
As with the full histoiy of the 19Sus, it is not oui place heie
to explain the entiie stoiy behinu the Feueial Reseive's fateful
uecision. Insteau we will give enough eviuence to whet the ieauei's
appetite to follow-up with the books citeu in the enunotes. Beie is
the 19S1 testimony of Feueial Reseive membei A. C. Nillei, befoie
the Senate Committee on Banking anu Cuiiency, on the causes of the
1929 ciash:

In the yeai 1927.you will note the pionounceu inciease in
|Feueial Reseive holuings of 0niteu States goveinment uebt
secuiitiesj in the seconu half of the yeai. Coupleu with the heavy
puichases of acceptances it was the gieatest anu boluest
opeiation evei unueitaken by the Feueial Reseive System, anu,
in my juugment, iesulteu in one of the most costly eiiois
committeu by it oi any othei banking system in the last 7S
yeais!...
What was the object of Feueial Reseive Policy in 1927.
It was to biing uown money iates, the call iate |the inteiest iate
on loans to "maigin buyeis" who buy stock anu othei secuiities
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2SS
with boiioweu capitalj among them, because of the inteinational
impoitance the call iate hau come to acquiie. The puipose was to
stait an outflow of goluto ieveise the pievious inflow of golu
into this countiy.
12

Now assuming Nillei's testimony is accuiate, why in the
woilu woulu the Feueial Reseive have consciously auopteu an
inflationaiy policy in 1927, with the intention of causing golu to
2#/9# the countiy.
The answei is a long anu nuanceu one, anu has been a
favoiite topic of "conspiiacy theoiists" who blame woiluwiue
calamities on the hiuuen machinations of iich bankeis anu othei
poweiful inuiviuuals. What we can say with confiuence is that uieat
Biitain was in tiouble aftei Woilu Wai I, because the Biitish
authoiities wanteu to ietuin to the golu stanuaiu at the pie-wai
paiity, but hau piinteu too many papei notes to funu the wai effoit.
In oiuei to stiengthen the pounu to its pie-wai position vis--vis the
0.S. uollai, theiefoie, Biitish laboi unions woulu have hau to
toleiate a painful ueflation anu its concomitant impact on wages.
Rathei than this politically uifficult stiategy, anothei ioute
woulu have been foi the Ameiicans to 6#/:#( theii own cuiiency,
taking the stiain off the Biitish pounu. A uevaluation of the 0.S.
uollai woulu have iemoveu the speculative piessuie on the pounu,
which was uiaining golu ieseives fiom the Bank of Englanu. Libeial
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S4
economist }ohn Kenneth ualbiaith uesciibes a seciet meeting that
may explain the Feu's uecision to bail out Biitain:

0n }uly 1, 1927, the =/3$#)/(*/' aiiiveu in New Yoik
with two notable passengeis, Nontagu Noiman, uoveinoi of the
Bank of Englanu, anu Bjalmai Schacht, heau of the ueiman
Reichsbank.The seciecy coveiing the visit was extieme anu to a
uegiee ostentatious. The names of neithei of the gieat bankeis
appeaieu on the passengei list. Neithei, on aiiiving, met with the
piess.
In New Yoik the two men weie joineu by Chailes Rist,
the Beputy uoveinoi of the Banque ue Fiance, anu they went
into confeience with Benjamin Stiong, the uoveinoi of the
Feueial Reseive Bank of New Yoik |anu the ue facto heau of the
entiie Feueial Reseive System at the timej.
The piinciple.subject of uiscussion was the peisistently
weak ieseive position of the Bank of Englanu. This, the bankeis
thought, coulu be helpeu if the Feueial Reseive System woulu
ease inteiest iates, encouiage lenuing. Bolueis of golu woulu
then seek the highei ietuins fiom keeping theii metal in Lonuon.
Anu, in time, highei piices in the 0niteu States woulu ease the
competitive position of Biitish inuustiy anu laboi.
1S

To bolstei ualbiaith's inteipietation, we can quote fiom a
lettei penneu by Benjamin Stiong himself a few yeais eailiei, in Nay
1924, to the 0.S. Tieasuiy Secietaiy Anuiew Nellon:

!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2SS
At the piesent time it is piobably tiue that Biitish piices
foi goous inteinationally uealt in aie as a whole, ioughly, in the
neighboihoou of 1u peicent above oui piices, anu one of the
pieliminaiies to the ie-establishment of golu payment by uieat
Biitain will be to facilitate a giauual ieaujustment of these piice
levels 4#%&$# monetaiy iefoim is unueitaken. In othei woius, this
means some small auvance in piices heie anu possibly some
small uecline in theii piices.
The buiuen of this ieaujustment must fall moie laigely
upon us than upon them. It will be uifficult politically anu socially
foi the Biitish uoveinment anu the Bank of Englanu to face a
piice liquiuation in Englanu.in face of the fact that tiaue is so
pooi anu they have ovei a million unemployeu people ieceiving
goveinment aiu.
14

uuiueu by oui knowleuge of the business cycle, uevelopeu by
Nises anu Bayek, we can now unueistanu the seveiity anu length of
the uieat Bepiession. The 0niteu States in the late 192us
expeiienceu the laigest asset boom in histoiy, which was fueleu by
the Feueial Reseive System (which hau been in full opeiation since
1914). Aftei the boom collapseu in 1929, the feueial goveinment
unuei Beibeit Boovei embaikeu on an unpieceuenteu "iecoveiy"
piogiam of massive inteivention, which ciippleu the ability of the
maiket to heal itself. With the election of FBR in 19S2, the New Beal
piogiam only took the 0niteu States even closei to full-blown
socialism. It is no suipiise then that the uieat Bepiession lasteu at
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S6
least a uecaue, wheieas eailiei 0.S. financial panics hau usually been
iesolveu within two to thiee yeais.

PQ$=#1.1.?(%"&(R+'&#%(>&<&221,.S(

Equippeu with the Austiian unueistanuing of the opeiation
of a tiuly fiee maiket, anu especially with the Nises-Bayek theoiy of
business cycles, we can inteipiet the iecent housing bubble anu
subsequent financial ciash in a similai mannei to the uieat
Bepiession. Contiaiy to conventional wisuom, the housing bubble
was not causeu by "ueiegulation" unuei the allegeu paiagon of
capitalism, ueoige W. Bush. (Woulu a laissez-faiie iueologue have
paitially nationalizeu majoi 0.S. banks at the enu of his seconu
teim.)
In fact, following the uot-com ciash, then-Feu Chaiiman Alan
uieenspan slasheu inteiest iates to extiaoiuinaiily low levels. Beie
is a chait showing the piice-inflation-aujusteu feueial funus iate:
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S7

As the chait inuicates, by late 2uuS uieenspan hau pusheu
0.S. inteiest iates uown to theii lowest levels (ielative to piice
inflation) since the late 197us. }ust as the Nises-Bayek theoiy woulu
pieuict, the iesult was an unsustainable boom leauing to an
inevitable ciash. As histoiian Thomas Woous explains in his
bestselling book =#2)0&6(:

The Feu.staiteu the boom by incieasing the money
supply thiough the banking system with the aim anu the effect of
loweiing inteiest iates. In the wake of Septembei 11, which
came just ovei a yeai aftei the uot-com bust, then Feu chaiiman
Alan uieenspan sought to ieignite the economy thiough a seiies
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S8
of iate cuts.In oiuei to biing about this iesult, the supply of
money was incieaseu uiamatically uuiing those yeais.
This new money anu cieuit oveiwhelmingly founu its
way into the housing maiket, wheie aitificially lax lenuing
stanuaius maue excessive home puichases anu speculation in
homes seem to many Ameiicans like goou financial moves. The
Feu also encouiageu the uSEsFannie Nae, uinnie Nae, anu
Fieuuie Nacanu the Feueial Bousing Auministiation to
boiiow anu lenu at levels nevei befoie seen. So the alieauy
existing campaign to lowei lenuing stanuaius, along with the
monopoly piivileges enjoyeu by the quasi-goveinmental
agencies Fannie Nae anu Fieuuie Nac, playeu a iole in
channeling into the housing maiket the new money the Feu was
cieating. But it was the Feu, ultimately, that maue the aitificial
boom in housing possible in the fiist place, anu it was all the new
money it cieateu that gave the biggest stimulus to the unnatuial
iise in housing piices.
1S

+,-&'./&.%( @.%&'-&.%1,.( #( T"'&#%( %,( F1U&'%8( #.7(
H',2$&'1%8(

This chaptei has shown that the stuuy of Austiian economics
is not a meie pastime. Aimeu with an unueistanuing of the
mechanics of a fiee maiket economyanu how goveinment
inteivention in money anu banking ciipples the capitalist system
we can uiagnose the causes of touay's economic ciisis. We also
!"#$%&'$&()*+,("%(+"&,)
??????????????????????????????????????????????????????????'
'
2S9
unueistanu what must be uone to enu the boom-bust cycle, anu the
thieat of hypeiinflation, once anu foi all.

1
Ludwig von Mises, Economic Freedom and Interventionism, p. 244.
2
For a very readable introduction, see Robert P. Murphys The Politically Incorrect
Guide to Capitalism (Regnery, 2007).
3
Mises, The Theory of Money and Credit, p. 461.
4
See Hankes calculations at: http://www.cato.org/zimbabwe. Accessed May 20, 2010.
5
G. Edward Griffin, The Creature From Jekyll Island (Westlake Village, CA:
American Media, 2002), pp. 187-188.
6
Quoted in Creature, p. 188.
7
Rothbard, The Case Against the Fed (Auburn, AL: The Ludwig von Mises Institute,
1994), pp. 62-63.
8
Robert P. Murphy, The Politically Incorrect Guide to the Great Depression and the
New Deal (Washington, D.C.: Regnery, 2009).
9
These facts are cited in Murphys book on the Great Depression, though some are
documented in his online article The New Deal Was a Bad Deal, August 10, 2009,
at: http://www.publicsquare.net/article_new-deal-was-a-bad-deal-302.htm. Accessed
June 3, 2010.
10
Herbert Hoover, The Memoirs of Herbert Hoover: The Great Depression, 1929-1941
(New York: The Macmillan Company, 1952), p. 29.
11
Herbert Hoover, quoted in Murray Rothbard, Americas Great Depression, Fifth
Edition (U.S.A.: The Ludwig von Mises Institute, 2008), p. 321.
12
A. C. Miller, quoted in Lionel Robbins, The Great Depression (Auburn, AL: The
Ludwig von Mises Institute, 2007 [1934]), p. 53.
13
John Kenneth Galbraith, quoted in G. Edward Griffin, The Creature From Jekyll
Island, p. 425.
14
Letter from Benjamin Strong, quoted in G. Edward Griffin, The Creature From
Jekyll Island, p. 426.
15
Thomas E. Woods, Jr., Meltdown:A Free-Market Look at Why the Stock Market
Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse
(Washington, D.C.: Regnery, 2009), pp. 26-27.
!"#$%&'$&()*+,("%(+"&,)
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!"#$
$
261
!"#$%&'()*(
+"&(,-./0(1-/&2(,-3.%4-/(

!"#$%#$&'(%%$)*+#"(#,-.%'#"/+#&+.0$0,#(1#
"/+#$2+.#(1#%(302#&(0+4#$1#(0+#2(+%#0("#
-+.*$5+# "/."# $"# 6.%# 2+7$%+2# .%# .0#
$0%"-3&+0"# 1(-# "/+# '-("+8"$(0# (1# 8$7$*#
*$)+-"$+%# .,.$0%"# 2+%'("$8# $0-(.2%# (0#
"/+# '.-"# (1# ,(7+-0&+0"%9# !2+(*(,$8.**4#
$"# )+*(0,%# $0# "/+# %.&+# 8*.%%# 6$"/#
'(*$"$8.*# 8(0%"$"3"$(0%# .02# )$**%# (1#
-$,/"%9#
:;326$,#7(0#<$%+%
=
#

e have seen the uestiuction wiought by fiat money
anu cential banking. The obvious solution to the
pioblems of iampant piice inflation anu economic ciises, is to
iemove political inteifeience with the institutions of money anu
banking. When money is once again a goou piouuceu by the maiket,
anu when bankeis ieceive no special piivileges exempting them
fiom theii contiactual obligations, people will once again be able to
lean heavily on a stable meuium of exchange foi theii financial
planning. We will have a %(302#&(0+4.
W
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
262
As Nises explains in the quotation above, sounu money was
an integial plank in the classical libeial piogiam. }ust as a fiee piess
is necessaiy foi a fiee citizeniy, so too is sounu money necessaiy foi
a fiee economy. All othei aspects of what is meant by the teim
"economic fieeuom" in conventional ciicleslow tax iates, milu
iegulation, no tiaue baiiieisaie a moot point if the goveinment
has a piinting piess at its uisposal.
0ltimately, a society can only ietuin to sounu money when
enough people uemanu it of theii goveinment. That is why
euucation is the fiist anu most impoitant steppeople neeu to
unueistanu the impoitance of sounu money, anu the uangeis of fiat
money anu cential banking. Eveiyone knows oui cuiient financial
system is sick, but only people steepeu in Austiian economics can
offei the coiiect uiagnosis anu cuie.
0nfoitunately, oui financial fieeuom was eioueu ovei many
uecaues; it was a slow path to oui cuiient ciisis. Theie aie also
many poweiful people anu institutions who benefit fiom the status
quo. This means that unwinuing the goveinment's stiangleholu on
oui money anu banking sectoi may take yeais of agitation anu
political iefoim.
The piesent book is not a political manifesto. The cuiient
authois uo not pietenu to be political stiategists, let alone
ievolutionaiy leaueis. In the iemainuei of this chaptei, we offei
some piactical suggestions foi how oui society coulu move, bit by
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
26S
bit, back towaius the ultimate goal of complete fieeuom in money
anu banking once again. Theie is nothing magical about the below
pioposals, especially in theii paiticulai uetails. But the following
goals aie fiequently iecommenueu by those who unueistanu the
lessons of the Austiian economists.

,%&$()5(+4&(%"&(67,7(8-33#'(9#:;(%-(<-30

Nises once wiote, "Sounu money still means touay what it
meant in the nineteenth centuiy: the golu stanuaiu."
2
Nany of Nises'
followeis enuoise his iecommenuation in oui own time as well. If
the 0niteu States goveinment officially announceu that it woulu
once again ieueem uollais foi physical golu, such a bolu move woulu
instantly ieassuie investois the woilu ovei that the uollai was once
again a beuiock asset.
Anothei viitue of this move is that it coulu be implementeu
at a moment's notice. To tie the uollai back to golu woulu iequiie no
new poweis on the pait of the goveinment, oi even iequiie any new
legislation. Stiictly speaking, Feu Chaiiman Ben Beinanke coulu
simply announce that the Feu woulu hanu ovei an ounce of golu foi
a stipulateu numbei of uollais, anu (less ciucially) that he woulu
hanu ovei a stipulateu numbei of uollais foi anyone selling an
ounce of golu. Beinanke has the powei to buy anu sell assets, anu he
woulu meiely be announcing in auvance his willingness to sell (anu
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
264
buy) golu at a paiticulai uollai-piice. 0f couise, to give the pleuge
ieal teeth, Congiess woulu eventually have to couify the new
aiiangement, peihaps even specifying penalties (such as immeuiate
uismissal) foi Feu officials shoulu they evei ienege on the new peg.
The point is, howevei, that we woulun't neeu to wait foi a
piotiacteu anu melouiamatic Congiessional battle )+1(-+ iestoiing
sanity to the woilu financial maikets with a stable cuiiency.
In oiuei to give a conciete example of how such a policy
coulu woik, suppose that Beinanke calleu a piess confeience anu
announceu the following (keeping in minu that the officially
iepoiteu 0.S. golu ieseives in Becembei 2uu9 weie a little ovei
8,uuu tons)
S
:
"Effective immeuiately, the Feueial Reseive will begin a
piogiam of golu accumulation, puichasing 1uu tons pei month, until
total official ieseives equal 1S,uuu tons. Eveiy quaitei we will allow
outsiue auuitois to inspect oui vaults anu veiify oui holuings.
Fuitheimoie, in exactly twelve months we will peg the one-month
futuie piice of golu at $2,uuu pei ounce. Any paity, whethei foieign
cential bank, foieign goveinment, oi piivate inuiviuualuomestic
oi foieignwill be guaianteeu the ability to obtain an unlimiteu
quantity of golu fiom the Feueial Reseive's holuings at $2,uuu pei
ounce, anu to sell golu to the Feueial Reseive at a piice of $2,uuu
pei ounce, less a small tiansaction fee. This peg will iemain a
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
26S
peimanent featuie of Feueial Reseive policy, anu the uollai-piice of
golu will iemain foievei fixeu at $2,uuu pei ounce."
To iepeat, theie is nothing magical about the paiticulai
numbeis in oui hypothetical scenaiio, but heie is the logic of the
iuea: By steauily incieasing its golu holuings, the Feu woulu bolstei
its ability to honoi its commitment to tie the uollai back to the
piecious metal. By setting the peg well above the cuiient maiket
piice (aiounu $1,1uu as of this wiiting), the Feu woulu obviate the
neeu foi a geneial uiop in the uollai-piice of all othei goous anu
seivices.
In othei woius, when the Feu begins a massive piogiam of
buying an assetincluuing goluthat asset's piice will iise. If the
Feu hau announceu, say, a taiget golu piice of $1,uuu oi $Suu in a
yeai's time, even as its massive golu puichases uiove up the ielative
piice of golu compaieu to othei goous, then achieving the low taiget
woulu foice a massive collapse in the piice of eveiything else
(wheie the piice is measuieu in 0.S. uollais). By setting the taiget
well .)(7+ the cuiient maiket piice, the Feu woulu allow the
aujustment to laigely occui in the spike upwaiu in the golu piice,
iathei than a laige uiop foi eveiything else.
As the months passeu, anu the ueauline appioacheu foi the
Feu to begin ieueeming uollais foi golu at the specifieu iate,
Beinanke anu the iest of the Feu's policymakeis woulu neeu to
caiefully monitoi theii activities. Piesumably the golu piice woulu
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
266
uiift upwaius (if it hau not immeuiately jumpeu up aftei the
announcement) to ."# *+.%"# $2,uuu pei ounce, because it woulu be
silly foi holueis of golu to sell at *+%% than that piice, when they
knew the Feueial Reseive woulu soon offei $2,uuu pei ounce to any
selleis.
0n the othei hanu, suppose that thiee months out fiom the
ueauline, the maiket piice of golu weie $2,4uu. Beinanke woulu
iealize that speculatois woulu line up at the Feu's uooi
(metaphoiically speaking) on the uay the ieuemption policy went
into effect, in oiuei to buy golu fiom the Feu at $2,uuu anu then sell
on the maiket foi $2,4uu. This woulu quickly uiain the Feu's golu
holuings, anu uestioy the Feu's cieuibility.
Theiefoie, if the Feu weie seiious about iestoiing faith in the
uollaigolu peg, Beinanke anu the othei Feu policymakeis woulu
have to act quickly to get the golu piice uown. Bow woulu they uo
this. Simple: they woulu have to tighten up on monetaiy policy. The
stanuaiu way of uoing this is to sell assets fiom the Feu's balance
sheet, in oiuei to uiain ieseives fiom the banking system. (This is
what the Feu uoes when it wants to iaise inteiest iates.) The
ieuuction in ieseives woulu foice the commeicial banks to likewise
iestiict theii own lenuing, in oiuei to get theii outstanuing ueposit
balances back in line with the smallei amount of ieseives. Loosely
speaking, if the uollai-piice of golu weie above the $2,uuu taiget,
Beinanke woulu neeu to iemove uollais fiom the economy. As moie
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
267
golu was biought into ciiculation thiough mining (uue in pait to the
high piices causeu by the Feu's puichases), anu as the outstanuing
amount of uollais shiank uue to the tighteneu Feu policy, then the
uollai-piice of golu woulu fall.
In oui hypothetical scenaiioin which Beinanke announceu
his intention to ietuin to a stiict uollaigolu peg in one yeai's time,
anu yet the maiket iesponueu by pushing the piice of golu .)(7+ the
announceu taigetthe Feu woulu have to sell off its othei assets,
such as 0.S. Tieasuiy uebt anu "toxic" moitgage-backeu secuiities,
in oiuei to make ioom foi its giowing stockpile of golu bullion. If the
golu piice stayeu above the taiget of $2,uuu, Beinanke woulu have
to shiink the oveiall size of the Feu's balance sheet, in auuition to
changing its composition towaius golu. Foi example, foi eveiy $1uu
million in new golu that Beinanke puichaseu, he might have to sell
off $12u million woith of Tieasuiy uebt oi moitgage-backeu
secuiities (which the Feu cuiiently possesses in abunuance).
0nce the ueauline hau passeu, anu assuming the Feu hau
uone its job anu gotten the maiket piice of golu uown to $2,uuu pei
ounce, it woulu foievei be constiaineu in its cieation of new
uollaisat least if it wanteu to keep its cieuibility. 0vei time, as
investois obseiveu that they coulu buy golu fiom the Feu at the
stateu piice, they woulu become fai moie confiuent in investing in
uollai-uenominateu assets. They woulu know that whatevei else
happeneu, they woulu have a "call option on golu" as it weie, as pait
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
268
of theii uecision to holu 0.S. uollais. Investois woulu know that
iegaiuless of the uollai-piices of othei assets, they woulu always be
able to bail out of uollais anu obtain physical golu bullion. This
option woulu give the uollai an enoimous auvantage ovei the fiat
cuiiencies issueu by othei cential banks, making the uollai
appieciate again the euio, yen, etc., yeai aftei yeai on the foieign
exchanges. Inteiest iates on uebt issueu by Ameiican coipoiations
woulu fall, as investois aiounu the woilu knew that the uollai woulu
be stiongei (ielative to theii own cuiiencies) when theii loans weie
iepaiu; theiefoie they woulu be willing to accept a lowei inteiest
iate as quoteu in uollais. Ameiican businesses anu consumeis, foi
theii pait, woulu finu that foieign goous woulu become cheapei to
buy ovei the yeais, as theii uollais' puichasing powei constantly
giew ielative to eveiy othei woilu cuiiency. Even on a puiely
uomestic fiont, the piices of Ameiican goous anu seivices (quoteu
in uollais) woulu be stable oi actually coulu gently fall yeai to yeai,
because the Feueial Reseive coulu only cieate a limiteu numbei of
new uollais uue to the maintenance of the peg to golu.
The ieason foi the ieneweu woiluwiue confiuence in the
uollai woulu be simple: 0thei cential banks, without having a peg
pinning uown the puichasing powei of theii iespective cuiiencies,
woulu be fiee to piint money whenevei a ciisis stiuck. The Feueial
Reseive, in contiast, unuei the new policy woulu have its hanus tieu.
It coulu only expanu the supply of uollais as new golu came into
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
269
ciiculation (thiough mining oi melting uown of jeweliy), oi as the
uemanu foi golu fell, two factois which woulu tenu to push uown
the golu piice. But except within that naiiow limit, the Feu coulun't
expanu the supply of uollais too quickly, because if it uiu the uollai-
piice of golu woulu suige above $2,uuu pei ounce, anu people
woulu tiaue theii papei uollais foi physical golu anu begin uiaining
the Feu's ieseives.
Natuially, it woulu be veiy unlikely that Feueial Reseive
officials woulu happily submit to the above scenaiio. It is in the
natuie of buieauciacies to expanu theii scope of aibitiaiy powei,
anu to iesent any constiaints. In oiuei to make investois believe in
the new uollaigolu peg, Congiess woulu neeu to couify the
aiiangement with stiff penalties foi the Feu's abanuonment of the
pleuge. Even in that case, investois woulun't -+.**4 take the Feu
seiiously until the fiist majoi ciisis, in which the "olu Feu" woulu
have cut inteiest iates anu pumpeu in boatloaus of new "liquiuity,"
wheieas the "new Feu" iesponueu much moie conseivatively foi
feai of unleashing too many new uollais.
To ieiteiate, meiely ieintiouucing a golu stanuaiu foi the
0.S. uollai woulu not eliminate oui financial woes. But it woulu be
an excellent fiist steppaiticulaily amiust oui cuiient woiluwiue
ciisisanu in piinciple the Feueial Reseive coulu implement this
stiategy immeuiately.

