Cutting To The Chase

1. So how was the West won? By an extraordinary burst of real economic development, supercharged by money and credit. It helped build modern America. It also produced a Credit Bubble.

2. The 1830s are astonishingly modern. Central banking, money creation, asset bubbles, leverage, government debt, foreign creditors, bailouts and the question of who pays when it all goes wrong. Change the names and we are still arguing about much the same things today.

3. The development was real and so was the bubble. In fact, genuine economic success can make a credit bubble even more dangerous because for a while the prosperity seems to justify all that borrowing.

4. Jackson destroyed the Second Bank but not fractional reserve banking. Changing who creates and controls the credit does not solve the underlying monetary problem. This is exactly the debate surrounding the Fed today.

5. So what actually disciplines money and credit creation? In the 1830s specie and the balance of payments eventually imposed a constraint that banks and politicians had managed to postpone. Today? Nothing really.

6. You don’t need leverage to grow. Credit can accelerate development, but it can also distort the Allocation of Resources and encourage us to borrow far too much against an imagined future.

7. The debts are fixed. The future isn’t. When asset prices, incomes and collateral collapse, the debts remain. Therein lies much of the history of financial crises.

8. Governments can get caught in exactly the same trap. They can borrow against future prosperity just as enthusiastically as farmers, speculators, banks and corporations.

9. Debt to GDP can be deeply misleading. Nine American governments stopped paying when total state debt was only around 12 percent of GDP. Debt is serviced from money governments can actually obtain, not GDP.

10. And what do we do when a credit bubble bursts? Apparently, create more credit. 1837 meet 2007.

11. Which leaves the oldest argument of all. Once the losses exist, somebody has to take them. Default, bailout, taxation, restructuring and inflation merely change who that somebody is.

12. The 1830s aren’t ancient history. They are a remarkably good guide to the monetary and political mess we are still arguing about today.

What a diabolical ideological mess.

It’s the Money System (Again!)

If this music doesn’t make you want to build a railroad, dig a canal or head west and start something, nothing will. There are lots of musical themes from Westerns that we can associate with that pioneering, go get ‘em’ spirit that built the U.S. West (warts and all). But for me, it is this one.

So, shall we get in our wagon and begin the journey to see how the West was won? As you might expect, the money system was front and center.

The Unfinished Argument Over Money

The Panic of 1819 left the United States with a problem much larger than the failure of a few banks or the collapse of a speculative boom. Americans had to decide what had gone wrong with their monetary system.

The Second Bank of the United States, the Fed Mark II, had been created in 1816 with a twenty year mandate partly to restore order after the suspension of specie payments and enormous expansion of state banking during the War of 1812.

Yet the new national bank had itself participated in the postwar expansion before suddenly reversing direction and helping impose the contraction that followed.

You can read all about it in my essay below. Same old story really: creating money from nothing through government combined with fractional reserve banking, creating a bubble and the inevitable disaster that follows.

Unlike Today, At Least They Had A Real Debate

One figure captures the problem. By July 1818 the Second Bank had approximately $21.8 million of notes and deposits outstanding against only about $2.4 million of specie. When it finally became concerned about its reserves, it contracted lending, collected debts and demanded specie from state banks. Borrowers who had entered commitments during the expansion suddenly had to obtain much scarcer money to repay debts whose nominal value had not changed.

The result was a monetary argument that would dominate American politics for decades. Supporters of the Second Bank concluded that the chaos demonstrated the need for a powerful national institution capable of disciplining state banks. Opponents could reply that the Second Bank had helped create the expansion before inflicting the contraction.

Even the Opponents Disagreed Amoungst Themselves

Some wanted easier money and debtor relief. Others reached almost the opposite conclusion: harder money, stricter specie redemption and less bank created credit.

Underneath all of this was the question that still has not gone away. If banks can create notes and deposits far beyond their monetary reserves, what prevents the banking system as a whole from creating too much money and credit?

The Hole In Jackson’s Solution

Am I the only one who sees the irony of central bankers having their annual love in at a place called Jackson Hole? I mean, President Andrew Jackson is probably history’s most famous political nemesis of central banking.

There are eerie echoes between the Jacksonian debates of the 1820s and 1830s and today’s arguments over the Fed, its independence and political attempts to change its direction. You will see what I mean as we go through the story.

Jackson believed that the concentration of monetary power in the Second Bank was itself part of the problem. But destroying an institution is not necessarily the same thing as solving the monetary mechanism underneath it. If the Second Bank disappeared, what would prevent hundreds of state banks from creating the same credit somewhere else?

That was about to become a very expensive experiment.

The Creditors Versus Debtors Fight.

There was another problem left behind by 1819. What do you do after a credit bubble has already burst?

A farmer who bought land during the boom could emerge from the collapse with exactly the same dollar debt but much lower commodity prices, much less money circulating and land worth considerably less than when he borrowed. From his perspective, debtor relief seemed perfectly reasonable. The creditor saw things differently: he had advanced money under a contract specifying repayment in dollars, and retrospective legislation could simply transfer the borrower’s loss onto him.

It Is As Old As Credit Itself

Go back to ancient Egypt or China and you find versions of the same argument. What about the farmer destroyed by a failed harvest? What about the speculator who borrowed to make a fortune from rising land prices? What about the creditor who lent recklessly? And what about completely innocent people who lose their jobs and businesses when the whole thing collapses?

I know. How about not creating the credit bubble in the first place?

But Decisions Need To Be Made

Unfortunately, once it has happened, there are real decisions to make. Protect the creditors? Rescue the debtors? Let the banks fail? Inflate the money supply? Restructure the debts? Default? Tax people who never borrowed the money to repay people who lent it?

The states responded after 1819 with various combinations of stay laws, appraisal requirements, state loan offices and paper money. Kentucky’s attempts at debtor relief even produced the extraordinary Old Court New Court controversy when the legislature tried to replace a court that had struck down parts of its programme.

It is the same basic problem I dealt with after the Revolution and Shays’ Rebellion in my essay below.

The important point for our story is that the argument produced two very different kinds of opponents of the Second Bank. Some disliked it because it restricted credit when debtors desperately wanted more. Others, including hard money critics such as Hezekiah Niles and Condy Raguet, thought excessive paper money had created the bubble in the first place and wanted stricter specie redemption and less bank created credit.

And America was about to confront the creditor debtor problem again on a much larger scale. This time some of the biggest debtors would be the states themselves.

What Disciplines A Bank?

This brings us to the central monetary problem.

A fractional reserve bank can create more notes and deposits than it holds in specie, but one bank cannot expand indefinitely. If it expands much faster than its competitors, its new money eventually reaches customers of other banks. Those banks demand settlement and the expanding bank begins losing its gold or silver reserves.

But What Happens If Most Of the Banks Expand Together?

