Author: @DoctorTaylorJay

In 2019, I committed to a weekly blog post on Tuesdays. Since then, I have almost always achieved that. This week will be a little bit of an update on my plans with this blog and then a rant about academic writing.

I am spending a lot of time creating an index post for the Theory of Money series. This involves me reading each post and figuring out how to summarize it in a single paragraph, which is not easy. I hope to have that ready by next week so it can be my next Tuesday post.

After that, I will get back to healthcare. Like I was saying before I started the Theory of Money series, I have been wanting for quite a while to start over reading different foundational healthcare economics and policy writings and sharing what I’m learning from them.

This will help me build a database in my reference manager of all the topics that interest me, so I’ll have ready access to lots of articles that support anything I’m writing about. And I hope it will be instructional for you guys as well.

But I don’t think doing that will solve my primary ongoing challenge related to referencing primary sources in a lot of my posts: Much of what I write about does not lend itself to citing studies.

If, for example, I’m talking about the different levers that determine profit, what am I supposed to cite? A Business 101 textbook? Or if I’m writing about my synthesis of the different building blocks that make up every payment reform program (shared savings, quality-contingent bonuses, etc.), what am I supposed to cite as evidence for that? How about when I write about the evolution of pharmacy benefit managers? There aren’t any academic works that talk about that, or if they do it’s based on the same information I’m using–educated inference and some interviews.

I had a medical student reach out once, asking for more evidence on a post I wrote, and I had to just send her the names of my favourite writers and thinkers on healthcare and tell her that they were my inspiration but that the synthesis was my own.

This sort of writing is looked down upon in academic circles, even when it’s information that is not amenable to citations. So what is a rational person to do? Just find something, anything, to cite anyway. I see this whenever I get notified that my Rewarding Value Instead of Volume article gets cited. I’ll go and read the section of the paper that cited my article, and I’ve never actually felt like my article was supporting what they were saying.

Here are a the most common citation-adding tricks I have seen academic writers use in my field to give their writing the illusion of academic rigor:

1. Throw in a citation to something that is at least somewhat relevant, even though you haven’t read it and it doesn’t actually support what you’re saying. Nobody will notice unless they actually go and read the whole article you cited. You think reviewers are going to question those citations? Maybe only rarely.

2. Say a whole bunch of unproven stuff, but then make it look like it’s evidence based by finding an example of hard evidence that’s at least obliquely related to a small part of what you just said.

3. Similar to the last one, say a bunch of unproven stuff and then find a random evidence-based statistic that at least establishes the truth of a peripheral aspect of your argument.

4. Possibly the most comical one, this is a two-step tactic. Step 1: Publish a paper with lots of citations and make sure to mix in some of your unproven or not-amenable-to-citations ideas. Step 2: Publish another paper, write those same unproven or not-amenable-to-citations ideas, and then cite your first paper as evidence of them. Mark Pauly, one of my favourite healthcare thinkers, does this all the time–and I absolutely can’t blame him because so often he’s writing about the same not-amenable-to-citation ideas that I do.

There are many others. This article does an awesome job of going through this issue in much more depth, and it lists 13 different tactics.

So what’s my point?

I am annoyed at the state of scientific writing with its overemphasis on citations. It dilutes the usefulness of any citation. It encourages deception about the reliability of things written. And it underappreciates any not-amenable-to-citation ideas (unless bogus citations are padded around it), including many of the things I write about.

Moving forward, as I acquire more and more legitimate citations, I will start including them. And for things that are not amenable to citations, I’m not going to add bogus ones.

This is it! The final post of this series.

In Part 42, I described the “catastrophic method” for getting us back to a sound monetary system. In this post, let’s explore the gradual method for doing so.

First, to recap, what is the most sound monetary system we want to get to? A mix of commodity money and 100% backed receipt money. And to add a couple more specifics, we want the commodity that this monetary system is based upon to meet as many criteria as possible for optimal money, as described in Part 9, especially the “stable value” characteristic because accurate prices are the most important component to the health of an economy. The receipt money could be paper issued by banks or, potentially even better, electronically issued tokens by a few competing cryptocurrencies, but we probably don’t want people to completely switch over to using exclusively receipt money, so hopefully the commodity is convenient enough and beautiful enough and hard enough to counterfeit to be desirable for regular use as well.

So how do we go about gradually shifting to that kind of monetary system? There are three main tasks we need to complete:

1. Get rid of the central bank
2. Get rid of fractional reserve banking
3. Trade out the 0% backed fiat dollars for an actual commodity

The first issue is a simple one. Repeal the Federal Reserve Act of 1913. Calls to “end the Fed” would be satisfied with that simple repeal because it would immediately get rid of the Federal Reserve.

But what about the 20% of the total U.S. federal government’s debt that the Federal Reserve owns? I say repudiate it. This means those private banks that own the Federal Reserve will stop getting interest on all that money that they created out of nothing, but I think that’s ok because it’s time for the government to stop transferring our wealth to those banks. Remember how the only reason the government designed it this way was so it could get away with creating the central bank in the first place? There was otherwise no need for the government to be paying interest to anyone for creating more of its own fiat money.

Boom, 20% of the debt is gone. The other 80% will still need to be paid off through future taxation, but that can happen regardless of the monetary system we have. We’ll just have to keep waiting for the political will to do it . . .

Once we’ve gotten rid of the central bank, it means we still have a 0% backed fiat currency, but it no longer has the capacity to create any more money. This, in and of itself, would be a major boon to all Americans because now the government doesn’t have the ability to generate inflation, including unmeasured inflation (discussed in Part 35), which means the purchasing power of the money we’re earning would finally start consistently going up again after generations of stagnation. Without a central bank, another thing that would go away would be all the tampering with the money supply, which is done primarily through altering the required reserve ratio and the discount rate. We would have a stable money supply! The boom-bust cycle would be over. Yes, of course there would still be economic challenges, but at least the worst ones, which are induced by expanding and contracting our money supply, would be gone.

But we can do better than that–having a stable money supply is good, but it’s not nearly as good as having a stable value currency, which can only come through using a commodity to back our money. This is why abolishing the Federal Reserve is only the first of three tasks we need to complete.

Our second task is to eliminate fractional reserve banking. Why would we want to do that?

Because we want to stop banks from making exploitative loans using our wealth. We want that wealth back so that we can use it for ourselves rather than letting banks permanently borrow it and earn money on it.

Unfortunately, getting rid of fractional reserve banking is going to mess with our newly stable money supply. I’ve said before, though, that inflation or deflation isn’t so bad if it’s slow and consistent. So what we need to do is slowly raise the required reserve ratio until it’s back up to 1.0. For the sake of deflation being more predictable, I think the government needs to set the reserve ratio increase schedule, report it publicly, and then stick to it exactly.

How fast should we go? I suggest doing it over 30 years. This allows prices to adjust nice and slowly and also allows longer bank loans, such as mortgages, to mature naturally. And whenever a loan term is completed, the bank will probably not make a new loan. In this way, the reserve ratio slowly rises back up to 1.0. This 30-year timeline prolongs banks making exploitative loans with our wealth, but the benefits of stability to the economy probably outweigh that.

One thing to bear in mind while all of this deflation is happening is that the U.S. government still has 80% of its debt to worry about, and being a debtor during inflation is a bad position.

How does deflation harm debtors? If the WU:money exchange rate was 0.05 when the government borrowed $1 billion, that means it borrowed 50 million WUs. Then, if a lot of deflation happens so the WU:money exchange rate increases to 0.25 and the government hasn’t paid off its debt yet, the government now owes 250 million WUs. That’s not a good deal.

Rather than expect the federal government to pay off the rest of its debt before we start raising the reserve ratio, I say we simply have the government alter all of its debt contracts to say that the value of the principal will adjust with inflation or deflation.

There’s a little snag to this. Remember that economic growth increases the WU:money exchange rate. So if, during the time that we are phasing out fractional reserve banking, there is any economic growth, that means money will become more valuable, and this is an additional independent factor that will be increasing the WU:money exchange rate, totally separate from the shrinking supply effect on it.

So even if the government debt of $30 trillion shrinks with deflation over 30 years to be $3 trillion, the government will still be overpaying.

So maybe you add an adjustment factor for economic growth in there or something. Voila, math problem solved. Let’s move on.

So where are we now? The currency has become a 0% backed non-fractional reserve stable supply currency. Did you process all that? The point is, no central bank, and now no more exploitative loans, which means no more banks taking our wealth to earn interest off of it! Instead, we now get to keep our wealth.

This has been another huge step forward. But there’s one last task to complete: We need to shift our currency to a 100% backed currency.

The time has finally come to open Fort Knox–plus the other government gold repositories–and find out how much of the gold is actually left. Actually, we should audit the government gold stores at the very beginning of this whole process so that the government is unable to sell off any more of it without accountability. Yes, when everyone finds out that not all of the gold is there, it will threaten our status as the reserve currency for other currencies. But hopefully these efforts to get to a more sound currency will counteract that.