!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
27u
,%&$(=5(>'4?#%4@&(1-/&2(#/0(9#/;4/A

In oiuei to make sense of the Sounu Noney Solution, an
analogy will be useful. Suppose it is the eaily 18uus, anu a Southein
plantation ownei has uieu in his olu age, leaving his estate to his
auult chiluien (the wife having uieu eailiei). Now pait of the estate
incluues uozens of slaves, which aie iecognizeu in the eyes of the
law as "piopeity." Bowevei, the chiluien have all ieau the wiitings
of the abolitionists, anu aie convinceu that slaveiy was a moial
outiage. What shoulu they uo.
0ne of the chiluien suggests that they immeuiately fiee the
slaves, then liquiuate the iemaining assets to give some money to
the foimei slaves to help them stait theii new life of fieeuom. This
sounus like a gieat iuea, until one of the chiluien woiiies that the
lifetime of uepenuency may not have equippeu the slaves to make it
on theii own. Aftei all, they have hau theii basic neeus taken caie of,
anu it might actually be unkinu to simply uump them into the woilu
with some uollais anu a hanushake.
Finally the chiluien hit upon an equitable solution: They will
immeuiately fiee all the slaves, as befoie. Bowevei, the chiluien will
continue to iun the plantation, anu will offei employment to any of
the foimei slaves who wish to iemain. In othei woius, any foimei
slave who wishes to "opt out" anu stait a new life is fiee to go,
immeuiately. But, foi those who aie not ieauy foi such a shock, they
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
271
can iemain on the plantation, woiking foi foou, sheltei, anu so on.
Buiing the winuing uown peiiou, the chiluien woulu uo what they
coulu to piepaie the foimei slaves foi an inuepenuent life, by
teaching them to ieau, keep tiack of money, anu so foith. The
ultimate goal woulu be to establish all of the foimei slaves as
inuepenuent membeis of the community, but this appioach woulu
take in the iealities of the legacy of slaveiy.
We in the 0niteu States face a similai situation in teims of
oui financial system. Thiough ueceit anu outiight foice, the
goveinment has taken contiol of oui monetaiy anu banking
institutions. In iecognition of this violation of piopeity iights, one
obvious solution woulu be an immeuiate abolition of the entiie
Feueial Reseive appaiatus.
Bowevei, many piivate sectoi institutions aiounu the woilu
have become uepenuent on the cuiient aiiangement. If the
Piesiuent of the 0niteu States weie to announce on a Nonuay
moining that he anu Congiess woulu abolish the Feu that week, it
might unleash a global panic. With the fate of the woilu economy so
intimately tieu to the 0.S. uollai, such a bombshell coulu wieak
havoc on the veiy people who weie being fieeu fiom financial
bonuage to the 0.S. cential bank.
In light of these unfoitunate iealities, a compiomise path
might be the best option. As with oui hypothetical chiluien
inheiiting the plantation, the 0.S. goveinment woulu give the iight
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
272
of immeuiate "opting out" to any bank oi othei financial institution.
In piactice, this woulu mean the immeuiate abolition of legal tenuei
laws, the elimination of capital gains taxes on golu anu silvei (to
facilitate theii use as alteinate foims of money), anu opening up the
banking sectoi to new entiants. In shoit, the goveinment woulu be
'-$7."$5$0, money anu banking, ietuining them once again to the
fiee maiket.
In the meantime, the Feueial Reseive woulu continue to
opeiate, engaging in open maiket opeiations, buying anu selling
assets, anu so foith. Those banks that wisheu to iemain unuei the
umbiella of the Feueial Reseive System coulu uo so, but othei banks
woulu have the fieeuom to leave. Anu of couise, if entiepieneuis
wanteu to stait 0+6 banks, peihaps ones that uealt exclusively with
golu ueposits anu maintaineu 1uu% ieseives on checking accounts
(uenominateu in golu), then theie woulu be no goveinment
obstacles, except foi the stanuaiu enfoicement of legal contiacts.
The appeal of this giauualist appioach is that it minimizes
the shock of tiansitioning to a fiee financial system, while at the
same time enuing the immoial monopoly. With the iemoval of legal
tenuei laws anu othei iestiictions on alteinate money, only those
meichants who wisheu to use the 0.S. uollai woulu uo so. At fiist,
piesumably only the iueologically chaigeu elements of Ameiican
society woulu begin conuucting theii opeiations in golu ounces, as
opposeu to 0.S. uollais. This is because of the inteitiawith
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
27S
eveiyone else in the countiy still using uollais, it woulu be uifficult
to iun a business on an alteinate unit of account. Even so, ovei time
moie anu moie people piobably 6(3*2 wean themselves fiom the
uollai, switching to a maiket-baseu haiu money such as golu oi
silvei. This woulu make the entiie society less vulneiable to the
actions of the Feueial Reseive, ieuucing the "shocks" fiom fuithei
policy changes.

,%&$(B5(C/0(%"&(D&0

Aftei the uollai hau been once again tieu back to goluanu
enough time hau passeu foi investois aiounu the woilu to believe in
the new aiiangementanu theie was a thiiving netwoik of piivate
banks opeiating siue-by-siue the goveinment-sponsoieu system,
the final step in the Sounu Noney Solution woulu be to abolish the
Feueial Reseive itself. In his book ?02# "/+# @+2 Ron Paul spells out
that oui cuiient financial system is untenable anu then explains:

Theie is anothei path, but it iequiies a complete
tuinaiounu. It iequiies only the political will to unplug the
machineiy of the Feu. Contiaiy to what people might think at
fiist, this will not mean an enu to the financial system as we
know it. In a post-Feu woilu, we will still have the uollai, banks,
ATNs, online tiauing, Web-baseu systems of funu tiansfeinone
of this is going anywheie..
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
274
When we unplug the Feu, the uollai will stop its long
uepieciating tienu, inteinational cuiiency values will stop
fluctuating wiluly, banking will no longei be a uice game, anu
financial powei will cease to giavitate towaiu a small ciicle of
goveinment-connecteu insiueis. The entiie banking inuustiy
woulu unuoubteuly go thiough an upheaval of soits as sounu
banks thiive anu unsounu banks go the way of the investment
banking inuustiy |in 2uu8j: out of business as they shoulu be.
Those who aie uepenuent on Feu welfaie woulu have to clean up
theii act oi shut uown. Bepositois woulu become intensely
awaie of which banks aie sounu anu which aie not.
4

As with Step 1, the specific uetails of Step S aie beyonu the
scope of the piesent book. But to pioviue a geneial sketch, shutting
uown the Feu coulu occui in the following possible mannei: Fiist
the Feueial Reseive woulu ietuin its holuings of goveinment uebt
as of this wiiting valueu at $777 billion
S
to the Tieasuiy, canceling
it out. (In othei woius, this poition of Feu assets woulu uisappeai,
but simultaneously the feueial uebt woulu shiink by the same
amount.) This action woulu not change the amount of uollai
ieseives in the financial system, because the Feu woulu simply be
wiiting off the loans to 0ncle Sam, iecoiuing it as a loss in the Feu's
"equity."
Seconu, the Feu woulu sell off all of its othei assets, except
golu, anu use the pioceeus to auu to its golu holuings. In othei
woius, aftei fiist subtiacting out the goveinment bonus, the size of
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
27S
the Feu's balance sheet woulu then iemain the same, but the
composition woulu change to consist entiiely of golu ieseives.
Thiiu, the Feu woulu piint up cuiiency anu give it to any
banks still holuing electionic uollai ieseives on ueposit with the
Feu, then it woulu close those accounts. In othei woius, all of the
commeicial banks woulu "withuiaw" theii cash fiom checking
accounts with the Feu, befoie closing uown the accounts. This
pioceuuie woulu not affect the total amount of uollai ieseives in the
financial system, it woulu simply change the composition to consist
entiiely of papei cuiiency. Insteau of keeping a poition of theii
uollai ieseives paikeu at the Feu electionically, the commeicial
banks woulu have all of theii uollais in the foim of gieen pieces of
papei stoieu in theii own vaults.
Finally, the Feu woulu tiansfei its golu holuings to the 0.S.
Tieasuiy, which woulu then assume iesponsibility foi issuing new
papei cuiiency anu honoiing the uollaigolu peg. At this point the
Feu woulu have no iole left to play, anu coulu shut uown without
uisiupting the financial maikets.
The above foui-piongeu pioceuuie foi phasing out the
Feueial Reseive is not intenueu as a bluepiint foi iefoim. Befoie
embaiking on such a plan, obviously acauemic economists, as well
as expeiienceu financial playeis, woulu neeu to have long
uiscussions about the pios anu cons of vaiious pioceuuies. The
impoitant point is that eliminating the Feu $% possible, anu it neeu
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
276
not iuin the uollai oi the woilu economy. Aftei all, the uollai existeu
long befoie the Feueial Reseive, which was not cieateu until 191S.

EF(+"4F(>-FF4G3&HI

Nany ieaueis may unueistanu the goals of the Sounu Noney
Solution, but will uismiss them as hopelessly unattainable. It's tiue,
theie aie many obstacles on the path to a fiee maiket in money anu
banking. The Feueial Reseive System uiun't just spiing into place by
acciuentpoweiful people installeu it, anu guiueu its uevelopment,
because they benefit hanusomely fiom it!
Nonetheless, the Feueial Reseive is a cieation of the feueial
goveinment, anu it can be abolisheu thiough the political piocess, so
long as enough citizens uemanu it. Theie is histoiical pieceuent foi
such iefoim, namely when Piesiuent Anuiew }ackson abolisheu the
Seconu Bank of the 0niteu States, the pieuecessoi of the Feueial
Reseive. Aftei vetoing a measuie to iechaitei the cential bank
which was iun by the ciafty anu poweiful Nicholas Biuule}ackson
baseu his ie-election campaign on this cential issue. Accoiuing to
}ackon's biogiaphei:

0n his homewaiu jouiney |Piesiuent }acksonj
iepoiteuly paiu all his expenses in golu. "No moie papei money,
you see, fellow citizens," he iemaikeu with each golu payment, "if
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
277
I can only put uown this Nicholas Biuule anu his monstei bank."
uolu, haiuly the populai meuium of exchange, was helu up to the
people as the safe anu sounu cuiiency which }ackson anu his
auministiation hopeu to iestoie to iegulai use. 0nlike papei
money, golu iepiesenteu ieal value anu tiue woith. It was the
coin of honest men. Rag money, on the othei hanu, was the
instiument of banks anu swinuleis to coiiupt anu cheat an
innocent anu viituous public.
6

The contest between }ackson anu Biuule is a fascinating one.
Although }ackson hau vetoeu the iechaiteiing of the bank, its
oiiginal teim hau not yet expiieu. "The hyuia of coiiuption is only
%8("8/+2, 0("#2+.2," }ackson saiu. Aftei he was ie-electeu on his anti-
cential-bank campaign, }ackson oiueieu his Tieasuiy secietaiy to
place all new feueial ueposits with %"."+ banks, anu to pay the
goveinment's expenses out of funus still on ueposit with the Seconu
Bank of the 0niteu States. In this mannei, feueial ueposits with the
cential bank woulu be eventually uiaineu away, iemoving one of the
chief pillais holuing it up. (This iaiseu an inteiesting constitutional
question, because the secietaiy iefuseu to comply with the oiuei, oi
iesign, anu it was uncleai whethei the piesiuent coulu uismiss a
membei of the cabinet without Senate appioval. In any event,
}ackson 2$2# fiie his insuboiuinate secietaiy, anu got the funus
iemoveu fiom the bank.)
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
278
Nicholas Biuule uiun't take the attacks on his bank sitting
uown. Bistoiian Robeit Remini explains:

Biuule counteiattackeu. Be initiateu a geneial
cuitailment of loans thioughout the entiie banking system..It
maikeu the beginning of a bone-ciushing stiuggle between a
poweiful financiei anu a ueteimineu anu equally poweiful
politician. Biuule unueistoou what he was about. Be knew that if
he biought enough piessuie anu agony to the money maiket,
only then coulu he foice the Piesiuent to iestoie the ueposits. Be
almost gloateu. "This woithy Piesiuent thinks that because he
has scalpeu Inuians anu impiisoneu }uuges, he is to have his way
with the Bank. Be is mistaken.".
"The ties of paity allegiance can only be bioken," he
ueclaieu, "by the actual conviction of existing uistiess in the
community." Anu such uistiess, of couise, woulu eventually put
eveiything to iights. "Nothing but wiuespieau suffeiing will
piouuce any effect on Congiess..0ui only safety is in puisuing a
steauy couise of fiim iestiictionanu I have no uoubt that such
a couise will ultimately leau to iestoiation of the cuiiency anu
the iechaitei of the Bank..Ny own couise is ueciueu. All othei
banks anu all the meichants may bieak, but the Bank of the
0niteu States shall not bieak.
7

At this point, it's woith ieminuing the ieauei of the
tiemenuous powei that a cential bankei wielus ovei a countiy's
entiie financial system. Regaiuless of the valiuity of Biuule's
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
279
stiuggle with }ackson, no inuiviuual ought to have the stiategy of
"wiecking the economy" in his toolbox!
Biuule uiu not stop with contiacting cieuit. Be also useu his
tiemenuous influence to have the Senate launch a campaign
ciiticizing the Piesiuent's ieckless actions, culminating in a foimal
vote of censuie against }ackson on Naich 28, 18S4. Then as now,
those in chaige of the cential bank coulu cultivate ties with othei
poweiful people, especially politicians. Biuule even hau the
esteemeu Senatoi Baniel Webstei in his uebt. Accoiuing to
ualbiaith:

Biuule was not without iesouices |in his battle with
}acksonj. In keeping with his belief that banking was the ultimate
souice of powei, he hau iegulaily auvanceu funus to membeis of
Congiess when uelay on appiopiiations bills hau help up theii
pay. Baniel Webstei was, at vaiious times, a uiiectoi of the Bank
anu on ietainei as its counsel. "I believe my ietainei has not been
ieneweu oi -+1-+%/+2 as usual. If it be wisheu that my ielation to
the Bank shoulu be continueu, it may be well to senu me the
usual ietaineis." Numeious othei men of uistinction hau been
accommouateu, incluuing membeis of the piess.
8

In the enu, uespite Biuule's tiemenuous auvantages, he
coulun't uefeat a ueteimineu piesiuent who hau public opinion on
his siue. The Seconu Bank of the 0niteu States' chaitei expiieu in
18S6. Ameiica woulu piospei 6$"/(3" a cential bank until the
!"#$%&'()$*&(#+$%&,'-.&($
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>#
#
28u
establishment of the Feueial Reseive in 191S. Although cential
banks aie foimiuable institutions, anu theii uiiectois have
cultivateu ties with the woilu's most poweiful people, ultimately
they aie cieatuies of the goveinment. An infoimeu citizeniy can
pioviue suppoit foi politicians who uaie to enu the cozy alliance of
Big uoveinment anu Big Banks.

