 4. Money and Banking This chapter will examine the indispensable role that money and banking play in society. Scarcely any other concept is more important to understanding the nature and beauty of economic spontaneous order than money and banking. Money allows us to protect ourselves against unpredictable contingencies. Holding cash balances is an attempt to mitigate an uncertain future by commanding purchasing power in the maximum number of possible situations. This is the purpose of liquidity, to provide immediately saleable goods to trade for anything else one might want. Money prices serve as an indispensable guide in our daily economic decisions, be they as simple as deciding which toothpaste to purchase or as complex as which production method to use for assembling a series of automobiles. Finally, and perhaps most fundamentally, money facilitates cooperation with our fellow man through the harmonisation of each of our unique self-interests. Money and money prices weave our interests together in voluntary and mutually beneficial ways. Money that emerges naturally from a state of barter is organic and promotes harmony in much the same way harmony or equilibrium is achieved in nature. This phenomenon of spontaneous order manifests a sustainable and enriching environment for all of its participants, perpetually reorienting itself according to the infinite number of constantly changing variables in a manner that no central planner could ever hope to parallel. Economic Fundamentals Many references have been made toward goods, however this term has not been explicitly defined. Economic goods are simply any scarce means that a person sees as having the capacity to achieve a certain desired end. Thus, undiscovered or ubiquitous resources are not considered economic goods. For example, a deposit of gold that has been undiscovered in the Ozarks would not be considered a good because no one would be aware of its existence and therefore could not see it as a means to a desired end. Homesteading, original appropriation, as discussed earlier, is the process by which scarce non-goods are transformed into goods. Additionally, something like oxygen would generally be considered a free good or general condition because it is virtually ubiquitous at sea level on earth. In other words, one can use as much oxygen as he wants without limiting his own or any other person's access to it. It is important to keep in mind that property rights are only applicable to scarce goods, not non-scarse or free goods. Value is subjective. Even in similar situations opportunity costs may vary from person to person. If both Victor and Bobby go out for lunch, Victor's opportunity cost may be skateboarding, while Bobby's opportunity cost may be spending time with his girlfriend. Economic decisions are those involving the use of scarce, rivalrous goods. Economising goods simply refers to the act of treating them with the understanding that they are scarce and can only satisfy a limited number of desires. This concept may also refer to using or allocating goods in such a way that the greatest number of desires are satisfied to the greatest degree. There are three types of economic goods. Consumer goods, producer goods and money. Consumer goods are those which directly satisfy desires. The drinking of water as a means to quench one's thirst puts the water into the category of a consumer good. One has a desire to quench his thirst and consuming the water directly satisfies this desire. Producer goods on the other hand are those goods used to indirectly satisfy desires. Depending on how it is used the same good could act as a consumer or producer good. Water used to boil food serves as a producer good as its usefulness is indirect in that it merely assists in the creation of food, the desired consumer good. Producer goods otherwise known as means of production may be further subdivided into the following three categories. Land or natural resources, labour and capital goods created by the use of land and labour. Land or natural resources refer to any goods that are found in nature. Oil is a natural resource whereas a hammer is not. Only when these gifts of nature are used to indirectly satisfy a desire can they be considered a producer good. Eating a coconut purely to satiate my hunger renders it a consumer good. However use of the coconut as ammunition in my coconut cannon for the sake of hunting wild game would render it a producer good. Labour refers to activity emanating from a person's body that contributes to the production of goods or services. If one directs his efforts toward the indirect satisfaction of desire then he is engaging in labour. Conversely using his efforts to directly satisfy his desires would be considered leisure. If one's desire is to quench his thirst then the act of drinking water is considered leisure. However the procurement of this water is considered labour. A related concept is the disutility of labour which refers to the fact that people prefer leisure to labour and will only commence in labour if they believe it will produce more satisfaction in the future than the leisure foregone in order to produce it. Capital goods refer to man-made means of production. Screw drivers and factories are examples of capital goods since they are used to produce consumer goods and are man-made i.e. not gifts of nature. In modern society many capital goods are produced by other capital goods thus compounding their productive utility e.g. factories producing screwdrivers. The purpose of capital goods is to make labour more productive, to enable a given amount of labour to generate more goods than it otherwise would. The third major type of good is money. Money is any good that serves as a universal or prevalent medium of exchange. It is neither used for direct consumption nor for the production of goods, but is rather used to facilitate the exchange of consumer and producer goods. Rothbard expands upon this definition. Money is the medium of exchange, the asset for which all other goods and services are traded on the market. If a thing functions as such a medium as final payment for other things on the market then it serves as part of the money supply. Supply and demand. The concepts of supply and demand are integral to understanding economic matters and social relations. Oftentimes they are confused or misunderstood. For the sake of clarity a quick review is in order. Supply is a relationship between the number of goods held and at what price sellers are willing to trade them. For instance Sarah may only be willing to sell two melons at a price of $3 each, but may be willing to sell five melons at a price of $6 each. This leads us to the law of supply, which states as the market price of a good or service rises, producers offer the same or greater number of units. To illustrate supply as being a relationship rather than a number, economists will often times construct a supply curve, which is a graphical illustration of the supply relationship with price placed on the vertical axis and quantity on the horizontal axis. Sometimes a generic supply curve is drawn as a smooth curved line or even as a simple straight line. Supply curves are upward sloping, meaning that they start in the lower left and move up and to the right. Finally a reduction in supply refers to a situation in which a change other than the price of a good or service causes producers to reduce the number of units they want to sell at various possible prices. An increase in supply would be the inverse. For instance if a drought in the midwest significantly hampers grain production, this event may be said to have caused a reduction in supply, because due to the reduction of saleable goods grain sellers may offer fewer units of grain for a given price than they otherwise would. Demand is a relationship between how many goods consumers desire and at what price they are willing to trade for them. Just like supply demand is not a number but a relationship. For example Harry may only be willing to purchase one game at a price of $10 each but may be willing to purchase five games at a price of $7 each. This demand schedule is a snapshot in time. In different more desperate circumstances Harry may be willing to pay more for the gains than if he were in less desperate circumstances. This follows the law of demand which states if other influences stay the same then a lower price will lead consumers to buy more or the same number of units of a good or service, while a higher price will lead them to buy fewer or the same number of units. A common objection given to the law of demand is that a given person may be more drawn to buying a particular handbag if it were more expensive due to its reflection as a status symbol. However this does not contradict the law of demand as the added social status of the handbag would render it a different good entirely from any near handbag. For instance imagine a card with a typical baseball player on it and then imagine if this same card were to become a collector's item in the future. Though the physical properties of the card did not change its perceived status did thus it went from being a common card to a collector's card an entirely new good. To demonstrate the nature of demand economists oftentimes construct a demand curve which is a graphical illustration of the demand relationship with price placed on the vertical axis and quantity on the horizontal