Interbank claims increasingly cancel through clearing and that particular restraint becomes weaker. The discipline then has to come from outside the banking system. Individuals can demand specie and, crucially, payments to foreigners can cause specie to leave the country. In that sense, the balance of payments can discipline an entire national banking system much as competing banks discipline an individual bank.

Even that only works if redemption is actually enforced. As Condy Raguet explained to Ricardo in 1821, depositors and borrowers often had strong incentives not to demand specie, while governments repeatedly permitted banks to suspend payment when the pressure became severe.

Gold and silver therefore provided an ultimate constraint, but politics could weaken that constraint precisely when it began to bite.

That was the monetary system Andrew Jackson was about to take on.

Who Disciplines the Disciplinarian

The Second Bank survived the Panic of 1819 largely because its new president, Langdon Cheves, brutally tightened lending, collected debts and rebuilt its specie reserves. Nicholas Biddle, who took over in 1823, then transformed it into a much more effective national institution. Meanwhile, McCulloch v. Maryland (1819) had confirmed Congress’s constitutional authority to charter the Bank and prevented states from taxing it out of existence.

The Economic Case Seemed Straightforward

America had hundreds of banks issuing notes of varying quality, often trading at discounts far from their place of issue. The Second Bank provided a more widely accepted currency and, crucially, could collect state banknotes and demand their redemption in specie. A state bank expanding too aggressively could therefore find Biddle’s Bank knocking on its door demanding hard money.

But the Bank was itself a fractional reserve bank, creating notes and deposits against a smaller specie reserve. This produced the fundamental dilemma. If hundreds of banks could not adequately discipline themselves, a national bank seemed useful. But if the solution was to give one enormously powerful bank the ability to discipline all the others, who disciplined it?

Then There Was the Small Matter of Power

The federal government owned one fifth of the Bank and deposited its money there, while most of the institution remained privately owned and some shareholders were foreigners. Biddle was unelected, yet decisions made in Philadelphia could influence credit conditions across the country. Supporters regarded this independence as a strength. Opponents regarded it as a danger.

The Erie Canal Illustrates the Spirit of the Times

The Erie Canal showed what could happen when the borrowing actually worked. New York financed much of the project with state debt, spending about $7.1 million to connect the Hudson River with Lake Erie. When it opened in 1825, transport costs between the Great Lakes and the Atlantic collapsed, western produce could reach eastern and European markets far more cheaply, and manufactured goods could move west just as dramatically.

The Economic Consequences Were Enormous

Trade surged, towns grew along the route, western land became more valuable and New York collected substantial toll revenues. The canal did not merely make its debt manageable; it appeared to demonstrate that a state could borrow heavily, build infrastructure, create economic growth and use the resulting prosperity to repay the borrowing.

What politician wouldn’t want some of that? Canals, roads and later railways suddenly looked less like government expenditure and more like investments in a much richer future.

The trouble was that every state now wanted to be New York.

The Voice Goat Sets the Scene For the 1830s

Here is a very short video on the main events of 1830s America to set the scene.

Jackson and Biddle. Sort of Like Trump and Powell.

Andrew Jackson entered the presidency in 1829 deeply suspicious of banks, debt and concentrated financial power. The confrontation came in 1832 when Henry Clay and Biddle sought an early renewal of the Bank’s charter. Congress approved it and Jackson vetoed it, attacking monopoly privilege, foreign ownership and the extraordinary concentration of financial power in a federally privileged private institution. He then won re-election decisively.

Jackson subsequently removed federal deposits from the Second Bank and redirected new government receipts into selected state institutions, the so-called pet banks. Biddle responded by tightening credit, partly from financial necessity but also in the belief that the resulting distress would demonstrate the Bank’s importance and force Jackson to retreat.

That produced the great irony of the Bank War. Biddle could argue that the resulting distress demonstrated why America needed his Bank. Jackson could reply that the ability of one unelected banker to tighten credit across the country to influence government policy demonstrated precisely why it was dangerous.

Jackson won. The federal charter expired in 1836. But moving government money from one enormous fractional reserve bank into numerous smaller ones had hardly solved the underlying monetary problem.

What Happened After Jackson Won?

The aftermath provides a useful test of both arguments. If the Second Bank had been causing the instability, its destruction should have improved matters. If it had been restraining the state banks, removing it should have encouraged further expansion.

Expansion certainly followed. The American money supply rose from approximately $150 million at the beginning of 1833 to about $267 million by early 1837, an increase of almost 80 percent. State banking expanded, credit increased and land speculation accelerated.

But this was not simply banks creating more paper against an unchanged quantity of metal. America’s specie stock also surged from approximately $31 million to $73 million. Mexican silver and changing international silver flows played important roles, giving the banking system a much larger metallic base upon which to expand credit.

The Results Were Spectacular

Federal public land sales, previously around $4–6 million annually, jumped to $16.2 million in 1835 and $24.9 million in 1836. More specie supported more bank credit; credit financed land purchases; rising land prices strengthened collateral; and expectations of continuing western expansion encouraged still more borrowing.

Jackson had destroyed the Second Bank. He had not destroyed the credit cycle.

Back Home In the Cotton Fields

There was a perfectly sound economic reason for the boom. Britain’s Industrial Revolution created enormous demand for American cotton just as production was moving west into the fertile lands of Alabama, Mississippi and Louisiana.

It is impossible to make sense of the American cotton industry (and indeed the expansion Westward) without understanding the Industrial Revolution which began in Britain. Watch the above video for a refresher. It is equally impossible to understand the slavery situation in the U.S. without understanding the cotton industry. See the video below for that.

Of Course There is the Slavery Issue

With All This In Mind…

Cotton prices rose from roughly 10 cents a pound in 1830 to 15 cents or more in 1835, while exports increased in value from about $30 million to more than $71 million by 1836. Production surged from roughly 977,000 bales in 1830 to 1.42 million in 1837 and more than 2 million by 1840.

Credit allowed this expansion to happen much faster. Planters borrowed to buy land, enslaved people and supplies, using land and future crops as collateral. Cotton factors and merchants advanced money against crops, while bills drawn against shipments were discounted through New Orleans, New York, Liverpool and London. Rising cotton and land prices increased collateral values, supporting still more borrowing and production.

Credit also allowed merchants to finance cotton inventories rather than sell immediately.

Go West Young Man. Build, Build, Build.

But cotton was only part of the enormous expansion westward. Settlers and speculators borrowed to buy federal land; farmers borrowed to establish farms; merchants financed the new communities; and states borrowed to build the canals, roads and railways connecting them to markets. Some states also borrowed to establish or capitalise banks.

The logic seemed compelling. Borrow today, build the infrastructure, open new territory, increase land values and commerce, and repay the debt from tolls and the revenues of a much richer future state. The Erie Canal, completed for about $7.1 million, appeared to prove that it could work.