1
Ludwig von Mises, The Theory of Money and Credit, p. 454.
2
Mises, The Theory of Money and Credit, p. 480.
3
See the Wikipedia entry at: http://en.wikipedia.org/wiki/Gold_reserve. We also
acknowledge that many cynics doubt the Federal Reserves official numbers. An added
benefit of our hypothetical scenario is that it would force the Fed to prove the
authenticity of its reports. (The Fed currently does not submit to outside audits of its
gold holdings.)
4
Ron Paul, End the Fed (New York: Grand Central Publishing, 2009), pp. 202-203.
5
See http://www.federalreserve.gov/releases/h41/current/.
6
Quoted in G. Edward Griffin, The Creature From Jekyll Island (Westlake Village,
CA: American Media, 2002), pp. 352-353.
7
Quoted in Griffin, The Creature From Jekyll Island, pp. 354-355.
8
John Kenneth Galbraith, quoted in Griffin, Creature, p. 351.
!"#$
!"#$%&&&%
'()%&*+%+,-$#./0$.,-%
$
$
!"# $%&'# !!# ()# )*+,%-").# '/)# 012".# 31")4# 01,2'-1"5# 6/)# 1",4#
(%4# '1# &)7'1&)# 7%"-'4# '1# 12&# 8-"%"9-%,# 747'):# -7# '1# &)'2&"# :1")4# %".#
;%"<-"=# '1# '/)# +&->%')# 7)9'1&?# 8&))# 8&1:# %&;-'&%&4# +1,-'-9%,#
-"')&8)&)"9)5# !8# )"12=/# +)1+,)# 9%"# ,)%&"# '/)# ;%7-9# +&-"9-+,)7# 18#
@27'&-%"#)91"1:-97A%".#-"#+%&'-92,%&#'/)#3-7)7BC%4)<#'/)1&4#18#'/)#
;27-")77# 949,)A'/)"# '/)4# (-,,# .):%".# '/%'# '/)# =1>)&":)"'# %;%".1"#
-'7# .)7'&29'->)# 912&7)5# 6/)# 012".# 31")4# 01,2'-1"# 8-&7'# '-)7# '/)# .1,,%&#
;%9<# '1# =1,.?# '/)"# +&->%'-D)7# '/)# -"7'-'2'-1"7# 18# :1")4# %".# ;%"<-"=?#
%".# 8-"%,,4# ),-:-"%')7# '/)# E).)&%,# F)7)&>)# -'7),85# @,'/12=/# '/)# 81&9)7#
72++1&'-"=# 9)"'&%,# ;%"<-"=# %&)# +1()&82,?# '/)4# %&)# "1'# -">-"9-;,)?# %7#
+&1>)"# ;4# @".&)(# G%9<71"H7# >-9'1&4# 1>)&# '/)# 0)91".# I%"<# 18# '/)#
J"-').#0'%')75#
J"81&'2"%'),4?# '/)&)# %&)# ,-:-'%'-1"7# '1# '/)# 012".# 31")4#
01,2'-1"?#%7#-'#/%7#;))"#-:+,):)"').#'/27#8%&5#!"#'/)#8-&7'#+,%9)?#-'#(-,,#
'%<)# %&'(# '1# ).29%')# )"12=/# @:)&-9%"7# 1"# '/)# .%"=)&7# 18# 8&%9'-1"%,#
&)7)&>)# ;%"<-"=?# %# '1+-9# '/%'# -7# K2-')# .-88-92,'# %".# -"'-:-.%'-"=# 81&#
:17'#+)1+,)5#0)91".?#)>)"#-8#'/)#9&-'-9%,#'/&)7/1,.#18#)"&%=).#%9'->-7'7#
-7# %9/-)>).?# '/)&)# -7# "1# =2%&%"'))# '/%'# '/)4# (-,,# )".# 2+# >1'-"=# 81&#
+1,-'-9-%"7# (/1# &)%,,4# (-,,# -:+&1>)# :%'')&75# @,&)%.4# ()# 7))#
.):%=1=2)7#7))<-"=#'1#9%+-'%,-D)#1"#'/)#8&27'&%'-1"#18#'/)#:):;)&7#18#
!"#$%&'()*%+,-%-./$#012$0./%
LLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLL#
#
!"!$
'/)# 6)%# $%&'4# :1>):)"'?# %".# :%"4# 1;7)&>)&7# %&)# 2".)&7'%".%;,4#
&),29'%"'# '1# '/&1(# '/)-&# ()-=/'# ;)/-".# %# M+1,-'-9%,# 71,2'-1"5N# 6/)4#
/%>)# K2-')# 7-:+,4# ;))"# ;2&").# '11# :%"4# '-:)7# -"# '/)# +%7'# ;4#
+1,-'-9-%"7#+&1:-7-"=#'1#&)81&:#%#;&1<)"#747'):5#31&)1>)&?#'/)#&%.-9%,#
&/)'1&-9# 91:-"=# 8&1:# 71:)# ),):)"'7# /%7# 8&-=/')").# :%"4# (/1#
1'/)&(-7)#%=&))#(-'/#'/)#9&-'-K2)7#18#'/)#O5P5#;%-,12'7#%".#.)8-9-'75#
!"# ,-=/'# 18# '/)7)# +&1;,):7?# ()# %&)# 1>)&Q14).# '1# &)+1&'# '/%'#
'/)&)# -7# %# :29/# 7-:+,)&# %++&1%9/5# !".->-.2%,# /127)/1,.7# 9%"# '%<)#
&''()&*%(#%9'-1"#'1#,-:-'#'/)#+1()&#18#'/)#E).#%".#91::)&9-%,#;%"<7#
'1# -"8,%')# '/)# :1")4# 72++,45# 6/)4# 9%"# &''()&*%(+,# -:+,):)"'# 0')+# R#
18# '/)# 012".# 31")4# 01,2'-1"A+&->%'-D).# ;%"<-"=A(-'/12'# (%-'-"=#
81&# %# 7288-9-)"'# "2:;)&# 18# >1')&7# .):%".-"=# 9/%"=)5# I)7'# 18# %,,?# '/-7#
")(#7'&%')=4#.1)7#"1'#&)K2-&)#7%9&-8-9)#;2'#-7#%9'2%,,4#-"#'/)#8-"%"9-%,#
-"')&)7'#18#)%9/#/127)/1,.#'/%'#-:+,):)"'7#-'5#I)9%27)#18#'/-7?#()#9%"#
)*+)9'# :1&)# %".# :1&)# -".->-.2%,7# %".# 8%:-,-)7# '1# %.1+'# '/)# 7'&%')=4?#
'/)&);4# 82&'/)&# ,-:-'-"=# '/)# +1()&# 18# '/)# E).)&%,# F)7)&>)# %".# '/)#
;%"<-"=#),-')5#
6/-7# 7'&%')=4# -">1,>)7# "1# .-&)9'# 91"8,-9'# (-'/# +1()&82,#
-"7'-'2'-1"7?# ;2'# :)&),4# %# (-'/.&%(%,# 18# 72++1&'5# !'# 9%"# (1&<# '1#
)88)9'->),4# ;&-"=# %;12'# 7)>)&%,# 91:+1")"'7# 18# '/)# 012".# 31")4#
01,2'-1"?#(-'/12'#%#7-"=,)#),)9'1&%,#2+7)'?#,)'#%,1")#%#7/1'#;)-"=#8-&).5#
F%'/)&# '/%"# /%>-"=# %"=&4# :1;7# 7'1&:# S%7/-"='1"?# '/)# 7'&%')=4#
-"7')%.# )"912&%=)7# /127)/1,.7# '1# :%<)# (-7)?# ,1"=B')&:# 8-"%"9-%,#
+,%"7# '/%'# +&1>-.)# 7'%;-,-'4# 81&# '/)-&# 8%:-,-)7# )>)"# -"'1# '/)# ")*'#
!"#$%&'()*%+,-%-./$#012$0./%
LLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLL#
#
!"-$
=)")&%'-1"5#F%'/)&#'/%"#&)>1,2'-1"?#'/-7#7'&%')=4#&)+&)7)"'7#.(/(..&01#
8&1:#'/)#)*-7'-"=#1&.)&5#
S/%'# -7# '/-7# 7'&%')=4T# !7# -'# 71:)# ")(8%"=,).# ;&%-"9/-,.# 18# %#
,-;)&'%&-%"# +/47-9-7'?# -">1,>-"=# .)&->%'->)7# %".# ),)9'&1"-9# 92&&)"9-)7T#
U1?#'/-7#M")(N#7'&%')=4#-7#%9'2%,,4#1")#18#'/)#:17'#91"7)&>%'->)#:1")4B
:%"%=):)"'# 7'&%')=-)7?# (/-9/# /%7# ;))"# %&12".# 81&# :1&)# '/%"# '(1#
/2".&).#4)%&75#S)#7+)%<#18#(/1,)#,-8)#-"72&%"9)#+1,-9-)75#
C1()>)&?#'/)#91"")9'-1"#;)'())"#(/1,)#,-8)#-"72&%"9)#%".#'/)#
012".# 31")4# 01,2'-1"# (12,.# ")>)&# /%>)# ;))"# :%.)?# ()&)# -'# "1'# 81&#
'/)# M!"8-"-')# I%"<-"=# P1"9)+'N# V!IPW# %7# .)>),1+).# ;4# F5# U),71"# U%7/5#
S)#)*+,%-"#'/)#91"")9'-1"#;)'())"#!IP#%".#'/)#012".#31")4#01,2'-1"#
-"#'/-7#8-"%,#7)9'-1"5#
!"#$%&'()*%+,-%-./$#012$0./%
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!"#$
$
28S
!"#$%&'()*(
+"&(,-./-/%&(0#-1/-2(!3-4&$%(

!"#$%"&' "(' )*"+%$(,' -+' *$.$(' /)&*0'
"*' #"0+' 1-*)*2-)3' 45(50' +%)+' 6"5' can
2"*+("3' +%$' 1-*)*2-)3' $*.-("*#$*+' -*'
&%-2%' 6"5' "7$()+$8' 9$(%)70' -+' -0'
2)50$/' :6' 3)2;' "1' -#)4-*)+-"*,' :5+'
&%)+$.$(' +%$' 2)50$,' 3$)(*-*4' +"'
2"*+("3' -+' -0' the most piofitable +%-*4'
+%)+'6"5'2)*'/"'".$(')'3-1$+-#$8'
<=8'>$30"*'>)0%
?
'

s he tells the stoiy in his unueigiounu classic, @$2"#-*4'
A"5(' B&*' @)*;$(which has solu moie than 2uu,uuu
copiesR. Nelson Nash hit upon the "Infinite Banking Concept" in a
flash of ievelation in the eaily 198us. Nash iealizeu that the piopei
use of uiviuenu-paying whole life insuiance coulu eventually allow
someone to "become his own bankei," meaning that he coulu obtain
his lifetime financing neeus (foi cais, chiluien's euucation,
ietiiement income, anu even house puichases) fiom policy loans
anu uiviuenu payments, ()+%$('+%)* fiom tiauitional banks oi othei
lenuing institutions. Nash explains in the intiouuction:

A
!"#$%&'(&()#$*+&,(&-$./&0#1)$
CCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCCC'
'
286
The whole iuea is to iecaptuie the inteiest that one is
paying to banks anu finance companies foi the majoi items that
we neeu uuiing a lifetime.
This book is not about investments of any kinu. It is
about how one 1-*)*2$0 the things of life, which can ceitainly
incluue investments..
It is not a pioceuuie to "get iich quickly." To the
contiaiy, it iequiies long iange planning. I'm euucateu as a
foiestei, having woikeu in that fielu as a consultant foi ten yeais;
I tenu to think seventy yeais in the futuie. I won't be heieanu
neithei will youbut theie is no ieason not to behave in this
mannei. "Plan as if you aie going to live foievei anu live as if you
aie going to uie touay" appeais to me to be a goou thought. 0ne
can leain how to plan anu act inteigeneiationally. That's one of
the piimaiy auvantages of having been a foiestei. I leaineu to
think beyonu the lifespan of my cuiient geneiation.
2

In the above quotation, Nash is iefeiiing to the fact that
whole life insuiance policies aie an excellent way to tiansfei laige
amounts of wealth (with significant tax auvantages) to the next
geneiation, eithei thiough (1) naming chiluien as the beneficiaiies
on one's own policy, oi (2) by funuing policies on chiluien oi
gianuchiluien when they aie quite young, which will pioviue them
access to a laige stoie of capital latei on in theii lives.
Bowevei, in oui context Nash's statement caiiies a special
significance. As we will see, the wiuespieau piactice of IBC woulu
gieatly acceleiate the achievement of the Sounu Noney Solution. In
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
287
a veiy ieal sense, a householu's uecision to piactice IBC woulu
inciease the likelihoou that futuie geneiations can giow up in a
woilu enjoying monetaiy anu banking fieeuom.

,0!5(+"&(6&4"#-/47

The piesent book is not a substitute foi Nash's oiiginal
classic. Inteiesteu ieaueis may also benefit fiom Bwayne Buinell's
2u1u book
S
which gives a moie conventional piesentation of the
compelling case foi uiviuenu-paying whole life insuiance as a
piuuent component of a householu's financial plan. In the
iemainuei of this chaptei we will pioviue a meie sketch of Nash's
iuea, so that the ieauei unueistanus the logistics of self-financing
thiough whole life policies. We will then be in a position to explain
the significance of IBC to the Sounu Noney Solution.
The fiist step to piacticing IBC is to take out a uiviuenu-
paying whole life insuiance policy, pioviueu by a mutual insuiance
company (in which the policyholueis, not thiiu-paity stockholueis,
aie the joint owneis of the company). Noimally this will be a policy
on the peison who wishes to implement IBC, but if that peison is
uninsuiable he can still enjoy the "living benefits" of IBC, by taking
out a policy on someone else in whom he has an insuiable inteiest
(such as a spouse, chilu, oi business paitnei).
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
288
Recall fiom Chaptei 1S that a whole life insuiance policy
allows the ownei to accumulate "equity" in the policy, as long as he
continues making piemium payments. Noie specifically, the oiiginal
contiact specifies guaianteeu suiienuei cash values, which giow
eveiy yeai the policy is in foice. (These values aie "guaianteeu" in
the sense that the policyholuei is legally entitleu to them if he
ueciues to abanuon his policy at any point.) Beyonu the 45)()*+$$/
cash values, the contiact will also show piojections of )2+5)3 cash
values, given assumptions about the peifoimance of the insuiance
company's asset poitfolio, anu the ieinvestment of uiviuenus into
the puichase of auuitional insuiance. In othei woius, the cash value
of a whole life policy has a constantly iising flooi, but its actual value
at any futuie uate will likely be highei than the contiactually
guaianteeu minimum.
If you talk with an actuaiy, he will tell you that the cash value
of a whole life policy at any given time, is computeu as the piesent-
uiscounteu value of the ueath benefit, minus the piesent-uiscounteu
value of the "aujusteu futuie piemium flow." What makes these
values uifficult to compute is the unceitainty of the time of ueath.
But notice that with eveiy passing yeai, the piesent value of the
looming ueath benefit obviously incieases, while the piesent value
of the iemaining stieam of potential piemium payments obviously
uecieases. This is why the cash value of a policy giows
(exponentially) ovei time.
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
289
A moie intuitive way of unueistanuing the giowth in cash
values, is to iealize that if the insuieu attains a high enough age (121
yeais foi example), the giowing cash value will have "caught up"
with the giowing ueath benefit. At that point the policy is
completeu, anu the insuiance company senus a check (piobably foi
seveial million uollais) to the veiy senioi citizen. Because the
insuiance company knows that it will ultimately have to pay a laige
sum on a whole life policyeithei to the nameu beneficiaiy when
the insuieu uies, oi to the policyownei when the insuieu attains the
iequiieu age anu the policy is completeuthe company neeus to
wisely invest the stieam of piemium payments to make suie theie is
sufficient wealth to meet its contiactual obligations. As a policy
matuies, theiefoie, the poition of the insuiance company's asset
poitfolio "backing up" the paiticulai whole life policy continues to
giow in maiket value. The guaianteeu cash value of the policy
iepiesents (loosely speaking) this accumulating pool of assets being
tenueu by the insuiei.
In auuition to the ueath benefitwhich is paiu tax-fiee to the
nameu beneficiaiy upon the ueath of the insuieua whole life
policy also geneiates "living benefits." 0ne of these benefits is the
payment of uiviuenus. By theii natuie, insuiance companies aie
veiy conseivative, chaiging highei piemiums than they will likely
neeu (in an actuaiial sense) to make the next yeai's ueath benefit
payments. In a mutual companyone in which all the policyholueis
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
29u
collectively own the assets of the insuiance companythe excess
eainings aie peiiouically uistiibuteu as uiviuenus to the
policyholueis. The policyholueis can uiaw out the uiviuenus (tax-
fiee, up until the oiiginal cost basis of lifetime piemium payments
has been suipasseu), oi they can choose to ieinvest them by
puichasing auuitional life insuiance. In essence, by ieinvesting the
uiviuenus a policyholuei buys a "mini" veision of his oiiginal policy,
in a one-shot tiansaction. (Note that the piemium payments uo not
inciease with the puichase of auuitional insuiance. The "mini"
puichases aie completely funueu by the one-shot payment of a
ieinvesteu uiviuenu.)
Theie is anothei majoi "living benefit" of a whole life
insuiance policy, which gets to the heait of IBC: The insuiance
company is piepaieu to make low-inteiest-iate 3")*0 to
policyowneis, with the "cieuit limit" being piopoitional to the cash
value of the policy. The vaiiable iate on the loan is contiactually
specifieu, anu may allow the boiiowei to obtain the same low
inteiest iate that majoi coipoiations achieve on theii own bonus.
The piocess is also quite simple. Theie aie no lengthy foims to fill
out, no neeu foi a cieuit check, anu no neeu to piove one has the
income to pay back the loan. In fact, the insuiance company uoesn't
ieally 2)($ whethei the policyownei pays back the loan!
The explanation is that the insuiei giants the loan, using the
policy's ueath benefit as 2"33)+$()3. Fiom the insuiei's point of view,
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
291
theiefoie, a loan to a policyownei in a sense is the safest investment
imaginable. Even 0.S. Tieasuiy bonus caiiy some iisk of uefault.
Bowevei, the insuiance company ;*"&0 that it will uefinitely iecoup
eveiy last penny that a policyownei owes on a loan, even incluuing
the accumulateu inteiest, because whenevei the ueath benefit is
paiu out, the outstanuing loan balance will be subtiacteu befoie the
insuiei cuts a check to the beneficiaiy. Natuially, if the policyownei
pays back all oi a poition of his policy loan, then this uiminishes the
lien against the ueath benefit, anu fiees up the cash value of the
policy foi futuie loans anuoi a fullei ueath benefit payment.

,0!5(+"&(8'#4%/4&

Nash iecommenus that inuiviuuals configuie theii whole life
policies to allow foi the quickest accumulation of cash values
ielative to the size of the piemium payment. (Theie aie IRS
iegulations limiting this piactice, so it is of couise ciucial that
anyone attempting to implement IBC ueals with a competent agent
who unueistanus Nash's philosophy as well as the ielevant tax
laws.) Pusheu to its logical extieme, a peison wishing to implement
Nash's vision woulu take out insuiance policies not only on himself,
but also on vaiious people in whom he has an insuiable inteiest,
until the point at which his entiie annual income is useu to pay
insuiance piemiums. In this way, one woulu tiuly have become his
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
292
own bankei, meaning that the fiist stop oi "heauquaiteis" of his
paychecks anu othei souices of income woulu be in a collection of
his whole life policies. Foi such a peison, the only point in having a
stanuaiu commeicial bank account, woulu be foi the convenience of
wiiting checks. The commeicial bank woulun't be necessaiy as a
place to put savings, howevei, oi even as a tempoiaiy iesting spot
when one figuies out what to uo with his "cash."
Natuially, most people uo not push the concept this fai, anu
in any event it woulu take many yeais to achieve such a position. In
the beginning, Nash iecommenus that a peison funu a single policy
enough to ieach the fiist milestone of buying his next cai using his
whole life policy, iathei than with a tiauitional auto finance
company. If the cash value has giown sufficiently, the policyholuei
coulu buy the new cai by uiawing out the uiviuenus fiom the policy.
Bowevei, it is moie likely that a newcomei to IBC will not eain
enough in stiaight uiviuenus in the yeai he wishes to buy a new cai.
In that case, he can take out a policy loan fiom the insuiance
company, iathei than tuining to a tiauitional auto financing lenuei.
When newcomeis to IBC apply foi theii fiist policy loan, they
will be elateu to uiscovei that they can boiiow at iates compaiable
to blue-chip bonu yielusin othei woius, the inuiviuual can boiiow
on teims available to majoi coipoiations. Even so, Nash
iecommenus that someone who boiiows against his life insuiance
policy at these low iates, nonetheless acts as if he is being chaigeu
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
29S
the highei inteiest iate he 50$/' to pay, thiough conventional
channels. Foi example, someone buying a new cai coulu fiist obtain
a wiitten statement fiom the auto finance company stating the
inteiest iate they &"53/' have chaigeu foi the paiticulai cai (anu
cieuit scoie of the boiiowei) in question. Nash then auvises that the
policyholuei pays +%-0 inteiest iate back to the insuiance company.
0vei the life of the loan, the policyownei who "pays himself back" in
this mannei will enu up not only with a paiu-off cai, but also with
highei cash values than he otheiwise woulu have hau, anu all with
the same out-of-pocket cashflows that he otheiwise woulu have sent
to the auto finance company.
In teims of psychological motivation, it is uefinitely veiy
useful foi people to view the situation as withuiawing money fiom
"theii bank" anu then paying the inteiest as well as the piincipal
"back into theii own bank." Bowevei, it is impoitant to unueistanu
piecisely what happens when one finances a puichase in this
mannei.
In the fiist place, stiictly speaking the policyownei uoes not
"withuiaw" money fiom the whole life policy when taking out a
policy loan. 0n the contiaiy, the piemiums continue to be paiu,
while the cash value anu ueath benefit of the policy giow as they
noimally woulu, iegaiuless of the loan.
4