axis. Sometimes a generic demand curve is drawn as a smooth curved line or even as a simple straight line. Demand curves are downward sloping meaning that they start in the upper left and move down and to the right. Finally a reduction in demand refers to a situation in which a change other than the price of a good or service causes consumers to reduce the number of units they want to purchase at various possible prices. An increase in demand would be the inverse. For example if there were reports indicating that there had been an outbreak of E. coli amongst poultry products then this may be said to have caused a reduction in demand because consumers as a whole would not be willing to purchase the same quantity of poultry at a given price as they otherwise would have purchased had the outbreak never occurred. Many economic concepts may be extrapolated from supply and demand mechanics however we will only cover three surplus shortage and equilibrium prices. A surplus occurs when producers attempt to sell more units of a good or service than consumers are willing to purchase at a given price. For example if a television salesman offers 15 units at a price of $1,000 each but only 10 people are willing to purchase them then the salesman will have a surplus of five units that he is unable to sell. A shortage occurs when consumers want to buy more units of a good or service than producers are willing to sell at a given price. Using the television analogy suppose the salesman offers his 15 units for 700 dollars each but there are 20 people who wish to purchase them at this price. In this case the salesman will have a shortage of five units. Finally the equilibrium price or market clearing price is the price at which producers want to sell exactly the number of units that consumers want to purchase. On a graph the equilibrium price occurs at the intersection of the supply and demand curves. This situation occurs if our salesman prices his 15 television units at $900 each and exactly 15 people are willing to purchase them at such a price. Origin of money. Money spontaneously rose out of the barter economy due to its trade facilitating properties. Participants in the economy tend to pick the most saleable good on the market as their unit of trade. Silver coins are more saleable than horseshoes and so the former will tend to beat out the latter as a medium of exchange. Users will tend to gravitate towards saleable objects as they allow each person the maximum degree of control over future uncertainties. Guido Halsman describes the process individualistically. Quote the emergence of money happens through a gradual process in the course of which more and more market participants each for himself decide to use one commodity rather than others in their indirect exchanges. Thus the historical selection of gold, silver and copper was not made through some sort of a social contract or convention. Rather it resulted from the spontaneous convergence of many individual choices. A convergence that was prompted through the objective physical characteristics of the precious metals. Money selected in the free market i.e. money that comes into use by the voluntary cooperation of acting persons is also called natural money. End quote. Hopper explains how money's gain inertia. Quote by adding a new component to the pre-existing barter demand for these goods their marketability is still further enhanced. Based on their perception of this fact other market participants increasingly choose the same goods for their inventory of exchange media as it is in their own interest to select media of exchange that are already employed by others for the same purpose. Initially a variety of goods may be in demand as common media of exchange. However since a good is demanded as a medium of exchange to facilitate future purchases of directly serviceable goods i.e. to help one buy more cheaply and simultaneously widen one's market as a seller of directly useful goods and services i.e. help one sell more daily the more widely a commodity is used as a medium of exchange the better it will perform its function. End quote. And Mises describes the inevitable tendency of a successful money. Quote. Because each market participant naturally prefers the acquisition of a more marketable and in the end universally marketable medium of exchange to that of a less or non-universally marketable one there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained which was universally employed as a medium of exchange in a word money. End quote. It is observed that money spontaneously chosen by market dynamics tends to have a certain set of characteristics. Homogeneity, portability, divisibility, durability, verifiability, scarcity and from all of these liquidity. One. Money must be homogeneous. The natural process by which money emerges is one in which one good is set up against all others so as to enable simple and accurate economic calculation by means of exchange ratios. Heterogeneous money, money units that differed from each other would undermine the process of economic calculation by requiring multiple exchange ratios. Not only this but a heterogeneous money would imply that some of its component goods would be more saleable than others given their differing qualities. Thus rendering this monetary unit necessarily less efficient than a money comprised of the single most saleable good. Two. Ease of transport is highly regarded among monetary units as having to lug around cumbersome and hefty goods for trade incurs unnecessary transaction costs i.e. the space and energy required to transport it. Three. Divisibility of the unit is of chief importance as this allows the users of money to make small and large purchases of varying degrees. Four. Durability is another important consideration for money would hardly be useful if it melted in your pocket or disintegrated once touched. Five. The ability to verify the integrity of a money unit is paramount. Units that could be easily counterfeit would not survive long as the most common medium of exchange. If a seller finds it difficult to verify the authenticity of money he will be less likely to accept it as payment. Six. Scarcity is one of the most important factors for if a money had an infinite supply then it would be unable to yield comprehensible prices. Money prices are simply the exchange ratios set up between monetary units and all other goods and services in the economy. Thus if one side of this ratio was infinite then it would be impossible to compare and contrast the values of individual goods and services. This would effectively defeat the purpose of a medium of exchange to enable market participants to more objectively ascertain the costs of their economic decisions. Seven. All these criteria fit together and reinforce the marketability of a good giving it liquidity. This is perhaps the most important characteristic of money as the overall utility of money is primarily measured by how widely it is accepted as payment. Highly reproducible, fragile or non-divisible goods will seldom become liquid. Liquidity is a state of acceptance. The very purpose of money is to facilitate exchange and the facilitation of exchange is completely contingent upon the desirability of what is being used as a medium of exchange. There are two different types of money, commodity money and fiat money. Commodity money is a scarce money unit such as gold or silver or its redemption is promised in terms of such a good. Fiat money is commonly referred to as paper money as it is not backed by or redeemable for any particular good or commodity. Such money is brought into existence by the coercive dictates of states and is deemed legal tender by law i.e. by central fiat. When the state supports or creates fiat money it usually does so by means of legal tender laws. This requires that all creditors under jurisdiction accept it as payment of debt and a threat of legal action for non-compliance. Moreover taxes are generally required to be paid in the form of legal tender. Such legal tender laws are one of the primary reasons that commodity money is not in more prevalent use today. Without the violence and coercion of the state market actors would utilize sound currency that bears little to no resemblance to today's government fiat. According to Robert Murphy a sound money is one for which the value doesn't bounce around erratically and doesn't lose its purchasing power over time. In addition sound money is one in which tight control over the production of the money unit is maintained. This may be due to wise stewardship over fiat production. Geological factors limiting production of precious metals or advanced cryptography securing the scarcity of digital money. Double coincidence of wants. Barter is the act of trading consumer or producer goods directly for other consumer or producer goods. One of the advantages the use of money has over direct barter is that its users are not constrained by the double coincidence of wants. This is a situation in which both trading partners must desire precisely what the other offers. A double coincidence of wants situation may play out loosely. Suppose that Bob is a strawberry producer who wants to acquire shoes from Joe the Shoemaker. Bob decides to offer Joe a bucket of strawberries in exchange for a pair of shoes produced by Joe. But as it turns out Joe places little value on strawberries and refuses Bob's offer. Naturally Bob