"It is curious that people tend to regard government as a quasi-divine, selfless, Santa Claus organization. Government was constructed neither for ability nor for the exercise of loving care; government was built for the use of force and for necessarily demagogic appeals for votes." ~ Murray Rothbard
The Reserve Bank of Oz (Part Two)
(Read Part One here.)
"We're off to see the Wizard, the wonderful Wizard of Oz. Because, because, because, of the wonderful things he does." ~ People of Oz
"I can turn paper into gold," the Wizard said.
The Council and the Sheriff laughed, but some fools said: "How?" The Council and the Sheriff then looked at each other sideways and asked the Wizard to come before them in private to explain this wonder. Some people said they wanted to hear too, but the Council assured them that they were wiser and did not want any distractions when listening to the Wizard to be sure that he did not fool them. The fools and their compassionate friends agreed that this was a good idea. So the Council, the Sheriff and the Wizard withdrew to Hyde Island, where they went behind Council Chamber doors to discuss the miracle of turning paper into gold.
The Wizard went before the Council with a smile and said, "Do you have banks in Oz?" The goldsmith said of course, he had the biggest bank in town. The wizard asked, "Do you provide certificates for gold bullion to your customers and are they traded just like the gold?"
The goldsmith laughed at the Wizard, "That's it? We have gold certificates that act like gold money, but you have to have gold to back up those certificates. It's the same as putting your horse at a stable with a record of account for your property. Other than my small fee for handling the transaction and storing the gold, it must all be accounted for or no one will use my services. I even tried making fake certificates and got away with it for a while, but a few people discovered it and word spread like wildfire. We even tried getting the sheriff to make them use the fake certificates, but it didn't work. It all turned out bad. You are wasting our time." The Council began to leave, thinking the Wizard was a fraud.
"Wait," said the Wizard, "I needed to see how sophisticated your money system was before I could tell you about the secret of modern banking so that you will understand." The Council, being in dire straights financially, decided to hear the Wizard out. The Wizard asked the Gold Banker if everybody ever showed up to redeem their gold certificates at the same time, and the Gold Banker said they did not, and that's why he thought he could get away with the fake certificates scheme before anybody got the wiser. The Wizard spoke as a teacher, "That is because you are a warehouse banker and not a modern banker."
The Wizard offered that if the Council would give him a salaried chair at Oz University, he would train a new generation of disciples to spread the word about the wonders of modern banking and they would all get rich. Oh, and it was good for the people too, overall, anyway, kind of. The Council agreed if this modern banking system did what the Wizard said it could, then he could have his salaried chair. The Wizard began to explain his miracle of modern banking.
"You need to understand three things that are tied together to form the fabric that acts as a veil over the system: fractional reserve banking, legal tender laws and credit expansion of the money supply." The council became quiet as they realized only a wizard would use such magical sounding words. "You have already done all of these things individually, and that is why they didn't work. They must be integrated and sold as banking reform to the people if they are to trust you again. Here is how it works."
"If you just print fake certificates hoping that nobody finds out, those sticklers about property rights will hound you to death just like when you clipped the coins. So you pass a law that says fractional reserve banking is legal, and I will teach students at the university that this is sound practice. We will write this for the newspapers to help spread these ideas. After a while when people give your bank 20 dollars and you loan him back 80 based on those reserves, they will think that is just fine."
"The people of Oz are too smart for that, Wizard," a Councilman scoffed.
"The beauty of my system is that, like the Emperor's Clothes, only smart people can see it. Nobody will want others to think they're not smart, so once I get all the smart people at the university and the experts who will work for the Council to understand, nobody will question it. We will only allow the smartest to enroll at Oz University and teach them the secrets. The university can let your kids in too, and everyone will think they are smart and elect them to the Council. We could start a secret club at the university for your kids so that we can teach them how to keep secrets from the others and make them feel more important than everybody else. We could call it Dungeons and Dragons or something spooky like that. The kids will love it."
"You see, I will teach my students about the 'law of large numbers.' This means that when you make things appear to be so large that they no longer have any meaning to any normal person, then you can tell them that what you're doing isn't really wrong even if it looks kind of wrong, and they believe you. The Sheriff will increase his staff to make sure that the bank is following the laws on how much reserves they must keep, and it all looks so official that it must be OK. People buy it all the time for long periods of time. Trust me, I've seen it."
"Wow! You really are a Wizard. You must be from New England ." The Council and the Sheriff were beginning to smile and get excited about this miracle of modern banking. "Please continue."
"I will also show you how to pay people a small amount of interest to 'invest' their savings in your bank, but then you hit them with fees to get it all back and then some. But that comes later. First, you have to have legal tender laws, which I know you are familiar with. The laws will work this time because they are integrated into the system with the wonders of credit expansion."
"Instead of printing fake certificates, you will print legal tender bank notes and give out loans with checks. Here's what happens. Say people put ten million ounces of gold in your bank, so you print up ten million ounces of bank notes and let people see this audited account. Trust is built, and we call this account asset reserves. These bank notes circulate and business picks up and people want loans. Up until now, you would put Joe who wanted a loan in contact with Bob who had money to loan, and they would work out the interest and repayment terms while giving you a fee for your help. Now you offer the service of paying everyone a fixed interest payment who wants to 'invest' their savings and spending money in your bank while offering to make loans to anyone who meets the banks terms. The people will love the convenience, and it appears completely risk-free to them. Savers get a safe and secure place to put their money at a guaranteed interest rate, and borrowers get a relatively low interest rate loan and longer repayment terms from a safe institution. Everybody wins, so it's an easy sell to the people."
The Goldsmith Banker jumped up, "We tried that too, but it got out of hand and we had a run."
