Understanding Money Mechanics, by Robert Murphy, was published in 2021. It is available at mises.org in free pdf format.
“This book provides the intelligent layperson with a concise yet comprehensive overview of the theory, history, and practice of money and banking, with a focus on the United States. Although the author considers himself an Austrian school economist, most of the material in this book is a neutral presentation of historical facts and an objective description of the mechanics of money creation in today’s world.”
This is a good short introduction to the book. Although Murphy is certainly in the neighborhood of the “Austrian” camp, he maintains some independence, and recognizes some of the excesses and errors of the Rothbard crew.
Nevertheless, the book is characterized by a confusion that certainly goes back to The Theory of Money and Credit (1913), by Ludwig von Mises; and probably well before then, as I don’t think Mises created it. Basically, it is a confusing stew between “money” and “credit.” Although much error and confusion has arisen from this, nevertheless it had some relevance in 1913, because in those days (or actually about fifty years earlier, before the spread of central banks in the late 19th and early 20th centuries), “money” and “credit” was indeed often a confusing stew, mixed together on a single balance sheet of commercial banks. In the United States in the 19th century, for example, many commercial banks issued their own banknotes; and these banknotes were on the same balance sheet as lending and deposits. You could have commercially-issued banknotes (“free banking”) that are separate from lending and deposits, in a separate company with a separate balance sheet, although probably part of the banking group company. I think this would be a good idea going forward.
I’ve talked about this in the past, at some length, especially in Gold: The Monetary Polaris, but I think it is worth going over some points again and in maybe a new light, to describe how my stance differs from the Mises/Rothbard/Murphy group, or the Monetarist group (almost the same), or indeed what you would find in any mainstream textbook on economics.
Let’s imagine getting rid of all forms of money except for silver coins. Silver coins, and silver coins alone, are acceptable in payment for goods and services, or payment of debts. In other words, only silver coins are Legal Tender. This is actually defined in the US Constitution, and represents the norm in Europe in the late 18th century, although of course there were already some paper money experiments. But, these paper money experiments tended to blow up quickly in inflation and hyperinflation, as in the French assignats of the 1790s. Paper money that had some reliability was somewhat rare, limited mostly to Britain and Sweden. The American Colonies, being British, also had extensive use of paper money, but it was always highly unreliable and was typically inflated quickly. That’s why Britain banned paper money in the Colonies in 1752.
Although paper currencies had a long history in China and elsewhere in East Asia, including Vietnam, Korea and Japan, in the West they began around the mid-17th century, in Britain and Sweden. Even at the end of the 18th century, most of Europe used coinage rather than paper.
Banking, however, is very old, going back to Sumer in the third millennium BC. Thus, excepting China and East Asia, the norm for many centuries, and indeed for thousands of years, was banks that used only coinage.
You can go back further than coinage, typically ascribed to Lydia in the 7th century BC. Before then, silver and gold traded hand to hand, but not in standardized units we call “coins.” Typically, metals were weighed for every transaction. They came in regular units, for example a bar with a shekel weight of silver (about 8 grams), but they were not so perfectly standardized that people traded them without weighing. The modern equivalent would be a “400 oz gold bar” that has a specific weight and fineness. But even in the 8th century BC, before “coinage,” banks were already thousands of years old.
This is a “full weight” coinage system, not a “token” coinage system. The value of the coin is equivalent to its contained silver. We have “token” coins today. The $0.25 quarter doesn’t have a value because of its contained metal. It has a value because you can take four of them to a bank (and the bank can take four of them to the Treasury), and you can get a $1 bill in return.
Let’s imagine a modern economy (at least, a mid-19th century economy) that only used silver coins as legal tender. We would still have banks, and all the functions of banks, including checking accounts and checks, and savings accounts. We can add various more recent payment systems to this, including credit and debit cards, or some kind of app that makes payments like Venmo or Zelle, or some electronic function for larger payments instead of paper checks, which today might be an ACH transfer.
For convenience, these banks use a Bank Clearinghouse, just as they do today, and did in the nineteenth century before central banks took over this role. At this Clearinghouse, each bank holds an “account,” which it uses to pay other banks. However, on the asset side of the balance sheet of this Clearinghouse, we have only silver coins. This clearinghouse is a “100% reserve” system, similar to GoldMoney or Tether Gold today. To emphasize the character of this system, we will discard currency names and just refer to kilograms of silver, which might take the form of 10 gram coins, or other larger or smaller units.
| Assets | Liabilities | ||
| Silver Coins | 1000 kg | Bank A | 400 kg |
| Bank B | 600 kg |
Of course there are more than two banks. There might be a thousand. But, we can see the basic principle with two banks.
Let’s say that you use your Bank checking account, a paper check, a debit card, a credit card or whatever mechanism you prefer, to pay somebody. You bought some furniture in a store, and paid with a debit card. The store has an account at Bank B. You have an account at Bank A. Bank A pays Bank B the amount of your purchase, using its account at the Clearinghouse. 1 kg of silver goes from the account of Bank A into the account of Bank B.