asks Joe what it is he does want and Joe replies one pound of bacon. Bob then proceeds to offer the local butcher a bucket of strawberries in exchange for one pound of bacon. But tragically finds himself in the same predicament because Sam the butcher desires butter not strawberries. The poor strawberry producer Bob inevitably repeats this process until he finds someone who does desire his strawberries and is willing to trade. For simplicity's sake assume the local dairy farmer does accept Bob's strawberry offer in exchange for butter which in turn Bob now uses in exchange for the butcher's bacon and finally uses the bacon to acquire the shoes he originally sought from Joe the Shoemaker. This tedious process is clearly inefficient when compared with a monetary economy where Bob can simply sell his strawberries for money a common unit of account and then use the money to purchase the shoes directly. This significantly reduces Bob's otherwise high transaction costs involved with executing many exchanges in order to procure one desired good. Calculation In addition to being able to trade more easily Bob realises he is able to have a much clearer understanding of the costs of any good or service under a monetary system. Prior to the advent of money Bob had to keep track of a myriad of exchange ratios between various goods. He had to figure out how much shoes were worth in terms of strawberries, pounds of butter and gallons of milk. A gallon of milk itself would be priced in terms of horseshoes, sheep, leather, strawberries etc and every other good likewise would be priced in terms of every other good. Bob would repeat this valuation process for every other good he might desire. Even if he were able to understand or calculate his costs in terms of all of the economy's exchange ratios by the time he finished most of them would have become irrelevant and obsolete due to the likely shift in availability and preferences that would have occurred in the interim. Thanks to money Bob now only has to keep track of the exchange ratios between units of money and all other goods offered on the market. This exchange ratio is more commonly referred to as a goods price. With money Bob is also able to make more rational economic decisions in regards to production and consumption because he is now able to quantify his opportunity costs in terms of monetary units. Bob can compare how much money it would cost to purchase strawberry producing equipment with how much income he expects to receive from the greater production of strawberries this equipment will yield. If he predicts that the extra income he generates will be less than what the equipment costs he will likely decide to refrain from purchasing it. If he predicts his additional income would be more than the cost of the equipment he will likely follow through with the purchase. This is how money facilitates and simplifies entrepreneurial decisions. It allows actors to appraise their costs in terms of one unit the most popular and saleable instead of maintaining and updating hundreds of exchange ratios simultaneously. Money also simplifies the testing of these predictions. For example it may be the case that Bob receives much less income than he predicted by incorporating this new machinery. Such erroneous predictions will occur in any economic context because no one can or will have perfect information. However money and the pricing mechanism it manifests allows entrepreneurs like Bob to more easily recognise when they are generating losses thus allowing them the insight necessary to modify their production processes accordingly. Without money it would be much more difficult for Bob to determine whether or not his business was profitable. It would be even more challenging to pinpoint the specific business practices that were succeeding or failing and to what degree they yielded profits or generated losses. This calculation process enabled by money can be applied to any economic decision. Of course the entrepreneur does not have to do what is most profitable in terms of money. The availability of money and prices merely provides him with a better understanding of which activities will satisfy the desires of the consumer and to what degree they do so. Such information allows him to make more informed economic decisions regarding where to produce his goods, how to produce them, from which materials to produce them, where and how to distribute them, how many to produce and so on. The introduction of money informs all these choices. To further illustrate consider the case of a furniture producer seeking a location to construct his factory. On the surface it may seem most sensible for him to place his factory next to the retailers willing to sell his products so as to cut down on transportation costs. However it may be the case that the land in this area is of even greater value to a computer chip manufacturer who is willing to bid more for it than our furniture producer. Thus it may make more sense for the furniture producer to locate his factory at a more distant location if he projects that the increased costs in transportation will be less than the additional costs he would otherwise have to pay to secure the location nearest the furniture retailers. The same may be said regarding which materials to use. It may not be profitable to use the best or highest quality materials as such materials may be valued more for use in other productive processes than in the furniture entrepreneur's plans. Thus the pricing mechanism takes into account all of the opportunity costs regarding what to produce, how to produce, where to produce, and what materials with which to produce when conveying to the producer what course of action will be most profitable. Without such a mechanism this entrepreneurial decision-making process would be highly arbitrary and comparatively less efficient. It is only through the private ownership of economic goods that the market is able to produce prices which accurately reflect the relative demand for and supply of the world's scarce resources. To understand this further simply consider how prices are generated. The seller generally wants to price his goods such that the number of people willing to purchase them equals the number of units he is offering. In other words he wants to price his goods at the highest level possible without having a leftover surplus of his wares or services. Conversely the consumer wants to spend the least amount of money on a given good that a seller is willing to offer. The buyer and seller have an incentive to negotiate with each other in the presence of competition. If the seller offers a good for too high of a price the buyer may decide to go to his competitor offering the same or similar good at a lower price. If the buyer insists on making offers which are too low he may lose out on the opportunity to acquire the given good or service to the next potential customer who is willing to pay a higher price. Thus opposing desires in the context of a competitive economy drive a tendency towards a meeting in the middle. This is also known as the market clearing price. There is always a tendency for such a harmony to be achieved in the free market where economic goods are privately owned. Most socialist doctrines however call for the collective ownership of all the means of production. In light of our understanding of the function of private ownership of goods let us examine the consequences of this arrangement. Those who employ the means of production in a socialist economy are not as able or incentivized to experiment in novel ways to make profit, that is to continually search for new ways to reorient or modify their employment so as to increase productivity as private owners of the means of production would be in a competitive economy. Patronage for the services of such productive means is guaranteed. As all means of production would be collectively owned no counterpart providing competitive disruption may exist. Without competition wasteful and or undesirable enterprise abounds because its survival is shielded from market pressures. Socialist enterprise is not guaranteed to experience the consequences otherwise faced in a free market for poor performance loss of business and money. Let us assume however that the workers and managers of such collectively owned producer goods are saints and angels and wish to maximize production owing to their altruistic love of mankind and of achieving the greater good. Even with such magnanimity without prices amongst the means of production it is virtually impossible to determine the way in which they may be economized. With market prices entrepreneurs have quantifiable and objectively comparable indicators of the demand for varying arrangements of the means of production. For instance without market prices for the means of production there is no way to objectively determine the true production costs of any particular good and therefore whether it's production or the method used to produce it is profitable. Knowledge of market prices for the means of production enables entrepreneurs to structure their capital or productive projects in a manner that yields the lowest opportunity costs. Another way of saying this is that competitive pressures continually exert on the entrepreneur to provide the most valuable products and services while using those resources which have the least relative demand for alternative