That’s Not Leverage. This Is Leverage

But some states took the idea to extraordinary lengths. Indiana authorised $10 million for internal improvements in 1836 when annual state tax revenue was only around $50,000. Illinois followed with a $10 million programme when annual state revenue was around $57,000. They were borrowing not against the economies they had, but against the much larger economies they expected to create.

Teachable Moment. You Don’t Need Leverage To Grow.

This is the important distinction between genuine economic development and a credit bubble. America really did need more cotton, western farms, canals and railways. Much of it would have happened anyway. Credit did not invent the economic transformation; it accelerated it and affected how resources were allocated.

Without such rapid credit growth, cotton production probably would have expanded more slowly, and infrastructure projects would have competed more vigorously for scarce capital. The Erie Canal would surely still have been built. Whether Indiana would simultaneously have attempted its enormous Mammoth Internal Improvement System is another question.

Nothing New Under The Western Sun

By the middle of the 1830s the cotton, land, banking and infrastructure booms were feeding one another. Credit pushed up land and cotton prices; higher asset prices supported more credit; infrastructure increased western land values; and British demand and capital helped finance the entire process.

The weakness was simple: the debts were fixed while the values supporting them were not. This is a movie we have seen many times in history. Cotton prices could fall, land values could collapse and projected canal tolls could fail to appear, but the loans and bonds remained.

The Crash Came In 1837

The trigger came from both sides of the Atlantic. The Bank of England, worried about declining gold reserves, tightened credit during 1836 just as increasing quantities of American cotton were arriving in Britain. American related bills became harder and more expensive to finance. Merchants who had previously borrowed to carry their cotton inventories suddenly needed cash and began selling.

The Process Then Fed Upon Itself

Cotton prices fell, reducing the value of the cotton behind existing loans and bills. A shipment expected to realise £10,000 might now be worth only £8,000 even though £10,000 had already been advanced against it. Lenders became more cautious, credit contracted further, more cotton had to be sold and prices fell again.

The shock travelled back across the Atlantic. American banks and merchants had lent against rising cotton and land prices, so falling cotton prices weakened collateral and threatened the bills and loans built upon it. At the same time the American land boom was already vulnerable and banks faced increasing pressure on their specie reserves. What had been a self-reinforcing credit expansion began working just as powerfully in reverse.

In May 1837 the New York banks suspended specie payments and the suspension spread across much of the country. The cotton, land and banking boom had finally broken.

But the interesting part for what follows is what happened next. Rather than simply allowing the credit structure to unwind, America found ways to start expanding credit again. And this time the states themselves would be right in the middle of it.

Are You Thinking 2007? Solve A Credit Crash By Creating More Credit.

The financial system did not simply liquidate the debts and start again. Banks suspended specie payments, meaning their notes and deposits could no longer necessarily be converted into gold or silver on demand, while various forms of credit were used to keep commerce moving.

Nicholas Biddle’s Bank of the United States of Pennsylvania became particularly aggressive, including issuing post notes promises to pay at a future date rather than ordinary notes payable immediately in specie.

These could circulate or be discounted and therefore provided another way of extending credit when specie payments and conventional bank finance were under severe pressure.

What Could Possibly Go Wrong?

At the same time, borrowing did not disappear. It increasingly reappeared in other forms and in other places. State governments and state supported banks continued raising enormous sums, much of it through bonds sold to American and British investors, to finance banks, canals, railways and other internal improvements.

In effect, the economy was trying to escape one credit crisis while another enormous structure of debt was still being built.

That Distinction Is Imposrtant

The Panic of 1837 was the immediate banking and commercial crash. The Crisis of 1839 exposed something deeper: debts had migrated and accumulated throughout the states, banks, land market and internal improvement programmes. When credit tightened again, some states discovered that the future revenues against which they had borrowed simply did not exist.

And that brings us to the extraordinary part of the story: the state debt crisis.

The Borrowing Had Moved To the States

The Panic of 1837 was severe, but there was enough recovery during 1838 for many contemporaries to believe that the worst had passed. Banks resumed specie payments in many places, commerce revived and, remarkably, state governments continued borrowing on an enormous scale.

During 1838, 1839 and 1840 the states authorised approximately $96 million of additional debt and issued around $78 million. To put that in perspective, Washington had borrowed approximately $82 million to finance the entire War of 1812.

State debt had been only around $13 million in 1820 and $27 million in 1830. Estimates vary somewhat, but by 1835 it was approximately $66–81 million and by 1841 around $198 million. Jackson had extinguished the federal debt, but America had certainly not stopped borrowing.

Let’s Default. And the Problem Is?

Nine Governments Stop Paying

By 1841 and 1842 eight states and the Territory of Florida had defaulted: Pennsylvania, Maryland, Indiana, Illinois, Michigan, Arkansas, Mississippi and Louisiana, together with Florida, which did not become a state until 1845.

Total state debt of approximately $198 million was only around 12 percent of estimated American GDP. By modern standards that sounds almost trivial.

So how did so many American governments default with aggregate debt equivalent to only about 12 percent of national output?

Governments Do Not Service Their Debts Out Of GDP

The answer begins with the denominator. Debt is not serviced out of GDP. It is serviced from government revenue, investment income, asset sales, new borrowing or some other source of funds available to the government.

Antebellum state governments were tiny institutions by modern standards. Their tax systems were narrow, administrative machinery limited and political resistance to direct taxation often intense. Some development programmes had been deliberately designed around the expectation that canals, banks, land values and future growth would service much of the borrowing without requiring enormous immediate taxes.

Why Couldn’t They Just Print The Money?

This takes us directly back to the monetary question at the centre of the story. Why didn’t the states simply create the money required to pay their debts?

The answer requires a distinction between creating credit and creating the asset in which that credit ultimately had to be settled. State governments could charter banks, and those banks could certainly create notes and deposits. Several states were directly involved in banking institutions. There was therefore no absolute prohibition on the creation of additional monetary claims.

But a Banknote Was a Promise To Pay Specie

A bank deposit was ultimately a claim on a bank promising redemption in specie. Creating another million dollars of banknotes created another million dollars of liabilities. It did not create another million dollars of gold or silver.

During the boom this distinction could disappear because people were willing to hold the promises. During the contraction everybody began asking what stood behind the promises.

A state could issue another bond and use the proceeds to pay interest on an earlier bond, but only while somebody was prepared to buy it. A state bank could create additional notes, but if holders demanded redemption the bank required specie. British bondholders did not have to accept an unlimited quantity of Indiana banknotes as final payment.

Oh, the Foreigners Matter

The foreign ownership of state bonds made the constraint particularly obvious. International payments ultimately required financial claims acceptable abroad or, at the end of the settlement chain, gold or silver.

The states could create credit, but they could not create the ultimate settlement asset.

