In Chapter 2 we examined Carl Menger’s framework for defining money and its use primarily as a medium of exchange. Chapters 3–5 described the monetary and debt system as it exists today. I hope it left you with some significant doubts about the state of our existing financial system. Now it’s time to peel the monetary onion further to glimpse money’s fundamental core, which will help illuminate why some of the root problems with this system relate to characteristics of the fiat currency system that has been adopted throughout the world.

The 14 Characteristics of Good Money

As we established, money is fundamentally a medium of exchange. But what makes something a good medium of exchange? What causes it to accrue a monetary premium? It appears that moneyness is an emergent phenomenon that depends on the aggregation and interaction of a collection of lower-level properties. Aristotle is credited with proposing that money is durable, divisible, portable, and intrinsically valuable. This definition is a good start but still omits the majority of the factors that I believe define money. To my mind, good money has no fewer than 14 important characteristics. Furthermore, no form of money in the history of civilization scores highly on all of these factors—not a single one. This means that each form of money that has been used in society has strengths and weaknesses among its various characteristics. Here are my 14 Characteristics of Good Money.

1. Identifiable. Any time you are selling a good or service for money, you need to be able to identify the money you are receiving. The most usable money will be easily identifiable, because this reduces the work required for the seller to verify that she is receiving the amount of value for her merchandise that she thinks she is. Accepting money that isn’t valid results in the merchandise seller being defrauded. Such an outcome can occur due to negligence (the seller accidentally accepting a ten-dollar bill in place of a twenty-dollar bill) or due to a buyer attempting to purchase the merchandise using counterfeit money (whether a home-printed bill or a lump of fool’s gold). No form of money that is difficult to identify or easy to fake will succeed.

2. Transferable. Since money is first and foremost a medium of exchange, you must be able to efficiently transfer it to someone else and thereby transmit value.

3. Durable. Durability is important for transacting across both space and time. Money that is delicate and cannot survive travel is not very useful. Neither is money that is perishable. A staple crop that can rot or a metal that easily rusts or tarnishes is of limited use as money.

4. Divisible. In order to achieve salability across scale (see Chapter 2), money must be divisible into small units of value so that it can be exchanged for low-value goods and services and so that higher-value goods and services can be priced precisely. A type of rare shell used as money that is worth twice as much as a single book cannot be used to purchase the book. Likewise, a hundred-dollar bill is a very inconvenient way to buy a gallon of milk.

5. Dense. For money to be useful for sizable purchases, it must be relatively dense in value. A substance such as sand is quite divisible into individual grains that each have very small amounts of value, but those units are so low-value that even a great number of them in aggregate isn’t valuable enough to use as money.

6. Scarce. Throughout history, one of the major killers of currencies has been excess supply. The result is price inflation. A money whose value can easily be diluted due to increase in supply is doomed. Any successful money must be difficult to create. Its creation must therefore be costly. “Unforgeable costliness”, a key concept we will address later in this chapter is therefore crucial to any money’s long-term success.

7. Short-Term Stable Value. Even if it doesn’t lose purchasing power over the long term, a money whose purchasing power jumps up and down in the short term is of limited use. A money’s purchasing power is effectively its price, which is set by the balance of supply and demand for the money. Short-term supply/demand imbalances that dramatically move the money’s price (and therefore the prices of all goods and services in terms of the money) make the money less effective as a medium of exchange.

8. Long-Term Stable Value. Short-term price stability is useful for transactions across space and scale, but not across significant periods of time. Storing value in money in order to purchase a good or service at a much later date requires long-term price stability.

9. Fungible. Fungibility means that one piece of money of a given stated value is the same as all the others of that stated value. All units should be identical such that one piece can substitute for another, and no particular piece is deemed better or tainted. Precious stones like diamonds would be superior forms of money if each stone were not unique. The fact that there are differences between each individual stone requires the seller of the good or service to assess the value of the gem being offered, which significantly reduces ease of exchange.

10. Unseizable. Transferability is a double-edged sword. Money that can be transferred away from you without your consent (i.e., seized) is not as good as money that is hard to seize. The best money is resistant to parties who seek to seize it, including thieves, sticky-fingered border guards, invading armies, and corrupt tax collectors.