applications. However if such factors of production are collectively owned it is comparatively much more difficult if not impossible to determine their opportunity costs as no money prices can emerge for them. Thus rendering the productive infrastructure in a socialist paradigm comparatively less efficient than its counterpart in a free market economy. Economic actors in a fully socialist economy cannot engage in rational economic calculation the process of reducing opportunity costs by discovering less valued means of production. Centrally planned industries bear only superficial resemblance to competitive markets for they operate with workers and managers and sell products at certain money prices. However in socialist economies production processes are given down from government fiat. Planning boards determine all the relevant economic details of a firm what supplies to be used and from where to acquire them how many laborers must be hired and to what employments they will be put even down to the products and the prices at which they are to be sold. In such a society there are no entrepreneurs merely managers. Heads of industry simply obey the production dictates given from on high. For every production process chosen they must operate in the dark. Therefore to the extent market prices are perverted through measures which infringe on the private ownership of any scarce good entrepreneurs are hindered in discovering efficient means by which to produce goods resulting in the economy's departure from its optimum productive potential. Murray Rothbard explains the importance of Mises's calculation insight and the need for money prices to translate opportunity costs. Mises was one of the very first to realize that subjective valuations of the consumers and of laborers on the market are purely ordinal they are expressible by preference rankings only and are in no way measurable but market prices are cardinal and measurable in terms of money and market money prices bring goods into cardinal comparability and calculation e.g a ten dollar hat is worth five times as much as a two dollar loaf of bread. But Mises realized that this insight meant it was absurd to say as Schumpeter would that the market imputes the values of consumer goods back to the factors of production. Values are not directly imputed the imputation process works only indirectly by means of money prices on the market therefore socialism necessarily devoid of a market in land and capital goods must lack the ability to calculate and compare goods and services and therefore any rational allocation of productive resources under socialism is indeed impossible. end quote profits one of the most incredible attributes of free markets is the ability to harmonize our self-interests with the interests of greater society contrary to the popular demonization of profits as extraction of surplus value profits in freed markets actually represent the adding of value to society making a profit in free markets requires one to combine or transform some goods in such a way that its resulting configuration is valued more by the consumer than the cost of labor and original materials including time used to produce it. In other words a profit is the positive difference between the total costs of production and the resulting price paid for a good or service by the consumer. If Joe constructs a bench that costs $50 in materials $20 in labor and $10 in overhead costs the fixed cost of the facility, utilities etc then the total production cost would be $80. Assuming Joe is able to sell the bench for $100 this would indicate that he would have added over $20 of value to society. Remember prior to Joe's efforts the sum value of the resources and labor used only amounted to $80. However through his entrepreneurial insight Joe was able to combine all these resources in such a way to create a product that was worth more than the sum of its individual components. Moreover the trade is mutually beneficial. Joe benefits because he gets to pocket $20 more than he originally possessed and the consumer benefits by receiving a product that he or she necessarily values more than $100. All parties to a voluntary trade must necessarily expect to be better off after conducting the trade otherwise the trade would never have occurred. In unhampered economies profits are always and necessarily a win-win. Thus the quest for profits by way of voluntary exchange and not political entrepreneurship is surely a humanitarian one. It should also be noted that profits need not be monetary they may also be psychic. For instance if one were to decide to give a homeless man on the street $5 this would not yield the benefactor a monetary profit. However the psychic pleasure he received from the gesture is more valuable to him than the $5 he surrendered. Once again such an act would be considered one whose aim is profit. It is through this concept of psychic profit that economists are able to explain actions taken by actors in the economy that deliberately result in monetary losses. Monetary profits are merely a subset of all possible motivations. Money as protector against uncertainty. Because money can be employed for the instant satisfaction of the widest range of possible needs it provides its owner with the best economically possible protection against uncertainty. In holding money its owner gains in the satisfaction of being able to meet instantly as they unpredictably arise the widest range of future contingencies. The investment in cash balances is an investment contra the subjectively felt aversion to uncertainty. A larger cash balance brings more relief from uncertainty aversion. As money is by definition the most saleable good in the economy it can be exchanged against any resource that is for sale that one may need at a moment's notice. Unlike insurance however it has the capacity to protect against all possible contingencies. In contrast insurance requires that one have some degree of certainty as to the particular nature of the risk he expects to encounter. Thus uninsurable risks otherwise known as uncertainties may be mitigated by adding to one's cash balances or savings. In this way money behaves as the best possible guarantor in ensuring one that his unknown future needs may be fulfilled as they spontaneously arise. Some economists consider additions to one's cash balance as a form of savings. Nearly everyone at all times hold some quantity of cash on them whether in a bank account or in a wallet. This is done to protect oneself from as many unforeseen contingencies as possible by retaining the most saleable good in society. This utility of money proves it is not barren or sterile an unproductive asset that hamstrings economic activity in the Keynesian view. In order to retain cash holdings however one must have earned some prior income. One cannot have exhausted all his possible consumptive options if he still carries cash. Cash's consumption power is a potential while assets remain there is as of yet unconsumed income. The cash holding actor has invested this retained savings in the form of cash. As William Hutt noted money held serves a yield. It is a productive asset that serves the one who holds it by best preparing him for the greatest number of possible outcomes in which he might want to consume or invest further in any number of ways. If all this is true then assets retained in the form of cash holdings are savings just as certificates of deposit or a stock of food. Money is different in that its yield is expressed only in psychic terms. The peace of mind that comes from being able to fulfill unforeseen future desires. And never in nominal terms contrary to typical savings vehicles such as equity or bonds. While the total volume of savings is determined by the level of one's time preference the degree to which it is high or low the proportion between our cash holdings and other save assets is determined by our subjective valuations regarding the uncertainty of the future. Division of labour and specialisation The concept of the division of labour simply refers to the economic arrangement whereby participants specialise in different tasks and exchange the products of their efforts with one another. The result of this specialisation and cooperation yields an output that is greater than what would be achieved if each individual attempted to produce the entire array of his own goods himself. To illustrate this suppose Bob decides to specialise in shoe production dedicating a majority of his labour toward this end. In doing so he expects to exchange the excess production of shoes with the products or services of others e.g for food, medicine, housing etc. Bob has essentially decided to engage in the division of labour. The only way for Bob to abstain from the division of labour would be for him to make his own food, produce his own medicine, build his own housing and even create his own clothing and shoes. However this would not be very practical for a variety of reasons. First Bob may not have ready access to the resources requisite to produce the entire set of goods or services he desires. Perhaps Bob wants Alaskan crab but lives in Florida. Perhaps Bob doesn't have the necessary tools to build the type of house he wants or maybe he does not currently have the necessary skills or physical ability to do so. The quality of housing or seafood he could create will inevitably be lower than if he simply traded with those