Once we have calculated the total amount of government gold stores, we do a simple calculation:

Total grams of gold / Total # of USD

And now we know how much gold each USD represents based on the existing stores. So, if we wanted to be hasty and immediately require everyone to switch out all of our USD for gold, there could be a redemption period where any owner of USD could bring it to Fort Knox and get the corresponding weight in gold. So if each USD ends up being worth 0.1 g of gold, that means you could bring $10 to the government vault and exchange it for 1 g of gold.

And this is where things get dicey. Because people are about to get hit with a loss of Wealth Units when they make that exchange. For example, if there’s only enough gold to give people 1 g for $10, but the market price of gold says that 1 g of gold is worth $20, people are about to lose half of their cash wealth when they are forced to make that exchange.

And the poor will get hit the hardest since they tend to have a larger percentage of their wealth stored in cash rather than non-cash assets. Some of that financial damage may be mitigated by the fact that, by this point, we will have been free from a 0% backed fiat currency for long enough that the wealth of Americans will be in a much better place, so instantly losing some percentage of their cash wealth would not be as devastating as it would be right now. But it would probably be devastating to many people nonetheless.

This “gradual method” has been trying to switch to a sound currency carefully to avoid sudden shifts in the value of money, so is there a way to do so in this third task as well?

Yes–again, we’re going to have to do it the slow way. Before retiring the USD and requiring everyone to exchange their Federal Reserve Notes for gold, the government will have to accumulate enough gold to be able to make the exchange at market prices to avoid causing anyone to lose any Wealth Units in the process. This would probably involve a requirement that the government use a certain percentage of its tax revenue each year to acquire gold. And that definitely going to increase the demand for gold worldwide, so it may be a rising target.

But, once the government finally has enough gold, it can lock in that market price as the exchange rate and initiate the exchange window of time. And when that exchange window ends, the government will officially declare the USD to be retired, and any remaining Federal Reserve Notes and token coins will be worthless from a currency standpoint.

*Moment of silence for the end of the USD* no, nevermind

One risk that is worth pointing out with this gold-accumulating method is that if the government declares that it is going to retire the USD and completely switch to gold, and then it announces how much gold it still has, the value of the USD may immediately drop to reflect the market price of gold.

Does this mean the government has to keep the amount of gold it has a secret? Maybe it does. But once the USD has been retired, then it can declassify how much gold there actually was. I hope they also release who spent the gold and how it was spent.

And there you have it. Task three complete: The currency has made its final transition to a 100% backed commodity currency. And now, finally, we can expect the value of money to be highly stable. There is sure to be some short-term price fluctuations with the final exchange of gold and USD, and there will be some mental effort of switching over to denominating cash wealth in terms of weight of gold. But just like you start to get used to prices pretty quickly when you visit a new country and use their currency, I think it will be a quick transition in the United States as well.

And then the competition will be on to see which form of 100% gold-backed receipt money–bank notes or crypto–wins out. Or maybe there will be room for all of them in the market. Ultimately, those details don’t matter nearly as much.

Now that we’ve discussed the catastrophic method and the gradual method for switching back to a sound monetary system, which one would you prefer? Which one do you think is most realistic?

I think the catastrophic method is more likely. It’s hard to imagine this ever happening since nearly everyone alive has only seen USD as the currency in America, but the history of the world is littered with the great empires of the past and their fallen currencies. My hope is that having the USD collapse as a currency will actually preserve the United States, so maybe the catastrophic method is better because it will get us to a healthier place faster. Rip the bandage off, right?

Understanding all of this creates a kind of strange persistent cognitive dissonance. On the one hand, my brain tells me that the USD will live forever, and my brain projects forward a future that is generally the same as the past but with more technology. And on the other hand, my brain knows that a correct understanding of the principles of how the world works–in this case, monetary policy–confers a powerful predictive ability, and I see the writing on the wall when it comes to U.S. government spending and the risk for eventual hyperinflation of the USD.

I see the Establishment, which I define as the millions of people who have found a way to take advantage of the complexity and non-transparency of our government and get a slice of the government spending pie, as the major driver of our government’s overspending. And, fortunately, the Establishment is not a monolithic unified group; rather, it’s people and their organizations that have found themselves in a position to profit off of the out-of-control government spending. And the fact that they’re not unified is a good thing, because it means they will all independently fight with every tool in their arsenal to influence politicians and bureaucrats to keep the money flowing to them. This is why any cut in government spending is so difficult. And it’s what will push us toward hyperinflation.

Do you see the irony here? The collective greed of the Establishment will become the means of our liberation from the bondage of our 0% backed fiat currency. But this won’t come without great cost to the generation that experiences it.

**********************

I guess that’s it. That’s the end of what I set out to explain about the theory of money.

I am struck right now by two things: (1) the extent to which we have been royally screwed by governments and their modern monetary policies, and (2) the extent to which people don’t even know that they’re being screwed. Heck, I had no idea about any of this, even after an undergraduate business degree from a traditionally conservative university, until monetary theory became a passion of mine and I started intensively studying the topic for fun. It’s been an incredible amount of reading and time and mind-twisting agonizing grappling with confusing ideas. And I hope the eventual clarity I was able to wrest from all of that miasma of confusion and complexity has been effectively conveyed in this series.

If, by now, you understand clearly that our 0% backed fiat currencies are a form of wealth bondage that has stolen the prosperity that our parents and grandparents labored so hard for us to get, then you might be angry. Maybe you’re even looking for someone to blame.

The problem is, we can’t really blame anyone for this. The two groups most responsible for getting us here–politicians and bankers–have made rational and even justifiable decisions all along the way, which I’ve tried to show in this series. I guess the default path of some things in this universe tends toward bad outcomes. And the economics of money is one of them.

So instead of reacting unproductively to that anger, I hope you can channel it into motivation to help fix things. Talk to people about these ideas. Share them. Support politicians who are pushing for the necessary changes. The more these ideas spread, the more support for the right kind of policies will arise, and the more likely we are to win in this fight for freedom from monetary system bondage. And maybe, in the future when new governments and monetary systems are being crafted, the right constitutional restrictions will be put in place to prevent these issues altogether.

Thank you to everyone who has followed along for almost a year of money blogging (on a healthcare policy blog no less!) as I sated my desire to make this information accessible to the world. I hope it has enriched your life and made your dreams of a better world more vivid.

In Part 41, I described what I believe to be an optimal monetary system, which is based on commodity money and 100% backed receipt money. It is simple, it does not allow for any manipulations of the money supply, and it should be very stable from a value standpoint as well.

In this post, let’s sketch out a pathway toward that kind of monetary system for the U.S.

There are two different methods to getting there: the catastrophic method and the gradual method. I’ll describe the former in this post.

The catastrophic method is pretty straightforward. For whatever reason, the government loses all restraint with how much new money it’s creating and kills the goose that’s laying the golden eggs (which is its 0% backed fiat monetary system). By creating too much new money, it induces hyperinflation, and the monetary system collapses.

I’ve already outlined possible ways this could happen in earlier posts, but something I never explicitly stated is that any major innovation that significantly brings down the wealth prices of things and generates a lot of economic growth–such as the impending AI revolution–could trigger hyperinflation.

It would happen like this: the government loosens the purse strings as it soaks up all of the unmeasured inflation without people noticing, the potential for unmeasured inflation decreases again as the economy gets back to more normal rates of innovation and growth, the government can’t tighten those purse strings back up, huge government deficits are no longer hidden by unmeasured inflation and turn into measured inflation, government has to print even more money each year to maintain programs, and the death spiral of hyperinflation ensues.

We actually saw a mini version of this during and after the COVID-19 pandemic. Government spending to stimulate the economy and also to deal with the costs associated with the pandemic (including higher prices due to disrupted global supply chains) skyrocketed, which caused tons of inflation, and then even after the pandemic ended the government wasn’t able to get back to pre-pandemic levels of spending.

The central bank will do everything it can to shrink the money supply to restrict inflation, but there’s a limit to how much it can do before it starts interfering with economic growth (and, thus, innovation), which then kills the potential for unmeasured inflation. And if there’s no capacity for unmeasured inflation, then all of the inflation will be measured inflation, which works against what the central bank is trying to do, so it has to shrink the money supply even more aggressively, which slows down the economy even more, which requires even more aggressive constriction of the money supply. . . . Do you see how that turns into a downward spiral too? The point here is that central banks don’t have an unlimited capacity to prevent hyperinflation. They do what they can to stabilize inflation–and they succeed 99% of the time!–but there’s a tipping point where they become helpless too.

People, seeing the rapid rate of inflation, realize that if they don’t spend their money this week, it could be worth half as much next week, so they start spending like crazy, probably including buying crypto. Short-term demand for food and other non-cash assets skyrockets, which increases prices.

Businesses are also realizing that they need to price things to take into account how much less the money they’re getting will be worth next week, so they are pricing with an anticipation of further rapid inflation.

All these factors combine to cause prices to launch up so fast that people are soon paying with wheelbarrows of money. We’ve seen this many different times in history.