When a policyownei takes a loan against his policy, it is the
-*05($('who auvances him the money. Then this loan balance giows
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
294
with inteiest, accoiuing to the teims of the loan. To iepeat, the
insuiei has the policy's ueath benefit as collateial, so it uoesn't caie
how quickly, if at all, the boiiowei iepays the loan.
Now if someone auopts the full stiategy iecommenueu by
Nash, in which he boiiows fiom the insuiance company at (say) S
peicent but makes payment on the loan as if it weie iolling ovei at 7
peicent (which is what the stanuaiu auto finance company woulu
have chaigeu), technically what happens is that the loan fiom the
insuiei is paiu off moie quickly than the same loan woulu have been
paiu off thiough the auto finance company. (This is obvious, since
the outstanuing loan balance iolls ovei at S peicent on the insuiei's
books veisus 7 peicent hau the loan been obtaineu in the tiauitional
mannei.) At some point, the loan to the insuiance company will
have been fully iepaiu, anu then the iemaining "cai payments"
actually puichase auuitional life insuiance, causing a gieatei
inciement in the cash value anu ueath benefit of the policy. This is
why it is so much smaitei to finance a cai loan (oi othei majoi
puichase) thiough a whole life policy loan, iathei than seeking
outsiue financing: Because the insuiance loan is typically at a lowei
iate than the outsiue loan (which can't seize the boiiowei's life
insuiance asset in the event of uefault), the same cash flow
ueuicateu to cai payments will tianslate into net capital
accumulation, iathei than simply eliminating an outstanuing uebt.
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
29S
If the above veibal uesciiption has not convinceu the ieauei,
the numeiical illustiations in Nash's book will make it cleai that
financing via IBC veisus outsiue lenueis is a "no biainei" in teims of
enuing up with both the puichaseu asset anu moie net wealth. (To
iepeat, if a peison has built up his policy sufficiently, he can finance
a new cai puichase completely out of the uiviuenus, iathei than by
taking out an actual loan against the policy.)
When consiueiing an inuiviuual who buys a new cai with
outsiue financing, compaieu to someone who uses the IBC appioach,
some of the lattei's auvantage is simply uue to the fact that the
peison using IBC has pieviously 0).$/ the necessaiy capital in oiuei
to puichase the cai. So pait of the ieason so many people have hau
theii lives tiansfoimeu thiough IBC, is that it has instilleu uiscipline
in theii householu finances anu they save a highei poition of theii
income than they uiu pieviously. In one sense this is an "apples to
oianges" compaiison then, when evaluating the auvantages of IBC
veisus the typical Ameiican householu's appioach to cieuit caius,
auto financing, anu bank moitgages.
In othei woius, pait of the "magic" of IBC is simply that it
encouiages householus to 0).$' 57 befoie making puichases, iathei
than buying cais anu othei goouies by going into uebt. This aspect of
IBC's auvantages has nothing to uo intiinsically with whole life
insuiance, but ieflects the obvious fact that people who uefei
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
296
consumption enu up wealthiei ovei time, compaieu to people who
spenu theii whole paycheck as soon as it comes in the uooi.
Baving saiu all that, it is still unueniable that most Ameiicans
aie not iobotic moneychangeis, choosing the stiictly "optimal"
stiategy when it comes to theii finances. Theie is a uefinite
7062%"3"4-2)3 ieinfoicement that the IBC philosophy gives to many
householus who have begun piacticing it. This ieinfoicement is just
as "ieal" as othei factois when consiueiing vaiious financial
stiategies, anu it shoulu not be uismisseu as iiielevant.
S
Simply put,
people aie much moie likely to sock away money when they view it
*"+'as, "Saving whatevei is left ovei this month" anu insteau view it
as, "This is my life insuiance piemium, which I neeu to make in
oiuei to keep my policy in foice, anu also it funus the inciease in my
cash values so I can boiiow it latei on when I neeu it."
We shoulu also mention that the ability to finance puichases
thiough policy loans can caiiy paiticulai auvantages foi policy
owneis who also iun theii own businesses. Foi example, the
householu may puichase a cai (using a policy loan) anu then lease it
to the business. The lease payment woulu then be a business
expense. Anothei populai piactice is foi uentists anu othei meuical
piofessionals to use policy loans to puichase expensive office
equipment, anu then lease it to theii own piactices. This can yielu
significant savings compaieu to seeking outsiue lenueis. Yet anothei
iuea is to use policy loans to allow patients to pay on cieuit, which
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
297
allows the uentist (foi example) to inciease his sales while offeiing
bettei financing teims to his patients than they coulu have obtaineu
fiom a thiiu paity.
Sometimes uiscussions of the many possibilities of IBC
aftei all, it is calleu the D*1-*-+$ Banking Conceptleau the skeptical
outsiuei to think, "This is too goou to be tiue. What's the catch. Bow
can I geneiate money fiom nothing."
Foitunately, theie is a stiaightfoiwaiu answei: It's not too
goou to be tiue. Setting asiue the psychological motivation to save
moie, the auvantage of boiiowing fiom one's life insuiance policy
as opposeu to seeking outsiue financingis simple: The loan iate is
lowei. This is why a uental piactice, foi example, will enu up with
fai moie wealth aftei a few yeais of self-financing, than if it ielieu on
conventional lenueis.
Theie is nothing magical about this fact. The ($)0"* the
insuiei is willing to lenu at such ieasonable teims, is that it has the
policy's ueath benefit as collateial. What this means is that, if the
uentist shoulu get hit by a bus while he still has a $Su,uuu
outstanuing loan, then his wiuow oi othei beneficiaiy will get that
much loppeu off the ueath benefit check.
Foi this ieason, it is impoitant foi those who aie inteiesteu
in IBC to uo two things: Fiist, they shoulu make suie the
beneficiaiies of theii policies unueistanu the implications; the
insuiance company uoesn't want angiy wiuows uemanuing "full
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
298
payment" aftei an IBC aficionauo uies of a heait attack at 42. Seconu,
those piacticing IBC shoulu make suie that they aie nevei
boiiowing so much against theii policies, as to leave a hole in theii
householu financial plan in the event of an untimely ueath. In othei
woius, if a householu's financial plan iequiies $1.S million in ueath
benefit payments in oiuei foi the beneficiaiy to pay off uebts anu
live comfoitably without the majoi bieauwinnei, then if that
bieauwinnei is piacticing IBC, he oi she shoulu only boiiow against
the poition of the ueath benefit that is in $E2$00 of $1.S million. IBC is
a technique to )#73-16 the benefits of insuiance; it shoulu not be
useu in a way that uefeats the oiiginal puipose of life insuiance.

+"&(2/345#(3.(,-%&'&7%(97:(%"&(6+)#(3.(,-%&'&7%(

In this book, we claim that the "money masteis" in the
goveinment anu majoi meuia have pulleu a giant con on the
Ameiican public. When it comes to inflation, foi example, Ameiicans
aie encouiageu to look at villainous Aiab nations, gieeuy
coipoiations, oi giasping laboi unions. Ameiicans aie *"+ tolu to
look at the tiue souice of the inflation, namely the Feueial Reseive
anu fiactional ieseive banking system. It is the magician's classic
iuse of misuiiection.
Foi anothei example, in Ameiica "eveiybouy knows" that the
smait thing to uo foi ietiiement planning is to contiibute the
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
299
maximum amount into tax-qualifieu mutual funus yeai in, yeai out.
The iuea of using life insuiance as a methou of ietiiement planning
is so foieign, that the quotations in this book to that effect fiom
Luuwig von Nises sounu hopelessly anachionistic.
Anu of couise, the biggest con of all was to convince
Ameiicans that gieen poitiaits of 0.S. piesiuents aie a peifectly
noimal thing to use foi money. 0sing golu anu silvei was "so 19
th

centuiy."
Along these lines, Nelson Nash has founu anothei example of
the financial ignoiance of the Ameiican public: the focus on the ()+$
of inteiest (oi yielu) iathei than the ."35#$ of inteiest. Consiuei
Nash's uiagnosis of the financial situation of miuule-class Ameiica:

Seveial yeais ago I uiu a goou bit of stuuy on the
spenuing habits of Ameiican families..I builu scenaiios aiounu
the "All-Ameiican family" because I uon't want people to think
you have to be iich to cieate a banking system that can hanule all
youi neeus foi finance. |0ui hypotheticalj young man is 29 yeais
olu anu is making $28,Suu pei yeai aftei taxes. What uoes he uo
with the aftei-tax income.
Twenty peicent is spent on tianspoitation, thiity
peicent is spent on housing, foity-five peicent is spent on "living"
(clothes, gioceiies, contiibutions to ieligious anu chaiitable
causes, boat payments, casualty insuiance on cais, vacations,
etc.). Be is saving less than five peicent of uisposable income.
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
Suu
But, to be as geneious as possible, let's assume that he is saving
+$*'7$(2$*+ anu spenuing only foity peicent on living expenses.
The pioblem is that all these items aie 1-*)*2$/ by othei
banking oiganizations. An automobile financing package foi this
hypothetical peison is $1u,SSu foi 48 months with an inteiest
iate of at least 8.S% with payments of $26u.uS pei month. But, if
you will check with the sales managei of an automobile agency
you will finu that 9S% of the cais that aie tiaueu in )($'*"+'7)-/'
1"(F This means, at the enu of Su months, if the cai is tiaueu, 21%
of eveiy payment uollai is -*+$($0+.
Now let's move to the housing situation. This young man
can qualify foi a Su yeai fixeu-iate moitgage in the amount of
about $9S,uuu at a fixeu inteiest iate of 7% APR with payments
of $618.7S anu closing costs of some $2,Suu. The pioblem is that
within S yeais he will move to anothei city, acioss town, oi
iefinance the moitgage. Something happens to a moitgage within
S yeais. Incluuing the closing costs anu inteiest paiu out uuiing
these 6u months he hau paiu $S9,62S, but only $S,4S8 has gone
to ieuuce the loan. This means $S4,167 has gone to inteiest anu
closing costs.|Yjou finu that GHI'"1'$.$(6'/"33)('7)-/'"5+'4"$0'+"'
+%$'2"0+'"1'1-*)*2-*4F...'
Now, auu up all the inteiest he is paying out anu you finu
that S4.S cents of eveiy uisposable uollai paiu out is -*+$($0+. Foi
the aveiage All-Ameiican male this piopoition *$.$('2%)*4$0..If
you will get this young man togethei with his peeis at a coffee
bieak oi some such gatheiing anu have one of them suggest that
they uiscuss financial matteis, I can pieuict what they will talk
aboutgetting a %-4%' ()+$' "1' ($+5(* on the poition they aie
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
Su1
saving! Neanwhile, eveiy paiticipant in the conveisation is uoing
the above!
6

Now one of the piesent authois is a piofessional economist,
anu he can anticipate a typical ieaction to Nash's uiscussion. A
"sophisticateu" financial plannei might ieau Nash's uiagnosis of the
pioblem facing Ameiican householus anu say, "Rubbish! 0f 2"5(0$
inteiest iates mattei! Suppose theie aie two householus making the
same annual income, anu fuithei suppose that they uevote the same
fiaction of theii uisposable income to finance chaiges eveiy
monthin othei woius, they make the same amount of money anu
also pay out the same 'volume of inteiest' in Nash's teiminology.
The only uiffeience is, the fiist householu's uebts ioll ovei at 1%,
wheieas the seconu householu's uebts ioll ovei at 1u%. Now
accoiuing to Nash, both householus aie in the same boat, since they
have the same volume of inteiest payments. But that's nuts; with the
same income, the people in householu A live in a mansion anu uiive
Bummeis, wheieas the people in householu B live in a two-beuioom
house anu uiive volvos. 0f 2"5(0$ inteiest iates mattei, anu of
2"5(0$ it's bettei to eain a highei yielu on youi investments than a
lowei yielu."
This stanuaiu ieasoning is coiiect as fai as it goes: Yes, -1'&$'
1-E' +%$' ."35#$' "1' -*+$($0+' )' %"50$%"3/' &-33' 7)6' +"' "5+0-/$(0' -*' 1-*)*2$'
2%)(4$0'$.$(6'#"*+%,'then the lowei the inteiest iate being chaigeu,
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
Su2
the highei the householu's stanuaiu of living. This is uue to the
simple fact that foi a fixeu uollai amount of finance chaiges, a lowei
inteiest iate will allow the householu to take on )'4($)+$(')#"5*+'"1'
/$:+ anu thus to buy biggei houses, fanciei cais, anu moie vacation
ciuises.
But Nash is pleauing with Ameiicans to 0+"7'3$++-*4'0"2-$+6')+'
3)(4$' +$33' 6"5' &%)+' +%$' J7("7$(K' )#"5*+' "1' "5+0-/$' 1-*)*2-*4' 0%"53/'
:$F In othei woius, we uon't neeu to "fix" the volume of inteiest
payments going out the uooi eveiy month, anu then within that
fiamewoik sciamble foi the best ueals to ioll ovei oui mountain of
uebt.
Consiuei the iecent housing boom in the 0niteu States. When
Alan uieenspan cut the feueial funus taiget iatein oiuei to
pioviue a "soft lanuing" aftei the uot-com ciashthis pulleu uown
long-teim inteiest iates, incluuing conventional moitgage iates.
Now if Ameiicans hau continueu to buy the same types of houses as
they hau at the highei moitgage iates, then uieenspan's
inteivention woulu've simply tianslateu into lowei moitgage
payments foi the typical householu, anu hence moie money left ovei
each month foi uining out, meuical bills, tuition, oiuaie we say
it.foi 0).-*4.
0f couise, that's not what most Ameiicans uiu when buying a
new home in the peiiou 2uu2 - 2uuS. Insteau, they useu the
"expeit" iule of thumb to ueteimine how much of one's uisposable
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
SuS
income "shoulu" go to a moitgage payment. At the absuiuly low
moitgage iates, this automatic uevotion of a fixeu uollai amount to
monthly housing expenses, tianslateu into a willingness to buy
much moie expensive houses. In othei woius, many Ameiicans
uiun't fiist ueciue what type of house they wanteu, anu then sought
a loan to puichase it. No, many Ameiicans woikeu the othei way,
fiist staiting out with the question, "Bow much of a moitgage
payment can we affoiu." anu then seeing "how much house" they
coulu get foi it.
In this paiticulai example, of couise, the tiageuy was that
moitgage iates eventually tuineu back up, anu the bubble
eventually poppeu. At that point, many Ameiicansespecially those
who hau bought a house foi puiely speculative ieasons, anu
financeu it with an aujustable iate moitgage (ARN)weie caught in
a teiiible pieuicament: They weie unueiwatei on a house foi which
they coulun't affoiu the moitgage payments.
But even in an enviionment of stable inteiest iates, we see
the pioblem that Nash has iuentifieu: Too many householus pay
theii bills eveiy month anu then finu, "Theie's nothing left!" Even if
a spouse takes a seconu job, it seems theie is no way to get aheau.
Nany householus iemain one sickness oi layoff away fiom financial
iuin.
Theie aie many ieasons foi this, incluuing punitive taxes anu
the boom-bust cycle itself. But Nash has pointeu out that much of
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
Su4
the iesponsibility lies with the householus themselves, in theii
attituue towaiu uebt. Theie is nothing "natuial" about paying a huge
fiaction of uisposable income to outsiue lenueis eveiy month. The
only ieason it seems natuial is that "eveiyone's uoing it," but oui
motheis supposeuly iefuteu +%)+ paiticulai justification in oui
chiluhoous.
As a simple expeiiment, we ask the ieauei to guesswithout
lookinghow much his oi hei householu spenus puiely on
1-*)*2-*4'2%)(4$0 each month. Wiite this guess uown. Then, the next
time the ieauei pays the bills, calculate the actual numbei.
Remembei that it incluues not just obvious items such as the explicit
finance chaiges on cieuit caius, but also the component of moitgage
anu cai payments that uoesn't go to piincipal ieuuction.
The iesult will piobably shock most ieaueis. What the
numbei means, is that this is how much $E+()' J-*2"#$K' the
householu woulu have each month, if its uebts magically
uisappeaieu. It shows how much 7)0+ uecisions to accumulate
uebtto spenu beyonu the householu's means at the timeaie
constiaining the householu's 25(($*+ finances.
No one likes a pastoi who claims to be sinless, anu the
piesent authois fieely aumit that they have been just as susceptible
to the peiveiteu vision of "the Ameiican uieam" as anyone else. 0ui
point in this section is not to wag oui fingeis at the ieauei anu scolu
him oi hei foi iiiesponsible piouigality.
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
SuS
0n the contiaiy, oui hope is to help the ieauei by /-)4*"0-*4'
+%$' 7(":3$#. 0nce the pioblem is iuentifieunamely, taking on fai
too much exteinal uebtthe solution is blinuingly obvious:
Bouseholus neeu to 3-.$'&-+%-*'+%$-('#$)*0. They neeu to 0).$'#"($.
They neeu to postpone big-ticket puichases because "we just uon't
have the money yet."
The main iueas in this book aie quite simple. We stiess that
money shoulu be sounu, banking shoulu be honest, anu householus
shoulu be fiugal. Somehow the viitue of thiifta penny saveu is a
penny eaineubecame yet anothei casualty of "mouein
economics."
It -0' possible to salvage youi householu's financial situation,
uespite the shackles put in place by poweiful foices. But you uon't
stanu a chance if you allow these same foices to uesign youi
bluepiint foi escape. As on so many othei topics, when it comes to
financing uecisions Ameiicans shoulu consult the leauing
"expeits"anu then uo the opposite.

0&43;/-2(<3='(>?-(0#-1&'(

It is easy to get lost in the uetails of paiticulai applications of
the IBC piocess. In the gianu scheme, what Nelson Nash is
iecommenuing is quite simple: Be auvises eveiy householu to go
into the banking business, in auuition to whatevei othei souices of
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
Su6
income it enjoys. Bowevei, an IBC bank is special in that it has only
one "uepositoi": the peison who owns it. In this way, the householu
banking opeiation is not subject to the numeious iegulations
conceining conventional banks, because the only peison's wealth at
iisk is the one making life insuiance piemium payments.
0nce someone has built up a sufficient amount of saveu
capital in his "bank," he is ieauy to begin making loans to boiioweis.
Again, an IBC bank uiffeis fiom a conventional bank in that the fiist
customei is going to be the bankei himself! That is, the peison
piacticing IBC will begin "lenuing himself" money when he neeus to
buy his next cai, oi when he neeus to pay foi his uaughtei's
weuuing. Yet as the uecaues pass, anu the IBC piocess yielus an
evei-giowing stockpile of available capital, the householu bankei
can begin using policy loans to take auvantage of luciative
investment oppoitunities, as opposeu to conventional lifetime
neeus. This means that the IBC piactitionei has options unavailable
to the aveiage Ameiican. To give just one example, Nash has a veiy
intiiguing section in his book showing that it might uo a chilu fai
moie goou to funu a policy iathei than pay the same cashflow foi a
foui-yeai college uegiee. The hefty cash value in such a policy woulu
then allow the 22-yeai-olu (without a college uegiee) to stait a
luciative cai leasing business, assuming he oi she hau the iequisite
business savvy.
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
Su7
The genius of Nash's concept is that he iuentifieu a
tiauitional financial piouuct sitting within eveiyone's giasp, anu yet
escaping eveiyone else's notice. In piinciple, householus coulu
stockpile savings using othei techniques, anu become "banks"
without using whole life insuiance policies. Yet as we'll see in the
next chaptei, whole life policies aie appealing on seveial ciiteiia,
wheieas othei vehicles have at least one majoi uiawback.
As a final note in this section, we ieminu the ieauei that IBC
is not a "gimmick," noi uoes it iely on a "tax loophole." It is tiue, one
of the auvantages of IBC veisus othei possible appioaches is the
excellent tax tieatment that whole life policies cuiiently enjoy. In
paiticulai, if uiviuenus aie ieinvesteu back into the puichase of
auuitional life insuiance, the accumulating cash values aie not
subject to tax. Latei on, if the ownei elects to withuiaw the uiviuenu
payments as income, these too aie tax-fiee up until the point at
which the lifetime piemium payments have been exhausteu. In
othei woius, the policyholuei is only taxeu on the uollais taken out
of the vehicle, ovei anu above the ones initially put in. (The ieason is
that the IRS tieats these payments not as uiviuenu oi inteiest
income, but as a "ietuin of piemium," because the policyownei was
chaigeu moie piemium than the insuiei enueu up neeuing, in oiuei
to meet its ueath benefit obligations.) Anu a veiy significant tax
auvantage is that the entiie ueath benefit goes to the beneficiaiy
tax-fiee.
!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
Su8
Baving saiu all this, IBC uoesn't woik #$($36 because of the
cuiient configuiation of the tax coue. Whole life insuiance has been
aiounu twice as long as the IRS; it is not a cieatuie of the state. It
just so happens that the featuies of mutually owneu, uiviuenu-
paying whole life insuiance companies aie almost peifectly suiteu to
allow miuule-class householus, with ielatively little hassle, to begin
accumulating financial capital in oiuei to entei the banking
business.
0n the subject of taxes, we shoulu issue one final note of
caution so that the ieauei unueistanus the coiiect case foi IBC: If a
policyownei auvances loans oi leases equipment to his outsiue
company, anu then has his company tieat the inteiest anu lease
payments as tax-ueuuctible business expenses, he must be suie to
ueclaie these payments as taxable -*2"#$ when filing his householu
taxes. As of this wiiting, the IRS uoes not object to the techniques
uesciibeu above, anu actual IBC piactitioneis have suiviveu auuits.
The key to a successful uefense, howevei, is to uocument eveiy
tiansaction anu to make suie that any claimeu business expense
involving payments to the householu, has a coiiesponuing income
claim on the householu's tax filing.

!"#$%&'(&()#$*+&,(&-$./&0#1)$
'
Su9

1
R. Nelson Nash, Becoming Your Own Banker, Fifth Edition (Birmingham, AL:
Infinite Banking Concepts, 2008), p. 18.
2
Nash, Becoming Your Own Banker, p. 3.
3
Dwayne Burnell, A Path to Financial Peace of Mind (Bothell, WA:
FinancialBallGame Publishing, 2010).
4
We are simplifying somewhat in this section of the text, in order to introduce the
mechanics of a policy loan. In practice, some insurance companies reduce the dividend
that they pay to a policyholder, based on the size of any outstanding policy loan. (In
other words, if two policyholders had identical whole life policies and cash values, but
one had an outstanding loan while the other did not, some insurance companies would
pay higher dividends to the second policyholder.) The advantages of self-financing
through policy loans are obviously reduced, if doing so slows the internal rate of return
on a policys cash values. However, this slight complication does not change the fact
that the borrower still does much better by obtaining his financing at much lower
interest rates from the insurer, than by turning to a traditional finance company.
5
The psychological motivation is not the only advantage of IBC. Depending on the
specifics, it is possible that the internal rate of return on a whole life policys cash
values are greater than the after-tax yield on bank CDs. Nashs Table 1 (p. 45)
illustrates a plausible scenario in which someone eventually accumulates more wealth
by financing car purchases through IBC, rather than by using a sinking fund involving
bank CDs.
6
Nash, Becoming Your Own Banker, pp. 17-18.
!"#$%&'(&()#$*+&,(&-$./&0#1)$
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!"#$
$
S11
!"#$%&'()*(
!+,,+-(./0&1%2+-3(%+(45!(

!"#$%& '()*+*,-,./& )0& .$%& 1)--%2%3
%451+.%4& '%(6)7& %8%(& -%+(7,72& .$%&
*%7%0,.6&)0&9*+7:,72;&.$()52$&.$%&56%&)0&
<$)-%& -,0%& ,765(+71%& ,6& 7).& 8%(/& 2))4=&
>%& <,--& *%& %?')6%4& .)& 6)@%& '()0%66)(&
.%+1$,72& $,@& .$+.& 9<$)-%& -,0%& ,765(+71%&
,6& +& 8%(/& '))(& '-+1%& .)& '5.& @)7%/=;& A.&
<,--& .+:%& +& -).& )0& %00)(.& .)& 2%.& .$,6&
7).,)7& )5.& )0& $,6& $%+4B& *%1+56%&
957-%+(7,72;& ,6& @)(%& 4,00,15-.& .$+7&
-%+(7,72=&
CD=&E%-6)7&E+6$
F
&

he oveiaiching theme of this book is to show the
connection between Nelson Nash's IBC anu the Sounu
Noney Solution. Bowevei, theie aie many fieice ciitics of IBC on a
puiely financial level. Weie we to ignoie these typical objections,
the ieauei coulu not concentiate on the final chaptei, which spells
out the connection. In this chaptei, theiefoie, we will fiist piesent
the stanuaiu case foi whole life insuiance, anu then uefuse some of
T
!"##"$%&'()*+,"$-%+"%./!%
GGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGG&
&
S12
the most common ciitiques of IBC.

