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against his/her commitment. . . . A second possibility, is to
maintain an “insurance” pool, funded by fees levied on all
transactions, to cover any possible losses. A third possibility . . .
is reliance upon group co-responsibility, i.e. having each
participant within an affinity group bear responsibility for the
debits of the others.7
Those are possibilities, but they are not so practical or efficient as
the contractual agreements used today, with interest charges and late
penalties enforceable in court. Contracts to repay can be legally
enforced by foreclosing on collateral, garnishing wages, and other
remedies for breach of contract, with or without interest provisions.
But interest penalties make borrowers more inclined to be prudent in
their borrowing and to pay their debts promptly. Eliminating interest
from the money system would eliminate the incentive for private
lenders to lend and would encourage speculation. If credit were made
available without time limits or interest charges, people might simply
borrow all the free money they could get, then compete to purchase
bonds, stocks, and other income-producing assets with it, generating
speculative asset bubbles. Imposing a significant cost on borrowing
deters this sort of rampant speculation.
In Moslem communities, interest is avoided because usury is
forbidden in the Koran. To avoid infringing religious law, Islamic
lawyers have gone to great lengths to design contracts that avoid
interest charges. The most common alternative is a contract in which
the banker buys the property and sells it to the client at a higher price,
to be paid in installments over time. The effect, however, is the same
as charging interest: more money is owed back if the sum is paid over
time than if it had been paid immediately.
In large Western metropolises, where mobility is high and religion
is not a pervasive factor, interest is considered a reasonable charge
acknowledging the time value of money. The objection of Greco and
others to charging interest turns on the “impossible contract” problem
-- the problem of finding principal and interest to pay back loans in a
monetary scheme in which only the principal is put into the money
supply -- but that problem can be resolved in other ways. A proposal
for retaining the benefits of the interest system while avoiding the
“impossible contract” problem is explored in Chapter 42. A proposal

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for interest-free lending that might work is also described in that
A more serious limitation of private “supplemental” currencies is
that they fail to deal with the mammoth debt spider that is sucking
the lifeblood from the national economy. “Supplemental” currencies
all assume a national currency that is being supplemented. Taxes
must still be paid in the national currency, and so must bills for tele-
phone service, energy, gasoline, and anything else that isn™t made by
someone in the local currency group. That means community mem-
bers must still belong to the national money system. As Stephen
Zarlenga observes in The Lost Science of Money:
[S]uch local currencies do not stop the continued mismanagement
of the money system at the national level “ they can™t stop the
continued dispensation of monetary injustice from above through
the privately owned and controlled Federal Reserve money
system. Ending that injustice should be our monetary priority.8
The national money problem can be solved only by reforming the
national currency. And that brings us back to the “money question” of
the 1890s “ Greenbacks or gold?

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Chapter 37

You shall not crucify mankind upon a cross of gold.
-- William Jennings Bryan, 1896 Democratic Convention

A t opposite ends of the debate over the money question in the
1890s were the “Goldbugs,” led by the bankers, and the
“Greenbackers,” who were chiefly farmers and laborers.1 The use of
the term “Goldbug” has been traced to the 1896 Presidential election,
when supporters of gold money took to wearing lapel pins of small
insects to show their position. The Greenbackers at the other extreme
were suspicious of a money system dependent on the bankers™ gold,
having felt its crushing effects in their own lives. As Vernon Parrington
summarized their position in the 1920s:
To allow the bankers to erect a monetary system on gold is to
subject the producer to the money-broker and measure deferred
payments by a yardstick that lengthens or shortens from year to
year. The only safe and rational currency is a national currency
based on the national credit, sponsored by the state, flexible,
and controlled in the interests of the people as a whole.2
The Goldbugs countered that currency backed only by the national
credit was too easily inflated by unscrupulous politicians. Gold, they
insisted, was the only stable medium of exchange. They called it
“sound money” or “honest money.” Gold had the weight of history
to recommend it, having been used as money for 5,000 years. It had
to be extracted from the earth under difficult and often dangerous
circumstances, and the earth had only so much of it to relinquish. The
supply of it was therefore relatively fixed. The virtue of gold was that
Chapter 37 - The Money Question