11. Censorship-Resistant. The type of transferability envisioned in the earlier definition is based on mutual consent by both the seller and the buyer of the good or service. As surely as a third party taking your money from you without your consent is a problem, so is a third party preventing you from engaging in a transaction to which both buyer and seller of a good or service have consented. You probably don’t want a third party to have the power to stop you from transferring the money to someone.

12. Private. Most of us don’t want every action we take (whether intimate, exciting, or mundane) to be broadcast to the world. Just as we would like to occasionally communicate privately, we sometimes need to transact privately. You might not mind having some of your purchases broadcast to the world, but you probably want to at least have the option of privacy on occasion.

13. Required for Some Important Purpose. One effective way of bolstering a form of money is to make sure it’s required for some purpose. Governments who require their native currency for payment of taxes are a good example. But a business can also create demand for its particular money by requiring its use when purchasing its goods or services, such as a laundromat that requires you to buy customer tokens to operate the washing machines, or a carnival that requires the purchase of tickets to spend on rides.

14. Backed by a Powerful Agent. It helps if a powerful agent or group of agents (such as a government) explicitly or implicitly supports it. Probably the greatest strength of the U.S. dollar is that it is backed by the world’s most powerful military. However, backing by a powerful agent can also be double-edged if it means less censorship-resistance and greater seizability.

Since no existing form of money scores highly on all of the above factors, it’s understandable that there are multiple forms of money in existence with different “scores” in the different categories. Let’s examine one modern form of money and one more ancient form of money and see how they rank. I score each category on a 0–5 scale, with 5 being the highest.

U.S. Dollar

Identifiable. 4 out of 5. Most people know more or less what cash bills look like. However, a portion of the bills in circulation are counterfeit. Electronic dollars can also be fraudulent in certain cases (as with debit card and credit card fraud).

Transferable. 4 out of 5. Physical cash is highly transferable, except you have to hand it off in person. “Cash” in a bank account (which is really a demand deposit) is highly transferable, except you have to pay a fee for large transfers, and such transfers take at least 24 hours to settle domestically and several days to settle internationally.

Durable. 4 out of 5. Physical cash bills are somewhat sturdy, and coins more so, but coins don’t store much value since they are low-denomination almost everywhere. Bank deposits are subject to the functioning of banks’ centralized information technology systems and also inter-bank payments/settlement systems including SWIFT (the Society for the Worldwide Interbank Financial Telecommunication).

Divisible. 4 out of 5. There aren’t many things that require payment of less than a penny. However, when paying for something using electronic dollars (via the banking or credit card systems) dollar payments effectively aren’t divisible to much less than a few dollars apiece because of minimum charges imposed by the payment systems. This appears to be the key reason that “micropayments” don’t exist in the United States today.

Dense. 4 out of 5. While the U.S. dollar allows for units as small as a penny, it also allows for relatively high value density through the hundred-dollar bill. A million dollars’ worth of hundreds can easily fit into a briefcase or backpack.

Scarce. 2 out of 5. The Federal Reserve tries to partially limit the supply of dollars, but it printed over $4 trillion worth after the Global Financial Crisis of 2008–2009. Every single fiat currency in history has ultimately been debased to a fraction of its original value.  Currencies that are scarce tend to be more resilient in the long run.

Fungible. 4 out of 5. Generally speaking, a dollar is a dollar is a dollar. However, there are certain cases in which dollars are “tainted” (e.g., when stolen from a bank and hurriedly spent). Also, some people won’t accept badly damaged or overworn bills.

Short-Term Stable Value. 5 out of 5. In the short term (e.g., today versus last month) the dollar’s value is quite stable. If you’re not ready to spend your dollars until next month, you don’t lose too much by holding them.

Long-Term Stable Value. 3 out of 5. In the long term, the dollar consistently loses purchasing power. Inflation has debased the dollar dramatically over the decades. Its value has held up better than those of many other fiat currencies, but that’s a pretty low bar to clear.

Unseizable. 2 out of 5. Bank deposits can be frozen or expropriated by the government. Cash can be seized if not extraordinarily well-hidden.

Censorship-Resistant. 3 out of 5. Physical cash bills are relatively censorship-resistant, provided the user isn’t under surveillance. But it’s hard to move lots of cash if you’re being watched. Payments through the banking system are certainly not censorship-resistant, as the government can prevent, freeze, or even reverse payments.