When the value of money drops so rapidly like this, it soon becomes completely worthless, which means people lose all their cash assets. Luckily, most people probably have more assets stored in non-cash assets, so many people do okay in this situation. But not everyone. Those who didn’t have any food storage or emergency supplies (like a generator for when the power grid goes down as a result of all of this turbulence) are going to have a rough go of it. There will probably be starvation. Also, many creditors who had long-term contracts suddenly have no claim anymore because their debtor just paid off their entire loan with worthless money, so many financial lives and financial institutions are ruined.

And then there’s the effect on the economy as a whole. When an economy loses its monetary system, which acts as the grease that lubricates the gears of the economy to keep it moving forward, economic activity grinds almost to a halt. Very quickly you discover the incredible utility of having a common medium of exchange and the reliable prices that arise from that common medium of exchange. Having an economy without those would be catastrophic. That’s why I called this the catastrophic method.

The upside of all this comes when there’s no official money anymore. Initially, people revert back to the very beginning of the evolutionary road of money and enact trades through barter. And, soon enough, generally accepted commodities to facilitate exchange start to naturally arise. We call that commodity money. My hope is that this is the point where 100% backed cryptocurrencies would come into common use as a convenient means of storing and transferring that commodity, which is what I described in Part 38. But, with crypto or not, a society in this situation starts over with the progression of money that we just went through in this entire series.

If 100% backed crypto fills the giant void left by the collapse of the 0% backed fiat currency, it may stay there permanently. But I doubt it. Any owner of a crypto company–even one that is 100% backed–is susceptible to looking into those vaults full of a valuable commodity “just sitting there doing nothing,” and sooner or later we’re back to a fractional reserve currency again. So, before that happens, the country has a prime opportunity to lay the foundation for a permanent sound monetary system by enacting some constitutional amendments to prevent money from ever going down the same road again, which is the road that always terminates in 0% backed fiat money.

A country has never capitalized on that situation to achieve this, but I am hopeful that one day it will happen, especially if the theory explained in this series becomes general knowledge at least among country leaders and their advisers. I would love to see this happen. It would be a million times more persuasive than anything I could ever write at convincing people that sticking with a commodity money (plus 100% backed receipt money) is far and away the best way to improve the quality of life for the people in that country.

That completes my description of the catastrophic method. In Part 43, we’ll talk about the gradual method, and then you can decide which is more likely to occur.

P.S.: As I learn more about different issues related to government, I have been realizing lately that my learnings always seem to consolidate into clauses that I would put into a constitution. A well-crafted constitution is the holy grail of setting up an optimal government, and I think getting to be involved in writing one would be a pretty incredible opportunity. Maybe one day I will put the thought and research into writing an optimal constitution [Edit July 2025: I did that.] But, in the meantime, I will accumulate my recommended clauses, which already include insights from studying money, lots of things about how government should and should not get involved in markets (including healthcare), how to structure checks and balances in a way that prevents would-be dictators from killing the democracy (I learned about this in How Democracies Die by Levitsky and Ziblatt), and structuring the voting system to allow for greater cooperation and freedom of ideas than our current American system allows (I learned about this in The Politics Industry by Gehl and Porter).

Over the course of 40 installments in this series (Part 40 here), I have tried to explain the theory of money as clearly as I can. Writing is a big part of my learning process, and before I started this series of posts I didn’t actually know that I would end up believing that the best monetary system is the most rudimentary one–commodity money and 100% backed receipt money.

And yet, even though I think that anyone who truly understands the theory of money would feel the same, I completely understand (and tried to demonstrate) why every major modern economy has gone down money’s evolutionary path to 0% backed fiat money. It’s the natural path that money will go down unless someone with the knowledge and power to stop it intervenes. But usually the time to intervene is when a constitution is written, otherwise governments will push money down that evolutionary path for the reasons described in this series.

And now, let’s suppose I could design a monetary system from scratch. (I like designing systems from scratch–it’s an opportunity to imagine the idealized version of a system so we know what our goal is.) The from-scratch monetary system I outline in this post is based on the theory of money I have explained in the last 40 posts, and it’s also mixed with my personal biases toward simplicity and market-based solutions (for reasons I’ve described elsewhere). So I’m not claiming it’s the only form a good monetary system could take. But I believe it would be optimal. If you’ve come on this journey with me, I hope you will easily be able to understand the rationale behind these choices.

Ok, where to start? The first important thing to recognize is that if a country’s monetary system is left to its own devices, it will sooner or later go down the path that terminates in 0% backed fiat money, possibly as a central bank digital currency. Thus, to prevent that, some rules need to be outlined up front. And unless these rules are codified in the government’s constitution, sooner or later the expediency of the moment will prod the government into pushing money the next step down its evolutionary path, until finally it comes to its final resting place as a 0% backed fiat money. And, according to my research, no country has succeeded at forcing a currency back up the evolutionary pat–even just to the gold standard–since the U.S. went off it in 1971.

Here is my list of constitutional rules that would shape a country’s monetary system:

1. No national currency. This does not mean there will be no common medium of exchange–it just means the government will not give a special name to a specific weight of a specific precious metal. Instead of a national currency, prices will be dictated in weight of whatever precious metal is being used as the common medium of exchange. On this point, I don’t know if it’s best for the government to help solve a collective action problem and specify a preferred (but not required) precious metal–which would probably be gold or silver–or if this could be left up to the market.

The reason I don’t want the country even defining a specific weight of a specific precious metal as its national currency is because it adds conversion factors and complexity to the world market (which creates inefficiencies in the international market), and it may lock a country into a specific precious metal or a specific amount of a precious metal that ends up being less useful in the future.

Also, if people start thinking of money as anything other than a quantity of the commodity they are using to help facilitate exchange, it is the very first step down the path toward 0% backed fiat money. In other words, once you think of money as this specific thing that the government has defined, it is much easier for you to apply that same name to a piece of paper that represents the original money, and, given enough time exclusively using those pieces of paper, a society can eventually forget that those pieces of paper are not actual money. I demonstrated all of this already in this series.

2. No government involvement in coinage. If people want to use precious metals in the form of coins as opposed to lumps that need to be weighed, then businesses will arise to provide that need to the market. This means different weights of coins will be produced by different companies, and it means any number of coins can exist in the market. Standardization will naturally arise around certain weights according to what people end up finding the most useful and therefore preferring. And those will be free to change (no pun intended) over time as the situation dictates.

3. Receipt money is allowed. This means people can pay for things using bank notes–physical or electronic. A bank note will state its value in terms of the weight of a precious metal that it can be redeemed for. To get a bank note from that bank, it will be a simple process of giving the bank the appropriate quantity of precious metal, and they will give you a bank note in return. There may be a small fee associated with this exchange to cover the cost of the bank verifying the quality and weight of the gold coins you are giving them.

I don’t know if this should be required in a constitution, but I’m considering including a requirement for merchants to accept payment in specie. But a requirement like that may cause other problems. The idea is this: if we can ensure that people continue to use the actual gold coins for transactions, it will be a reminder to them, generation after generation, that the thing they’re using as money is that thing of intrinsic worth, not some piece of paper or some number on a screen.

4. No fractional reserve banking. Actually, I could expand that to prohibit any form of exploitative loan (remember that an exploitative loan is a loan where the person loaning the money is not the actual owner of the money and doesn’t have the consent of the owner to loan it out). This means that if a financial institution is overseeing someone else’s money, they will have to get the consent of the owner of the money before loaning it out. And this means that the owner of the money will expect the financial institution to tell them when they will have access to their money again and how much the institution will be compensating them for allowing it to be loaned out like that.

When fractional reserve banking is not allowed, that means that all money substitutes will be required to be 100% backed, which will prevent those monetary expansions and contractions that are so harmful.

And to ensure banks are being honest and keeping 100% of the total demand deposits (i.e., deposits that someone can go and withdraw immediately, whenever they want) on hand, they would probably have to be audited randomly multiple times per year to make sure the amount of precious metal in the vault matches up with the total amount of demand deposits.

5. The government will be required to save up an emergency fund as I described in Part 40. The specific details of the saving method and rate (such as a required 3% annual savings until the emergency fund is filled up) and what constitutes an emergency are important to define. But the important point here is that we have to acknowledge that if a government doesn’t have the ability to create money whenever it likes, it needs another way to reliably access more money in the event of an emergency, and saving up for the future makes the most sense here.

The government may also need to be allowed to borrow money in case a second emergency follows closely on the heels of the first emergency and the emergency fund is not yet replenished. But this would be risky to allow because governments will find ways to justify borrowing money for any pressing need. The concern, though, of not having this option is that an enemy country could see that the emergency fund is depleted and decide to attack when it knows the enemy will not have the funds to defend itself. A better solution may be to not allow such borrowing, which forces the government to increase taxes in the short term, which would also make war an unpopular thing, so citizens would be less susceptible to the propaganda justifying the potential war.

6. No bank bailouts. This may be mostly a non-issue if there’s no fractional reserve banking, but it’s worth adding in here to make it clear that banks, like every other business, have a risk of failing. And if we don’t let the natural consequences of the market weed out the imprudent banks, the industry will be filled with imprudent financial decisions.

So, for an individual deciding where to store their money, they will also have to consider how risky a bank is before choosing to store their money in it. This forces banks to be prudent in their financial decisions because they know that nobody will want to choose them if they are overly risky. Standardized public financial reporting requirements for banks would probably be helpful so that everyone can compare the risk of different banks apples to apples.