who are gifted and practised in the creation of such goods. One may see how quickly Bob's standard of living would plummet if he was in a position where he was required to produce all the goods he desires himself. One can now easily recognise the distinct advantages of the division of labour. Under the division of labour, one may be able to focus on one task or a limited set of tasks geared towards producing a particular good or service as opposed to the entire spectrum of tasks required to fulfil all his needs. The fact that under such an arrangement people are able to focus on a more limited set of tasks allows them to increase their proficiency at these tasks and thus become more productive i.e to be able to produce more with the same amount of labour. Moreover because they can choose to specialise in one field or another they now have the opportunity to engage in that which they have the comparative advantage at doing. In other words they may choose to do that which offers them the greatest amount of profit. Without money it would be quite difficult to determine such profits due to calculation limitations. Who is to say producing 20 bananas a month is more or less productive than producing 10 shoes in the same span? However in the context of a monetary-based economy one may compare the profits yielded from producing the 20 bananas with the profits yielded from producing the 10 shoes. It may be the case that producing 10 shoes per month yields a profit of $50 whereas producing the 20 bananas only yields a profit of $25. Of course this doesn't mean our hypothetical producer is prohibited from producing bananas. It simply means he now has an additional piece of information that allows him to more accurately determine his opportunity costs associated with each task. Moreover there are large costs associated with having to switch from the task of making shoes to growing food producing medicine and constructing a house when compared with specialising in one of those activities and contracting out the rest. Thus specialisation and the division of labour enable people to more easily do what they want and what they excel at doing while at the same time enjoying a higher standard of living afforded by the more efficient hands of others. Money enables economic actors to engage more deeply and more effectively in the division of labour due to its trade facilitation properties. For instance if a cobbler desires bacon but is unable to find a bacon producer willing to trade him bacon for his produced shoes then the cobbler must resort to either producing the bacon himself, producing or procuring that which the bacon producer does want and what he likely does not have the desire or comparative advantage at producing or go without. In contrast the bacon producer is much more likely to accept money in exchange for his bacon thus allowing the cobbler to produce shoes and sell them for cash to ultimately attain the bacon he desires. One more example will suffice to explain the idea of comparative advantage. Suppose that Molly is a surgeon who also owns a bakery and that Louis manages the bakery for her. When Molly manages the bakery she is able to turn $300 per day in profit. However on the days when she performs surgery she is able to create $1000 per day in profit. When Louis manages the bakery he only generates $250 per day in profit. In this case Molly has what is known as the absolute or all-round advantage. Seeing that Molly is able to generate more profit than Louis at the bakery would it behoove her to quit her surgical practice in order to manage the bakery full time? Of course not because even though she can generate more profit than Louis at the bakery she would be giving up her performance at her surgical practice in order to do so. In other words she would be relinquishing $1000 in profit at her surgical clinic for the sake of recouping $50 extra profit at the bakery. The monetary opportunity cost of managing the bakery is $1000. Should she commit to baking full time this decision will leave her $950 poorer per day than she was prior. Even though Louis is less apt at managing the bakery than she is she will realise greater profits overall if she performs the role at which she excels surgery than if she managed the bakery herself. The money supply Reliability in the scarcity of the money unit is one of the chief criteria granting it value. An easily duplicated or produced money unit hurts the integrity of that unit's exchange value. Central bankers or advocates for economic central planning often claim that contracting or expanding the money supply can be a great method to regulate and stabilise the economy in comparison to the spontaneous twists of free markets. However such a claim is nonsense for to increase or decrease the amount of monetary units does absolutely nothing to increase actual wealth in society as expressed by the presence or lack of goods and services. Once a good has achieved a large-scale or universal consensus regarding its money-ness any amount of it is sufficient to optimally perform its role. An increase in the money supply without a corresponding increase in the total number of goods will only serve to dilute the purchasing power of money whereas decreasing the monetary units will accomplish the opposite. Tampering with the money supply only serves to redistribute wealth. In the case of inflation or monetary expansion wealth is transferred from later users to earlier users as the first users of this newly created money will be able to enjoy spending it in an economy where the prices have yet to adjust to the new increase in money supply. By the time this money makes its way down to the last recipients market prices will have adjusted to this larger money supply in the form of higher prices. Thus the last users may have the same nominal amount of money but would have comparatively less wealth than they did before the additional monetary units were injected into the economy. This redistributive effect of inflation is known as the Cantalon effect. Thus someone's wealth in a monetary economy may be determined by the proportion of the money supply he yields along with the market value of all of his assets. In other words the number of monetary units in itself means very little. Population growth in excess of the growth of the money unit will simply increase the purchasing power of the unit. No new units need be introduced. Rothbard addresses the unique category of good money occupies. With respect to the supply of money Mises return to the basic Ricardian insight that an increase in the supply of money never confers any general benefit upon society. For money is fundamentally different from consumers and producers goods in at least one vital respect. Other things being equal, an increase in the supply of consumers goods benefits society since one or more consumers will be better off. The same is true of an increase in the supply of producers goods which will be eventually transformed into an increased supply of consumers goods. For production itself is the process of transforming natural resources into new forms and locations desired by consumers for direct use. But money is very different. Money is not used directly in consumption or production but is exchanged for such directly usable goods. Yet once any commodity or object is established as a money it performs the maximum exchange work of which it is capable. An increase in the supply of money causes no increase whatever in the exchange service of money. All that happens is that the purchasing power of each unit of money is diluted by the increased supply of units. Hence there is never a social need for increasing the supply of money either because of an increased supply of goods or because of an increase in population. People can acquire an increased proportion of cash balances with a fixed supply of money by spending less and thereby increasing the purchasing power of their cash balances. Thus raising their real cash balances overall. Banks serve two distinct functions as safe warehouse of funds and as intermediaries between borrowers and savers. On the one hand banks come forward to meet the increasing demand for the safekeeping, transporting and clearing of money. On the other hand they fulfill the increasingly important function of facilitating exchanges between capitalists, savers and entrepreneurs, investors. Actually making an almost complete division of labour between these roles possible. As institutions of deposit and in particular as savings and credit institutions banks quickly assume the rank of nerve centres of an economy. Increasingly the spatial and temporal allocation and coordination of economic resources and activities takes place through the mediation of banks. In facilitating such coordination the emergence of banks implies still another stimulus for economic growth. As Hopper mentions banks are absolutely crucial in not only protecting one's wealth but also in coordinating resources throughout the economy. Banks enable entrepreneurs to pursue the most economical ends with resources that would otherwise be unemployed. However unlike banking in societies dominated by fiat money and ubiquitous state intervention a free market banking system will be segregated into two distinct roles. Deposit banking and loan banking. Deposit banking refers to the safeguarding services provided by a bank. People generally feel their money is better