Since these Clearinghouse accounts have a 100% reserve of silver coins, and since these Clearinghouse accounts are convertible to silver coin on demand (banks can “withdraw” their silver coins), we can see that this is equivalent to someone from Bank A literally delivering a sack of coins to Bank B.
In addition to these banking transactions, we also have silver coins in regular circulation themselves. You might pay the furniture store directly with 1 kg of silver coins.
Between these two modes of payment, some kind of Bank transactions or direct payment with silver coins, we can see that these include all the forms of monetary transaction in the entire society. There is no kind of “money” that we have omitted, or any kind of transaction that we have omitted. We have described the entire monetary system. And this is not just imaginary fantasy, it was the norm for banking and coinage in Europe for centuries, even millennia.
Some people might argue here that you can pay for your furniture with “debt,” and that “debt” thus constitutes a form of payment. For example, you can go to the furniture store, buy some furniture, and the furniture store simply “accepts” that you will pay them 90 days in the future. It is a debt. This debt goes on to the furniture store’s balance sheet as an “accounts receivable.” This is somewhat uncommon for retail purchases (usually there is an intermediary such as a credit card), but it is the norm for commercial transactions where 90 day credit is common.
Isn’t this debt a form of payment? Weren’t you able to buy something with it? Only the silliest economist would make this claim (there are plenty of silly economists). Any business knows very well whether it has been paid or not. The debt is recorded as an “accounts receivable” because it has not been paid. It is a debt.
Thus we have a very simple monetary system. It is silver coins.
Now, these banks have all the features of modern banks. There is a capital ratio. There is a reserve ratio. Here is a common bank balance sheet:
| Assets | Liabilities | ||
| Loans | 700 kg | Deposits | 900 kg |
| Securities (bonds) | 200 kg | Shareholders’ Equity | 100 kg |
| Reserves (coins) | 100 kg |
Here we see that the Capital ratio (the ratio between Shareholders’ Equity and Assets) is 1:10. The Reserve Ratio (the ratio between Reserves, or cash on hand, in this case silver coins either in a separate vault or as a deposit at the Clearinghouse, and Assets) is 1:10. There is also a ratio between the Reserves and Deposits, which is 1:9.
Are these Deposits a form of money? No, they are not. We already went through all the forms of payment in the entire monetary system, and there was never a transfer of Deposits. All payments were silver coins; in the case of banks, silver coins held at the Clearinghouse.
You can’t transfer a Deposit. It is not a transactional device. If you have Account #1187 at Bank A, you can’t transfer ownership of Account #1187 at Bank A to a furniture store. You can pay the furniture store using your Deposit account, but the furniture store’s Bank, Bank B, receives silver coins from Bank A via the Clearinghouse system. Account #1187 does not change hands.
Account #1187 is simply a debt, that is payable on demand. It has “zero maturity.” This is how it is recorded on a bank’s balance sheet, so this is no great insight, it is just regular banking as it has been done for centuries.
Now, it is true that a Deposit can serve as a money substitute. Instead of an iron box of silver coins under the bed, we have a Deposit account at a Bank, which we can very conveniently use to buy furniture with. But, it is not money. As we established very rigorously, only silver coins are money, in our example. It is the only thing that actually changes hands, in payment.
In this way, I think you can see that we have effectively split Money and Credit into very different spheres. Banks do this and that. But, the only Money is silver coins. Thus, any talk of Money must focus on silver coins. For example, they might be debased, containing less silver than their face value. They might undergo the “natural debasement” of coin wear. There might be some problem with coinage issue, with the Mints, or import or export restrictions on silver, or some such thing. But, it doesn’t have anything to do with banks. Nothing that banks do can affect the silver coins. You can have all kinds of convulsions, even a Great Depression, but the silver coins are unchanged.
Although commercial banks in the 19th century did issue banknotes, which did change hands and were an effective form of money, and their banknote issuance was mixed together with all their other banking activities on one balance sheet, this is not the case today. Today, we have a situation that is actually quite similar to our silver coin example. In our silver coin example, banks have nothing to do with money creation; in this case, making silver coins. They do not mine silver and they do not mint silver into coins. Today, commercial banks engage in all the usual banking activities (actually not much changed since 500 years ago), but they don’t have anything to do with the money, which is banknotes issued by a Central Bank, and an electronic Clearinghouse operated by modern central banks. With digital solutions even more popular today, we could get rid of banknotes altogether — basically, Central Bank Digital Currencies, or the private-sector equivalent — and just do everything digitally. However, behind this payment system, we could have a 100% reserve system based on gold, with all Digital units convertible to gold, perhaps in the form of 100g and 1000g bars rather than smaller coins. And in fact, most digital payments systems based on gold today, such as Tether Gold, Pax Gold, Kinesis or Lode, are 100% reserve systems. So, it would be identical to my example, and in fact identical to other historical 100% reserve-type systems, such as the 17th century Bank of Amsterdam. You could of course “pay” directly with a 100g gold bar, or a 10g coin. But, even a 10g coin today is worth about $970, so that would be rare.
Quite a lot arises from this confusion between Money and Credit, and the very bad habit of mixing them together in some Theory of Money and Credit. I will talk about some of those consequences in the future.