Banks can go out and buy deposit insurance if they want to especially reassure potential customers, but this would not be government-sponsored deposit insurance program, so the insurance company would have every right to deny the request for insurance, and they will probably want to analyze the bank’s level of risk very thoroughly and also employ risk management strategies prior to agreeing to insure the bank’s deposits. In this way, the price of the deposit insurance that the bank pays will be based on the bank’s true actuarial risk. This may be enough of a solution to reassure potential depositors that the standardized reporting requirements may not even be necessary.

7. No government bank. And to avoid various conflicts of interest, the government will not own any share in any bank either. And, of course, the other rules above already make it clear that there will be no central bank either.

All right, I think that covers the main things that would be needed in a constitution to permanently establish my idealized version of a financial system. Let me talk about the expected effects of those rules.

First, they would force the government to get all its money through taxation and, in very rare emergency cases as discussed above, borrowing. But, ultimately, since the government would have to use taxes to pay back those loans, all money that the government receives ultimately comes from taxation. The overall effect of this is that government spending will be much more transparent because it will almost always be coming directly out of taxation instead of out of the hidden tax of inflation or the future tax of debt. And this is very important because only when citizens know the full cost of something (and are required to pay it in the near term) can they more rationally weigh the true costs of any policy against its benefits.

Second, these rules will make the financial sector much simpler and more stable. A lot of benefits come from those two characteristics. Simplicity keeps administrative expenses to a minimum and allows investments to be more comprehensible (more transparent), so investors will be able to make more rational investment decisions. Stability encourages more investment, so domestic and international capital would flow in.

Third, the benefits to the economy as a whole would be even more significant. Booms and busts would be minimized, and societal defaults would probably be done away with entirely; think of all the shattered lives and lost fortunes and ruined retirements that that benefit alone would prevent. The economy overall would also be more efficient and would facilitate the generation of greater wealth. And there wouldn’t be so many forms of incidental and destructive wealth redistribution. There also would be no inflation, measured or unmeasured, so the purchasing power that workers earn would consistently rise.

It’s hard to adequately describe the protean benefits, large and small, that people would experience on a day-to-day basis if we could get to a monetary system like this, but I hope that gives you a glimpse of it at least. And the rest of this series up to this point should also serve as a strong picture of all the damage a monetary system like what I’ve described above will avoid.

To end this post, I want to emphasize that maximizing the generation of wealth is not the only goal an economy has. There are many reasons that policies can be enacted that decrease the generation of wealth in favor of other priorities, whether it be to secure various human rights that the culture has agreed upon or to promote ecological sustainability or others. And those priorities are perfectly compatible with a monetary system like this. In fact, I believe this monetary system would secure a more firm foundation for pursuing other non-wealth-increasing purposes than any monetary system currently existing on earth. Governments just have to make sure they enact those priorities in a way that doesn’t interfere with the sound monetary system doing its thing.

In Part 42, I’ll describe the simplest path I can imagine that could get us as close to a system like this as possible.

In Part 39, I started my work of doing some cleanup of various topics before moving on to discussing solutions. We talked about what would happen if the U.S. federal government paid off its debt and if that would be a good thing.

In this post, I’ll address two last cleanup items.

First, a question that arises when you talk about getting rid of a fiat currency: What would happen if the government suddenly has a large expenditure need, such as a war or natural disaster, and can’t create money at will anymore to pay for it?

Could it get insurance, which was invented specifically for this purpose of protecting a financial entity against uncommon, unpredictable, and financially catastrophic events? Probably not–do you think there’s an insurance company out there that is so large it could sell war insurance to a government and be able to pay for the cost of that war without going bankrupt? Not even close. And even if one were large enough to do that, I doubt any would because governments usually (but not always) have a fair amount of control over whether they get into a war, so war insurance would almost act like an incentive for the government to go to war because now their insurance company would be paying for it. Natural disaster insurance is possible, but unlikely.

So, aside from getting insurance, how else could a government prepare for a large unpredictable expense? Think about how individuals prepare for something like that. They get insurance for all the biggest things, and then for all the rest they do this crazy thing called saving up an emergency fund. Usually that means saving 3-6 months’ worth of expenses. That way, if the primary breadwinner of the family suddenly loses their job, or if their house burns down, or whatever, they already have enough money to cover the gap in income or the large unexpected expense.

What I’m suggesting, then, is that governments should save up for an emergency rather than reactively take our money through inflation or, in the absence of a fiat currency, rapidly jack up taxes and borrow a ton of money.

What I think would be amazing is if a government could save up enough that it could continue running indefinitely just on the interest its earning on its emergency fund, which would be invested in stocks and bonds. This would work just like a university with a huge endowment. Imagine that–no more taxes!

But, realistically, maybe saving up something like 50% of annual expenditures (equivalent to a family’s 6-month emergency fund) would be a good solution. No politician would be able to convince enough people to forego all their urgent funding requests to ever make this happen, so a requirement to do this would probably have to be written into the country’s constitution. Maybe it would say that the government is required to save 3% of all income every year until it has built up an emergency fund that is equal to 50% of the most recent year’s spending. And the tricky part would be figuring out how to define an emergency that would allow that money to be used and not abused. But when any of that money ever gets used, then the 3% savings requirement goes back into effect immediately once the emergency is over. An emergency fund like this wouldn’t cover the biggest expenses, but it would buy time for the government to figure out alternative financing options, such as cutting spending, increasing taxes, and borrowing.

But having a fund like that also may incentivize governments to go to war, so maybe there should also be a required war tax implemented any time the country goes to war. That way, the cost of it is felt directly and immediately by the people, so politicians would be more likely to take the unpopular cost of a war tax into consideration when they are deciding whether to enter or start a war. Without inflation to hide taxation, the government would always have to rely on less hidden forms of taxation, so citizens would be able to quantify much better the cost to them of their country entering a war, which would also discourage politicians from inducing such large and unpopular costs on citizens.

These ideas probably sound crazy, but that’s only because we’re so used to governments creating money whenever they want. And the two main problems that creates are (1) their spending choices are insulated from public opinion because they’re not directly seen and (2) we pay for emergencies through inflation, which is definitely the most damaging form of taxation to an economy.

Overall, I’m trying to make it clear that even though spending for an emergency through inflation feels normal to us, it is the worst way of doing it. An emergency fund would be way better.

Second, I want to list a few of the other ways that inflation hurts the economy and slows wealth building:

• It messes up calculations of the profitability of companies, especially companies that have asset depreciation as a major portion of their costs. Here’s an example. Let’s say a company owns a small factory, which has a single machine that makes bolts. It bought the machine for $300,000 and expects it to be used for 30 years, making 20,000 bolts per year. It will depreciate the machine by $10,000/year so that it will be fully depreciated at the end of its 30 years. The company has other costs of about $5,000/year. If it is selling bolts for $1 each and selling all of them the machine produces every year, its revenues are $20,000/year, and its costs are only $15,000/year ($10,000 of which comes from depreciation, so it can keep that $10,000 and put it in a savings account to slowly save up for the time when it has to buy a new machine). This company is pretty profitable! Then serious inflation strikes–100% over a very short period of time–and the company has to raise its prices to $2/bolt. Its other costs also double from $5,000/year to $10,000/year. So its revenues are now $40,000/year, and its costs, assuming it sticks with the same depreciation plan for its machine, are now $20,000/year. Now the company looks even more profitable! Its stock price soars, and it definitely doesn’t want to update its depreciation schedule now, even though if it doesn’t it may not be able to buy a new machine when the current one dies. Seeing all of this success in the bolt industry, tons of other investors start bolt-making companies because of how profitable of an industry it appears to be. But then, at the end of the 30 years when that machine is fully worn out and the company goes to buy a new one with the $300,000 it saved up (by putting $10,000 in its account every year for 30 years, remember), it finds that the cost of a new machine is $600,000 due to inflation. It can’t get a loan to buy a new machine and goes bankrupt. Suddenly everyone realizes that the profitability of the bolt companies are super overvalued because they hadn’t been adjusting their depreciation for inflation! Investors’ decisions were also totally skewed because of the complexities inflation caused in accurately evaluating the profitability of different industries. Which means investments were not going to the highest-potential projects. This is yet another explanation of why achieving a stable-value currency is so imperative to an efficient economy.
• Long-term fixed contracts become much more risky when the risk of inflation is larger. Businesses usually need large investments to get going or to try new things, so long-term contracts are the foundation of most innovations. But when those contracts are more risky, more of them fail simply because of the impossible-to-predict changes in the value of the money they borrowed.
• Inflation suspends the market’s punishment of unprofitable firms because everybody seems to be profiting until prices finally adjust.
• Inflation encourages people to buy sooner than later because they believe things are cheaper now than they’ll be tomorrow. Thus, inflation encourages going into more debt than would otherwise be prudent.
• Inflation is the primary cause of business cycles, as I have shown already in this series.

All right, I did it. I got through those last two things that I wanted to address before moving on (next week) to discussing how to fix a monetary system.