protected behind a heavy vault as opposed to under their mattresses. Thus many people would happily pay a fee in exchange for a bank's warehousing services. The bank benefits by being paid for its services and the customer benefits by having the peace of mind of knowing that his money is professionally protected. Competition amongst different banks offering these services will tend to keep prices at a minimum and ensure that various banks distinguish themselves by offering more locations to conveniently withdraw or deposit funds and other important functions. In the case of a gold standard such banks may offer banknotes or electronic credits redeemable in gold. To be used by its customers in lieu of them physically carrying metal in their pockets or as an additional form of security backstopped by the bank's digital security practices. When the number of banknotes or electronic credits offered directly corresponds with the amount of money in this case gold in the vaults such an arrangement is referred to as 100% reserve banking. The second type of banking is loan banking. Under loan banking savers lend their money to the bank so that it can lend this capital to borrowers. The saver lends these funds with the expectation of receiving interest payments from the bank and the bank proceeds to lend this saved money in the hopes of earning more interest than it must pay. This division of labour benefits the saver by delegating to the bank the task of successful forecasting in which the saver may have no skill or desire to perform. Delegating the lending to the bank would in most cases provide the customer with a more secure investment than if he were to lend the money out himself on the basis of his own judgments of entrepreneurial success. The bank benefits from this arrangement by having access to capital from which it can now earn interest. Interest payments primarily are paid for the service of acquiring access to capital sooner rather than later. Competition between various banks will tend to minimise the differential between what the bank's charge borrowers in terms of interest and what the bank provides to savers in terms of interest paid. This is due to the fact that savers have the incentive to select those banks which pay out the highest interest rates. Conversely borrowers have the incentive to patronise those banks which charge the lowest interest rates for borrowing. Along with the interest rates themselves such customers will also be interested in the bank's track record. That is to say how often it has defaulted on its debt obligations and how well it is capitalised. This tempers a given banks propensity to engage in high-risk lending practices. What distinguishes loan banking from deposit banking is that customers cannot expect to be able to withdraw their money at any time. When they loan their money, the banks are only obliged to return the whole of their money plus interest at a predetermined point of time in the future. Banks could hardly be expected to maintain interest payments on funds that savers could withdraw on demand. The bank is only able to pay savers interest because it was first able to procure interest from borrowers which exceeds the interest payments promised to the saver. For example, suppose Bob deposits $100 in a loan banking institution. In exchange for letting them borrow his money, the bank offers Bob a 5% quarterly interest rate in return. Now imagine that Joe wishes to borrow that same $100 from the bank so that he can start a small business. The bank will proceed to review Joe's credit, which may include his assets, his history of timely payments, his current income, etc. After his credit has been evaluated, the bank may also evaluate his business plan and determine its likelihood for success. The bank will then offer Joe the loan with an interest rate that corresponds to his appraised risk, as determined by the bank's investigative process. Suppose the bank offers Joe $100 with a 10% interest rate to be paid in two months. Joe accepts the funds and two months transpire. Joe has responsibly paid the bank the principal of his loan, $100, along with the 10% interest, $10. The following month, Bob arrives to collect his investment, at which point in time, the bank may return to Bob his principal and interest, or offer to keep the funds and renew the lending agreement. Even if Bob refuses the offer to continue and decides to collect his funds, both parties benefit as both parties become $5 richer. Even Joe the borrower benefited by gaining access to capital needed to start his small business sooner, as opposed to waiting later. Perhaps starting the business at that current point of time was crucial to its success. This is one example of how banks efficiently coordinate the allocation of scarce resources. Their specialisation in lending and risk management benefits both parties through a division of labour. Money in a free market system represents real resources. In order for Joe to borrow money, claims to resources, now Bob had to refrain from claiming said resources until later. Thus the monetary supply remained unchanged during the course of this lending borrowing process. Fraudulent banking practices in the free market. With the advent of banknotes comes the temptation for banks to engage in inflationary practices and to print more notes than assets they've accepted in deposit. This is tantamount to the bank providing multiple titles to the same set of goods. If the bank has 100 ounces of gold in its vaults, but issues 100 ounce banknotes to both Sam and Juliet, then both Sam and Juliet essentially have conflicting titles over the same set of goods, despite the promise issued by the bank for instant redemption. In other words the bank is handing out titles for non-existent goods, promised assets which do not exist. The bank hopes to gain from this by relying on its customers, Sam and Juliet, not to ask for redemption before it is able to replenish its reserves, to the point where it may be able to satisfy both of their requests. By engaging in this practice, the bank will be able to earn interest on double the assets it actually holds. This practice is risky, however, for in a free banking system, if Sam and Juliet redeem their notes simultaneously, the bank must default on its obligations and suffer reputational damages, which directly impact its future business prospects. If it is true that a bank cannot make good on its outstanding obligations, it is insolvent. The insolvency is only revealed at the time it fails to honour depositor agreements. The risk of this situation occurring would serve as a serious deterrent against this practice. The issuance of extra unbacked notes is more commonly referred to as fractional reserve banking, which is the practice of holding only a fraction of what one has obliged himself to redeem instantly and at any time. If depositors learn that their bank is engaging in fractional reserve practices, they will be more inclined to redeem their notes as soon as possible, so as to avoid default on part of the bank. Guido Halsman elaborates on the necessary discount between holding money proper and holding bank IOUs with redemption promise. Bank runs can be extremely disruptive to an economy, as many savers, having trusted banks to be excellent stewards of the funds, lose their deposits and a cascading set of systemic defaults ensue, hurling the economy into a recession or depression. Such bank runs could not occur in a 100% reserve banking system, where all deposits are held securely without claims to them given to third parties. Thus only loan banking institutions would be at risk for default, and even this would be minimal due to competition and consumer preference, as savers have a vested interest in lending their money to reputable institutions. High rates of return might indicate that the institutions offering such rates would be engaged in high risk lending practices. In any case, such defaults would be more limited and predictable in a free banking system, where banks are separate competitive enterprises and not shackled to each other by central bank operations. Thus the risk for systematic economic distress would be virtually nil when compared to its fractional reserve banking system counterpart. Hopper explains how competition between banking institutions may serve as an additional fraud deterrent under a free banking system. Under a system of free banking with no legal tender laws and gold as money, an additional constraint on potential bank fraud arises, for then every bank is faced with the existence of non-clients or clients of different banks. If in this situation additional counterfeit money is brought into circulation by a bank, it must invariably reckon with the fact that the money may end up in non-client's hands who demand immediate redemption, which the bank would then be unable to grant without at least a painful credit contraction. In fact such a corrective contraction could only be avoided if the additional fiat money were to go exclusively into the cash reserves of the bank's own clients, and were used by them exclusively for transactions with other clients. Yet since a bank would have no way of knowing whether or not such a specific outcome could be achieved or how to achieve it, the threat of a following credit contraction would act as an inescapable economic deterrent to any bank fraud. End quote. A sophisticated critic may retort that