Private. 3 out of 5. Physical bills are generally an effective way of transacting privately, unless you are under surveillance at the time of the transaction. Another way privacy (and fungibility) can be foiled is by marking bills. Payments through the banking system are not private, since the government can easily monitor such payments.

Required for Some Important Purpose. 5 out of 5. The U.S. government requires citizens to use dollars to settle tax liabilities.

Backed by a Powerful Agent. 5 out of 5. The dollar is backed by the full faith and credit of the U.S. government, which is backed by the strongest military in the world.

U.S. Dollar Total Score: 52 points out of a possible 70. Pretty good.

Gold

Identifiable. 3 out of 5. A lot of people know more or less what gold looks like and how hard it is (hence the old trick of biting it to test its hardness). However, many people would not be willing to accept a payment in gold without an expert on hand to verify its authenticity.

Transferable. 3 out of 5. Gold is compact and can be carried, though the amount of value that can be conveyed this way is limited. It cannot be sent electronically, and it cannot be sent securely over long distances without great expense for shipping and security.

Durable. 5 out of 5. Gold is inert and can survive physical and chemical abuse far better than most materials.

Divisible. 2 out of 5. It’s not easy to carve up a block of gold, and it’s especially tough to divide it into pieces of value small enough that they are useful for everyday purchases. Even gold coins aren’t usually small-enough in denomination to be useful for buying a sandwich.

Dense. 4 out of 5. A 400-ounce gold bar is worth over half a million dollars assuming $1,300 per ounce of gold. At 25 pounds apiece, two bars can store a million dollars in 50 pounds of weight in a space that is smaller than a suitcase full of hundred-dollar bills but also heavier.

Scarce. 4 out of 5. There is ongoing gold mining, but that adds less than 2% to world supply annually.

Fungible. 3 out of 5. Chemically, pure gold is fully fungible. Unfortunately, it’s difficult to tell on the spot how pure it is, which makes it difficult to substitute gold in different physical forms.

Short-Term Stable Value. 3 out of 5. Gold’s price is somewhat volatile in the short term and frequently sees weekly movements in its purchasing power of several percentage points.

Long-Term Stable Value. 5 out of 5. Gold seems to have kept its purchasing power over centuries and even millennia. One popular metric is that an ounce of gold (today around $1,300) has purchased a man’s suit over the ages, whether at Brooks Brothers in New York today or at a toga retailer in Rome two thousand years ago.

Unseizable. 2 out of 5. Gold can be hidden, but protecting it reliably from seizure requires taking significant security measures. Good luck getting it past the border guard if you have to flee the country.

Censorship-Resistant. 3 out of 5. If someone wants to transact in gold, it’s hard to stop them, but they have to do it physically and in person.

Private. 3 out of 5. As with dollars, gold transactions via intermediaries, such as a gold fund or a gold vault provider, are not private, since the government can easily monitor such payments. Like dollar bills, gold coins can be traded privately unless they are surveilled, tracked, or marked. However, unmarked gold bullion traded physically is harder to track.

Required for Some Important Purpose. 3 out of 5. People the world over demand it, though such demand varies by country and often other substances (diamonds, silver) can substitute. Governments hold significant reserves, but only a fraction of the value of the total supply.

Backed by a Powerful Agent. 3 out of 5. Central banks buy/own/support gold in significant amounts, albeit less than when there was an official monetary gold standard.

Gold Total Score: 46 points out of a possible 70. Not as good as dollars, but better in certain categories and overall not bad.

The foregoing analysis is undoubtedly flawed and simplistic, not least because of the following limitations:

(A) The 0–5 scale has only six possible levels and therefore lacks precision.

(B) Reasonable people can disagree on the right score for each factor.

(C) Each factor is given equal weight, but some factors are likely more important than others, although this may depend on the user’s preferences (more on that later).

Nevertheless, this analysis highlights the important characteristics of good money, and it illustrates that some forms of money score better on certain characteristics than others. Moreover, since different people have different preferences, different forms of money can appeal to different people.

Just over a decade ago, a new form of money that is based on open-source software and native to the Internet was introduced to the world. In the next chapter we will see how it compares to the dollar and gold with respect to the 14 Characteristics of Good Money. But first we will augment our monetary toolset with a few more useful frameworks for analysis.