There are, of course, so many other things about the theory of money that I haven’t even touched. For example, there are theories out there about bankers and their control over governments (especially when it comes to decisions about war) because of their power over money and how much they stand to gain when they finance those wars through debt to governments, which gives them even more control over government actions. And I haven’t covered the different stages of evolution that money goes through from an international perspective, including the stepwise abolition of the gold standard, fixing exchange rates, using some currencies as reserves for other currencies, the Bretton Woods Conference, sneaky ways governments have transferred wealth to other governments, etc. And don’t forget about the curious and questionable things the International Monetary Fund and World Bank are doing!

But I won’t discuss any of those in this series, and we’ll see if I ever decide to do a The Theory of Money, International Version series. I am not planning on it yet, for multiple reasons:

1. I am, for the time at least, satisfied with this foundation of the theory of money. It gives me enough to have a solid idea of which monetary policies to support and which to oppose.
2. I haven’t yet taken the time to thoroughly process the international aspects of money shenanigans.
3. I am not yet ready to write more about money because I want to get back to my primary focus of healthcare (although I’m sure I’ll write a blog post here or there on money topics).
4. Most importantly, I feel like I have conveyed through this series what the world needs most from a theory of money standpoint. Until you read a ton of books on the subject like I have, you don’t understand how much clearer money issues become when you have the theoretical foundation in this stuff that I have explained, like the purposes of money, the difference between wealth and money, Wealth Units, where wealth comes from, determinants of the aggregate wealth in a society, the characteristics of optimal money, how inflation hurts a society, and everything else in this series. I wanted to provide a clear theoretical foundation of money that can act as a launchpad to enable you to read anything else on money (or analyze any monetary policy-related current event issue) and truly understand it, even if the author or reporter or “expert” talking head doesn’t quite understand it themself. And the reason that’s so important to me is because the more people who understand this stuff, the more people who can advocate for sound monetary policies and spread this knowledge to others to do the same, which ultimately can result in a shift in our world toward monetary systems that no longer exploit citizens and benefit governments and banks instead.

Part 41 here.

In Part 38, we discussed how bad central bank digital currencies could be, and then we talked about the potential for cryptocurrencies to come into common use through market mechanisms.

I did my homework and, as I promised at the end of Part 38, read through my notes to see if any additional cleanup of scattered topics is necessary before moving on to discussing different ways to fix our monetary system.

One claim I hear people sometimes make and that is worth addressing is this: “All of our money is created through government debt, so if our government pays off its entire debt, then all of our money would disappear.” When smart and knowledgeable people make this claim, it feels pretty persuasive. But are they right? Will the federal government getting out of debt make all of our money disappear? This has important implications on whether it would even be fiscally safe for the government to pay off its debt!

To answer that question, let’s very briefly trace the origins of all the money we have.

First, people were using various commodities to facilitate trade. Ultimately, they landed on using gold because it was the most convenient commodity (again, check out Part 9 for details on the optimal form of money). Eventually, gold was being stamped into coins that were a standardized weight and were difficult to counterfeit. As individuals got wealthier, they were able to store any newly acquired wealth by buying more gold and having it stamped into coins. Let’s say there were a total of 5,000 gold coins at this time. And even when people started using receipt money instead of the coins themselves, the receipt money was 100% backed by gold coins, so the only difference was one of convenience by switching to receipt money. At this time, if all of the gold coins were in the bank vault, then there would be 5,000 Goldnotes in circulation.

Then along came fractional reserve money, which, if the reserve ratio went down to 0.2, caused the amount of money to expand 5x, so then there were 25,000 Goldnotes circulating. But still there were only 5,000 actual gold coins in the bank vault.

Then, skipping a few steps that aren’t relevant to this example, the government decided to centralize the money into First Bank Notes, so now we have 25,000 First Bank Notes instead of Goldnotes. And, not long after, the government liberated all that money from its gold backing, which then allowed it to take the 5,000 gold coins and give it to foreign companies as compensation for war supplies.

Next, with the newfound freedom to print as many First Bank Notes as it wants, the government started printing more and more First Bank Notes using that accounting trick where an equal amount of government debt is created at the same time. Let’s say it printed 75,000 new First Bank Notes, so now there are a total of 100,000 First Bank Notes, and the government debt is worth 75,000 First Bank Notes.

We could now divide all of the country’s money into three categories according to how they were originally created: the commodity-created money (5,000 First Bank Notes), the fractional reserve-created money (20,000 First Bank Notes), and the fiat-created money (75,000 First Bank Notes).

So, if the government suddenly pays off all its debt, would all of the money disappear? Of course not. Only the fiat-created money would disappear.

The only way all of the money would disappear is if there was no commodity-created money or fractional reserve-created money in the society prior to the government starting to add fiat-created money to the money supply. But since no society ever jumps from no money (i.e., the barter system) straight to fiat money, that would never happen.

In the United States, we have a ton of fiat-created money, especially relative to the commodity-created money and fractional reserve-created money. But, regardless of how much more fiat-created money we have than the other two types, there will still be money if the U.S. federal government pays off all of its debt. True, not very much money would be left, but there’s no such thing as not having enough money for a society to function, as I explained in Part 5. The only challenge would be that the Wealth Unit:money exchange rate would change drastically, and that would make prices unreliable and hard to interpret until everything settles.

Obviously the pricing uncertainty would, in the short term at least, be a huge downside to the government paying off its debt (specifically, the debt owned by the Federal Reserve). But would there be a benefit to it as well?

Of course. I don’t like this intergenerational pyramid scheme the government is running, and I know my posterity will like it even less than me. I call it a pyramid scheme because government debt is future taxation (plus interest). So future generations are going to pay heavily for the deficit spending that the government is doing now. And the other benefit to paying off this debt is that it will free up a huge chunk of the government’s budget again so it doesn’t have to send 19+% of its revenue every year to creditors, most of whom are foreign.

To summarize: Yes, let’s pay off the entire U.S. federal debt!

Part 40 here.

Pardon the brief interruption in my Theory of Money series. This isn’t a money blog anyway, but it IS a healthcare and economics blog, and the modern money and banking system is one of the most interesting applications of economics outside of healthcare! So I will be completing that series, I just wanted to share a timely something else this week.

For the longest time, I’ve just been blogging my way through my passion for healthcare policy as I’ve worked on figuring out how to fix the healthcare system. I have advertised the blog a little bit here and there simply by syndicating on a handful of other healthcare blogs plus sharing the link to posts on LinkedIn and Twitter, but that’s about all I’ve done to expand my reach. This has mostly been because I didn’t want to spend time on that kind of project–I wanted to instead spend my limited health policy time each week reading and writing, which strengthens my understanding of and ability to explain the healthcare system. But, with a recent job change (still working as a full-time hospitalist, just at a different hospital), I now have a little more health policy time each week.

That is why, over the last few months, I have gotten some help to plan how to broaden my reach. Initially this will be through sharing health policy content on Instagram, and the first post was yesterday! I’ll be posting about 4 times per week, including a weekly video (with the help of my wife’s filming equipment and skills) on Wednesdays that will feature me explaining healthcare policy principles in under 1 minute. I’ll be cross-posting those videos to YouTube for people who want to watch them there instead, but so far I haven’t planned to do any YouTube-specific (longer) videos. That may change as I learn and adapt to what seems will be most effective.

So, I hope you’ll engage with me on those platforms! I recently added the links to my Instagram page and YouTube channel to the sidebar of this blog: @DoctorTaylorJay.

(I’m working on getting that handle for Twitter as well, but some guy named Taylor Jeff McDonald created a Twitter account in 2016 with that handle and hasn’t used it once, which is probably why he hasn’t responded to my message on there. If any of you have insights into how to solve that little quandary, please let me know.)

As always, I encourage feedback to help me improve the usefulness of my content. I also love getting to talk to others interested in this space to connect over ideas and to hear your unique backgrounds. So I hope you’ll reach out to me sometime on social media or directly via email (see my About Me page for that). Talk to you all soon!

In Part 37, we discussed “too big to fail” and why it’s a terrible thing for our economy in the long run. It’s yet another example of how the government’s power over our 0% backed fiat money leads to them making policies that hurt us more in the long run.

This post, let’s see where money could go from here. And then finally dig into cryptocurrencies!

One intriguing idea to evolve money further, which is already being tried in many countries, is central bank digital currencies (CBDCs). A 0% backed fiat currency that gets converted to a CBDC is still a 0% backed fiat currency, but now the money would be only digital–there would be no more physical cash. There are lots of ways to accomplish this, but every application of it involves people having to use a card- or phone-based digital payment method for every single transaction. We already do that for nearly every transaction in many industrialized countries, even when we are sending money to friends, so it’s not too huge of a jump to move us to this kind of digital-only cash.

I said the idea is intriguing because it almost seems like having a CBDC would be the same as having a country’s currency switch completely over to Bitcoin or some other popular cryptocurrency, especially if the CBDC uses blockchain technology.

But having a CBDC couldn’t be more diametrically opposed to having a private cryptocurrency. When a government and central bank run a 0% backed fiat currency that is purely digital, many new ways to take our wealth and control us arise.