That made their position fundamentally different from that of a modern sovereign government issuing debt in a fiat currency it controls.

The Latin America Of Their Day

The modern United States government cannot create real resources without limit, and excessive monetary financing can produce inflation, depreciation and loss of confidence. But it cannot involuntarily run out of nominal dollars in the same sense that Indiana could run out of the specie or internationally acceptable funds required to meet its obligations.

The nineteenth century states therefore faced something closer to the problem of a modern government borrowing in a currency it cannot create. In short, they were the 1980s Latin America of their day.

Once lenders refused to refinance them, their choices became brutally limited: tax, sell assets, borrow somewhere else, restructure or default.

Tax, Default Or Repudiate. That Is the Question

The different outcomes among the states demonstrate the importance of fiscal capacity. Pennsylvania and Maryland defaulted temporarily but ultimately imposed effective property taxation, resumed payments and honoured their debts. Their underlying economies contained substantial taxable resources; the governments had simply failed to construct adequate revenue systems before the crisis.

Indiana and Illinois Faced a Harder Problem

Their ambitious development programmes had been financed partly against the future population, land values and tax bases that the projects themselves were expected to create. Indiana substantially increased property taxation, but it was attempting to tax more heavily while the value of the property being taxed was collapsing. Both states ultimately restructured their obligations.

Several southern cases were different again because state bonds had been issued to support banks. The banks were expected to service the obligations from their own profits. When they failed, what had looked like a self-financing arrangement suddenly became a claim against taxpayers. Mississippi became the most notorious case, repudiating major bank related obligations, while Florida and several other governments also repudiated or failed to repay portions of particular debts.

Not Every Heavily Indebted State Defaulted

New York owed almost $22 million and continued servicing its debt. Ohio owed nearly $11 million and also avoided default, substantially increasing taxation. Alabama carried more than $15 million without formally defaulting at this stage.

Debt alone therefore did not determine the outcome. The structure of revenues, unused taxing capacity, quality of the investments, exposure to failed banks, ability to refinance and political willingness to impose taxes all mattered.

Deflation Turns The Screw

The monetary contraction made every part of the fiscal problem worse. Historical estimates suggest that the American money supply fell from approximately $240 million at the beginning of 1839 to around $158 million in 1843, a decline of roughly one third. One historical price index falls by more than 40 percent between early 1839 and early 1843, while the number of banks also declined substantially.

The crucial point is that debts did not fall with prices. If Indiana owed $12 million, a collapse in land values did not reduce the bonds proportionately. Interest remained contractually due in nominal dollars even while property prices, wages, toll revenues, bank collateral and the taxable base were falling.

The Debt Burden Increases

The real burden of the debt therefore increased precisely as the resources available to service it contracted. Banks responded to deteriorating collateral by restricting credit and collecting loans. Borrowers sold assets into falling markets. Lower asset prices further damaged collateral and tax bases, encouraging still more contraction.

The same mechanism visible after 1819 had returned on a much larger scale. This time governments themselves were among the leveraged borrowers.

Washington Says No

The defaults created an American sovereign debt crisis with international consequences. British and European investors discovered that bonds issued by American states were not guaranteed by the United States government. Pennsylvania could default without Washington paying Pennsylvania’s creditors, and Mississippi could repudiate obligations without the federal Treasury making the bondholders whole.

Demands consequently arose for federal assumption of the state debts. There was an obvious precedent: Alexander Hamilton’s assumption of Revolutionary War state obligations in 1790. But Washington refused.

No Federal Bailout. Deal With It

A federal bailout would have transferred losses from heavily indebted states and their creditors onto national taxpayers, including citizens of states that had borrowed much less. Instead, the states and their creditors largely had to absorb the consequences themselves. Some states raised taxes, others restructured or repudiated their debts, and during the 1840s and 1850s many introduced constitutional restrictions on future borrowing.

And That Brings Us To Where We Started

The development of the West was real. The farms, cotton, canals, roads and railways were real. But the monetary system allowed an enormous structure of credit to grow around that development. Banks created money against rising land and commodity values, while states borrowed against the tolls, population, tax revenues and prosperity they expected to arrive in the future.

That was Credit Bubble Number Two. When it burst, cotton and land prices fell, collateral collapsed, banks contracted credit and the money supply shrank. But the debts remained. Andrew Jackson had destroyed the Second Bank, but he had not destroyed fractional reserve banking or the credit cycle.

Who Should Pay?

Which leaves the question that has followed credit bubbles throughout history: who pays?

The debtor can pay through bankruptcy and foreclosure. Creditors can pay through default or restructuring. Taxpayers can pay through higher taxes or bailouts. Holders of money can pay through inflation and depreciation. Or the losses can be shifted onto people who had nothing to do with creating the debt in the first place.

There is no magic solution in which the loss disappears. Default, bailout, taxation, restructuring and inflation merely distribute it differently. That is the default position on default.

What a diabolical ideological mess.

Cutting To The Chase

1. China is approaching an economic and political crisis after decades of failed CCP policies.

2. The “social contract” is broken. The one child and other policies left forced abortions, demographic collapse, a huge gender imbalance and an ageing population. Now add lying flat, leftover women and growing disillusionment.

3. The property bubble has burst. Evergrande left unfinished apartments, destroyed savings and mortgages that still have to be paid. The CEO is in jail for life, but what about the rest of the CCP hierarchy that made bazillions from the credit fuelled property bubble? The people have noticed.

4. Yet Xi received three standing ovations from America’s business elite in San Francisco. The WEF/globalist establishment has a lot to answer for.

5. Frank Dikötter argues the CCP did not lift China from poverty. Ordinary Chinese did it when they escaped Communist controls. In fact, the CCP tried to stop them.

6. But the CCP kept control of the banks, credit and the Allocation of Resources. Party survival always came first.

7. Tiananmen was also a financial crisis. The CCP crushed the revolt but retained the financial system that helped create the underlying economic tensions.

8. The result was the mother of all credit bubbles, pouring resources into property, infrastructure and other wasteful investments.

9. When property collapsed, resources shifted into manufacturing, producing massive overcapacity and an enormous trade surplus. You reckon the rest of the world won’t react to that?

10. China now sends real goods overseas in return for financial claims. Belt and Road raises the same question: what will all these IOUs ultimately be worth in real terms?

11. Property, troubled banks, overcapacity, Belt and Road disaster and the trade surplus are all part of the same gigantic Allocation of Resources problem.

12. Persistent trade surpluses always correct somehow. More often than not, violently. Think the Opium Wars and the American Revolution. The money system matters big time.

13. Eventually the losses have to fall somewhere. With the “social contract” already broken, I reckon the CCP is finished.

China Has a People Problem. And It Is Not Just China.