6"&(!#3&(7+'(8"+9&(:27&(4-3;'#-1&(

A stanuaiu way to motivate the puichase of a uiviuenu-
paying whole life insuiance policy, is to fiist ask the piospective
client about the attiibutes of a theoietically peifect investment.
These woulu incluue things such as safety (meaning the asset's piice
woulu not likely uiop), liquiuity (meaning the ownei coulu tuin the
asset into its "faii" maiket value quickly if neeueu), high iate of
ietuin, tax auvantages, a souice of income (i.e. not meiely
appieciation in piice), uncoiielation with the stock maiket, a heuge
against piice inflation, anu piotection fiom cieuitois in the event of
bankiuptcy.
The most populai investment vehicles aie stiong on some
ciiteiia but veiy weak on otheis. Foi example, golu is an excellent
inflation heuge, but it uoes not pioviue a flow of income, its
appieciation can be taxeu as a capital gain, anu the goveinment has
confiscateu golu in the past. Real estate too is an inflation heuge, but
it can be veiy illiquiu anu its value too can be quite volatile. Anu the
stock maiket, though piomising a high iate of ietuin, also comes
with the iisk of massive shoit-teim losses.
The stanuaiu case foi whole life insuiance is that it is
iemaikably stiong on seveial of the above ciiteiia, anu even its
!"##"$%&'()*+,"$-%+"%./!%
&
S1S
weak points aie not as bau as the ciitics think. In ieality theie is no
such thing as the peifect investment, but the case foi miuule- to
uppei-income families incluuing whole life as pait of theii
conseivative financial plan is quite compelling. When we
supplement the stanuaiu case with Nelson Nash's insights, anu in
paiticulai the ielationship of insuiance anu fiactional ieseive
banking (as we spell out in the next chaptei), the case foi piacticing
IBC becomes stiongei still.
In oui expeiience, most people ieject IBC out of hanu,
because they have one oi two "uevastating" objections to the use of
a whole life insuiance policy. In the iemainuei of this chaptei, we
uefuse these common ciiticisms.
(
<=>&'?+-&(@-+A3(?+;(B+(/&%%&'(%+(/;?(%&',(#-B(2->&3%(
%"&(B277&'&-1&CD(

It is "common knowleuge" among many people that the
inteinal iate of ietuin on a whole life policyeven if uiviuenus aie
ieinvesteuis much lowei than coulu be achieveu on alteinative
investments. In paiticulai, many financial auvisois will quite
confiuently state that only a fool woulu buy peimanent life
insuiance, since it is so much bettei to "buy teim anu invest the
uiffeience." In othei woius, they claim that an inuiviuual shoulu
!"##"$%&'()*+,"$-%+"%./!%
&
S14
sepaiate the two uecisions: Fiist, he can buy whatevei ueath benefit
he wants in the cheapest mannei possible (i.e. by acquiiing a teim
life insuiance policy). Seconu, he can then use the savings on
piemium payments to invest in a mutual funu, which histoiically
will yielu a highei iate of ietuin than the cash value of a whole life
policy.
Theie aie seveial pioblems with this glib uismissal of whole
life as a "teiiible investment." Foi one thing, so long as the
policyownei sticks with a paiticulai policy foi many yeais, the
aveiage annualizeu iate of ietuineven on a plain vanilla whole life
policy with no fancy IBC maneuveiingis piobably much bettei
than many ciitics iealize. When we consiuei the uangeis attenuant
with othei potential investments, the case foi putting one's genuine
6+8,726 into a whole life policy becomes stiongei.
Foi a conciete illustiation, the website Insuie.com offeieu an
analysis
2
that took

.a look at buying.a New Yoik Life whole life insuiance policy
compaieu to buying teim life insuiance in the same face amount
anu investing the piemium uiffeience in a "siue funu" such as a
bank oi mutual funu. This compaiison comes couitesy of }ames
Bunt, an actuaiy foi the Consumei Feueiation of Ameiica (CFA)
anu foimei insuiance commissionei of veimont. Bis analysis
estimates the "ieal" inteiest iate eaineu on savings within a cash
value policy.
!"##"$%&'()*+,"$-%+"%./!%
&
S1S

Beie aie the iesults:

In this compaiison, Bunt shows that if you buy a
compaiable teim life insuiance policy you neeu to eain 4.6
peicent in youi investment vehicle in oiuei foi youi siue funu to
equal this whole life's cash value aftei 2u yeais. If youi teim life
insuiance siue funu is investeu in a bank CB oi bonu funu, you
may not be able to net 4.6 peicent aftei taxes.

Although Bunt was looking at the cash values foi a paiticulai
New Yoik Life whole life policy, his iesults aie typical foi policies
issueu in this peiiou. Foi example, a piesentei at the IBC Think Tank
in eaily 2u1u showeu a stanuaiu table of piojecteu cash values foi a
whole life policy, in which the (aveiage annualizeu) inteinal iate of
ietuin eventually iose to 4.24 peicent by the thiitieth yeai of the
policy.
S

At fiist such a iate of ietuin may seem unueiwhelming, but
we shoulu keep in minu that at a SS peicent tax biacket, someone
woulu neeu to eain 6.S2 peicent on an alteinative investment, in
oiuei to match the ietuin illustiateu foi whole life. Alieauy we see
that whole life insuiance is not neaily the "boneheau" investment
that so many people allege.
Noieovei, we neeu to consiuei safety. In oiuei to eain 6.S
peicent annually ovei a Su-yeai peiiou, someone woulu have hau to
!"##"$%&'()*+,"$-%+"%./!%
&
S16
put his money in investments that weie iiskiei than a whole life
insuiance policy, with its guaianteeu cash values. (It's tiue, in ieality
nothing is "guaianteeu," but a whole life policy is still quite safei
than most othei investments.) To eain a tax-aujusteu 6.S peicent on
an extiemely safe anu faiily liquiu investment, is uefinitely an
attiactive option that most householus shoulu consiuei in theii
oveiall poitfolio.
Yet theie is one moie thing to consiuei, in the compaiison of
whole life veisus a cheapei teim insuiance policy. Suppose Will anu
Tom aie iuentical twins who aie Su yeais olu. Will opts to buy a
whole life policy with a million uollai face value, while Tom ueciues
to buy a 2u-yeai teim policy caiiying the same ueath benefit. It's
tiue, Will's piemiums will be much highei than Tom's, anu it's also
tiue that Will's accumulating cash values will be quite mouest the
fiist few yeais of the policy. If Will anu Tom compaie notes at age
SS, Tom woulu feel that he maue the cleaily supeiioi choice in
opting foi teim insuiance.
Bowevei, let's jump aheau to age Su. At this point, the
accumulateu wealth of the twins (we'll suppose) is ioughly the
same; Will's whole life policy has become much moie efficient as it
matuieu, while Tom was able to use the savings on his cheapei
piemiums in oiuei to builu an investment poitfolio that appieciateu
(aftei taxes) about the same as Will's cash values.
!"##"$%&'()*+,"$-%+"%./!%
&
S17
But theie is one majoi uiffeience between the two biotheis
now that they have useu theii iespective stiategies foi two uecaues:
Will can continue paying his level piemiumthe same one he began
paying at age Suanu keep his life insuiance policy in foice, until
the uay he uies. Tom, on the othei hanu, will piobably 7). ienew his
expiiing teim policy. Paiticulaily if he has hau any health pioblems,
at age Su Tom woulu finu it veiy expensive to obtain a new teim life
insuiance policy. So even if Tom happeneu to have moie wealth to
his name at age Su, that alone woulun't be uecisive, because Will
coulu easily maintain his insuiance coveiage while Tom coulu not.
Foi example, if both biotheis uieu in a cai acciuent at age S1, cleaily
Will's wiuow will be @51$ bettei off than Tom's wiuow.
We aie not tiying to aigue fiom a naiiow financial planning
peispective, whole life insuiance is necessaiily the best option foi
eveiy householu. What we aie pointing out, howevei, is that the glib
auvice of "buy teim anu invest the uiffeience" oveilooks many
impoitant ieal-woilu consiueiations. Think again of the uiffeience
of buying a house veisus ienting: Yes, the cheapei iental payments
(foi a compaiable living aiea) may make the most sense foi some
people, especially if they aie young. But builuing up equity in a
house makes a lot moie sense foi a stable householu with a long-
teim financial plan, %6'%1,+--/ if lanuloius piacticeu age
uisciimination anu chaigeu highei iates the oluei a ientei became.
!"##"$%&'()*+,"$-%+"%./!%
&
S18
As a final point, we iepeat an obseivation maue to one of the
authois by an actuaiy, who pointeu out that whole life ,6& "buying
teim anu investing the uiffeience." That is, when the insuiance
company takes in piemiums on whole life policies, it must
conceptually isolate the component of each payment ueuicateu to
the piovision of the ueath benefit, while the iemainuei is useu to
funu oveiheau anu accumulate assets to satisfy the cash value
taigets.
In a sense, the whole life insuiei is acting as both a teim
pioviuei (wheie the teim is the entiie life of the client) +74 as a
veiy conseivative investment funu managei. It is of couise
impoitant foi inuiviuuals to exeicise uue uiligence to see if it makes
sense to go to a single pioviuei of these uual seivices (i.e. an insuiei
offeiing a whole life policy), but the compaiison shoulu be apples to
apples. Someone who opts foi a 2u-yeai teim policy anu invests the
uiffeience in a mutual funu composeu of stocks anu bonus may
accumulate wealth at a fastei iate, but he is taking on fai moie iisk
than the peison builuing up a whole life policy.

<6"&'&( #'&( +%"&'( %#EFG;#9272&B( $9#-3H( 3;1"( #3( ,?(
IJ)K@LMD

It is tiue that whole life insuiance is not the only investment
vehicle to enjoy tax auvantages. Bowevei, othei vehicles such as a
!"##"$%&'()*+,"$-%+"%./!%
&
S19
4u1(k) caiiy numeious iestiictions, making these assets fai less
liquiu than the cash values of a whole life policy. Foi example,
except in specifieu cases of extieme haiuship, a peison has stiict
iules on when he can withuiaw his money fiom a 4u1(k) oi similai
tax-qualifieu plan, anu also when he @56. begin withuiawing (to
avoiu penalties).
Theie is also the pioblem of confiscation. Simply put, many
analysts expect the feueial goveinment to "iaiu the 4u1(k)s." Theie
have alieauy been tiial balloons (quickly withuiawn) suggesting
that Ameiicans woulu be bettei off if the goveinment assumeu theii
volatile stock poitfolios anu insteau guaianteeu them ietiiement
benefits uown the ioau.
4
Nelson Nash in fact has wiitten on
piecisely this topic,
S
imploiing the ieauei to be suspicious when the
goveinment offeis a "solution" (i.e. tax-qualifieu plans) to a pioblem
that the goveinment itself cieateu (i.e. high tax iates).
Finally, we point out that even uiveisifieu mutual funus took
a biutal beating in the 2uuus. Bepenuing on the composition of theii
funus, many householus weie lucky if they bioke even uuiing the
entiie uecaue. It's all well anu goou to tell someone, "Buy anu holu,"
but many bieauwinneis with 4u1(k)s anu othei compaiable plans
hau to uelay theii ietiiement aftei the blooubath in 2uu8. As of this
wiiting in spiing 2u1u, the 0.S. equity maikets aie swinging by up to
S peicent 4+,-/.

!"##"$%&'()*+,"$-%+"%./!%
&
S2u
<8+-N%(4(O&%('2$$&B(+77(/?(%"&(";O&(#O&-%(1+,,2332+-PD

It is tiue that a laige poition of a new policy's initial piemium
payment funus the commission that the insuiance company pays to
the agent who biings in the client. This is the main ieason that the
inteinal iates of ietuin on the cash values of a whole life policy aie
abysmal in the fiist few yeais.
0nfoitunately, pait of the explanation foi high commissions
is goveinment inteivention (at the state level). As anyone who has
applieu foi a state license to become an insuiance "piouucei"
knows, the caiuinal sin in this inuustiy is giving a "kickback" to the
customei foi buying a policy. If an agent is caught shaiing his
commission fees with anyone who uoesn't also have a license
(incluuing the customei whose initial piemium payments aie
funuing the entiie commission), then the offenuing agent will lose
his license. In this way, the state goveinment enfoices a caitel anu
keeps the piice of commission-baseu insuiance highei than it
otheiwise woulu be.
Notwithstanuing the inteivention by state goveinments, it is
entiiely ieasonable that agents eain a commission on whole life anu
othei peimanent insuiance piouucts. Aftei all, as the uiscussion in
this veiy book attests, a whole life insuiance policy is complex, anu
iequiies fai moie guiuance than a stanuaiu teim insuiance policy.
The insuiance agent who explains the mechanics of a whole life
!"##"$%&'()*+,"$-%+"%./!%
&
S21
policy to a piospective client neeus to be compensateu foi his oi hei
time, anu the inuustiy has auopteu the commission appioach that is
common foi many types of salespeople. (Keep in minu that all of the
peifoimance iesults we have thus fai piesenteu ,71-54% the
commission fees.)
It is impoitant to note that a whole life policy configuieu
accoiuing to Nelson Nash's philosophy actually @,7,@,H%6 the
piopoition of the initial piemium payments going to the agent's
commission. This is why it is impoitant to obtain a whole life policy
fiom an agent who tiuly unueistanus anu believes in the IBC
minuset; othei agents woulu have a natuial incentive to steei the
client away fiom the piopei configuiation, anu into a policy wheie
the cash value's giowth is stunteu in the beginning. In fact, weie it
not foi state laws we woulu expect IBC salespeople to offei the
gieatest commission cuts to theii clients, because someone who has
a goou expeiience with IBC will ultimately acquiie many policies.
Finally, we point out that the insuiance agent "caitel"
actually has ielatively low baiiieis to entiy. The iequiiements uiffei
fiom state to state, but a peison with no backgiounu in insuiance
can typically obtain a license aftei two uays of classioom
instiuction, a shoit test that is quite easy, anu a few hunuieu uollais
in vaiious fees.

!"##"$%&'()*+,"$-%+"%./!%
&
S22
<4( "&#'B( %"&( 2-3;'#-1&( 1+,$#-?( %#@&3( ,?( 1#3"( >#9;&3(
A"&-(4(B2&CD

The inteinet is full of accusations of the uastaiuly ueeus
committeu by whole life insuiance companies, anu peihaps theii
most nefaiious ploy is to keep the cash values the policyholuei has
spent so many uecaues patiently accumulating, iathei than give
them to the beneficiaiy when the insuieu uies. Inueeu, the stingy
insuieis meiely senu a check foi the ueath benefit, but uo not senu
an auuitional check foi the cuiient cash value of the policy.
Although some expositions of the beauty of whole life
insuiance may give the opposite impiession, let us be cleai: I')7&
.$%&4%+.$&)0&.$%&,765(%4B&.$%&,765(+71%&1)@'+7/&6%746&+&1$%1:&0)(&.$%&
0)1+2%')$)3,+%"$45&.)&.$%&*%7%0,1,+(/. The cash value of a policy, foi
any given yeai, meiely shows what the policyholuei woulu ieceive if
he weie to 65((%74%( the policy at that time. (Equivalently, it shows
the uppei limit of what he coulu boiiow against the policy.) The
ieason the insuiei can affoiu to give a cash value upon suiienuei, is
that it won't $+8% to pay a ueath benefit on a suiienueieu policy.
Theie shoulu nevei have been a question of the insuiei paying *).$
cash value anu ueath benefits to a beneficiaiythough we conceue
that this point can be confusing to the newcomei, since some
expositions of IBC tieat the ueath benefit as a "bonus" in auuition to
the financing capabilities.
!"##"$%&'()*+,"$-%+"%./!%
&
S2S
Let us ietuin once again to the housing analogy: Suppose a
man uutifully pays uown the moitgage yeai aftei yeai, builuing up
the equity in his home. Aftei Su yeais he makes the final moitgage
payment, then walks into the bank. The bank tellei congiatulates
him anu hanus him the ueeu to his house. The man then cleais his
thioat. "Excuse me, but my accountant tells me I have accumulateu
$SSu,uuu in equity in my house, now that I've cleaieu the moitgage.
Bo you have my check."
The man woulu no uoubt be shockeu anu outiageu to leain
that the bank was meiely hanuing ovei the ueeu, anu was "keeping
his home equity" foi itself. But obviously that woulu completely
misconstiue what was happening all those yeais uuiing the
payuown of the moitgage.
In the same way, someone builuing up the cash value of a
policy is neaiing the point at which he (oi his beneficiaiy) can claim
full access to the ueath benefit. The cash value is 4%0,7%4 as the
uiffeience between the looming ueath benefit anu the iemaining
piemium payments, aujusteu foi the time value of money anu the
piobabilities of ueath at vaiious points in the futuie. 0nce we
unueistanu what the cash value ,6, anu why the insuiei is willing to
make policy loans against it, it becomes obvious why the beneficiaiy
only ieceives one payment when the insuieu uies.

!"##"$%&'()*+,"$-%+"%./!%
&
S24
<47( %++( ,#-?( $&+$9&( $'#1%21&( 45!H( A+-N%( %"&(
O+>&'-,&-%(3";%(2%(B+A-PD

Nany people leain the mechanics of IBC anu then become
veiy piotective. They uon't want anybouy else leaining the best-
kept seciet in the financial woilu! Theii unueistanuable feai is that
if too many people take theii money out of the politically-favoieu
sectois (such as Wall Stieet) anu paik it in whole life policies subject
to minimal taxation, then eventually the goveinment will change the
iules anu spoil eveiything.
Natuially no one can piomise that a paiticulai financial
stiategy is immune to political inteifeience. If the goveinment
began taxing eainings on whole life policies, that woulu ceitainly
ieuuce theii attiactiveness. 0n the othei hanu, we must ieiteiate
that whole life insuiance is 7). a cieation of the tax coue; these
policies existeu a centuiy befoie the IRS. In oui mouein woilu, even
if the tax auvantages weie eliminateu, the othei auvantages of IBC
might still ienuei whole life insuiance a piuuent place to stoie a
poition of a householu's wealth.
Iionically, we can flip this objection on its heau by asking a
simple question: Why hasn't the goveinment iemoveu the tax
ueuuction foi moitgage inteiest expenses, even though many
economists aigue that this "loophole" is economically inefficient anu
uistoits the ieal estate maiket. The answei is obvious: It woulu be
!"##"$%&'()*+,"$-%+"%./!%
&
S2S
extiemely contioveisial to iemove the ueuuction, since so many
householus maue a majoi financial uecision baseu on its existence.
The same coulu holu foi whole life insuiance policies. If
millions of Ameiican householus begin investing in laige policies,
they will iaise quite an upioai if the politicians thieaten to iemove
theii special tax tieatment. This is why it is ciucial foi piactitioneis
to spieau the woiu to theii fiienus anu families. It is also ciucial foi
people to piactice IBC (%6')76,*-/. If the goveinment evei uoes "go
aftei IBC," it will want some juicy stoiies of shauy businessmen
cheating on theii taxes in a complicateu scheme involving whole life
policies anu pooi uocumentation. We uige the ieaueis of this book
to 7). pioviue such examples to the piess oi the politicians.