For example, the government would be able to track every transaction, which opens up new taxation opportunities. It could even decide to tax every single transaction if it wanted. It could also disapprove certain transactions, so now it has direct control over what we can buy. Or it could cause money that hasn’t been spent in a certain amount of time to “expire,” which basically means it just disappears straight out of our bank account. (That would be even worse than inflation causing the money to lose its value–at least the money doesn’t completely disappear from your bank account!) So now it could force us to spend money when it wants to “stimulate the economy.” Or it could restrict money’s use to certain regions. And then there’s the risk of the government leveraging this power over money against its political rivals, which is analogous to (but more frightening than) what has already taken place in the United States when certain businesses have been “debanked,” except in this case the control would be even more direct.

And all of that doesn’t even consider the risk of the internet going down, which could completely prevent transactions from taking place. Hacking of the money is yet another risk, although that one is present any time you have digital money.

So, with everything I know about money, I believe CBDCs are only good for governments and banks furthering their selfish interests and that they create a terrible risk to the freedom and financial security of the people.

If we look at money again from an evolutionary perspective, I would say that CBDCs are actually the final possible stage of money’s evolution. Each evolutionary step past 100% backed receipt money has gotten worse, and CBDC is no exception; it is the worst possible form of money.

But what about private cryptocurrencies? Will any of them ever become a country’s official currency?

Originally, I wrote that I highly doubt it. But since then, further reflection has changed my mind. Now, my answer would be that it’s possible.

Not that I think any government would willingly give up its 0% backed fiat currency. Can you imagine any government willingly giving up its ability to create new money for spending whenever it wants? Suddenly politicians would become very unpopular when they have to raise taxes instead and people start to see the true cost of government actions. No more hidden taxation!

Governments would also not like switching over to a private cryptocurrency because much of a government’s power of taxation/tax law enforcement is dependent on transactions being reported. But if the two parties involved in a transaction choose to keep it anonymous (and nobody knows who the account owners are), then there’s no way for government to trace the transaction back to any individual. Which means there’s no one to send a tax bill to!

But, in spite of how much governments would oppose it, there are two factors that make a private cryptocurrency displacing a government’s 0% backed fiat money possible: (1) the strong and well-funded crypto lobby and (2) the private market.

The strong crypto lobby is obviously influential in shaping the crypto-related policies that get passed. But here’s something I bet most people don’t think of: The crypto experts dictating which policies the crypto lobby should support are more knowledgeable about that still-enigmatic industry than the politicians, so I think there’s a very real chance that some of the policies that are being advocated for by the crypto lobby (and that eventually will get passed) are policies that the politicians don’t fully understand the long-term implications of. This could lead to a sort of covert crypto takeover of the 0% backed fiat currency. At the very least, it will lead to the crypto owners making more money, which ultimately comes from increasing investment in their cryptocurrencies. And a huge way to increase interest and subsequent investment in crypto is by getting crypto to come into common use as a means of exchange and also as a store of wealth, as opposed to purely as a speculative financial instrument, which is mostly what cryptocurrencies are right now.

Now, how could the private market facilitate crypto taking over a 0% backed fiat money?

Remember what leads to the collapse of a fiat currency–a loss of trust in the money maintaining its value, which then causes it to no longer be a good means for storing or exchanging wealth. The value of fiat money is determined by its supply and its demand. Governments are already expanding the supply like crazy, which is devaluing their fiat currencies. But what governments don’t have direct control over is the demand for their money. Sure, they can institute legal tender laws to try to force people to accept their money, but what if an alternative to their money comes along and holds its value much better? People would increasingly turn to that alternative currency, and the demand for the fiat currency would drop.

So then you would have a fiat currency that already chronically has decreasing value due to ballooning supply, but on top of that you’d have decreasing demand, the combination of which would tank the fiat currency’s value. Then, the government, which is so reliant on funding itself through printing more money, would have to print even more money to be able to continue buying the same number of things. All of this would trigger a hyperinflation death spiral, and soon everyone would turn to using the alternative currency. Workers would start demanding to be paid in crypto by their employers, and stores would require they be paid in crypto as well.

I haven’t delved deep into what would happen to the government at this point. I think it might just implode. Services would just disappear, even though there’s still laws on the books requiring those services to continue. This could be the source of major political upheavals, with dire consequences. It could even lead to revolutionary attempts and civil war. I don’t doubt that at least one faction would be looking to establish a new constitution supporting a true socialist form of government, which is becoming increasingly popular among the younger generation who obviously haven’t read enough Friedrich Hayek or Milton Friedman or this blog. I really hope that the implosion of government that would likely happen as a result of it losing its power over the currency doesn’t lead to all of that. But, if there’s any major regime change, I hope they use my constitution (work in progress) the next time around instead.

So what kind of private cryptocurrency is most likely to win out when the competition kicks into high gear for general use?

Stablecoins pegged to the value of any other 0% backed fiat currencies are no good, especially if the fall of the USD starts a domino effect with other fiat currencies. Supply-limited 0% backed cryptocurrencies, such as Bitcoin, are better, but remember the goal isn’t to have a fixed supply currency; the goal is to have a stable value currency. And the only way to achieve that is to have one that is backed by specie, which makes its value always be regulated by supply and demand. The best would actually be to have one that is fully (100%) backed by specie, because then essentially what we have accomplished is getting back to a commodity money (with the perk of having digital receipt money as well), and there would be no way to create more digital coins without adding more specie to the vault, so no tampering with the value of money anymore.

Which commodity would be best? Take a look back at my characteristics of optimal money in Part 9. There’s a reason this blog has used gold as the example–because it’s a great option. Silver might be a better option though because it’s more plentiful and spread across different regions, which makes it less easily monopolized. But there’s a persistently strong historical interest in gold as money, so that may make it take precedence over silver when it comes to the market choosing between the two.

While the transition to cryptocurrencies is taking place, we will probably have different cryptocurrencies with different commodity backing competing for general use, but the downside of that (until everyone standardizes around a single commodity) is that you would have to track the value of the different commodities, which would change independently, so stores would constantly need to post and frequently adjust multiple distinct prices.

And we should expect big value swings in every cryptocurrency until the market settles on a single commodity and the speculation dies down. After that, the competition will be narrowed to being between the cryptocurrencies that are 100% backed by the market-selected commodity. I would love to see 4 or 5 different cryptocurrencies with that commodity as backing continue to compete with each other, each with policies that ensure efficiency/low cost, safe storage of the commodity, audit transparency, and easy exchangeability (so you walk in with your crypto wallet and exchange digital coins for physical coins). Then those cryptocurrencies could establish branches in every major city, where people could go to redeem their coins for the commodity. And I hope merchants start accepting either the digital coins or the physical coins because the continued use of the commodity itself as money would be important to help generations of people remember what they are actually using as money even when they’re making digital transactions.

Prices would be super turbulent in the market for a while, and that would hurt economic efficiency. But, as things settle, the new monetary system would unlock incredible economic growth, which would finally also start translating into continually rising purchasing power.

So that’s what I hope happens. I hope the private market comes in, with the help of some clever policies pushed through by the crypto lobby, and sets us free from the bondage of a 0% backed fiat currency.

Does that mean we should all start buying crypto?

Yes and no.

The more pressure that stores have to accept crypto in payment, the sooner this transition to a private cryptocurrency will happen. So getting set up with a crypto wallet and owning a few coins for the sake of experiencing transacting with crypto is a great idea! But, with cryptocurrencies still being so unstable in value, I don’t recommend anyone start storing too much of their cash wealth in any of them–at least, not until the USD starts down its hyperinflation spiral, and then at that point most crypto options would probably be better than keeping your cash wealth in the form of USD.

But, to be clear, cryptocurrencies should not be considered sound investments. Using them as investments is pure speculation, which you should understand by now (but, as a refresher, go back and read my definition of speculation in Part 20). I will not judge anyone for speculating in crypto, but I really hope that those who do are only allocating a small percentage of their portfolio to it and can stand to lose that money. Some people have a lot of fun with gambling, and if crypto is your game of choice, then go right ahead. I personally do not have any of my investments in crypto.

I will be interested to watch the crypto market over the next couple decades, and I hope it elevates quickly from a mere speculative financial instrument to an actual useful form of money that saves our economy and facilitates a drastic improvement in our quality of life.

Before writing Part 39, I’ll look over my notes from some of the books I’ve read on this subject of money and banking to see if there are any other important topics to cover. And once I’ve done that cleanup effort, I’ll move on to discussing other solutions to help get us out of this 0% backed fiat currency mess.

In Part 36, I clarified a few random topics and also summarized the ways the government and central bank can control our money supply and how it hurts us.

Now that we have a thorough enough background in how modern governments control money, let’s look at what the government might (will) do when a bank is about to fail. This situation may be somewhat reminiscent of the U.S. in 2008 . . .

Let’s say that a bank is looking for the most lucrative places to lend money, and it finds that there is a particularly high demand for mortgages at that time. Maybe demand went up up as a result of some new government policies that are encouraging people to buy a house . . . they loosened the financial requirements for people to qualify for a mortgage, for instance. The bank sees this spiking demand for mortgages and recognizes it as a potentially lucrative investment opportunity.