You cannot ignore the cultural and societal implications of the past 77 years of communist rule of China by the CCP. It obviously has huge impact on what social scientists call “social capital”.

There are all sorts of weird stuff out there, but the video below is the most balanced I have come across.

They probably overestimated their 1.4 billion official estimate of their population by around 130 million but it is the lack of births, that is the real problem for them.

There’s a viral theory that China’s real population is only 300 million, and that hundreds of millions secretly died during Covid. See footnote 1 at end of article

This is what happens when you interfere with human nature with the one child policy. There are all sort of related economic problems related to this. For example, how, in a poor per capita country, does one child look after their aging parents without a real social security system.

Give Me One Of Those Diapers

Most will be aware that the problem is Asia wide but China, being much poorer than the other Asian nations, has a much worse problem.

Did you know that Japan now sells more adult diapers than baby ones? That says it all about the people problem.

Lying Flat. Better Than Flatlining.

Chinese youth are increasingly opting out and joining the “Lying Flat” movement. This is serious and real. Watch the video below. What do you expect when the financial system gives rise to the economic catastrophe that China now faces.

Limited job opportunities and social resources make the competition for young people in modern China increasingly fierce. See Footnote 2 at end of article.

100 Million Leftover Women

How is it that a country with a surplus of men (thanks one child policy, I won’t go any further to explain why) has a problem with what is termed “Leftover women”. Part of the answer seems to be a combination of economic, Asian culture and the rise of Western cultural trends relating to gender in Asia.

Today’s topic is: The gender imbalance in China’s urban and rural areas is striking: the number of unmarried young and middle-aged men in rural areas is approaching 30 million, while in cities, there are 100 million “leftover women” struggling to find ideal husbands. See Footnote 3 at end of article.

This is an Asian wide issue. See the interesting take on Korea below, but like most of the social issues, China’s problem seems to be more severe than other Asian countries.

I will let you go down this rabbit hole. What’s that normal disclaimer about “the views in this video do not necessarily…”

“Feminism destroyed society.” That’s the claim trending on every platform. See Footnote 4 at end of article.

The ‘Social Contract’ Is Broken

The point to all this to show that past policies, especially the one child policy, have created societal frictions that will come to fore when the economy inevitably collapses from the credit bubble.

Some argue that that collapse is already here. Keep all this background in mind when we get to our usual economic analysis below.

Evergrande: The Property Bubble Bursts

The conviction of Evergrande founder Hui Ka Yan provides an extraordinary bookend to the bursting of China’s great property bubble. On 20 August 2026, Hui, once Asia’s richest man, was sentenced to life imprisonment for crimes including massive financial fraud, illegal fundraising and bribery; Evergrande collapsed with more than US$300 billion in liabilities.

The Real Scandal Goes Far Beyond Hui

For years the property boom generated enormous revenues for developers, banks and local governments, particularly through land sales, taxes and the credit system. When the bubble finally burst, ordinary Chinese households were left holding the bag.

China jailed Evergrande founder Xu Jiayin, but nearly $330 billion in liabilities, unfinished homes, and shattered family savings remain. This video reveals how the CCP turned one billionaire into a scapegoat while ordinary Chinese citizens were left to pay for the collapse of the country’s property machine.

Many had bought apartments before they were built and taken out mortgages to pay for them; when developers ran out of money, construction on countless projects stopped, yet buyers could remain liable for their mortgage payments.

It is a brutal illustration of the wider property collapse discussed earlier: the boom enriched those surrounding the system, including the state, while many of the people who ultimately financed it were left paying for homes that did not even exist.

This all happened before the November 2023 in San Fran. Read on.

Of Course, the World’s Business Elite Love the CCP

In November 2023, Xi Jinping walked into a room packed with some of America’s most powerful business leaders in San Francisco and was greeted with a standing ovation. In fact, Reuters reported:

“Xi was greeted with “not one, but three standing ovations” from the U.S. business community.”

Many of the same corporate and financial elites move comfortably through the World Economic Forum and the wider globalist establishment.

I get that our politicians must do the old go along to get along routine. Maybe even some businesses at times. But the sycophantic three standing ovations?

Come On Man!

At least some in the media were concerned about the how this looks. I mean we are talking self-inflicted famine, hundreds of millions killed for a whole host of reasons, at the very least ten of millions forced abortions (a large percentage late term for obvious reasons).

I could go on but the CCP is certainly in the conversation for the evilest empire in the whole of human history and there is stiff competition for that title.

Keep all this in mind as we turn to what the CCP is, how it operates, and Frank Dikötter’s argument that beneath the polished international image sits something much closer to a paranoid mafia organisation than the conventional picture of a normal government.

The Rise Of China?

I reckon some of you may be thinking: “I agree but at least they lifted hundreds of millions out of poverty and maybe that is what the multiple standing ovations was all about.” Well, we will see below that it wasn’t the CCP that did all that.

In fact, it was the exact opposite: it was the CCP losing some control of the countryside after the Great Leap Forward and the Cultural Revolution that set off the economic revolution.

Frank Dikötter is a senior fellow at the Hoover Institution who has recently returned to the United States after living in Hong Kong since 2006. See Fottnoet 5 at end of article.

What are the chances of you watching the whole of the video above? Not big I would think but maybe you should. In case you don’t, I unpack a lot of it below.

Who Really Lifted China Out of Poverty?

One of the great claims made on behalf of the Chinese Communist Party is that it lifted hundreds of millions of people out of poverty. Frank Dikötter turns that claim on its head. His question is beautifully simple: who lifted whom out of poverty?

When Mao died in 1976, after almost three decades of Communist rule, Dikötter argues that the living standards of most Chinese were lower than they had been in 1949. The Great Leap Forward had produced a catastrophic famine, and the Cultural Revolution had devastated much of what remained. China was desperately poor.

A Real Peasant Uprising

But something extraordinary had already begun happening beneath the surface. The Cultural Revolution had inadvertently weakened the Communist Party’s ability to control the countryside. From the early 1970s villagers increasingly reclaimed the economic freedoms that collectivisation had taken from them.

They divided collective land among themselves, reclaimed tools, opened underground factories, traded on black markets and decided for themselves what to grow and where to sell it. Local Party officials sometimes resisted, but often they simply looked the other way or joined in. Dikötter calls it a “silent revolution”. It began before Mao died and well before Deng Xiaoping supposedly launched China’s great economic reform.

The CCP Fought Against It.

So Much For Lifting Hundreds of Millions Out Of Poverty

Indeed, this is the crucial part of Dikötter’s argument: Deng initially tried to preserve the collective system. As late as 1980 the leadership was insisting that collective agriculture was superior to private farming and launched a campaign against decollectivisation. It failed because events had already overtaken Beijing.