Money as Ledger

In Chapter 2 we noted that money must act as a medium of exchange, and to achieve this it must be a “store of value.” To accomplish this task, it must effectively act as a ledger. It’s easy to conceive of electronic bank account balances as a giant ledger that tracks who owns which amount of money. But physical U.S. dollar bills are also a sort of ledger since physical possession of the notes tracks ownership of a portion of the global total. Physical gold functions as a ledger also, as people know that extracting gold is expensive and that increases in its supply are limited to less than 2% annually (more on this later). A person who wears gold jewelry is effectively signaling to the public her ownership of a portion of her “account” on the global “gold ledger.” Monetary systems have always been ledgers that keep track of purchasing power, whether in (1) a computer database (as with a bank account today), or (2) a handwritten database (as with bank and merchant accounts hundreds of years ago), or (3) physical possession of gold coins or jewelry thousands of years ago.

Money as Story and Social Consensus

Perhaps nobody in recent history has done more than Yuval Harari to illuminate the governing dynamics of the human species. One of his key ideas is that the characteristic of humankind that has allowed our species to dominate the world is the ability to believe in stories that drive a social consensus. This is the only factor that allows “teamwork” among a group of people larger than about 150 (the “Dunbar number” cited in Chapter 1). If you are only able to cooperate with someone you know on a personal level, you won’t be able to cooperate with very many people, and you will never be able to construct a pyramid or engineer a modern airplane or deliver a package anywhere in the country within 24 hours. But if you can believe in a story that creates a social consensus and if others do the same, then you can create a large team to achieve a complex endeavor.

The concept of stories extends to many of the major social abstractions that literally govern our daily lives. For example, try handing someone a piece of the U.S. government. I am writing this book in my home office, which has at least a five-mile view of the city to the west since I live on a hill. Even from this perch, I can’t see any U.S. government anywhere around me. But the social consensus around the story of the U.S. government’s existence and legitimacy lives in the minds of over 300 million Americans, and this social consensus powers the world’s biggest economy.

One way to think about the story and associated social consensus is that the story includes the origin, which is then expressed in the detailed consensus. The story is often simple and principles-based. It exists in people’s minds. But the detailed consensus is often more complex, and in order for it to function, it must be explicitly codified and recorded. To flesh out the details, it must be written down. The story of the United States that we have agreed to believe in is that it originated in the attempt to escape oppression by a distant hegemon and was loosely defined by concepts such as liberty. That fuzzy idea was then codified in the Articles of Confederation, and later amended into the Constitution, which was itself subsequently amended numerous times.

Money, too, is a story about which we have woven a social consensus. The most popular forms of money have little or no value other than as money. This is true for the dollar, which has almost no non-monetary value.  It is also true for gold, which for centuries had almost no non-monetary value other than decoration, and later developed modest industrial uses, which still pale in comparison to gold’s monetary value. Once a form of money achieves status as money and accrues a monetary premium, it tends to maintain that monetary premium for a significant period of time as the social consensus around it attains a certain durability.  A key source of the durability of this consensus is money’s characteristic of being a protocol.

Money as Protocol

It has been argued that money is speech. Leaving aside legal definitions of speech, money certainly exhibits characteristics of language. While spoken or written language is a system for transmitting information, money is a language for transmitting value. Language has a “network effect”; the more people that use the same language, the more useful (and therefore valuable) that language is. This increase in value is true not just in aggregate, but also per user.

Nations and peoples have their own languages. However, the most successful people learn not only their native language, but also that of the global hegemon at the time. Whether Latin, Spanish, French, or English, there has for large portions of history been a common language used across nations. Partly this is a result of imposition by the dominant military and cultural power of the age. But aside from the threat of violence, a key driver of common language usage is the huge economic efficiencies realized by sharing a language. Notwithstanding the rise and fall of various superpowers over centuries, national languages have also succeeded within their borders due to the efficiency benefits of coordination. Any emperor could tell you that governing lands populated by people who do not speak the same language is difficult, and this fact has been known at least since the Biblical story of the Tower of Babel.

As with governing or coordinating people who speak disparate languages, conducting commerce is inefficient if you are saddled with many different currencies. Paying the butcher with a different currency than you pay the baker is cumbersome. Taken to an extreme, we can imagine a world in which each person has her own personal currency. In exchange for a copy of my book, I demand Andybucks, and in order to buy goods at Target I have to swap my Andybucks for Targetbucks. Then Target trades away its Targetbucks to pay its employees each in their own personal currencies. This world looks similar to the Tower of Babel story, in which everyone speaks a different language and therefore cannot communicate with each other.