<8"#%(27(%"&(2-3;'#-1&(1+,$#-?(O+&3(/'+@&PD

Theie is no such thing as the peifect investment. uolu may be
confiscateu by the authoiities, cash unuei the mattiess may be
stolen oi uestioyeu thiough piice inflation, anu ieal estate may
ciash in piice oi be too illiquiu in a time of neeu.
Whole life insuiance policies too aie impeifect. Even though
they "guaiantee" cash suiienuei values at vaiious ages of the policy,
of couise it is possible that the insuiance company will pooily
manage its assets anu be unable to meet its contiactual obligations.
Bowevei, both state iegulations anu the entiie tiauition of life
!"##"$%&'()*+,"$-%+"%./!%
&
S26
insuiance make it a veiy conseivative asset, ielative to most otheis.
Even if a paiticulai company goes unuei, the iest of the inuustiy will
typically assume its opeiations to ensuie that policyholueis aie
maue whole. It is in the inteiest of the inuustiy to maintain the
public's tiust that "life insuiance" is a veiy *)(,72 anu beuiock
institution. (The puipose of life insuiance is not to make a killing,
but to pioviue foi one's family in case of a killing.) As ue Soto
explains:

The institution of life insuiance has giauually anu
spontaneously taken shape in the maiket ovei the last two
hunuieu yeais. It is baseu on a seiies of technical, actuaiial,
financial anu juiiuical piinciples of business behavioi which have
enableu it to peifoim its mission peifectly anu suivive economic
ciises anu iecessions which othei institutions, especially
banking, have been unable to oveicome. Theiefoie the high
"financial ueath iate" of banks, which systematically suspenu
payments anu fail without the suppoit of the cential bank, has
histoiically contiasteu with the health anu technical solvency of
life insuiance companies. (In the last two hunuieu yeais, a
negligible numbei of life insuiance companies have uisappeaieu
uue to financial uifficulties.)
6

Be Soto goes on to explain that the veiy natuie of the life
insuiance business makes it an excellent heuge against the boom-
bust cycles causeu by fiactional ieseive banking:
!"##"$%&'()*+,"$-%+"%./!%
&
S27

The following technical piinciples aie tiauitional in the
life insuiance sectoi: assets aie valueu at histoiical cost, anu
piemiums aie calculateu baseu on veiy piuuent technical
inteiest iates, which nevei incluue a component foi inflation
expectations. Thus life insuiance companies tenu to
unueiestimate theii assets, oveiestimate theii liabilities, anu
ieach a high level of static anu uynamic solvency which makes
them immune to the ueepest stages of the iecessions that iecui
with economic cycles. In fact when the value of financial assets
anu capital goous plunges in the most seiious stages of iecession
in eveiy cycle, life insuiance companies aie not usually affecteu,
given the ieuuceu book value they iecoiu foi theii investments.
With iespect to the amount of theii liabilities, insuieis calculate
theii mathematical ieseives at inteiest iates much lowei than
those actually chaigeu in the maiket. Bence they tenu to
oveiestimate the piesent value of theii commitments on the
liabilities siue. Noieovei policyholueis take auvantage of the
piofits insuiance companies biing in, as long as the piofits aie
uistiibuteu +& ')6.%(,)(, |i.e. aftei iealizationj, in accoiuance
with.piofit-shaiing clauses.
7

<8"#%(#/+;%("?$&'2-79#%2+-PCD

As of this wiiting in spiing 2u1u, many membeis of the
Austiian movement aie veiy conceineu about the fate of the 0.S.
uollai. Inueeu one of the piesent authois has speculateu that Feu
!"##"$%&'()*+,"$-%+"%./!%
&
S28
Chaiiman Beinanke's ieckless policies may ultimately leau to an
outiight collapse of the uollai anu the intiouuction of a new
cuiiency. In light of these feais, isn't it ciazy to invest in a uollai-
uenominateu asset such as life insuiance.
Theie aie seveial iesponses to this legitimate question. In
the fiist place, we must constantly ieminu the ieauei that in the IBC
peispective, +& '%(6)7& ,6& 7).& J,78%6.,72K& ,7& <$)-%& -,0%B& *5.& ,6& (+.$%(&
$%+4L5+(.%(,72& $,6& <%+-.$& ,7& +& <$)-%& -,0%& ')-,1/. In paiticulai, if
someone wants to buy golu, ieal estate, non-hybiiu seeus,
ammunition, oi any othei inflation heuge, he is still fiee to uo so,
even while piacticing IBC. If his cash values aie laige enough, the
peison can withuiaw his uiviuenus foi these investments, oi he can
take out a policy loan if he neeus access to moie of his capital.
Although the uangei of massive piice inflation is still quite
ieal, we uon't know the exact timing. At this point, the maikets seem
to have taken Beinanke at his woiusuch as it isanu the uollai
has not collapseu. (In fact, the uollai has stiengtheneu amiust the
feais ovei the Euiozone's solvency.) In this enviionment, stockpiling
uollais in a veiy safe placeas opposeu to the incieuibly volatile
stock maiketis not a teiiible iuea, 6)& -)72& +6& .$%& ')-,1/$)-4%(& 1+7&
L5,1:-/&@)8%&<$%7&.$%&'(,1%&,70-+.,)7&2%7,%&*%2,76&-%+8,72&.$%&*)..-%.
We shoulu point out that futuie piice inflation is a uouble-
eugeu swoiu when it comes to a whole life policy. It's tiue, laige
incieases in consumei piices will uilute the puichasing powei of a
!"##"$%&'()*+,"$-%+"%./!%
&
S29
contiactually specifieu ueath benefit. 0n the othei hanu, laige piice
inflation will also ieuuce the buiuen of futuie '(%@,5@& '+/@%7.6.
Even though the insuiance company's asset poitfolio has a heavy
concentiation of bonus, the peison who buys a whole life policy is
not $,@6%-0 buying a poition of those bonus upfiont. Rathei, at the
moment of signing the policy, the peison is pleuging to pay a long
stieam of fixeu uollai payments, while the insuiei is piomising a
long stieam of (potential) fixeu ueath benefit payments.
We can think of one potential scenaiio in which a whole life
policy woulu become untenable. Suppose that someone begins
piling money into his policy, anu accumulates $Suu,uuu by the yeai
2u14. Bowevei, at that point the official CPI is iising at moie than 2u
peicent annually, anu long-teim coipoiate bonu yielus have spikeu
to Su peicent.
Fuithei suppose that this policyholuei saw the uangei anu
hau taken out $Suu,uuu fiom his policy to invest in golu anu othei
inflation heuges. 0n that fiont he uiu quite well. Bowevei, he is
tioubleu to uiscovei that his outstanuing $Suu,uuu policy loan is
giowing at a iate of Su peicent (because his contiact allows the
insuiei to aujust the policy loan iate in accoiuance with Noouy's
long-teim coipoiate bonu yielus). Although his cash values have
staiteu iising at a much fastei iate than his contiact oiiginally
piojecteu, nonetheless they aie not giowing as quickly as his policy
loan. Aftei all, the insuiei's bonu holuings have a long uuiation, anu
!"##"$%&'()*+,"$-%+"%./!%
&
SSu
it takes time foi the insuiei to ioll ovei its assets anu begin eaining
the highei inteiest iates.
In this scenaiio, the policyholuei woulu piobably not want to
watch helplessly as his policy loan quickly consumeu his $2uu,uuu
in available cash values. Foitunately, he woulu have the option to
65((%74%( his policy at that time, paying off the loan anu then
investing his $2uu,uuu howevei he uesiieu. In fact, if he still wanteu
to piactice IBC, he might open up a new whole life policy once things
hau settleu anu people weie moie confiuent in theii piojections of
long-teim inteiest iates.

<8"?( 1#-N%( 4( Q/#-@N( /?( /+''+A2-O( #O#2-3%( ,?( "+;3&( +'(
+%"&'(#33&%3PD

At fiist glance the IBC concept woulu seem to woik foi +7/
asset. Foi example, as an inuiviuual pays uown his moitgage, he
accumulates a laigei shaie of equity in his house. Then when he has
a majoi expense, he coulu obtain a secuieu loan fiom the bank,
using the house as collateial. In othei woius, he coulu (say) pay foi
his uaughtei's weuuing, oi finance a ciuise in his 6us, by taking out a
home equity loan. So what's so special about a whole life policy.
Why is Nash concentiating on this paiticulai vehicle to "become
youi own bankei".
!"##"$%&'()*+,"$-%+"%./!%
&
SS1
Theie aie two majoi ieasons that a whole life policy is the
peifect vehicle foi Nash's iuea, wheieas going to a bank to obtain a
secuieu loan on assets is uefinitely infeiioi. In the fiist place, when
someone applies foi a loan at the bankeven with a secuieu asset
such as home equity, a boat, etc.the bank will make the applicant
unueigo a iigoious piocess. The bank will want to know the '5(')6%
of the loan, anu it will also want to know the cieuit histoiy anu
income souices of the applicant to make suie he can '+/& *+1:& .$%&
-)+7. Theie will also be a fixeu payback scheuule. 0nce the loan is
maue, the applicant can't ueciue a few months in, that his finances
aie tightei than he iealizeu anu he's just going to stop paying his
installments.
In complete contiast, someone iequesting a policy loan on
his whole life cash values just neeus to give the uollai amount to the
insuiance company. They uon't ask the puipose, they uon't iun a
cieuit check, anu they uon't caie if the applicant has any income at
all. They will giant the loan with a contiactual iate of inteiest, anu if
the applicant ueciues to stop making payments, the outstanuing
balance will giow but the insuiei will not object.
The ieason foi this night-anu-uay uiffeience in tieatment
isn't that banks hiie jeiks while insuieis hiie sweetheaits. No, the
uiffeience is uue to the natuie of the collateial in the two scenaiios.
The bank uoesn't ieally <+7. to seize somebouy's house oi boat
when he uefaults on a loan. The bank woulu much iathei get its
!"##"$%&'()*+,"$-%+"%./!%
&
SS2
money back in the foim of checks in the mail, iathei than in the foim
of an extiemely illiquiu asset.
The insuiance company, on the othei hanu, is quite content
to let the balance on a policy loan ioll ovei at inteiest, because it will
instantly get its money back when the insuieu uies anu the ueath
benefit must be paiu on the policy. At that point, the insuiance
company ueuucts the outstanuing loan balance, with a simple
keystioke as it weieno neeu to put a house up foi auction, hoping
to get a goou piice foi it.
Theie is anothei ieason that ieaueis of this book shoulu
piefei to implement IBC with a whole life insuiance policy, iathei
than using othei assets as collateial foi loans fiom tiauitional banks.
In oui fiactional ieseive system, commeicial banks can only expanu
the money stock by gianting new loans. By going to insuiance
companies, iathei than commeicial banks, to satisfy theii financing
neeus, householus ensuie that they aie not pait of the pioblem.
In the next chaptei we elaboiate on the connection between
IBC anu the Sounu Noney Solution.

!"##"$%&'()*+,"$-%+"%./!%
&
SSS

1
R. Nelson Nash, Becoming Your Own Banker, Fifth Edition (Birmingham, AL:
Infinite Banking Concepts, 2008), p. 77.
2
Cash value in life insurance: Whats it worth to you? from
http://www.insure.com/articles/lifeinsurance/cash-value.html, accessed May 25, 2010.
3
The presentation was given by Scott Bretl, president of The Financial Self Reliance
Group.
4
See Robert Wenzels blog post:
http://www.economicpolicyjournal.com/2010/02/where-did-links-go-that-point-
to.html, accessed May 25, 2010.
5
See Nelson Nash, Tax-Qualified Retirement Plans, Etc. at:
http://www.lewrockwell.com/orig8/nash2.1.1.html, accessed May 25, 2010.
6
7
Huerta de Soto, Money, Bank Credit, and Economic Cycles, pp. 590-591.
!"##"$%&'()*+,"$-%+"%./!%
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!!"#
#
SSS
!"#$%&'()*(
+"&(,-!(!./%'012%0./(%.(%"&(3.2/4(5./&6(
3.72%0./(

!"#$ %&'($ ("&($ )*%#$ *+,-.&+'#$ '/01&+*#,$
2/$ +/($ #31&+2$ '.#2*($ +/.$ '.#&(#$ 0/+#4$
*,$ /56*/-,7$ #,1#'*&))4$ *%$ /+#$ '/01&.#,$
("#$ '/+(.&'(,$ ("#4$ 0&.8#($ 9*("$ 5&+8,:$
2#0&+2$2#1/,*($/1#.&(*/+,;$
<=#,>,$?-#.(&$2#$@/(/
A
$
$

n a post at the Nises Institute website, Austiian economist
}oseph Saleino piaiseu the spiiit (though not the full
economic unueistanuing) of the "Nove Youi Noney" campaign,
which uiges people to withuiaw theii money fiom the politically
connecteu, big Wall Stieet banks anu insteau to ueposit it with
community banks anu cieuit unions. To motivate his uiscussion
Saleino iecounteu a peisonal anecuote:

When I was an unueigiauuate at Boston College in the 197us,
one of the weekly unueigiounu newspapeis that cateieu to the
2Su,uuu college stuuents in the Boston metiopolitan aiea
featuieu a page length au by the left-wing giauuate economic
stuuents of the Boston chaptei of 0RPE (0nion of Rauical
I
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB$
$
SS6
Political Economists). The au appealeu to the college stuuents of
Boston to withuiaw all the cash fiom theii checking anu saving
accounts the following Fiiuay as a piotest against the vietnam
Wai. Being an economics majoi anu neophyte Austiian, I iealizeu
that such an action woulu cause seveie uifficulties foi the banks,
because they only helu (at the time) about 1S cents of eveiy
uollai of uemanu ueposits anu S cents of eveiy uollai of saving
ueposits in the foim of cash. The iest of the ueposits weie lent
out foi longei oi shoitei peiious of time uespite the fact that the
banks hau contiactually obligateu themselves to ieueem the
entiie amount on uemanu. Theie was much uiscussion of such
an action on the BC anu othei Boston campuses uuiing the week
leauing up to the planneu mass action. 0f couise, when Fiiuay
iolleu aiounu the event fizzleu, because stuuents weie too busy
paitying (Thuisuay being the unofficial stait of the weekenu).
But the iuea was a biilliant one.
2

Saleino explaineu that Nuiiay Rothbaiu himself iecognizeu
that infoimeu citizens weie not helpless in the face of the cuiient
financial system:

Nuiiay Rothbaiu nevei tiieu of pointing out that in a fiee society
plain citizens coulu biing inflationaiy fiactional ieseive banks to
heel thiough a uelibeiate anu conceiteu campaign to get people
to withuiaw theii ueposits in cash. "Antibank Leagues," as he
calleu them, woulu be foimeu by those "who know the tiuth
about the ieal insolvency of the banking system" to "uige bank
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
SS7
iuns." The bank iuns oi theii veiy thieat woulu "be able to stop
anu ieveise monetaiy expansion."

The pioblem with such stiategies, of couise, is that they ask
inuiviuual householus to "take one foi the team." It is obviously veiy
inconvenient to eschew the use of banking anu switch to cash-baseu
tiansactions. Young people anu pooi householus might be able to
suivive without using checking anu savings accounts, but a miuule-
oi uppei-income householu in a mouein economy cleaily coulu not.
The beauty of Nelson Nash's Infinite Banking Conceptanu
the ciux of this bookis that IBC is effective both inuiviuually &+2
collectively. Nash anu his followeis have uevoteu theii time to
showing householus that they can pioviue themselves with a much
moie secuie futuie by accumulating theii savings in whole life
insuiance policies, anu boiiowing against these policies to finance
theii majoi puichases. Nany membeis of the mouein Austiian
School, on the othei hanu, have been euucating the public on the
uangeis of fiactional ieseive banking, anu of the goveinment's
involvement in the financial sectoi.
It is time foi these two movements to join foices. As we
elaboiate in the next section, the commeicial banks can only expanu
the money supply by gianting new )/&+,. The moie householus
begin to piactice IBC, the fewei loan applicants the banks will have.
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
SS8
Thus IBC makes sense on an inuiviuual, householu level, but it also
contiibutes to the soununess of the uollai anu uampens the boom-
bust cycle.
It is no coinciuence that IBC is compatible anu even
complementaiy to Austiian policy iecommenuations. We have
alieauy noteu that Austiian economics has an affinity foi the
institution of insuiance. Beyonu that, Nelson Nash himself is a huge
pioponent of the Austiian tiauition, having peisonally been
instiucteu by Leonaiu Reeu in the 19Sus. In the suggesteu ieauing
list at the enu of C#'/0*+D$ E/-.$ F9+$ C&+8#., Nash lists seveial
books fiom the Founuation foi Economic Euucation anu the Nises
Institute.
The pioponents of IBC anu the scholais in the Austiian
tiauition can leain fiom each othei, anu in uoing so can make theii
messages moie attiactive to theii iespective auuiences. Those
tiying to show otheis the benefits of IBC can auu a new point in its
favoi: Its wiuespieau piactice woulu pieseive the cuiiency anu
stiengthen the economy!
Foi theii pait, Austiian economists have uifficulty teaching
the uangeis of cential banking anu othei goveinment inteiventions,
when it seems that a change can only occui once a sufficient numbei
of Ameiicans see the light. Noie people will be willing to listen to
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
SS9
theii uiagnosis of the pioblem, if the Autiians can offei an
immeuiate (paitial) ,/)-(*/+ as well.
0ltimately, the Sounu Noney Solution iequiies the complete
iemoval of goveinment inteifeience in financial affaiis. Noney anu
banking must be ietuineu to the piivate sectoi, wheie they
uevelopeu. uoveinment officials will only ielinquish theii vast
poweis in this iealm when public opinion uemanus it.
Foitunately, the ietuin to sounu money uoes not iequiie the
"conveision" of all the population, oi even a majoiity. Nany
Austiians believe that if they coulu just ieach a soliu 1u peicent of
the population, especially if they containeu iepiesentatives fiom key
positions in acauemia, the meuia, anu the business community, then
this gioup coulu tuin the tiue. A laige segment, peihaps a majoiity,
of Ameiicans aie too busy anu lack the inteiest to caiefully stuuy
the intiicacies of cential banking anu monetaiy theoiy. Bowevei, if
a sufficient numbei of iespecteu inuiviuuals challenge the
inteiventionist oithouoxy anu ,(&(#$ ("#$ /56*/-,namely that
politicians uon't make goou iegulatois, anu that piinting up gieen
pieces of papei uoesn't make the countiy iicheithen a ietuin to
sounu money can happen. The suipiising populaiity of Ron Paul's
2uu8 piesiuential campaignanu in paiticulai the iesonance of its
"Enu the Feu" message with college stuuentsis a sign that the
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S4u
Ameiican people know something is veiy wiong anu they want to
leain the tiuth.
In this book we have quite consciously blenueu the
piesentation of Austiian economics anu the piinciples of IBC.
Nelson Nash has uiscoveieu that a tiauitional financial piouuct
uiviuenu-paying whole life insuiancecan be useu to immeuiately
implement a foim of piivatizeu banking, one householu at a time.
Equally impoitant, when majoi puichases aie financeu thiough
whole life policy loans, this uoes +/( expanu the money supply anu
contiibute to the boom-bust cycle. We spell out this ciucial fact in
the next section.