Unfortunately, the new prospective borrowers were not allowed to get a mortgage before due to bad credit or too much debt, so even though now they can qualify for a mortgage, that doesn’t change the fact that they’re risky borrowers. But the bank is okay with this because higher risk means it will be able to charge higher interest rates. And, at this time, the economy is booming. Housing prices have been going up consistently for many years, and now they’re going up even faster due to the new policy increasing demand. And with the booming economy, loan defaults are relatively low, and the few who are defaulting are able to sell their house for a higher price than what they originally bought it for even months before, meaning banks will most likely get their money back even in cases of default.

Taking all these factors into account, the bank feels like it can charge high interest rates and not have the default rate that such risky loans typically have. It’s a perfect opportunity to earn a ton of easy profit!

I hope you can see where this is going. These days with 0% backed fiat money, if there’s a relatively sudden abundance of wealth, you know it’s usually going to be from new money being created and injected into the economy, which means the perceived wealth is higher than the actual wealth. And in this perceived abundance, everyone jumps onto the speculation bandwagon to make some easy money. And then there’s an eventual correction as prices adjust to the new lower value of money.

As long as housing prices continue to rise like this, everything’s fine. All the parties–including the ones building houses, the ones getting mortgages, the ones doling out those mortgages, the ones flipping houses, the ones investing in repackaged mortgage investments from other banks, etc.–are counting on prices continuing to rise like this. And they are making investments accordingly, pushing their leverage as far as they can to earn as much as they can while there is still easy money to be made.

And then something changes. Maybe the influx of newly created money slows down, so prices finally start to adjust to this new lower value of money. The illusion of abundant wealth starts disappearing. The real price of a house starts to become clear as people realize their money isn’t worth as much as they thought. Demand starts to erode. Prices no longer look like they’ll keep increasing forever. Many businesses in the housing market were making big investments predicting continued rapid growth and big profits, but these investments no longer make sense given the slowdown, and many of them end up being lost. This puts some companies in financial trouble, and they start laying off workers. Things spiral from there, and soon the trickle of people losing jobs and being unable to pay their mortgage increases to a deluge. The tipping point has been reached, and tons of houses start going on the market as people are trying to get out before prices drop further.

Banks start having to foreclose on houses, and it’s them who are forced to absorb all the losses. How? Well, if they gave a borrower $800,000 to buy a house and then the market drops 50% and they foreclose on the house (becoming the new owner of the house), now they own a house that basically they bought for $800,000 (by sinking an $800,000 loan into) and is now worth $400,000.

The banks all knew it was a risky market to invest in based on the risk evaluation of the people who were getting those mortgages, but they downplayed the risks based on the illusion of wealth and because of historical trends that they expected to continue. And who can resist investing in something that everyone else seems to be making huge profits investing in?

Part of the challenge here is the difficulty in pricing things like the land the houses are sitting on, which makes it easier for the prices in markets like this to lose touch with reality because there isn’t as reliable of an anchor to say what the things are actually worth.

Getting back to our bank, let’s say the required reserve is 0.2 and the bank has $20 billion in reserves, which means it is allowed to lend out $100 billion. This is a big bank! And of the $100 billion, it was pretty aggressive and invested (loaned) $40 billion of that money in the housing market.

We are back to the same situation Independent Bank was in way back in Part 17, except now it’s not a shortage of gold in a vault that is triggering panic. Let’s see how it works with modern banking in a 0% backed fiat money situation.

This can get confusing if I don’t make some simplifying assumptions, so I’m going to do that in the hope that it helps clearly illustrate the principle.

Let’s say the bank originated all $40 billion of its loans in the housing market at the same time, and immediately the bank had to foreclose all of those loans and then sell the houses. As long as it sells the houses for a total of $40 billion, it’s not a problem–the bank hasn’t lost any money. (Sure sure, there will be delays between loaning the money and getting it back after selling a foreclosed house, plus there will be a lot of bank employee time spent on all this stuff, but let’s ignore all that for now and say the bank breaks even.) This is the best case scenario for the bank.

Now let’s shift to a different scenario. Let’s say the bank makes the $40 billion in loans all at once and then it has to foreclose on all of them after 10% of the principal has been paid back. If the bank can at least sell those houses for 90% of the original purchase price, then it’s gotten 100% of the loans back (10% from the original borrower, 90% from the sale of the house), plus it earned interest while the loans were being paid on. This, too, is no problemo assuming inflation in the interim was 0%.

But what if the bank has to foreclose when only 10% has been paid back on the mortgages and then they can only sell those foreclosed houses for 50% of their original purchase price? The bank will only get a total of 60% of their loaned money back (10% from the original borrower, 50% from the sale of the house). So, of the $40 billion it loaned out, it got back $24 billion and lost the other $16 billion.

Where do you subtract this lost money? Does it come straight from the reserves?

Yes. Think about it this way. Before all this happened, the bank only had $20 billion of actual money. And this isn’t the bank’s money, remember. It’s customers’ money stored in the bank. Sure, the bank was lending out $100 billion, but that was money temporarily invented to exist until the loans get paid off, and then it disappears again until the bank makes new loans all over again.

The $16 billion that was just lost was actual money. So the bank’s reserve has now dropped to $4 billion. And how much does the bank still have out in loans? Of the total $100 billion in loans, $40 billion of that was in the housing market, none of which exists anymore, so it now only has $60 billion in outstanding loans.

Doing the math ($4 billion / $60 billion), this means that the bank’s reserve ratio just dropped to 0.07. To get its reserves back up to the 0.20 requirement, it’s going to need to borrow $8 billion. I doubt in this economic situation that the reserve pool will have any excess reserves for sharing, so it’s getting all this money from the the discount window. Depending on what the discount rate is, the bank will very likely owe a ton of interest every single day until it gets back up to the minimum reserve requirement. So much interest, in fact, that its other revenues cannot cover this interest cost. And now we have a bank that is going down the drain quickly. It will have to declare bankruptcy.

And now it’s decision time for the government. Do they step in to help?

Remember, this bank is huge. It has an enormous effect on the economy. If it fails, this will hurt everyone in one way or another. And politicians don’t like to be seen as just standing by idly watching as things go bad. The public clamor will be for them to “do something!”

The government definitely has the means to bail out this bank with newly created money. Sure, it will induce a lot of inflation, but most people won’t know where that came from. So what is a rational politician to do? They know that actively working to help during a crisis will be very popular, and they can easily justify any bailout as being beneficial for the economy by deeming the bank to be “too big to fail.”

So of course that’s what the politicians do. They end up creating a whole bunch more money, some of which will be a gift to this bank and some of which will be a loan to this bank with a very low interest rate (which is also a gift because it means the government is paying for the rest of the interest in one way or another).

As a result of this bailout, there has been a huge transfer of wealth. Wealth came from all people owning cash and it went to this bank (or, really, its owners). The cash-owning people just unwillingly and probably unwittingly had some of their wealth taken from them and given to this bank for the sake of helping the economy.

Just to make sure this is clear, the bank took a huge risk and initially made a lot of money. So they received the upside of this risk. But then, when things went bad, they got bailed out, so they experienced very little of the downside, and instead all the cash-owning people bore the downside of the risk the bank took. From a bank perspective, this is an amazing deal!

I don’t have the means of calculating how much this bailout would benefit the economy. But I suspect, based on all my other comparisons of similar situations (like in Part 15), the long-term cost of lost wealth to individuals and to the country as a whole will be much greater than the short-term economic benefit.

And this doesn’t even take into account the effects a bailout has on the future behaviour of competitors within the banking market. For every large bank, the incentives were just changed as soon as they saw that the government will bail out any bank that is big enough to hurt the overall economy if it fails. Large banks now know that they can make risky investments and not worry so much about major losses. This skews investment behaviour. It also skews bank merger decisions (“We gotta get too big to fail!”). Basically the government has incentivized mergers and is subsidizing risky investments, which leads to overinvestment in those risky investments and underinvestment in more solid investments.

And even if one bank wants to play it safe, they will be earning a lot less profit, and sooner or later their investment strategy will be changed to put them more in line with other banks.

I have a strong preference toward free markets, but I also believe government assistance to help markets run efficiently is important. Unfortunately, intervention in a market in this way does not help the market run efficiently; instead, it skews incentives and leads resources to being dedicated to different purposes than the market would otherwise direct them to, which leads to inefficiencies in ways that are often impossible to calculate. It’s the same principle as administrative pricing that I discussed in Part 36.

So, for this reason, bank bailouts represent yet another way that the government leverages its control over our monetary policy in an attempt to help but that harms us financially. And it’s one more example of how much benefit banks get from our 0% backed fiat money.

If we instead choose to let banks fail, regardless of their size, the economy would hurt in the short term, but we would avoid all the adverse effects of creating even more money and worsening incentives in the banking market, both of which would lead to greater wealth and financial security in the long run. But that’s a pretty nuanced explanation for a politician to make when they’re faced with supporting a bailout or not, so even a politician who understands these principles is unlikely to succeed at convincing their constituents that it’s the right choice and then be able to carry it out.