As we observe many of the same “network effects” arising from using the same money as from using the same language, what becomes evident is that both money and language are characterized by networks. But both money and language are also protocols. Merriam-Webster’s online dictionary includes several definitions of a protocol. Generally, a protocol is a set of procedures or rules for acting. In the context of participants in a network, that means a set of procedures or rules for network participants interacting with each other. Thinking about money as a type of protocol for interacting within a network is useful because it highlights the issue of network effects and other characteristics that we will explore later.

Today the U.S. dollar is a protocol on which numerous higher-level systems are built. These higher-level structures include the payments system; the banking system, which in turn includes the subsystems of mortgage lending, consumer lending (through credit cards and other instruments), and a portion of the market for corporate lending; the petrodollar system, whereby most oil contracts are priced in dollars; the world’s largest corporate bond market; and the world’s largest government bond market. All of these systems are denominated in dollars and depend on the dollar as a base protocol.

For something to become used widely as a monetary protocol, a social consensus must first develop among its users. Such a social consensus does not arrive out of thin air. It arises from the set of fundamental characteristics identified earlier as the 14 Characteristics of Good Money.

Scarcity from Unforgeable Costliness

Digital currency pioneer Nick Szabo defines scarcity as “unforgeable costliness.” According to Szabo, this can be achieved by an object via either the “improbability of [its] history” or its “original cost.” Improbability of history explains why asteroids are scarce. Space rocks don’t hit the earth’s surface very often. Historical artifacts, antiques, and other collectibles are scarce because there are a limited number of objects relevant to major historical events. But for most objects, scarcity arises from the fact that it is expensive to create or acquire the object. Practically, this expense of creation or acquisition arises from the energy required for creation or acquisition. The Great Pyramid of Giza in Egypt is obviously a scarce item because it’s clear that cutting, moving, and stacking 50-ton stone blocks is a very costly and energy-intensive exercise. There is little doubt that a significant economy was harnessed to create the Great Pyramid. Its very existence is proof of expenditure of vast amounts of energy (i.e., a “proof of work”) and evidence of unforgeable costliness and therefore scarcity.

If you’re married, chances are good that you have experience with unforgeable costliness and scarcity. The diamond ring that cost thousands of dollars isn’t merely a beautiful trinket. It could easily have been replaced by a plastic one that fools the untrained eye, or even a lab-manufactured one that fools the chemist’s well-trained eye, since lab-grown gems are chemically identical to the gems found in the ground. But such substitutes for a diamond pulled out of the earth are not scarce because they are not unforgeably costly to produce. For many brides, only a scarce and unforgeably costly mined diamond will do.

Diamonds are somewhat of a money substitute, and in a world without better options, they might feature more prominently as money. However, they are significantly hampered by their lack of fungibility (since each diamond is unique), limited divisibility (since it’s tough to make small change in diamonds), and difficult identifiability (since it’s possible to pass fake ones off as real to the untrained eye). But there are other scarce and unforgeably costly physical things that come out of the earth that have been among the most popular forms of money for millennia: monetary metals.

Monetary Metals

Monetary metals score well on the 14 Characteristics of Good Money. As a result, they have enjoyed a long and complex history as money. This history extends far beyond the scope of this book, and other writers have catalogued it exhaustively. But we will hit a few key points because they underscore the 14 Characteristics of Good Money.

There have been periods in history in which multiple metals served as money, including gold, silver, and copper. Gold won in the long run for a few key reasons. Relative to other monetary metals such as silver and copper, the primary reason for gold’s long-term success seems to have been its very high stock-to-flow ratio. Most metals have stock-to-flow ratios of around one or less. That means that in a given year, the amount of stockpiled inventory of the metal is approximately equal to the amount that was produced over the course of the year. This implies that people consume the metal almost as quickly as it can be produced. Gold stands in stark contrast to “industrial” metals that have low stock-to-flow ratios. Because of its few industrial uses (it doesn’t get “used up”) and the fact that gold has been mined for thousands of years, above-ground stockpiles of gold are enormous compared to annual new production. Such annual production has not accounted for more than 2% of the existing above-ground stock since 1942. This means that gold’s stock-to-flow ratio exceeds one divided by 2%, which is to say that it exceeds 50.