banking cartels may form to help circumvent this limitation. However Hopper addresses this as well. Quote. With no restrictions of entry in existence, any such bank cartel would have to be classified as voluntary and would suffer from the same problems as any voluntary cartel. Faced with the threat of non-cartelists and or new entrants, and recognising that like all cartel agreements a banking cartel would favour the less efficient cartel members at the expense of the more efficient ones, there is simply no economic basis for successful action, and any attempt to cartelise would quickly break down as economically inefficient. Moreover insofar as the counterfeit money would be employed to expand credit, banks acting in concert would set off a full scale boom bust cycle. This too would deter cartelisation. End quote. The state's involvement in money and central banking. Quote. The state's position regarding money and banking is obvious. Its objectives are served best by a pure fiat money, monopolistically controlled by the state. For only then are all barriers to counterfeiting removed, short of an entire breakdown of the monetary system through hyperinflation. And the state can increase its own income and wealth at another's expense, practically without cost and without having to fear bankruptcy. End quote. Before the state can reach its ultimate goal, as stated by Professor Hopper, it must first gain public support for its actions. The first step in the process of the state gaining ultimate control over money and banking is to establish legal tender laws, which demand tax debts and private payments to be settled in units of a specified medium of exchange. Other institutions may still create gold or silver coins or other private monies, however the money produced by the state is mandated to be accepted by any creditor, lender, as repayment for debts. Taxes are also required to be paid in such legal tender, usually its own designed fiat money. This gives the government issued money an artificial advantage over private monies, as its perceived acceptability is increased through coercive mandate. Initially the currency begins with promises of redemption into certain portions of gold or silver. However the state and central bank will inevitably begin issuing extra unbacked notes. The bank notes in such a scenario are identified by Mises as fiduciary media. The consequence of producing fiduciary media is inflation, which favours the early receivers of this newly printed fiat money at the expense of the later receivers, triggering cantilon effects. The early receivers tend to be government agencies themselves, government contractors, large commercial banks and major industrial leaders, thus giving this class of society the incentive to support such fractional reserve practices. The government engages in these banking practices because doing so makes it far easier to finance its operations. In contrast to taxing or borrowing, inflating the currency achieves a far more covert pattern of wealth redistribution in the state's favour. John Maynard Keynes identified the benefit of inflation's obscurity when he remarked, Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate secretly and unobserved an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily, and while the process impoverishes many, it actually enriches some. The site of this arbitrary rearrangement of riches strikes not only at security, but also at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become profiteers who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless, and the process of wealth-getting degenerates into a gamble and a lottery. Lenin was certainly right. There is no subtler, no sureer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. The institution that is used to mediate this process is the central bank. The central bank is sold to the public as a lender of last resort, endowed with the purpose of eliminating the threat of bank runs, as banks are now given the ability to borrow from the central bank whatever amount is needed to maintain immediate solvency. In addition to this role, the central bank is also responsible for setting monetary policy for the ostensible purpose of stabilizing the value of the money it issues, as well as the growth of the economy. In the eyes of its proponents, the central bank is to be used to depress an overheating economy by taking measures to contract the money supply, as well as to stimulate the economy during times of low market activity by expanding the money supply through inflation. In practice, the central bank will almost always resort to inflationary procedures, and will seldom take measures to contract the amount of credit in the economy. The central bank's true purposes are to finance government operations, cartelize the banking system, and win over support from the financial elite by allowing them access to newly created money before the rest of society, thus concentrating ever more wealth into the hands of a select privileged few at the artificial expense of the many. Wealth accrued in this way is destructive of the market process, as it is achieved through expropriation and not the production and voluntary exchange of genuine goods and services. In order to mask its true purposes, the central bank will generally employ obscure and clandestine means to counterfeit money and expand credit. Of these means, the three most common are 1. Purchasing government securities is the most direct way in which the central bank is able to finance government operations, i.e. by buying debt from it directly in the form of treasury bonds. To provide the funds to purchase government debt on the open market, the central bank will print or create the money out of thin air. It is able to acquire treasury bills without expending any resources of its own. This is modern alchemy and by its very nature, counterfeiting. But what separates the central bank from any other unscrupulous counterfeiter is that the government has given it the exclusive legal privilege to perform these acts. In other words, the government has granted the central bank a monopoly over the production of legal tender. Because the central bank buys government debt with newly created money, all those holding the fiat money must tolerate a reduction in their purchasing power to finance the principle of this loan. Because only the central bank is permitted to counterfeit in such a way, it is able to reap the concentrated benefits of such an expropriating practice, whereas all others in society are required to produce in order to make money. Thus, the central bank produces nothing but paper or digital entries, and in return receives real wealth. Setting reserve requirements is another arm of conventional monetary policy. Unlike in a competitive banking scenario, commercial banks are now able to engage in fractional reserve practices with virtually no risk due to the oversight of the central bank. Any amount of money lent to commercial banks by the central bank is itself multiplied, as commercial banks do not hold full reserves, but instead create additional credit from the deposit. Fractional reserve banking systems are, by their very nature, unstable. To combat the alleged evils of wildcat banking, central banks will often require minimum reserves in the vaults of their commercial bank clients. To illustrate how a 10% reserve requirement would play out, suppose the central bank deposits $1,000 in bank A, of which it is now able to lend $900. Let's assume that Jerry borrows this $900 and deposits it in bank B. His bank, due to the reserve requirements, may lend out $810 of those dollars. Once the $810 is lent out to Max, he'll deposit this money into bank C, which will now be able to lend out $729 of his deposit. This process will continue until the original $1,000 deposited into bank A has turned into $10,000 of newly created credit, now injected into the economy. The fractional reserve tactics of commercial banks multiply the amount of money they receive from the central bank through its discount window. 