A reasonable counterargument is that you could have the best of both worlds if you bail out the bank but then institute banking regulations to try to prevent it from ever happening again. To which I would respond that this series documents thoroughly how damaging a bailout-induced period of inflation would be to an economy, and that’s hard to overcome with the benefit of saving a bank. Also, more regulation creates more complexity in an already overly complex banking system, which in and of itself decreases the efficiency and innovation in the industry, but also that new pile of regulations will probably lead to more loopholes and obfuscation-induced policies that benefit banks in other ways. So I’m not hopeful that a middle-ground solution would be better than simply letting banks fail when they go bankrupt just like every other business. The rigors of the market have so much to offer in weeding out imprudent risks.

Part 38 here.

In Part 35, we got deep into the two types of inflation and showed how any government that institutes a 0% backed fiat currency has the ability to soak up all purchasing power increases from that point on, which is why Americans haven’t experienced much financial progress for the last few generations.

This far into writing anything about money, the writer tends to start getting lazy and skipping some of the micro-steps that are required for the reader to understand the new information being presented. This has happened in every book I’ve read about money. I am trying to avoid doing that. So let’s start this post by clarifying a few different topics that I’ve referenced but haven’t fully explained yet.

First, if a society is using gold coins as money, who should be stamping those into set weights with beautiful and difficult-to-counterfeit and difficult-to-clip shapes?

Government is one option, although that runs the risk of the government slowly making them smaller while still printing the same weight on them. Governments have done that in the past and ruined the society’s commodity money.

So I would prefer the private market to fill that job instead. It would probably lead to a few different companies establishing themselves by being honest and exact in their weights and designing the most convenient and aesthetically desirable stamped shapes. The different companies would be competing, so they would keep each other honest by monitoring the product and prices of the others. For example, if they find that one of the companies is skimping on the gold or something else shady, that would be the death of that company. The competition would also force them to work hard to provide this service for a reasonable cost for anyone who brings in some gold that they want coined. And standardization around certain weights would probably naturally emerge according to the demand in the market. I believe this scenario would lead to a long-term stable currency.

Second, is there any benefit to having the government (or anyone else) define a standard weight of gold for the purpose of naming their currency? For example, the Coinage Act of 1792 defined one U.S. dollar as 24.75 grains of pure gold.

I don’t think so. It just adds one more conversion to the mix. It would be easier to refer to the price of things directly according to their weight in gold. (And how about we use the metric system for weights, eh?)

The other benefit to not establishing a separate name for the currency is that the lack of a currency name lowers the risk of people starting to think of money as some nebulous named thing rather than thinking of it as the commodity itself. So even receipt money would be best if it simply states how much gold it entitles the bearer to and the bank that guarantees the exchange.

Third, I’ve never fully explained token coins.

Most modern societies still use metal as money, but the stated value on the metal coins is much higher than the intrinsic value of the metal by weight. So, they’re not real coins that have full intrinsic value like the gold coins of early Avaria. That’s why they’re called token coins instead. They are a token that represents a certain amount of money. Basically they’re just a metal version of receipt money.

Fourth, I’d like to review the three main ways the government and First Bank can manipulate the money supply.

1. It can change the required reserve ratio, which of course alters the money multiplier.
2. It can change the discount rate. Increasing the discount rate makes banks more conservative in how much money they lend out because it will be more expensive for them to go below their required reserve, so increasing the discount rate decreases the amount of money. And you see the opposite effect when the discount rate is increased.
3. It can create new money for lending to the government.

I could add a bonus fourth one in as well: Adding a new intangible asset to the list of things that can be used as reserves (like we talked about in Part 33). But this is uncommon enough that it’s not usually lumped in with the other three during discussions about how governments and central banks create more money.

Depending on how tasks are delegated, First Bank may be directly in control of setting the reserve requirement and discount rate. But generally the money creation mechanism is only used to facilitate government deficit spending, which First Bank has no direct control over.

So, if First Bank wants to manipulate the money supply, it has to rely on the first two. Probably it would only change the reserve ratio in more extreme circumstances, but it would use the discount rate as a sort of cushion for the economy.

What I mean by that is this: Whenever the economy is struggling, injecting some additional money into it by lowering the discount rate could help the economy bounce back. And whenever the economy is doing well, the central bank wants to increase the discount rate so that it has room to lower it again when another economic rough patch comes. It would also have to balance those changes with the impact on the aggregate money supply that changes in the amount of government debt incurs.

When I talk about manipulating the money supply in that way, doesn’t it seem like a great idea? Doesn’t it seem like the kind of thing that economists could get PhDs in by creating all sorts of sophisticated models to take every factor into account and set the discount rate just right to optimize economic growth? Doesn’t it seem like we should be so grateful for the Federal Reserve’s efforts to help our economy?

Yes, it does seem that way. But I would liken that positive sentiment to seeing a guy rushing to put out a raging house fire by throwing buckets of water on it. We’re watching him doing that and thinking he’s doing the best he can in a tough situation, and then later we find out that he’s the one who lit the house on fire in the first place.

And if that analogy isn’t enough to quell that positive sentiment toward the central bank manipulating the money supply in ways that ostensibly help the economy, I’ll refer you to (1) Parts 1-35 (especially Part 35) of this series and (2) this post I wrote more recently about how administratively setting the price of anything–including money–is unbelievably worse than letting the market set the price instead.

Fifth, I’ve already talked about various effects of monetary expansions and contractions earlier in this series (like way back in Part 21), but I haven’t ever summarized those effects all in one place. So let’s briefly review all of the main effects, looking at them from a monetary expansion point of view:

1. It causes wealth redistribution as the benefits of the change in money supply accrue primarily to the groups of people who are earlier in the chain of effects. For example, the first person to spend newly created money (usually government) gets to do it at pre-inflation prices, so there’s a wealth transfer to them and the other early recipients of that newly circulating money.
2. It induces inefficiencies in the market due to pricing uncertainty.
3. It causes wealth to be lost due to the investment failures induced by the pricing uncertainty and general market uncertainty.
4. It distorts purchasing decisions as people perceive they have more wealth than they really do because prices have not adjusted yet to the new supply of money. This can lead to significant hardship because people have purchased things that they realize after the fact they cannot afford. It can also lead to defaulting on loans, which puts the financial security of banks at risk too.

I want to expand a little bit on the second one listed there.

I’ve talked a lot on this blog about how deliberately changing prices (“administrative pricing”) interferes with a market working efficiently (here and here) because without having the market price anymore, all the information contained in it has been lost. Usually when I’m talking about that topic, I’m talking about administratively setting prices for specific goods or services. What about when the government deliberately changes the price of everything in one fell swoop by changing the value of money?

If the price of everything were to generally rise or fall at the same time, then maybe the relative price of things remains constant enough that it’s not so bad, and we only deal with the short-term generally-too-low or generally-too-high prices.

But prices do not rise and fall at the same time, so relative prices are going to be out of whack to some extent as well.

I currently don’t have any means of quantifying the degree of destructive inefficiencies these pricing inaccuracies cause, but I suspect they are not trivial.

So, when taking all these effects of a monetary contraction or expansion into account, I’m convinced that the costs far outweigh any benefits.

To conclude this post, I’d like to illustrate the effects of a monetary expansion with an example.

Let’s say there’s a pandemic. Global supply chains are disrupted, companies are closing down, and lots of people are getting laid off. People are not buying as much stuff (except for toilet paper and sanitizer and masks), so there’s a general slump falling on the whole economy.

The government sees this, and they think, “You know what can stimulate an economy? A big infusion of cash! Sure, it will induce all those negative effects that Christensen’s Theory of Money blog posts describe, but, until prices adjust, people will behave as if they have more money and will therefore start spending money again, which will help the economy. And a healthy economy helps everyone!”

So the government sends everyone below a certain income threshold a big fat stimulus cheque funded by newly created money. And the recipients of these cheques think they are wealthier, so they start spending money accordingly.

Little do they know that inflation will hit them hard enough down the road that it will more than compensate for the extra money they got in that cheque.

So what the government has essentially done is manipulated people into spending money that they otherwise wouldn’t have spent by convincing them in the short term that they’re richer than they are and then taking that wealth away again (through inflation) later on.

And the people have no idea. In fact, when they get the cheque with the President’s name on it, they think he’s such an amazing guy. And then, when inflation hits them later on, they blame the businesses for greedily raising prices so much.

It’s a perfect PR move by the government. They manipulate the people into doing what they want, get thanked for it (and are now seen as proactive and good politicians), and get none of the blame later on when the people realize they have less wealth than they thought and have been spending irresponsibly.

This sounds pretty critical of government, and I guess it is. But how clearly do politicians supporting these policies know that this is what they’re doing? Maybe some or all of them can claim ignorance. But regardless of their intentions, the effect of their policies is the same: they harm us financially. In fact, they do more harm than just leaving the economy alone. So, this is one more example of how a 0% backed fiat currency hurts us, in this case by facilitating the government manipulating us into spending money we don’t really have and convincing us they’re good politicians in the process.

Part 37 here.