This huge stock-to-flow ratio means that incremental supply is extremely inelastic to price. If an increase in demand for the metal causes the price to rise in the short term, suppliers cannot flood the market with supply and crash the price. For example, if the price of gold doubles tomorrow and new supply also doubles, as excited gold producers open new mines or re-open previously idled ones, the annual production will still be less than 4% of the existing stock. In contrast, a doubling in the price of copper could cause an over-reaction on the supply side, resulting in annual production as a percent of the existing stock jumping from 100% to 200%. Such a huge increase in supply could tank the price. Indeed, history demonstrates that industrial metals such as copper experience large fluctuations in supply and in price. Gold’s relative immunity to such outcomes has cemented its place as the monetary metal of choice.

Embedded in this dynamic is the underappreciated fact emphasized in Chapter 2 that the best money is something that is useless as anything other than money. Therefore, a commodity that has significant industrial utility actually makes a worse money than a thing that has little or no industrial utility. This is because any commodity with industrial uses generally gets consumed almost as quickly as it is produced, which prevents the accumulation of a significant stock of the commodity over time. This results in very low stock-to-flow ratios that can result in huge fluctuations in supply that cause huge fluctuations in price. Such large fluctuations in price make industrial metals bad stores of value and therefore ineffective media of exchange across time. Based on Bloomberg data, gold’s average monthly price volatility over the last 40 years measured by standard deviation of price change is 5.3%. For silver and copper, the figures are 10.1% and 10.7%, respectively. Therefore, silver and copper each have price volatility measured by monthly standard deviation in price movements that are roughly double that of gold.

Another reason for gold’s greater success as money than silver or copper is its durability. Gold is almost completely inert and, therefore, does not corrode over time. In contrast, silver and copper tarnish or rust over time. Additionally, gold has been favored over silver or copper because of its higher value density due to its greater scarcity. Fewer ounces of gold have been discovered in Earth’s crust than of silver or copper. This has helped achieve a value per ounce that is much higher than those of silver or copper.

This high value density is a double-edged sword. One of the key reasons that silver and copper have been used as money historically is that they can be coined into smaller amounts of value. They score better than gold on Characteristic of Good Money #4: Divisible. This makes them better media of exchange across scale than gold. Silver especially proved resilient as a monetary metal on and off for centuries, but its death knell came with the spread of gold-backed paper currency. Such gold-backed paper money took advantage of gold’s immense stock-to-flow ratio and resultant short-term and long-term price stability, while also allowing the printing of small denomination notes that facilitated transacting at low levels of value.

Fiat Money as a Regressive Taxation System

In the last few centuries, gold-backed paper money systems were not uncommon, with the most recent manifestation being the 27 years of the Bretton Woods system (1944-1971). Unfortunately for their citizens, governments realized that they could centralize the custody of gold in vaults, and once they had done so, it was too tempting to move to a fractional reserve system. A government that could print $20 bills at a cost of 10 cents each could collect the difference as profit, known as “seigniorage.” This potential profit was too enticing to resist.

For a time, these systems allowed governments to take advantage of the seigniorage they generated by running fractional reserve gold-backed paper money systems. Users were technically allowed to redeem their paper notes for gold, but the central bank didn’t have enough gold to satisfy all claims. Ultimately, these fractional reserve gold-backed paper money systems failed as noteholders sought to redeem their notes for gold, knowing that if they didn’t, someone else might redeem their stake and leave the rest of claimants without any golden collateral to claim. Governments can’t seem to resist the temptation of printing free money (notes/claims) “backed” by gold until the gold backing is so diluted that noteholders demand their gold back and the edifice crumbles in a classic “bank run.”  When Richard Nixon announced the “temporary” (ultimately permanent) end of the Bretton Woods gold-backed paper money system on August 15, 1971, it was effectively the end of gold-backed money in the modern era. From that moment onward, governments have been able to print money at near-zero expense and without the potential discipline imposed by the threat of holders demanding gold in exchange for their paper claims.

Today, this seigniorage, which is really a stealth tax, amounts to roughly $20 billion annually for the U.S. dollar. Unfortunately, this stealth tax is regressive. The rich, who have accumulated assets, have greater access to higher-return investments (the capital goods described in Chapter 2) than the poor do. This occurs for the simple reason that everyone must maintain at least some amount of money just to function in society, since operating in a modern economy requires transacting. This “working capital” required to buy groceries and pay the rent must be held as money, which under a fiat system loses its purchasing power via the stealth tax of seigniorage. Those people who have been able to accumulate some surplus wealth can invest it in capital goods with positive expected returns. But the poor who can accumulate only enough capital to fund their working capital needs (by holding money) see the value of that capital fall every year.