it was a rare commodity that could not be inflated by irresponsible
governments out of all proportion to the supply of goods and services.
The Greenbackers responded that gold™s scarcity, far from being a
virtue, was actually its major drawback as a medium of exchange.
Gold coins might be “honest money,” but their scarcity had led gov-
ernments to condone dishonest money, the sleight of hand known as
“fractional reserve” banking. Governments that were barred from
creating their own paper money would just borrow it from banks that
created it and then demanded it back with interest. As Stephen
Zarlenga noted in The Lost Science of Money:
[A]ll of the plausible sounding gold standard theory could not
change or hide the fact that, in order to function, the system
had to mix paper credits with gold in domestic economies. Even
after this addition, the mixed gold and credit standard could
not properly service the growing economies. They periodically
broke down with dire domestic and international results. [In]
the worst such breakdown, the Great Crash and Depression of
1929-33, . . . it was widely noted that those countries did best
that left the gold standard soonest.3
The reason gold has to be mixed with paper credits is evident from
the math. As noted earlier, a dollar lent at 6 percent interest, com-
pounded annually, becomes 10 dollars in 40 years.4 That means that
if the money supply were 100 percent gold, and if bankers lent out 10
percent of it at 6 percent interest compounded annually (continually
rolling over principal and interest into new loans), in 40 years the
bankers would own all the gold. To avoid that result, either the money
supply needs to be able to expand, which means allowing fiat money,
or interest needs to be banned as it was in the Middle Ages.
The debate between the Goldbugs and the Greenbackers still rages,
but today the Goldbugs are not the bankers. Rather, they are in the
money reform camp along with the Greenbackers. Both factions are
opposed to the current banking system, but they disagree on how to
fix it. That is one reason the modern money reform movement hasn™t
made much headway politically. As Machiavelli said in the sixteenth
century, “He who introduces a new order of things has all those who
profit from the old order as his enemies, and he has only lukewarm
allies in all those who might profit from the new.” Maverick reformers
continue to argue among themselves while the bankers and their hired
economists march in lockstep, fortified by media they have purchased
and laws they have gotten passed with the powerful leverage of their
bank-created money.
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Is Gold a Stable Measure of Value?

There is little debate that gold is an excellent investment,
particularly in times of economic turmoil. When the Argentine peso
collapsed, families with a stash of gold coins reported that one coin
was sufficient to make it through a month on the barter system. Gold
is a good thing to own, but the issue debated by money reformers is
something else: should it be the basis of the national currency, either
alone or as “backing” for paper and electronic money?
Goldbugs maintain that a gold currency is necessary to keep the
value of money stable. Greenbackers agree on the need for stability
but question whether the price of gold is stable enough to act as such
a peg. In the nineteenth century, farmers knew the problem first-
hand, having seen their profits shrink as the gold price went up. A
real-world model is hard to come by today, but one is furnished by the
real estate market in Vietnam, where sales have recently been under-
taken in gold. In the fall of 2005, the price of gold soared to over $500
an ounce. When buyers suddenly had to pay tens of millions more
Vietnamese dong for a house valued at 1,000 taels of gold, the real
estate market ground to a halt.5
The purpose of “money” is to tally the value of goods and services
traded, facilitating commerce between buyers and sellers. If the yard-
stick by which value is tallied keeps stretching and shrinking itself,
commerce is impaired. When gold was the medium of exchange his-
torically, prices inflated along with the supply of gold. When gold
from the New World flooded Spain in the sixteenth century, the coun-
try suffered massive inflation. During the California Gold Rush of the
1850s, consumer prices also shot up with the rising supply of gold.
From 1917 to 1920, the U.S. gold supply surged again, as gold came
pouring into the country in exchange for war materials. The money
supply became seriously inflated and consumer prices doubled, al-
though the money supply was supposedly being strictly regulated by
the Federal Reserve.6 During the 1970s, the value of gold soared from
$40 an ounce to $800 an ounce, dropping back to a low of $255 in
February 2001. (See Chart, page 346.) If rents had been paid in gold
coins, they would have swung wildly as well. Again, people on fixed
incomes generally prefer a currency that has a fixed and predictable
value, even if it exists only as numbers in their checkbooks.
The tether of gold can serve to curb inflation, but an expandable
currency is necessary to avert the depressions that pose even graver