3. Setting the discount rate is another tool which central banks use to expand the money supply. The discount rate is the interest rate at which various commercial banks may borrow money from the central bank during the discount window. If the central bank decides there has been a significant disruption in the economy that has caused the banking system to experience a shortage of liquidity, it will allow the affected banks to borrow from its own holdings as a lender of last resort. Thus, the lower the central bank sets the discount rate, the more the commercial banks will be encouraged to borrow. Once again, in order to acquire loanable funds, the central bank simply creates them from nothing. However, this fact in no way lessens the obligations for the borrowing banks to repay the loan in full with real wealth and savings plus interest. Once again, if depositors start withdrawing all their funds and a particular bank becomes insolvent, all it must do is take a bank holiday and borrow the discrepant amount of funds from the central bank, effectively eliminating the possibility of default. Fractional reserve practices multiply this expansion of the monetary supply. Suppose the central bank sets the reserve requirement at 10%, meaning of all the demand deposits in a given bank's ledger, i.e. the sum of all the money in all of its client's bank accounts, only 10% of this needs to remain in the vault. Now, suppose Joey and Mark each deposit $500 in bank A, leaving it with $1000 on the books. Due to the reserve requirements set by the central bank and the promise of a bailout if it becomes insolvent, a moral hazard manifests, which prompts the bank to lend out 900 of those demand deposit dollars. Economists call this a moral hazard, because if the bank were not guaranteed a government bailout in the case of insolvency, then it would operate much more conservatively. In other words, moral hazard occurs when one party assumes riskier behaviour because others have promised to bear the costs for them. In so far as a market's currency is backed by a scarce commodity, there is a concrete limitation to a bank-driven inflationary process. Initially, the central bank may, as was done in the United States by its central bank, the Federal Reserve, require its member banks to deposit gold in its own vaults, and issue the member bank's receipts or notes in return. Though an expansion of credit is possible in such a system through fractional reserve banking, it is still ultimately constrained by the supply of gold specie. For example, the central bank may itself have to keep a set proportion of gold specie deposits made by its member banks in the vault due to reserve requirements. Thus the gold would serve as the non-expanding and concrete base to this inflationary pyramid. However, as the circulation of notes becomes more normalised and the people tend to less and less associate gold with real money, the state will gradually debase the currency until the point where it becomes pure fiat, i.e. pure paper notes, without redemption. Thus, when the central bank's issued paper notes become the new currency, there is no more physical limitation to inflation and by extension to its power over the economy. The United States is under such a pure fiat money system today, along with virtually the entire civilised world. Austrian Business Cycle Theory In addition to the redistribution of wealth from late to early comers, the above inflationary process precipitates artificially severe and economically destructive business cycles. In so far as prices are distorted through central bank inflation, their utility as guides for rational economic calculation is diminished. In a free banking system, higher interest rates indicate that consumers as a whole have higher time preferences. They prefer to consume now as opposed to later, despite the fact that foregoing said consumption may lead to an enhanced capacity to produce consumer goods in the future. Conversely, lower interest rates indicate that consumers have a lower time preference as a whole. They prefer to forego consumption now so that they may enjoy a greater amount and or quality of goods at some future time. In the former case where higher interest rates are predominant, entrepreneurs will tend to invest in comparatively less efficient and shorter production processes, which correspond more appropriately with a prevailing high time preference on the part of consumers. In the latter case where lower interest rates are predominant, entrepreneurs will tend to invest in more efficient and roundabout production processes that require a comparatively longer and or greater degree of consumption forbearance in order for the consumer goods to manifest. In a competitive economy, banks harmonize the profit motive of these entrepreneurs with prevailing consumer time preference, as indicated by the supply of available savings. As all savings in a 100% reserve banking or free banking system are real savings, they represent actual resources in the economy. When there are higher savings, this means there are more actual resources available to be employed in productive investment channels, thus the low interest rates enables a larger amount of resources to be used for productive ends. Conversely, when there are lower savings, this implies there are fewer available unemployed resources present, and thus the higher interest rates ensure that these relatively scarcer resources will only be used by those entrepreneurs who project the return on their investments to be high enough to warrant paying such rates. It is in the bank's interest to only loan money out to borrowers that they expect to be capable of repayment at the designated time in the future, thus adding an additional mechanism to ensure that such resources are used efficiently. Furthermore, should these borrowers default on their debt obligations to the bank, this will be reflected on their credit, which will deter lending institutions from loaning money to them in the future, without adjusting their interest rates to account for the added default risk. It is in this way that competitive markets are able to efficiently and organically allocate scarce resources to their optimally productive ends. In distinct contrast, the central bank's involvement in the economy produces an entirely different result. When new money is injected into the economy via open market operations, bond purchases, and manipulation of reserve requirements and the discount rate, an illusion of greater savings is created, which in turn prompts greater levels of borrowing and investing. This artificial stimulation produces a temporary boom period, where consumers have not changed their consumption habits, and yet a simultaneous surge in investments takes place. So at least for a while, it may be possible for one to have his cake and eat it too. This illusion of greater savings pushes down interest rates, which misleads entrepreneurs into thinking there are more available unemployed resources than actually exist. Incentivised by lowered interest rates, entrepreneurs begin to engage in longer term and or more risky investment projects than they otherwise would. These investments then bid up the prices for labour, capital goods and natural resources required for their completion. Because these entrepreneurs are acting in a way that is consistent with the illusion of a larger quantity of resources available than there actually are, not all of them will be able to finish their investment projects. The prices for the goods and labour will increase over their originally projected amount, requiring entrepreneurs to borrow more money than originally intended in order to complete their projects. Eventually, in order to prevent a full-blown currency crisis, the banks will cease lending out more money to all of these investors at the interest rate they are seeking, thus forcing liquidation and the abandonment of their projects. This will create a ripple effect throughout the economy, as the sudden decrease in demand for labourers and early stage capital goods in these projects generates even more losses. Such decrease in demand for labour will take the form of layoffs. The unemployed workers, who may have otherwise been actively used for more productive and sustainable ends, are now unable to produce for the period of time it takes to find new employment. The preceding investments made under the illusion of greater savings are what are known as malinvestments. It is at this time that the malinvestments will have to be liquidated, i.e. halted and their components sold off or freed up to be used by others willing to purchase and put them to more productive use, usually at a substantial loss to the entrepreneur. Mass unemployment and capital liquidation is recognised as the bust period in the business cycle. As opposed to allowing this market correction or liquidation of malinvestments to occur, the central bank will often times inject even more money and credit into the economy, attempting to rebuild an uneven structure of production, prolonging the boom, and setting the stage for an even more severe bust in the future. In the long run, this is much more wasteful than allowing the banking system to operate organically, as many hours of labour and resources are used up during the boom cycle that are ultimately destined for bust, which could have instead been used for more productive and sustainable ends. Additionally, more labour, time and resources will be used to liquidate these projects, so that their component resources may be freed up for use elsewhere, an expenditure only made necessary by central bank interference. Hopper summarises this process, Yet in addition, this time a boom bust cycle is also set in motion. Placed at a lowered interest rate, the newly granted credit causes increased investments and initially creates a boom that cannot be distinguished from an economic expansion. However, this boom must turn bust, because the credit that stimulated it does not represent real savings, but instead was created out of thin air. Hence, with the entire new and expanded investment structure underway, a lack of capital must arise that makes the successful completion of all investment projects systematically impossible, and instead requires a contraction with a liquidation of previous malinvestments. End quote. In truth, the only thing that must be done to ensure a tendency toward efficient and ethical banking systems is to ground the legal system in the private property ethic. This naturally entails abolishing the state and allowing the organic governance of the free market to reign. The spontaneous order that is derived from this bottom-up approach produces greater harmony between self and societal interests than any central planner could possibly achieve.