It is therefore the poor who suffer more from the stealth seigniorage tax than the rich. Certain candidates for political office have recently been calling for a wealth tax as a progressive tool for redistributing assets from the rich to the poor. Unfortunately, we already have an inflationary seigniorage wealth tax on money that does the opposite by hitting the poor hardest.

Fiat Money as Regressive Subsidy to the Banking Industry, Corporations, and the Rich

While monetary inflation is a regressive tax that hits the poor hardest as a percentage of their income and wealth, proponents of this system label it “fair” based on the logic that all dollars are effectively taxed by seigniorage at the same percentage. Seventeenth-century economist Richard Cantillon recognized the folly of this argument, and Mises later articulated it further in Human Action. While it’s true that over time printing money will result in a general rise in the price level of goods and services in the economy, it doesn’t happen simultaneously across goods and services.

For example, when the central bank creates new money, it flows first to the financial system and primarily the banks. They are given the privilege of being the first to take those dollars into their reserves and then lend them to the businesses they think will offer the greatest risk-adjusted return to the bank. In turn, the businesses owners (capitalists) who receive those loans can make more capital expenditures and pay their workers more. This results in those workers being able to pay more for goods and services and bid up the prices thereon. So, the bankers get the money first, then the business owners, and last the workers. Considering that bankers and business owners tend to be wealthier than wage-earning workers, the system creates another regressive effect.

Another major subsidy that flows from the Federal Reserve to the broader banking system is the payment of interest on bank reserves held at the Federal Reserve. Currently, the Federal Reserve pays banks 2.35% annualized interest on funds that a bank deposits at the Federal Reserve. Such deposits are free of default risk since the Federal Reserve can always print money to satisfy such obligations. As of May 2019 the amount of reserves that depository institutions (mainly banks) were required to hold at the Federal Reserve was $200 billion. But the amount that institutions deposited in excess of that minimum was $1.368 trillion. Last I checked, the checking and savings accounts that I maintain at major national banks are paying me less than 0.1% interest. Effectively, the banks can hold my deposits, pay me 0.1% interest, and lend my money to the Federal Reserve risk-free to earn a 2.25% net interest margin. Applying this 2.25% net interest margin to the $1.568 trillion of total reserves ($200 billion minimum reserves plus $1.368 trillion excess reserves) implies a subsidy to the banking system of over $35 billion annually! 

It’s interesting that a group of businesspeople recently attempted to open what’s known as a “narrow bank.” Under this business plan, the bank would limit itself to one function only: taking its customers’ deposits and depositing them with the Federal Reserve to earn the 2.35% the Federal Reserve is paying. No business loans, no mortgages, or other typical bank activities—just collect the 2.35% from the Fed, take a cut for expenses and profits, and pass the rest to depositors. An actual company called the Narrow Bank filed its application in August 2017. Almost two years later, the Federal Reserve has not approved the application. I suspect it’s because it shines a spotlight on the Fed’s blatant giveaway to the banking system.

The Fed’s outright subsidy to the banking system is just one of the signals of the dysfunction of the existing monetary system. The Federal Reserve subsidizes the banking system, but not the ordinary depositors, like you and me, who hold bank accounts. And if anyone tries to challenge that system and return some of the profits to the people, as the Narrow Bank group has done, the Federal Reserve succumbs to pressure from the banking industry and stalls, offering up a variety of explanations for why it is doing so that ultimately amount to “because although it would be good for you and me, it’s bad for the banks.”

The Federal Reserve uses inflationary seigniorage to regressively tax the poor more than the rich. It further subsidizes the rich by keeping interest rates artificially low, which raises the prices of investment assets (capital goods) that are owned primarily by the wealthy. It prices young homebuyers out of the housing market because they can’t scrape together ever-rising down payments on ever-rising home prices. And it threatens to lower interest rates ever further in a misguided effort to “stimulate” the economy, which only stimulates ever-increasing debt incurrence. A decade ago, endless money printing and financial repression would have appeared inexorable. But now we have a potential solution.

It’s called Bitcoin.