By January 1981, 78% of households in Guizhou, 56% in Gansu and 51% in Anhui were effectively making their own decisions about what to plant, how to grow it and what to do with the produce. In some places the Ministry of Agriculture admitted that the collective economy had simply vanished.

The Government Had No Choice

The peasants were also destroying the state’s system of compulsory procurement from below. The government had forced them to sell grain and other agricultural products to the state at prices that could be below the cost of producing them. Farmers increasingly refused to play the game. They consumed their own grain, bartered it, sold it on the black market or switched to more profitable crops.

Eventually the government had little choice but to retreat, raise the prices it paid and loosen its control. The People’s Communes finally collapsed in 1982, but in Dikötter’s telling Beijing was largely putting its official stamp on a revolution that ordinary Chinese had already carried out.

Nor Did the Transformation Stop At the Farm Gate

Once villagers gained greater control over their labour, rural businesses and factories proliferated. These village enterprises generated much of China’s extraordinary early growth while the state-owned industrial sector remained remarkably inefficient.

Growth therefore did not initially trickle down from some brilliant economic transformation engineered in Beijing. It travelled in the opposite direction, from the countryside upwards. Millions of ordinary Chinese, given even limited freedom to produce, trade and invest, began transforming the economy themselves.

The Party Had To Tolerate It

That puts the famous claim that the Communist Party “lifted hundreds of millions out of poverty” in an entirely different light. Dikötter’s argument is not that China moved smoothly from communism to capitalism under the wise direction of Deng Xiaoping. It is that ordinary Chinese began escaping poverty as the Communist system progressively lost its ability to prevent them from making their own economic decisions.

The Party eventually tolerated and then harnessed much of this activity, while retaining control of the banks, land, major industries and ultimately the allocation of capital. On this interpretation, China’s great economic miracle was not evidence of the success of communism. To a remarkable extent, it began with the breakdown of communism in the countryside.

Once a Communist, Always a Communist

This brings us to Dikötter’s much bigger point. The mistake, he argues, was to believe that economic reform meant the Chinese Communist Party itself was gradually ceasing to be communist. It wasn’t.

Deng Xiaoping loosened parts of the economy because the old system was failing, but he simultaneously entrenched the principles that mattered most: the Communist Party would retain its monopoly of political power, and the socialist state would retain control of the commanding heights of the economy.

Dikötter’s striking conclusion from decades spent reading the Party’s own internal documents is that these people really did believe what they were saying. Reform was never intended to abolish the communist system. It was intended to make that system survive. As he puts it, in a one-party state “politics is always in command”; the economy is ultimately secondary to power.

These Clowns Are Paranoid Fools

Once you look at it that way, the CCP begins to resemble less a normal government than a deeply paranoid organisation whose overriding objective is its own survival. This paranoia is built into the system. They certainly don’t have the Mandate of Heaven. See my essay below.

A one-party state has no legitimate opposition, so any threat must be imagined as coming either from enemies hidden inside the Party or from hostile forces outside it.

Hence the Endless Purges

Mao purged supposed counter revolutionaries, Deng purged opponents, successive leaders did much the same, and Xi Jinping has taken the practice to another level. Anti-corruption campaigns therefore cannot be separated neatly from struggles for political control: potential rivals, unreliable officials and imagined enemies are continually removed.

The point is that Xi’s behaviour is not some strange departure from an otherwise benign post Mao system. It is a continuation of a much older Communist logic in which loyalty to the Party comes before almost everything else.

A Good Old Fashion Mafia Operation

The CCP provides enormous benefits to those inside the organisation, but in return demands loyalty, discipline and silence. It does not trust the population, and remarkably it does not even fully trust its own members.

The regime is frightened that a single protest, an independent organisation, Hong Kong’s freedoms or even an apparently insignificant act of dissent might become the “single spark” that sets off a counter revolution. At the same time, it remains convinced that the capitalist world is trying to infiltrate and ultimately destroy it.

That combination of privilege, secrecy, internal discipline, periodic purges and permanent suspicion gives the system its extraordinary resilience, but also its extraordinary paranoia. The CCP may have changed almost beyond recognition economically since Mao, but its deepest instinct has never changed: whatever happens to the economy, the Party must survive.

Tiananmen Was Also An Economic Crisis

In the West we remember the 1989 Tiananmen Square uprising principally as a student led democracy movement culminating in the tanks and the massacre of 4 June. There were demands for political freedom this misses much of what brought ordinary Chinese onto the streets across the country. Behind the political explosion was an increasingly dysfunctional financial system.

Don’t Tell Me: It Was the Financial System That Was the Real Cause

From the mid 1980s, state enterprises and local officials gained greater freedom to borrow, while banks remained controlled by the Party and credit was increasingly allocated through political connections rather than anything resembling a genuine market for capital.

See Footnote 6 at end of article.

The resulting credit expansion helped produce an investment boom with inflation that reached roughly 50 per cent by the summer of 1988 in parts of the economy. Urban Chinese who had been accustomed to remarkably stable prices were furious, while Party officials appeared able to convert political power into personal wealth.

Even more extraordinary was what happened in the countryside. The local cadres had leaned so heavily on the Agricultural Bank that parts of the rural banking system effectively ran out of money. Farmers who were required to deliver produce to the state increasingly found themselves being paid not with cash but with IOUs.

This Story Has Been Told Many Times Through History

When the protests erupted in 1989, it was not simply students asking for democracy.

Workers were angry about inflation and corruption, farmers were angry about not being paid, and demonstrations spread through cities across China. Tiananmen was partly the first great warning of a contradiction that will become enormously important to our story: China had loosened economic activity without creating an independent financial system to allocate capital.

Let’s not forget the CCP came to power in the first place largely because the government couldn’t get it monetary and economic act in order and the resultant hyperinflations destroyed the economic and social fabric as my essay above shows.

After Tiananmen, the banks remained instruments of the Party, political power determined who received credit, and when the resulting excesses threatened the system, the Party ultimately protected itself.

That financial structure did not disappear after Tiananmen. On the contrary, it became one of the foundations upon which the next three decades of China’s extraordinary investment and credit boom were built.

It Is Always About the Money System

Hence the Evergrande fiasco. See my essay below on Can China’s banking System survive all this? The Chinese have built a credit and money-making machine the likes of which we have never seen before (as someone we all know might say). The credit system is the machine by which the CCP has been able to extract the resources of the people for the benefit of those in the CCP hierarchy.

It is always about the money system. It always has been, everywhere, and always will be.

The War For Drugs

There is an extraordinary parallel between China’s enormous trade surplus today and the imbalance that eventually helped produce the Opium Wars and indirectly the American Revolution.

In the eighteenth and early nineteenth centuries, China exported tea, silk and porcelain while wanting relatively little from Britain. The difference was settled in silver. China accumulated the money while Britain progressively lost it. Britain eventually found a way of reversing the flow through Indian opium, China tried to stop it, and an economic and monetary imbalance ultimately became a military confrontation.