Chapter 37 - The Money Question

dangers to the economy. When the money supply contracts, so do
productivity and employment. When gold flooded the market after a
major gold discovery in the nineteenth century, there was plenty of
money to hire workers, so production and employment went up.
When gold became scarce, as when the bankers raised interest rates
and called in loans, there was insufficient money to hire workers, so
production and employment went down. But what did the availability
of gold have to do with the ability of farmers to farm, of miners to
mine, of builders to build? Not much. The Greenbackers argued that
the work should come first. Like in the medieval tally system, the
“money” would follow, as a receipt acknowledging payment.
Goldbugs argue that there will always be enough gold in a gold-
based money system to go around, because prices will naturally adjust
downward so that supply matches demand.7 But this fundamental
principle of the quantity theory of money has not worked well in
practice. The drawbacks of limiting the medium of exchange to
precious metals were obvious as soon as the Founding Fathers decided
on a precious metal standard at the Constitutional Convention, when
the money supply contracted so sharply that farmers rioted in the
streets in Shay™s Rebellion. When the money supply contracted during
the Great Depression, a vicious deflationary spiral was initiated.
Insufficient money to pay workers led to demand falling off, which
led to more goods remaining unsold, which caused even more workers
to get laid off. Fruit was left to rot in the fields, because it wasn™t
economical to pick it and sell it.
To further clarify these points, here is a hypothetical. You are
shipwrecked on a desert island . . . .

Shipwrecked with a Chest of Gold Coins

You and nine of your mates wash ashore with a treasure chest
containing 100 gold coins. You decide to divide the coins and the
essential tasks equally among you. Your task is making the baskets
used for collecting fruit. You are new to the task and manage to turn
out only ten baskets the first month. You keep one and sell the others
to your friends for one coin each, using your own coins to purchase
the wares of the others.
So far so good. By the second month, your baskets have worn out
but you have gotten much more proficient at making them. You
manage to make twenty. Your mates admire your baskets and say

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they would like to have two each; but alas, they have only one coin to
allot to basket purchase. You must either cut your sales price in half
or cut back on production. The other islanders face the same problem
with their production potential. The net result is price deflation and
depression. You have no incentive to increase your production, and
you have no way to earn extra coins so that you can better your standard
of living.
The situation gets worse over the years, as the islanders multiply
but the gold coins don™t. You can™t afford to feed your young children
on the meager income you get from your baskets. If you make more
baskets, their price just gets depressed and you are left with the num-
ber of coins you had to start with. You try borrowing from a friend,
but he too needs his coins and will agree only if you will agree to pay
him interest. Where is this interest to come from? There are not enough
coins in the community to cover this new cost.
Then, miraculously, another ship washes ashore, containing a chest
with 50 more gold coins. The lone survivor from this ship agrees to
lend 40 of his coins at 20 percent interest. The islanders consider this
a great blessing, until the time comes to pay the debt back, when they
realize there are no extra coins on the island to cover the interest. The
creditor demands lifetime servitude instead. The system degenerates
into debt and bankruptcy, just as the gold-based system did historically
in the outside world.
Now consider another scenario . . . .

Shipwrecked with an Accountant

You and nine companions are shipwrecked on a desert island, but
your ship is not blessed (or cursed) with a chest of gold coins. “No
problem,” says one of your mates, who happens to be an accountant.


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