The Wizard just smiled and continued, "That's because you stayed tied to gold. We are going to mix Council bonds with the gold and call them both assets, but I'm getting ahead of myself. In case you missed it, I'll note that the bank gets to loan people money that didn't really exist before the check was cut to the borrower, and then the borrower must repay the bank with real labor including interest. This magical system works because when you expand the money supply with credit, people go out and produce things to pay back the bank. When they pay the bank back, the money supply in circulation is reduced by the same amount you increased it when you made the loan. This is great, because the banks get some person's labor to replace what was just air. What a deal. When we sell this to the people, we can call it the Great Big Deal or something like that. Just not for them. How many working stiffs are ever going to look past their savings and checking accounts, horse and house mortgages to see the big picture?"
The Council began to murmur and stammer to one another. The Wizard could sense he was losing the Council. "This will work longer and better than anything you have ever tried going back to watering down your whiskey; yeah, everyone knew about that. The money supply does of course get a jolt when credit is expanded too fast, and misallocations will definitely occur, but that gets worked out too."
"You see, when the first really big correction, or depression or recession or whatever, comes along because of all these misallocations we caused, we blame it on the incompetent borrowers and businessmen and turn around and take the gold from the savers who were 'hoarding' it."
"Hey wait, that's us too. What do you mean?", several Council Members questioned the Wizard.
"Well, the people don't like you guys much anyway, which is why it plays so well to scapegoat some of you in public. So just take one for the team on that and be happy with the increased wealth and power of being connected to the Council and the Sheriff. And since you know that the Sheriff will be coming for everyone's gold in advance, you get to move yours to foreign banks, slowly, beforehand. We will use the gold the Sheriff takes from the people to be our reserves and stabilize the banking system. Now when the people panic and want us to pay them their gold, we must say people who want gold are endangering all the people who don't have gold, and move quickly to save everyone from each other. Since most people won't have gold and will want to protect their paper money and savings accounts, they will elect people who say that it's OK to take gold from people if they aren't loyal to Oz."
"Did you notice how your power is growing, Sheriff?" The Wizard looked to the Sheriff, who nodded his approval.
"Then you create a central bank and call it something safe sounding, like the Reserve Bank of Oz. That also helps give reserve banking an institutional sounding status, and we are home free. We use the peoples' gold as a reserve for a while and then, now this is the best part, we move the gold from the Reserve Bank of Oz that was holding it in trust for the people to Fort Oz where the Sheriff can better protect it. In the Reserve Bank of Oz vaults, we put Council Bonds where the gold was. Actually, we were already doing some of that as I said earlier, so it will look perfectly legitimate when we go all the way. Assets are assets, you know. I have turned paper into gold and then the banking system will always have virtually infinite liquidity, so you don't have to worry about runs. When the Council borrows lots of money, it looks really good for the economy. I will teach my students to say that Council deficits don't matter."
"The Council gets to raise money whenever it wants and put its bonds in the Reserve Bank of Oz vaults, and they get to then loan more money based on those legal reserves. Of course, the Council must pay off some bonds once in a while with tax money, and the Reserve Bank of Oz must sell some bonds to the public, but we just keep the pea moving under the shell to make it look like something's happening, and nobody asks the right questions until they're all just so confused they give up."
"Looks like I'm losing some Council Members here, so I'll summarize. OK, follow the pea. The Council prints a piece of paper that the Reserve Bank of Oz gets to hold as an asset, and then they turn around and create, say, five times that in loans with official looking paper checks, which tricks the people into paying it back. You see, we use their savings to create money out of thin air that we loan back to them. Then they work their butts off to pay us back with their labor, including interest. Plus you still get to inflate the currency and tax them directly to pay for some of the overhead, but it's easier and they'll think that that's OK to do too, after I get done with them at the university."
"Oh, and as a bonus, I'll teach you about withholding taxes from their paychecks so that they don't notice how much you're taking. We tell the people what we're doing up front and make it all legal instead of hiding it. Then it doesn't look like fraud, force or outright stealing. They will actually be begging the Council to work this miracle to save their jobs. The key to modern banking is honesty. When you can fake that, you got it made."
"Hello Wizard, I am Councilman Paul Ron, and I don't think you can fool everybody forever on this, and any system built on deception will eventually fail no matter how good you are at teaching the teachers."
"But that's one reason why we took all the gold. When this paper money is no longer accepted and we have to default on Oz Reserve Notes, and probably the Council Bonds as well, we just pass a law saying all those notes and bonds are worth, say, five cents on the dollar, find a scapegoat, invade some countries that refused to take them any more and reissue new bank notes based on the gold we have at Fort Oz. Then we start the process over again. You see, it's foolproof."
"You mean proof of fools. What about the long run and what about our grandchildren?", Councilman Ron dissented.
"In the long run we are all dead and your children will be just fine because you will keep your gold in foreign banks and the Council of Oz has its own gold. I figure if the foreigners buy into it, we could get over a hundred years out of it. If enough foreigners take our paper money, it will be mostly foreigners that get stuck holding the bag anyway. What a great system, huh? What do you say?"
The Council and the Sheriff quietly talked with the Sheriff, who stepped forward waving his hand at Councilman Ron to be quiet about morals because they were in an emergency situation. "Great Wizard, you truly can turn paper into gold. It is so bold that it will probably work. The Council agrees that you shall have your chair and we shall have modern banking for the good of the people of Oz. Thank you. We will have games and celebrations for the people. They will be happy when we tell them how we will provide jobs and easy credit for them. There's probably enough money to build a new Oz Sports Stadium for the people. Yes, they will be happy and we will be happy too."
So Oz was once again a happy place because of the wonderful things that the Wizard does.