Persistent Trade Surpluses Lead To Wars and Revolutions

Under a metallic system Britain could eventually run out of silver. If governments allowed the mechanism to operate, that imposed an adjustment. Money would become scarcer in the deficit country, relative prices change, imports become less attractive and exports more competitive. The opposite pressures would operate in the surplus country.

The process could be extremely painful and slow, but there was ultimately a constraint on how far the imbalance could go. Sadly, the British didn’t go down that route, and they lost America as a result.

The Great Difference Today Is the Money

Today there is no boatload of silver that America eventually runs out of. China exports real goods and receives mainly dollars and dollar and other currency denominated financial claims in return. Because the dollar is the principal reserve currency, the United States can sustain external deficits for far longer than would have been possible if international settlement ultimately required gold or silver.

The monetary system has therefore weakened an important mechanism through which relative prices once forced international imbalances to correct.

China Is Interfering With the Adjustment From the Other Direction

It subsidises and directs credit toward favoured industries, allowing production and investment to continue where a freer price mechanism might otherwise force contraction. This has become particularly important since the property bubble burst.

Resources that previously poured into property and infrastructure have increasingly been directed toward manufacturing, while weak domestic consumption means much of the resulting production must be sold overseas. The property crisis, banking problems, industrial overcapacity and enormous trade surplus therefore begin to look like different parts of the same story.

In the End It Is About the Allocation of Resources (AOR)

This is ultimately an AOR problem. Labour, land and capital are scarce, and prices are supposed to move them towards their most productive uses. A persistent trade imbalance tells us that adjustment is required: China must consume more or produce differently, while deficit countries must produce more or consume less.

Adjustment Was Never Meant To Be Easy

The problem is that China’s subsidies and directed credit can keep resources in industries that would otherwise contract, while the dollar-based fiat system allows deficit countries to postpone the adjustment that a harder monetary system would once have forced. Neither removes the imbalance. They allow it to grow.

And adjustment is never as easy as economics makes it sound. A steel mill cannot simply transform into a hospital, an empty apartment complex into a semiconductor factory. Even with efficient prices, reallocating resources can take years and involve bankruptcies, unemployment and enormous financial losses.

That Is the Opium War Parallel

Silver eventually imposed a hard constraint on the nineteenth century imbalance. Sadly, they chose war rather than adjustment. Fiat money and government intervention allow today’s imbalance to continue much longer, but they cannot abolish the underlying AOR problem. Eventually prices, currencies, production, consumption, debts or the monetary system itself must adjust. Given the scale of the distortions, we are probably in for troubled times.

Even the Council on Foreign Relations (CFR) Is Worried

The CFR warns that the increasingly imbalanced global trade and investment system looks “increasingly likely to collapse under its own weight.” Coming from CFR, hardly an opponent of the postwar global economic system, that is unusually strong language.

China’s current account surplus jumped from $462 billion in 2024 to $735 billion in 2025, while Brad Setser believes the true figure could be closer to $1 trillion. His key point is that imports have not risen with exports: “Trade should be two way.”

China still saves more than 40 per cent of national income, but with property investment collapsing and consumption remaining weak, more resources are being pushed into manufacturing and exports.

Setser’s conclusion is that China must consume and import more, reduce excessive manufacturing investment and allow the renminbi to appreciate. Otherwise, “China does more manufacturing, the world does less,” inevitably provoking tariffs and protectionism abroad. China either rebalances voluntarily towards domestic consumption or mounting international pressure eventually forces the adjustment.

What Does China Actually Get For Its Trade Surplus?

There is an obvious question underneath China’s enormous trade surplus. If China keeps producing more for the rest of the world than it receives in return, what does it get?

The answer is financial claims on foreigners: currencies, bonds, loans, shares and direct investments. In 2025 China ran a $735 billion current account surplus, taking the cumulative surplus since 2000 to about $5.8 trillion. China has therefore spent a quarter of a century exchanging enormous quantities of real production today for claims on foreign production in the future.

Boy, They’re Big Numbers

By the end of 2025 China owned about $11.8 trillion of foreign assets against $7.7 trillion of foreign liabilities, making it a net creditor by more than $4 trillion. Yet remarkably, China still recorded a primary income deficit of around $110 billion in 2025: it paid foreigners more income than it received from them.

Say What?

One reason is that China has historically accumulated large quantities of relatively low yielding reserves, government securities, deposits and loans, while foreigners have often owned higher returning direct investments and equities inside China. Being a huge creditor therefore does not necessarily mean China has received a particularly good return for all the real goods it exported.

China Also Appears To Be Changing Course

Its reported U.S. Treasury holdings peaked at about $1.32 trillion in 2013 but had fallen to around $633 billion by June 2026, even as its total foreign assets continued to grow. China has increasingly diversified into other investments, commodities and gold.

And that brings us back to the real question. China has already surrendered the labour, energy, raw materials and production embodied in its exports. The value of the financial claims it received in return ultimately depends upon how many real goods, resources and productive assets those claims allow China to buy in the future. Nominal trillions alone don’t answer that question.

Are Trade Surpluses In Their DNA

There is a wonderful historical irony here because China has been in this position before.

For centuries China exported tea, silk, porcelain and other goods while importing considerably less from the West. But Qing China did not accumulate trillions of dollars of foreign financial securities.

It accumulated silver. China saw foreign trade as a privilege for the foreigner. As they found out, the foreigners were none too pleased with the persistent trade surpluses.

The Contrast With Modern China Is Striking

This does not mean silver could never fall in value. Of course it could. Indeed, China’s later monetary history demonstrates precisely that. But there is nevertheless a fundamental difference between accumulating a scarce commodity and accumulating a nominal financial claim denominated in somebody else’s monetary unit.

Old China accumulated metal. Modern China accumulates claims. And that brings us back to the central question.

We Get Real Goods. They Get IOUs.

A trade surplus is usually presented as a victory: China exports more than it imports, therefore China is “winning”.

China spent decades producing real goods and sending some of them abroad without taking an equivalent value of foreign goods back. Instead, it accumulated claims against future foreign production.

The important question is therefore not simply whether those claims will be honoured. It is how much real production they will ultimately buy when China finally cashes them in. And who in China will get the money?

Persistent Trade Surpluses Are Unfair On the Workers

Chinese workers produce the EVs, electronics and machinery, but China does not take an equivalent value of foreign goods back in return. Instead, much of the difference ends up as financial claims held elsewhere in the Chinese system.

The West gets the real goods today. China gets the IOUs. And there is no guarantee the workers who produced those goods will ever receive the equivalent benefit.

It reminds me of Japan during its credit bubble in the 1980s. Australia got the Toyotas. Japan accumulated IOUs and bought resorts and other assets at inflated prices, many of which promptly halved and then halved again.