8".7&(90:&(;.70<6(9.#/=(>'&(4(*$,/:7#%0./#'6(

In Chapteis 8 anu 16 we explaineu how oui fiactional
ieseive system cuiiently allows commeicial banks to liteially cieate
money out of thin aii, when they extenu new loans. In oui example
fiom Chaptei 16, Billy founu $1,uuu in cuiiency anu uepositeu it in a
commeicial bank. Then the bank auvanceu a loan of $9uu to Sally.
This $9uu was an auuition to the money supply helu by membeis of
the community.
In othei woius, Sally was able to walk aiounu town, buying
goous anu seivices piiceu up to $9uu, while no one else in the
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S41
townincluuing Billy anu the commeicial bankeishau to iestiict
puichases. In the aggiegate, with eveiy commeicial bank making
new loans in a similai fashion, the piices in the community will be
pusheu up because of the new money cieation. We concluueu that
unuei noimal ciicumstances, the majoiity of piice inflation is
causeu +/( by the Feueial Reseive uiiectly but insteau by the
commeicial banks when they caiiy out stanuaiu business piactice
in the fiactional ieseive system fosteieu anu uphelu by the Feu.
In this context, it is ieassuiing to point out that when an
*+,-.&+'#$ '/01&+4 giants a new loan to a policyholuei, %"0=( 0=( /.%(
0/:7#%0./#'6. The insuiance company uoes +/( have the ability to
cieate new money out of thin aii. If Sally wants to boiiow $9uu foi
hei business, anu she has pieviously accumulateu sufficient cash
values in a life insuiance policy, she can tuin to the insuiance
company iathei than the commeicial bank. When the insuiei giants
the loan, *($0-,($'/+(.&'($*(,$/("#.$&,,#($"/)2*+D,.
It is helpful to step back anu consiuei the big pictuie. In
essence, the insuiance company ieceives piemium payments fiom
the policyholueis, anu it must invest them in veiy conseivative
assets to iesponsibly caiiy out its function of pioviuing ueath
benefit payments when neeueu. Tiauitionally insuieis invest in veiy
safe bonus anu in ieal estate (which weie consiueieu a safe asset
class until the iecent boombust). Bowevei, insuiance companies
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S42
can also invest in "bonus" issueu 54$ ("#$ 1/)*'4"/)2#.,$ ("#0,#)6#,.
That is essentially what happens when someone takes out a policy
loan.
Theie is thus nothing uubious occuiiing when a policyholuei
obtains a loan fiom the insuiance company, any moie than when a
majoi coipoiation obtains a loan fiom an insuiance company.
Inueeu, the loan to the policyholuei is actually ,&%#. than the loan to
a coipoiation, because the policyholuei can't uefault. (Remembei,
even if he oi she nevei pays back the loan, the insuiei iecoups the
investment by subtiacting the outstanuing balancewith acciueu
inteiestfiom the ueath benefit check.)
So we see, the insuiance company is in the position of
managing assets (funueu by piemium payments) in oiuei to meet
its contiactual obligations as spelleu out in the insuiance policies.
The policyholueis have "fiist uibs" on the supply of these assets,
meaning that the insuiance company fiist looks to the policyholueis
to see if any of them wish to boiiow fiom the pool of piemium
payments. Aftei the policyholueis have been satisfieu, the iemaining
pool of money is then investeu in outsiue piojects.
Natuially we aie ignoiing some of the ieal-woilu
complications. Although a paiticulai policy loan is safei than even a
blue-chip bonu in one sense, on the othei hanu the policy loan only
"matuies" (anu influences cashflow) at unceitain times, eithei when
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S4S
the policyholuei makes payments on the loan oi when the insuieu
uies anu the ueath benefit check is lowei than it otheiwise woulu
have been. In contiast, the coipoiate bonu offeis a moie pieuictable
stieam of cashflow, assuming no uefault. Notwithstanuing these
ieal-woilu consiueiations, ultimately policy loans aie just anothei
asset class in which the insuiei can invest its flow of piemium
payments, wheie the boiioweis just so happen to own life
insuiance policies with the company anu wheie these same policies
pioviue the collateial making the loans peifectly safe.
The ciucial point is that when a policyholuei iequests a loan
fiom the insuiance company, his acquisition of money necessaiily
means that someone #),# in the economy now has less puichasing
powei. When the insuiance company senus a check to a
policyholuei aftei a loan iequest, that money hau to '/0# fiom
somewheie. 0nlike a commeicial bank, the insuiance company can't
simply inciease the numbeis on its leugei, showing how much
money the customei has "on ueposit." No, the insuiance company
itself must fiist iaise the funus (fiom incoming piemium payments,
income eaineu on its assets, oi thiough selling some of its assets)
befoie tiansfeiiing them to the policyholuei as a loan. Peicy
uieaves, in his intiouuction to a book by Luuwig von Nises, uiives
home the cential point:

!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S44
|Tjhe cash suiienuei values of life insuiance policies aie
not funus that uepositois anu policy holueis can obtain anu
spenu without ieuucing the cash of otheis. These funus aie in
laige pait investeu anu thus not helu in a monetaiy foim. That
pait which is in banks oi in cash is, of couise, incluueu in the
quantity of money which is eithei in oi out of banks anu shoulu
not be counteu a seconu time. 0nuei piesent laws, such
institutions cannot extenu cieuit beyonu sums ieceiveu. If they
neeu to iaise moie cash than they have on hanu to meet
customei withuiawals, they must sell some of theii investments
anu ieuuce the bank accounts oi cash holuings of those who buy
them. Accoiuingly, ("#4$ G*;#;$ ("#$ *+,-.&+'#$ '/01&+*#,H$ &.#$ *+$ +/$
1/,*(*/+$ (/$ #31&+2$ '.#2*($ /.$ *+'.#&,#$ ("#$ +&(*/+:,$ I-&+(*(4$ /%$
0/+#4$ &,$ '&+$ '/00#.'*&)$ &+2$ '#+(.&)$ 5&+8,7$ &))$ /%$ 9"*'"$ /1#.&(#$
/+$ &$ %.&'(*/+&)$ .#,#.6#$ 5&,*,$ &+2$ '&+$ )#+2$ 0/.#$ 0/+#4$ ("&+$ *,$
#+(.-,(#2$(/$("#0;
S

So we see that not only uoes IBC make sense on an inuiviuual
financial level, but it also limits the ability of commeicial banks to
expanu anu contiact the total amount of money in the economy.
With each new householu that embiaces the IBC philosophy,
anothei small poition of the nation's financial iesouices will be
tiansfeiieu out of the volatile commeicial banking sectoi anu into
the conseivative, soliu insuiance sectoi. As moie people embiace
IBC, the amplituue of the boom-bust cycle itself will be uampeneu.

!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S4S
-#/?0/@(#/4(,/=2'#/<&(>'&(A0=%0/<%(B/%&'$'0=&=

Although Nelson Nash encouiages his ieaueis to become
theii own bankeis thiough the use of whole life insuiance policies, it
is impoitant foi IBC piactitioneis to iemembei that banking anu
insuiance &.# uistinct enteipiises. (As one insuiance executive
complaineu to the piesent wiiteis: "People keep iefeiiing to theii
policy as a bank, but uiu they evei have to pee in a cup to open a
checking account.")
In paiticulai, IBC piactitioneis shoulu always iemembei that
stiictly speaking, they aie not "withuiawing theii money" when they
take out a policy loan. Insteau, what happens is that the insuiance
company is )#+2*+D them *(, money, just as suiely as if the insuiance
company bought bonus issueu by a majoi coipoiation. In that case,
ueneial Electiic ceitainly woulun't be withuiawing some of "uE's
money" fiom the insuiei, anu neithei is the policyholuei when he oi
she applies foi a loan.
0f couise, an impoitant uiffeience between the cases of uE
anu a policy loan, is that the policyholuei can only boiiow against
the savings he oi she has &).#&24$&''-0-)&(#2 in a policy. Theiefoie
the taking out of a loan uoesn't signify an absolute inuebteuness, but
iathei an offset of the claim the policyholuei has against the assets
of the insuiance company (uue to the life insuiance policy itself).
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S46
IBC piactitioneis shoulu also keep in minu that the insuiance
company is not a waiehouse foi theii money; if they view it as a
bank, they shoulu iealize it is at best a )/&+$bank, not a 2#1/,*($bank.
In othei woius, if they aie viewing theii suiienuei cash values as a
bank balance, they must iealize it is analogous to a ,&6*+D, account,
anu not a checking account.
}ess Bueita ue Soto, the gieat opponent of mouein
(fiactional ieseive) banking anu the gieat champion of tiauitional
life insuiance, is quite waiy of the iecent tenuency of insuiance
companies to attiact customeis by emulating the techniques of
commeicial banking. Be Soto complains that

the uistinct bounuaiies between the institution of life insuiance
anu the banking sectoi have often been bluiieu in many westein
countiies. This bluiiing of bounuaiies has peimitteu the
emeigence of vaiious supposeu "life insuiance" opeiations
which, insteau of following the tiauitional piinciples of the
sectoi, have been uesigneu to mask tiue uemanu-ueposit
contiacts |i.e. checking accountsj which involve an attempt to
guaiantee the immeuiate, complete availability to the
policyholuei of the money uepositeu as "piemiums" anu of the
coiiesponuing inteiest. This coiiuption.has exeiteu a veiy
negative influence on the insuiance sectoi as a whole anu has
maue it possible foi some life insuiance companies to maiket
ueposits in violation of tiauitional legal piinciples anu thus to
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S47
act, in uiffeient uegiees, as banks, i.e., to loan money actually
placeu with them on uemanu ueposit.
4

In contiast to the "coiiupt" piactice in which a policyholuei
views the insuiance company as holuing his piemium payments as a
2#1/,*( that is immeuiately available foi "withuiawal"even though
the insuiance company has lent the money to otheis, eaining
inteiestue Soto piefeis a moie tiauitional unueistanuing:

|Ijt is impoitant to iemembei that the contiact of life
insuiance beais no ielation to the |checking account uepositj
contiact. Life insuiance is an &)#&(/.4 contiact by which one of
the paities, the contiacting paity oi policyholuei, commits to the
payment of the 1.#0*-0 oi piice of the opeiation, anu in ietuin
the othei paity, the insuiance company, agiees to pay ceitain
benefits in the event that the policyholuei uies oi suivives at the
enu of a (#.0 specifieu in the contiact. Theiefoie, ("#$ 1.#0*-0,$
1&*2$ 54$ ("#$ 1/)*'4"/)2#.$ '/01)#(#)4$ '#&,#$ (/$ 5#$ &6&*)&5)#$ (/$ "*0,
anu availability is fully tiansfeiieu to the insuiei. Bence, all life
insuiance contiacts involve an exchange of piesent, ceitain
goous |i.e. piemium payments of moneyj foi futuie, unceitain
goous (since theii payment uepenus on an unceitain event, such
as the ueath oi suivival of the policyholuei). The life insuiance
contiact is theiefoie equivalent to a savings tiansaction.but it is
a foim of 1#.%#'(#2 ,&6*+D,, because it makes it possible to
ieceive a consiueiable sum fiom the veiy moment the contiact
takes effect, given the anticipateu, unceitain event takes place
!"#$%&'$'()*+,-.*,()$*($*"#$/(.)0$$
1()#2$/(3.*,()$
$
S48
(foi example, the policyholuei uies). Any othei tiauitional
savings methou.woulu iequiie a piolongeu peiiou of many
yeais of saving to accumulate the capital paiu by an insuiance
company in case of ueath.
S

In ue Soto's view, insuiance companies can only ietain theii
piincipleu anu piagmatic auvantages ovei mouein fiactional
ieseive banking if customeis look at theii policies as long-teim
commitments. This is entiiely consistent with Nelson Nash's own
iecommenuation to conuuct one's affaiis inteigeneiationally.
Inueeu, if someone opens a whole life policy but then abanuons it
within a few yeais, the financial iesults will be miseiable. But if one
wants a methou to safely tiansmit wealth uecaues into the futuie, oi
even to one's chiluien anu gianuchiluien, a whole life insuiance
policy is an excellent vehicle.

1
2
Joe Salerno, Rothbardian Antibank League on the Rise, at:
http://blog.mises.org/11773/rothbardian-antibank-league-on-the-rise/. Accessed May
27, 2010.
3
Percy Greaves, quoted in Huerta de Soto, footnote 106, p. 592. The italics have been
added by de Soto.
4
Huerta de Soto, pp. 594-595.
5
Huerta de Soto, pp. 161-162, italics in original.
S49
!"#$%&'()*(
!+,-./01+,(

!" #$%&'(" #)#*+,-" .$/+0+1" 2+3+4&%&'(-"
%'33$*" /$15" &4" &*" &#" 3$*" #677$1*+8" 2)"
762(&%"$7&3&$39"
:;68/&<"0$3"=&#+#
>
"
"

e have coveieu a lot of giounu in this book. In Pait I,
we pioviueu an oveiview of the ciisis oui nation, anu
inueeu the entiie woilu, faces. Simply put, the soununess of oui
money itself iests on nothing but the technical wizaiuiy of Feu
officials anu the financial iestiaint of B.C. politicians. This
iealization is alaiming enough.
Yet it gets woise. We cannot hope to iefoim oui financial
system by tweaking a few iegulations, oi by changing the peisonnel
in a few key positions. The entiie fiactional ieseive banking system
&*#+(4 is bankiuptquite liteially. To ienuei such a juugment is not
to moially conuemn the millions of people woiluwiue who uiiectly
oi inuiiectly woik foi the commeicial banks; inueeu the piesent
authois themselves became fully awaie of the pioblem only within
the last few yeais. Nonetheless, iegaiuless of how we aiiiveu at oui
W
!"#$%&'("#)
??????????????????????????????????????????????????????????"
"
SSu
cuiient state, we must all iecognize that we face a tiue +,+1<+3%)
anu we must all uo oui pait to salvage the situation.
Foitunately theie is hope. As we explaineu in Pait II, the fiee
maiket economy, oi what is often calleu %'7&*'(&#,, can fostei
peaceful anu mutually beneficial aiiangements in the aieas of
money anu banking, just as suiely as the maiket obviously "woiks"
when it comes to iPous anu iestauiants. Inueeu, money anu banking
aiose spontaneously on the maiket, anu weie only latei co-opteu
anu coiiupteu by goveinment inteivention.
The task befoie us is possible. The 0niteu States has hau
cential banks befoie the Feueial Reseive, anu they weie alloweu to
uie. Whatevei woiiies people may have about a "wilucat" system
lacking the guiuance of technicians fiom B.C., suiely the iesults of
open competition anu contiact enfoicement in money anu banking
coulu only be 2+**+1 than the stiing of ciises the 0niteu States has
enuuieu since the Feu's founuing in 191S.
0f couise, befoie politicians anu Feueial Reseive officials
ielinquish theii powei back to the piivate sectoi fiom which they
seizeu it, public opinion will neeu to unueigo a uiamatic shift. We
have seen the stiiiings of such a change as a iesult of the
suipiisingly populai canuiuacy of Ron Paul. Foi the fiist time, the
Feueial Reseive is $3"*.+"*'2(+ as a mattei of uiscussion, as opposeu
to being taken foi gianteu as the existence of the weathei oi
hiccups. Noie than evei befoie, aveiage Ameiicans aie taking an
!"#$%&'("#)
??????????????????????????????????????????????????????????"
"
SS1
inteiest in economic affaiis, paiticulaily the Feueial Reseive's
massive bailouts anu the feueial goveinment's unpieceuenteu
ueficits.
The stuuent of histoiy knows that uniuly mobs, even when
fueleu by legitimate giievances, can often enu up ieplacing one
tyianny with an even woise monstiosity. That is why it is ciucial foi
the public to be +86%'*+8 on sounu monetaiy anu banking theoiy, at
least the basics. To assist in this impoitant task, the piesent authois
aie placing a PBF veision of this book online at theii iespective
websites,
2
to allow ieaueis the ability to pass along its analysis to as
many people who aie willing to listen. Natuially, the piesent book is
not a substitute foi ieauing the moie scholaily woiks fiom which it
uiaws, but we hope oui piesentation will pique the inteiest of
potential stuuents who otheiwise woulu not have iealizeu the
significance of these intimiuating topics.
Amiust these ueep issues stanus the contiibution of Nelson
Nash anu his Infinite Banking Concept. Nash has shown that a veiy
tiauitional, centuiies-olu financial vehiclewhole life insuiance
can allow Ameiicans to effectively seceue fiom the cuiient
fiactional ieseive banking system. 0nlike othei potential stiategies
foi "staiving the beast," the piactice of IBC makes #+3#+ at an
inuiviuual householu level, &3"'88&*&$3 to its social benefits of muting
inflationaiy cieuit expansion.
!"#$%&'("#)
??????????????????????????????????????????????????????????"
"
SS2
The piactice of IBC is not a panacea. Even if laige numbeis
began financing theii majoi puichases exclusively thiough
uiviuenus oi policy loans, the Feueial Reseive woulu still have the
ability to cieate unlimiteu quantities of money by keystioke, anu the
commeicial banks woulu still finu willing boiioweis if they cut
inteiest iates enough.
Even so, as moie anu moie householus begin piacticing IBC,
we will see thiee majoi effects: Fiist, the iuea of piivatizeu
bankingone of the planks in the Sounu Noney Solutionwill
seem less faifetcheu. Seconu, a giowing numbei of householus will
become financially &38+7+38+3*. Theii bonuage unuei the cuiient
uebt-baseu system will be bioken, anu they will not be neaily as
vulneiable to the cieuit whipsaws unleasheu by the Feueial
Reseive. Thiiu, as moie people auu sizable life insuiance policies to
theii long-teim financial plans, the public agitation '<'&3#*"
inflationaiy policies anu ueficit spenuing will be stiongei. The
piactitioneis of IBC will finu it in theii gieat peisonal inteiest to aiu
the Austiians anu othei champions of sounu money, because the
value of theii insuiance policies woulu be enhanceu with a stiongei
uollai.

!"#$%&'("#)
??????????????????????????????????????????????????????????"
"
SSS
2"&(300/&(30(4'&&5+67(8+%(9+,&:(

In this book we have maue the case foi sounu money, honest
banking, anu fiugal householus. It is tiue that the wiuespieau
piactice of these tiauitional viitues woulu fostei incieuible
piospeiity in oui countiy, anu aiounu the woilu foi those who
followeu oui example.
Yet in the final analysis, the issue isn't mateiial piospeiity. In
the fiist place, the tiuly wise have leaineu that happiness uoes not
flow fiom mateiial possessions. But even if we naiiowly focus on
commeice, by almost any measuie, Ameiicans touay aie wealthiei
than they weie in 191u. Bespite the shackles put on it, the basically
capitalist system of the 0niteu States showeieu Ameiicans with a
giowing volume of annual output ovei the couise of the 2u
th

centuiy. Even if the cuiient slump maiks the opening stages of the
seconu uieat Bepiessionas many Austiians pieuictAmeiicans
will still have a highei stanuaiu of living than theii counteipaits
fiom a centuiy eailiei.
But theie is one thing oui pieuecessois enjoyeu in much
gieatei abunuance than we cuiiently possess, anu that is 41++8$,.
In what economic histoiian Robeit Biggs uesciibes as the "iatchet
effect," with each ciisiswhethei financial oi militaiythe feueial
goveinment gieatly expanus its powei ovei the citizeniy. Aftei the
ciisis ebbs, the goveinment ielinquishes some of its new authoiities,
!"#$%&'("#)
??????????????????????????????????????????????????????????"
"
SS4
but it nevei ietuins to the pie-ciisis size. 0vei the uecaues, the
iesult is an evei-giowing leviathan State.
S

Because of the iatchet effect, many Ameiicans touay consiuei
it peifectly noimal that the goveinment can ueclaie gieen pieces of
papei legal tenuei, can oiuei Ameiican citizens assassinateu meiely
on the piesiuent's say-so, can manuate that eveiyone puichase
health insuiance, anu can iegulate how many gallons of watei a
toilet tank can holu. If 0.S. citizens fiom 191u ieau a uesciiption of
theii countiy's goveinment a centuiy in the futuie, they woulu have
thought it an absuiu (anu chilling) satiie.
Theie is a stiong connection between economic insecuiity
anu the emeigence of Big uoveinment; the two go hanu-in-hanu.
The moie oneious goveinment taxation, iegulation, anu inflation
become, the moie they ciipple the piivate sectoi. Yet the piocess
woiks in the opposite uiiection as well: As a volatile economy
thiows millions out of woik, anu the thieat of inflation makes it
impossible to save, aveiage citizens must tuin to the goveinment as
theii only iefuge. The veiy politicians who have ieuuceu them to
such helplessness then giaciously offei them secuiity, in exchange
foi just a few moie libeities.
When the natuial blessings of economic fieeuom aie
sabotageu, people become uespeiate. Nany histoiians anu
economists believe that Auolf Bitlei woulu not have achieveu powei
weie it not foi the teiiible hypeiinflation in inteiwai ueimany,
!"#$%&'("#)
??????????????????????????????????????????????????????????"
"
SSS
which wipeu out the miuule class. A teiiifieu populace will
acquiesce to incieuible usuipations of theii tiauitional libeities, so
long as the iuleis claim the new measuies aie necessaiy to ueal
with the immeuiate ciisis. This is the path to uespotism.

;#<&(=+/'0&.>7(?,5(@%"&'0(

The Austiian economists weie iight about the housing boom.
If they aie iight about oui cuiient ciisis, the 0niteu States is in stoie
foi an even biggei plunge in the neai futuie. }ust as Alan
uieenspan's "soft lanuing" aftei the uot-com ciash meiely paveu the
way foi a laigei bubble in housing, so too may futuie analysts come
to iealize that Ben Beinanke's u% inteiest iates weie simply laigei
uoses of the same poison.
You must not be paialyzeu by feai. Theie coulu still be
months, even yeais, befoie the next woiluwiue ciisis hits. In this
book, we have outlineu a conseivative stiategy foi minimizing youi
householu's exposuie to the volatile financial sectoi, anu in a
mannei that neutializes the haimful effects of fiactional ieseive
banking. Not only uoes the switch to insuiance financing make sense
at the inuiviuual level, but it also contiibutes towaiu the ultimate
solutionto iemove goveinment inteivention fiom money anu
banking altogethei.
!"#$%&'("#)
??????????????????????????????????????????????????????????"
"
SS6
If we have convinceu you of the quanuaiy oui nation faces,
anu if we have shown you that the Austiians have pointeu the way
out in the Sounu Noney Solution, we uige you to spieau the
message. We also uige you to ieview youi householu finances, anu
ieuouble youi effoits to bolstei youi savings. In the coming stoim,
we will neeu euucateu anu financially inuepenuent families if we aie
to ietain oui libeity.

1
1998), p. 861.
2
Lara and Murphys respective websites are http://www.usatrustonline.com/ and
http://consultingbyrpm.com/.
3
Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American
Government (U.S.A.: Oxford University Press, 1989).
!
!
!
!""#$%&'#()
!
!
!
!
!
!
!
!
!
!
SS9
!"#$%&'()%"*$+)
,
&
&
-($+&.#&/$"*$+$&(1SS6 - 1624), was a
Spanish }esuit piiest who taught at the
0niveisity of Salamanca. In many iespects the
scholastic tiauition centeieu at Salamanca was a
pioto-Austiian synthesis of subjectivist
economics anu political libeity. In 1S98 Naiiana
wiote !"# $"%"# "&# $"%'(# ')(&'&*&'+)"# ("0n the king
anu the ioyal institution"), uefenuing tyianniciue unuei ceitain
conuitions. Bis most impoitant book, !"# ,+)"&-"# ,*&-&'+)"# ("0n
the alteiation of money"), appeaieu in 16uS. Naiiana obseiveu that
inflation "taxes those who hau money befoie anu, as a consequence
theieof, aie foiceu to buy things moie ueaily."#

&
0*12$".& 3$+%*445+ (168u - 17S4), is
iegaiueu by many histoiians of economic
thought as the fiist gieat economic theoiist. Bis
legacy consists of one iemaikable tieatise,
.((-'# /*$# 0-# 1-&*$"# 2*# 3+,,"$4"# ")# 56)6$-0,
which William Stanley }evons uubbeu the
"Ciaule of Political Economy." Nuiiay
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S6u
Rothbaiu consiueieu Cantillonanu )+&# Auam Smithas the
"founuing fathei of mouein economics."

Cantillon anticipateu many featuies of the Austiian School. Be was
the fiist economic theoiist to exploie the iole of the entiepieneui.
Bis methou of analysis pioceeueu ueuuctively to uncovei the
"natuial" ielations of cause anu effect in the economy.

Bis most famous iesult is the iealization that injections of money uo
not cause all piices to iise piopoitionately in one fell swoop, but
insteau iipple thioughout the economy. These "Cantillon effects"
ieuistiibute wealth into the hanus of those who ieceive the new
money eaily in the game. Cantillon's analysis of the "ieal"
uistuibances causeu by monetaiy inflation was a necessaiy
component in the Austiian theoiy of the business cycle.
&
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S61
'++#&056#"%&-$17(#)&8("95%&(1727 - 1781) was
aiguably the leauing economist of 18
th

centuiy Fiance. Bis gieat woik,
"Reflections on the Foimation anu
Bistiibution of Wealth" (1766) was a meie
fifty-thiee pages, anu yet it was uense with
piofounu analysis fai aheau of its time.

Tuigot anticipateu the Bayekian insight
that knowleuge is uispeiseu thioughout the economy, anu that only
if people aie fiee can they ueploy theii specializeu knowleuge in
mutually auvantageous tiansactions. Tuigot was skeptical of
pateinalistic goveinment iegulations to piotect the consumei,
because he knew that an open maiket hau natuial checks on
iapacious businessmen. Tuigot went fuithei to say that such
iegulations coulu be counteipiouuctive: 89+# (*::+("# -00# 4+)(*,"$(#
&+# ;"# 2*:"(<# -)2# -00# ,"$4=-)&(# -)2# ,-)*>-4&*$"$(# &+# ;"# 4="-&(<# =-(#
&="# ">>"4&# +># -*&=+$'?')%# &=",# &+# ;"# (+<# -)2# +># 2"%$-2')%# -00# &="#
@+$A')%#,",;"$(#+>#&="#4+,,*)'&BCD
&
0ne of Tuigot's most significant achievements was his uiscussion of
savings anu capital accumulation, which was iemaikably similai to
the polisheu theoiy of Eugen von Bohm-Baweik that woulu come
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S62
only a centuiy latei. Tuigot unueistoou that capitalist-
entiepieneuis neeueu to iestiict consumption to accumulate
savings in the foim of money, which coulu then be investeu into
specific capital goous. The capitalists "auvanceu" foou anu othei
necessities to the woikeis, who neeueu to be feu immeuiately anu
coulu not wait foi theii piouucts to iipen into final output. It was
thus thiift anu faisighteu investment of the few capitalists that
alloweu society to giow in mateiial abunuance.

-#$+:;$<%*)%#& =$> (1767 - 18S2)
was a Fiench economist anu businessman. Be
was the epitome of a classical libeial who
favoieu open competition anu fiee tiaue.

Nowauays economists speak of "Say's Law,"
which they ciuuely ienuei as "supply cieates
its own uemanu." Keynesian economists iiuicule this supposeuly
nave faith in the ability of maikets to bounce quickly out of slumps.

Bowevei, in ieality Say's "Law of Naikets" was a sophisticateu
unueistanuing of the unueilying "ieal" foices unueilying maiket
exchanges. In Say's language, "piouucts aie paiu foi with piouucts."
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S6S
Foi example, if the bakei wants to obtain foou fiom the butchei, he
must offei enough money to puichase the meat. But wheie uoes the
bakei get the money. By selling his +@) piouucts to otheis. In the
gianu scheme, Say aigueu, the bakei ultimately "uemanueu" the
butchei's meat by supplying his own bieau to the community. Theie
is obviously a gieat ueal of tiuth to Say's analysis, which is haiuly
uone justice by the shoit phiase, "supply cieates its own uemanu."

Pushing his insight fuithei, Say obseiveu that "a glut can take place
only when theie aie too many means of piouuction applieu to one
kinu of piouuct anu not enough to anothei."& In contiast to those
who blameu business slumps as uue to a ueainess of moneyoi
inauequate consumei uemanu, in oui mouein teiminologySay
unueistoou that the economy coulun't be plagueu by a lack of
money pei se. It also coulun't be plagueu by "oveipiouuction," since
the veiy maik of economic piogiess was the steauy giowth in
output among vaiious sectois. As his quotation inuicates, Say
iealizeu that the pioblem of a business slump is uue to a ("4&+$-0#
',;-0-)4". This anticipates the mouein Austiian uesciiption of the
unsustainable boom anu then necessaiy bust.
&
&
&
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S64
34$(.#&?"@.@"*1&;$)%*$%
(18u1 - 18Su) was aiguably the gieatest
polemicist of fiee maiket economics who
has evei liveu. Bis essays in suppoit of fiee
tiaue in paiticulai iemain mouels to this
uay. Bastiat vieweu the fiee maiket as a
natuially haimonious institution in which
eveiyone's piopeily unueistoou inteiests weie aligneu.

Bastiat's most famous essay, "The Petition of the Canulemakeis," is a
satiiical open lettei wiitten by Fiench manufactuieis pleauing with
theii goveinment to bai the unfaii competition of light offeieu by
the sun. If only the Fiench goveinment woulu iequiie that
businesses anu homes close theii shutteis uuiing uaylight houis,
this woulu boost the uemanu foi uomestic canules, spuiiing
employment anu showeiing the community with untolu blessings.
Bastiat's point, of couise, was to exploue the common piotectionist
aiguments to impose taiiffs anu othei tiaue iestiictions in oiuei to
shielu uomestic manufactuieis fiom the "unfaii" competition of
foieign piouuceis.

Bastiat's essay "The Law" was a classic exposition of the piopei iole
of goveinment in piotecting natuial iights. If the goveinment ceaseu
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S6S
peifoiming this legitimate function anu began taking fiom one
gioup anu giving hanuouts to anothei, then the goveinment was
engageu in "legalizeu plunuei." Accoiuing to Bastiat, "The state is
the gieat fictitious entity by which eveiyone seeks to live at the
expense of eveiyone else."

3$"4& /#+9#"& (184u - 1921) was the
founuei of the Austiian School piopei; the
eailiei thinkeis weie meie foieiunneis.
Although no scholai wiites in a complete
vacuum, }oseph Schumpetei ueclaieu, "Nengei
was nobouy's pupil." By this Schumpetei
meant that what we now know as Austiian
economics can be tiaceu almost exclusively to Nengei's E$')4':0"(#+>#
.4+)+,'4( (1871).

viitually eveiy tiait of "Austiian economics" was piesent in
Nengei's pioneeiing book. Its single most impoitant achievement
was to oveituin the classical economists' cost oi laboi theoiy of
value. Rathei than explain maiket piices by the cost of the iesouices
going into them, Nengei ieveiseu the causal flow. Be aigueu that
maiket piices weie ueteimineu by the subjective piefeiences of
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S66
consumeis, anu that these piices in tuin gave entiepieneuis the
ability to biu up the piices of inputs. Foi example, engagement iings
aien't expensive because uncut uiamonus aie expensive. Rathei,
engagement iings aie expensive because women finu them
beautifulanu then because of this fact, jeweleis aie willing to
spenu a gieat ueal of money acquiiing uncut uiamonus.

A2*4*<& B*1C)%##.& (1844 - 1927)
was a contempoiaiy of Nengei. Be was
Biitish by oiigin anu coulu not even be
classifieu as "Austiian" in teims of his
economics. Even so, in many iespects his
woik boie a gieatei similaiity to the
ueveloping Austiian tiauition than to the
Biitish Neo-Classical School spawneu by Alfieu Naishall. Wheieas
Naishall sought to iefine the woik of the classical economists (such
as Auam Smith), Wicksteeu wanteu to ievolutionize economics with
the new appioach of subjectivism. Wicksteeu was one of the
pioneeis of the mouein concept of "oppoitunity cost," which views
costs )+& as technical facts but iathei as subjective evaluations of
foifeiteu oppoitunities.

!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S67
Anticipating the woik of Nises anu Bayek, Wicksteeu vieweu the
maiket economy as a :$+4"(( in which mistakes aie maue, but soon
coiiecteu.

D(9#+& E5+& ;F2G:;$H#"C&
(18S1 - 1914) was a membei of the seconu-
geneiation of the Austiian School piopei,
whose woik was heavily influenceu by
Nengei's E$')4':0"(. In auuition to his
uevastating ciitiques of Naixist economics,
Bohm-Baweik's most uistinguishing
contiibution was his theoiy of capital anu inteiest.

Bohm-Baweik explaineu that when people in a community liveu
below theii meansmeaning they consumeu less than theii
incomethis alloweu them to channel iaw mateiials anu laboi
houis into the piouuction of capital goous. The extia machines,
tools, anu semi-finisheu goous woulu then augment the piouuctivity
of laboi in the futuie. Thus, by investing natuial iesouices anu laboi
into moie "iounuabout" piocesses, society woulu eventually enjoy a
peimanently highei stanuaiu of living, as the piouucts of the new
equipment emeigeu out of the "pipeline."

!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S68
Bohm-Baweik explaineu inteiest by the highei subjective valuation
of piesent goous veisus futuie goous. In essence, Bohm-Baweik
took Nengei's uiscoveiy of subjective value theoiy anu applieu it to
goous available in uiffeient time peiious. Because people geneially
woulu be willing to pay moie foi, say, a house available $'%=&# )+@
iathei than a meie 40-', on a house that woulu only be ueliveieu in
12 months, Bohm-Baweik showeu that a capitalist coulu buy the
mateiials necessaiy to constiuct a house anu eain a ietuin on his
investment when he solu the finisheu house in one yeai's time. Thus
Bohm-Baweik showeu the ueep connection between inteiest iates
anu the community's willingness to uefei consumption.&

&
&?"$+C& '46#"%& ?#%%#"# (186S -
1949) was a membei of the Ameiican
"Psychological School" of economics,
meaning that helike the Austiians
vieweu economics as a stuuy in
subjectivism, because all economic
phenomena must ultimately woik &=$+*%=
inuiviuuals' mental opeiations. Physical facts as such coulu only
affect supply, foi example, to the extent that piouuceis ;"0'"F"2# ')
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S69
these physical facts anu aujusteu theii uecisions to buy anu sell
accoiuingly.

0f paiticulai inteiest to Austiians is Fettei's 4-:'&-0'?-&'+)#&="+$B of
inteiest anu ient, which was heavily baseu on Bohm-Baweik's own
woik. Fettei explaineu the piicing of a capital goou in the following
way: Its iental piice in any given peiiou woulu be ueteimineu by the
piouuctivity of its seivices. Foi example, if a faimei coulu haivest
$1,uuu moie in ciops pei week with a tiactoi than without it, then
the faimei woulu be willing to pay up to $1,uuu a week to ient the
tiactoi.

Bowevei, to calculate the :*$4=-("# :$'4" of the tiactoi, Fettei
invokeu the notion of time piefeience, which was the subjective
piemium people placeu on consuming soonei iathei than latei.
Because of time piefeience, futuie uollais weie less impoitant
fiom oui vantage point &+2-Bthan piesent uollais. When ueciuing
how much to spenu touay on a tiactoi, then, capitalists woulu
2'(4+*)& the futuie cash flows the tiactoi woulu yielu fiom iental
payments.

Because the capitalist coulu puichase the tiactoi foi a lowei piice
than the sum of iental payments it woulu yielu ovei its lifetime, the
capitalist woulu eain a positive yielu on his investment. Thus
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S7u
inteiest income, in Fettei's view, hau absolutely nothing to uo with
the piouuctivity of capital goousthis just explaineu theii iental
piices. Inteiest, saiu Fettei, was uue to time piefeience, the fact that
people will pay a smallei amount of money touay, foi an expecteu
stieam of futuie monetaiy eainings.
&
&
I(.H*9& E5+& /*)#)# (1881 -
197S) was the gieatest membei of the
next geneiation of Austiian economists,
who built on the woik of Bohm-Baweik.
Noie than any othei economist, Nises is
iesponsible foi the iesuigence of
Austiian economics in the lattei half of
the 2u
th
centuiy, which was laigely uue to his 1949 magnum opus
G*,-)#H4&'+).

Nises was a cieative genius who maue impoitant contiibutions in
many aieas of economics. Be is aiguably one of the most impoitant
economists in histoiy. Foi example, in 192u Nises fiieu the opening
salvo in the "socialist calculation uebate" by aiguing that socialist
planneis, lacking maiket piices foi capital goous, coulu not
efficiently allocate society's iesouices. Although mainstieam
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S71
economists concluueu that the mathematical mouels of the socialist
theoiists hau won the uay, many changeu theii tune uecaues latei
when the Soviet 0nion collapseu. In ietiospect, they conceueu that
peihaps Nises (anu his followei Bayek) hau been on to something in
theii ciitique of socialist efficiency.

In his 1912 9="# 9="+$B# +># I+)"B# -)2# 3$"2'&, Nises integiateu
"micio" anu "macio" economics into a unifieu bouy, by using
subjectivist piice theoiy to explain the puichasing powei of money.
(This hau eluueu othei economists until Nises showeu the solution.)
Noie impoitant, in this book Nises uevelopeu his business cycle
theoiy. Biawing on insights fiom vaiious pieuecessois, Nises
blameu the boom-bust cycle on the aitificial expansion of bank
cieuit which pusheu inteiest iates below theii piopei level.

Beyonu his technical woik, Nises was also a gieat contiibutoi to
economic methouology. Be conceiveu of economics itself as a
bianch of :$-J"+0+%B, which was the science of human action. In
Nises' unueistanuing, economists uiu not uevelop anu "test"
economic laws in the same way that physicists oi chemists testeu
theii hypotheses. 0n the contiaiy, Nises aigueu that economic
piinciples coulu be ueuuceu logically fiom the insight (oi "axiom")
that people have conscious goals anu act to achieve them.
&
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S72
&
J#+">& J$K4*%%# (1894 - 199S) was
the gieatest populaiizei of fiee maiket
economics in the 2u
th
centuiy. # Bis classic
woik, .4+)+,'4(#')#K)"#L"((+), uiaws on the
insight of Bastiat anu ueclaies: 89="# -$&# +>#
"4+)+,'4(# 4+)('(&(# +># 0++A')%# )+&# ,"$"0B# -&#
&="#',,"2'-&"#;*&#-&#&="#0+)%"$#">>"4&(#+>#-)B#
-4&#+$#:+0'4BM#'&#4+)('(&(#')#&$-4')%#&="#4+)("N*")4"(#+>#&=-&#:+0'4B#)+&#
,"$"0B# >+$# +)"# %$+*:# ;*&# >+$# -00# %$+*:(CD# Beavily influenceu by
Luuwig von Nises, Bazlitt's book iemains the single best
intiouuction to basic economics.
#
Nouein ieaueis may be suipiiseu to leain that uespite his stiong
commitment to fiee maikets, Bazlitt wiote euitoiials foi the 1"@#
O+$A# 9',"(# anu 1"@(@""A uuiing his illustiious caieei as a
jouinalist.
#
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S7S
?"*#."*12& '(9()%& E5+& J$>#C (1899 - 1992) is the
most wiuely known of the mouein
Austiians, having won the Nobel Piize in
1974 foi his elaboiation of Nises' theoiy
of the business cycle. Bayek also took up
the Nisesian bannei uuiing the celebiateu
socialist calculation uebate.

Paitially as a iesult of his spaiiing with
socialist economists, in the 19Sus anu 194us Bayek wiote a seiies of
seminal papeis on the connection between economics anu
knowleuge. In contiast to most of his colleagues who moueleu
economies as if all infoimation weie publicly available, Bayek
unueistoou that knowleuge is "uispeiseu" anu that one of the
piimaiy functions of the piice system is to communicate
infoimation between inuiviuuals who can each uiiectly obseive only
a tiny fiaction of the economy.

A majoi theme in Bayek's woik is that of (:+)&-)"+*(# +$2"$,
specifically of social institutions that aie "the iesult of human action,
but not of human uesign." Bayek waineu socialist iefoimeis against
the "fatal conceit"; just because paiticulai institutions, such as
piivate piopeity iights, weie not consciously uesigneu by any one
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S74
peison oi gioup of expeits, uiu )+& mean that the iefoimeis coulu
easily come up with a bettei ieplacement.

Bayek's most populai woik was his 1944 9="# P+-2# &+# /"$>2+,, in
which he waineu that uemociatically electeu socialist goveinments
woulu eventually succumb to the innei logic of totalitaiianism. Be
pointeu out that many of the iuealists in the Westein uemociacies
embiaceu the same piinciples of cential planning anu collectivism
auopteu by theii Nazi foes.
&
L)"$#4& /M& N*"K+#"& (19Su - ) is
one of the few Austiian economists who
was an actual stuuent of Nises uuiing
his time at New Yoik 0niveisity. Kiiznei
himself went on to teach at NY0,
keeping the Austiian tiauition alive. A
well-iespecteu histoiian of economic
thought even in mainstieam ciicles,
Kiiznei is best known foi his elaboiation of Nises' theoiy of
entiepieneuiship.

In Kiiznei's appioach, the entiepieneui possesses a special skill of
-0"$&)"(( to piofit oppoitunities that otheis have misseu. By buying
!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S7S
unueipiiceu iesouices, anu tiansfoiming them into a piouuct oi
seivice that can be solu foi a piofit, the entiepieneui steeis output
towaiu the pattein most pleasing to consumeis.&
&
&
/(""$>& OM& 05%26$".# (1926 -
199S) was an incieuibly piouuctive
economist who quite consciously woikeu in
the tiauition of his mentoi, Luuwig von
Nises. In his gieat tieatise I-)<# .4+)+,B<#
-)2# /&-&" (1962) Rothbaiu took Nises'
intimiuating G*,-)# H4&'+) anu ienueieu it
in piose that any intelligent laypeison coulu
unueistanu. But Rothbaiu was no meie seconu-hanuei, foi he also
uevelopeu seveial oiiginal lines of aigument.

Foi example, Rothbaiu completely thiew out the mainstieam theoiy
of monopoly piice, aiguing that the only benchmaik by which to
juuge an economy was the outcome occuiiing on a fiee maiket with
open competition. Rothbaiu also uiew on Bohm-Baweikian capital
theoiysomething that Nises hau ielatively neglecteuanu
integiateu it into the Nisesian fiamewoik.

!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S76
Beyonu his gieat theoietical contiibutions, Rothbaiu wiote
voluminously on economic histoiy. Bis uoctoial uisseitation on the
Panic of 1819 iemains a stanuaiu woik on the topic. In H,"$'4-Q(#
5$"-&# !":$"(('+), Rothbaiu useu the Nisesian theoiy of the boom-
bust cycle to explain the 1929 stock maiket ciash.

Rothbaiu was a gieat opponent of fiactional ieseive banking, anu a
champion of sounu money. Bis 1994 9="# 3-("# H%-')(&# &="# R"2
iemains the most succinct attack on cential banking.

!"#$%&'()%"*$+)&
7777777777777777777777777777777777777777777777777777777777#
#
S77

1
This entiie appenuix ielies veiy heavily on the shoit biogiaphical essays in
Ranuall Bolcombe (eu.), ST#5$"-&#H*(&$'-)#.4+)+,'(&( (Aubuin, AL: The Luuwig
von Nises Institute, 1999). We will omit specific citations to avoiu teuium.
!"#$%&'()%"*$+)&
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"
"
!
"#$!
!
S79
About the Authors

!"# $%&'()# !%&% manages a consulting fiim
specializing in coipoiate tiust seivices,
business consulting anu uebtoi-cieuitoi
ielations. The fiim's piimaiy seivice is
woiking with companies in financial ciisis.
Seiving business clients nationwiue ovei a
peiiou of thiee uecaues, these engagements
have involveu companies in most majoi
inuustiies incluuing, manufactuiing,
uistiibution anu ietail. Laia incoipoiateu his
consulting company in 1976 anu is
heauquaiteieu in Nashville, Tennessee.

Be maiiieu Anne B. Biowning in 197u. Togethei they have thiee
chiluien anu five gianuchiluien.

*(+,&-# ."# /0(+/# 12&345 Robeit P.
Nuiphy ieceiveu his Ph.B. in economics
fiom New Yoik 0niveisity. Aftei teaching
foi thiee yeais at Billsuale College, Nuiphy
left acauemia to woik foi Aithui Laffei's
investment fiim. Nuiphy now iuns his own
consulting business anu maintains an
economics blog at ConsultingByRPN.com.
Be is the authoi of seveial economics
books foi the laypeison, incluuing !"#$
%&'()(*+'',$ -.*&//#*)$ 01(2#$ )&$ )"#$ 0/#+)$
3#4/#55(&.$ +.2$ )"#$ 6#7$ 3#+' (Regneiy,
2uu9). Nuiphy is an aujunct scholai with the Luuwig von Nises
Institute. Be lives in Nashville, TN with his wife anu son.

How Privatized Banking Really Works

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

How Privatized Banking Really Works

Uploaded by

Copyright:

Available Formats

!

You might also like