So who do you reckon won out of that trade?

The Banking Story Hasn’t Changed

The banking story from my May 2025 essay above remains essentially unchanged, so I won’t repeat all the numbers and charts here. China is still dealing with the enormous stock of debt created during its property, infrastructure and credit boom. What has changed is the flow of new credit.

New yuan bank loans fell 19 per cent in the first seven months of 2026 compared with a year earlier, while lending contracted by RMB340 billion in July, the largest monthly contraction on record. Household lending alone fell RMB460 billion.

China therefore has the worst of both worlds: the enormous debts created by the previous credit boom remain, while demand for new bank credit has become remarkably weak.

For those who want to follow the whole money and credit movements and make sense of them as best you can, the very best place to go is to my friends over at AAS Economics.

From Silk Road to Sinkhole. A DEFCON 1 Problem.

The Belt and Road story has deteriorated substantially since my May 2025 essay. Earlier research estimated that around 60% of China’s overseas lending portfolio was associated with countries in financial distress.

AidData’s expanded evidence now puts that figure at roughly 80%, with developing countries owing China an estimated $1.1 trillion to $1.5 trillion in principle.

The Repayment Crunch Has Arrived

Around 55% of China’s loans to low- and middle-income countries have already entered principal repayment, rising to an estimated 75% by 2030. Around twenty developing countries owe Chinese state creditors more than 10% of their entire GDP. Zambia, Ghana and Sri Lanka have already defaulted, while Egypt and Pakistan have experienced near defaults.

The critical point is that China is not going to recover the full real economic value of many of these loans. Zambia’s 2024 restructuring, for example, involved a present value haircut of more than 50%. Horn, Reinhart and Trebesch reach essentially the same conclusion: “ultimate repayment from many of its borrowers will be partial.”

China supplied real steel, machinery, construction and other resources when these loans were made. Rescheduling the resulting financial claims does not restore those resources or their original value.

We Have Been There Before. Will There Be Lost Decades Ahead?

This increasingly resembles the old Paris Club experience. What begins as a supposed liquidity problem leads to repeated rescheduling until creditors eventually recognise that some debts simply cannot be repaid in full. Around $418 billion of Chinese lending is collateralised, often against commodity revenues or foreign currency receipts, which may improve China’s recovery. But collateral merely determines who gets first claim on the available resources. It cannot make an insolvent borrower solvent.

The Banks Are In Trouble

If the CCP collapses these countries may not have to repay their loans after all. Things could get interesting. Either way, China is unlikely to recover anything approaching the original real economic value of a substantial portion of these loans.

And this brings us straight back to China’s banks. Domestically, they are carrying loans created during the enormous property, infrastructure and local government credit boom. Internationally, Chinese state institutions are carrying another enormous portfolio of claims against developing countries. The assets are different, but the question is the same: what are these loans worth?

How Can China Have a Huge Trade Surplus While Its Banks Are in Trouble?

It sounds contradictory, but the two problems are connected. China’s banks are still carrying debts created when enormous amounts of credit flowed into property, infrastructure and local government. When property values collapsed, the debts remained. A trade surplus does not repair those losses because China receives foreign financial claims for its exports, not repayment of the bad loans sitting inside its banks.

More importantly, the property collapse helped increase the trade surplus. Property had absorbed enormous amounts of Chinese savings and investment. When that stopped, China could allow investment and production to contract or redirect resources elsewhere.

Instead, much of the emphasis shifted towards manufacturing. With domestic consumption too weak to absorb all that production, the rest of the world became the buyer.

The property collapse, troubled banks, industrial overcapacity and enormous trade surplus are not separate stories. They are different sides of the same Allocation of Resources problem. China is using exports to absorb production that its domestic economy cannot, but exporting more cannot recover the resources already lost in bad property and infrastructure investments.

The Bill Eventually Has To Be Paid

China has already used the real resources. The apartments, roads, bridges and Belt and Road projects have been built, the factories expanded and the goods shipped overseas consumed. What remains are the financial claims: mortgages, bank loans, government debt, Belt and Road loans and trillions of dollars of claims on foreigners.

Moving those claims around does not bring the resources back. Rolling over bad loans does not turn bad investments into good ones, and another trillion dollar trade surplus does not repair the losses buried in the banking system. Eventually the Allocation of Resources has to adjust and somebody has to bear the losses.

And that takes us back to where we started.

Yeh, Right. Give Them a Standing Ovation.

China faces that adjustment with the legacy of the one child policy, demographic distortions, destroyed property wealth, youth unemployment, lying flat and growing social frustration.

The CCP did not create China’s prosperity. Much of it came when ordinary Chinese were finally given greater economic freedom. But the Party retained control over the financial system that subsequently directed this extraordinary misallocation of resources.

The ultimate question is not what happens to China’s banks or its trade surplus. It is what happens to the CCP. It’s gonzo, I reckon.

Footnote 1

In this video we separate the clickbait from what’s happening. Why are the streets emptier? Where does the “missing billion” claim fall apart? We trace how China engineered this situation on purpose, starting more than 40 years ago, and why the one decision that built its economic miracle is now the exact thing unravelling it. Then we look at everything Beijing is throwing at the problem and why almost none of it is working. Because the question isn’t whether China is hiding a missing billion. It’s what a country becomes when the one thing it was built on starts to run out...

Footnote 2

But there is a group of young people who think differently, they do not compete, will not get married, will not have a child, and will not buy a house. This is now popular among young people in China - the “lying flat” doctrine. With the rising popularity of the article, “Lying flat” has gradually become popular among young people, and become a buzzword on the Chinese Internet. Although the article has been banned and removed from major forums by Chinese authorities, it is still spreading among the young people, who not only discuss how to “lie flat” but also share their experiences on maintaining a “lying flat” life.

Footnote 3

A large-scale matchmaking event was once held in Hangzhou City, expected to be a lively “love feast,” but the result was unexpected—of the 300 women present, not a single man showed up, a shocking scene. On the day of the event, the organizers put a lot of effort into the setup, with various interactive activities, hoping that single men and women could get to know each other and enhance communication in a relaxed and pleasant atmosphere. However, as the event began, an awkward situation arose: the spacious venue was almost entirely filled with women, with hardly any men in sight. Initially, many assumed this was a deliberate gimmick by the organizers to attract attention. But soon after, it was revealed that the number of registered men was already very small, and at the end of the day, not a single one showed up.

Footnote 4

And the weird thing is, a labor economist actually proved the core of it — and the people it hurt most weren’t the men. This is the mechanism behind South Korea’s fertility collapse, told through four structural forces that locked an entire country into a trap nobody designed. KEY POINTS: -How women entering the workforce compressed wages for everyone — and the data proving it -The second shift Korean women never signed up for -Why a ₩3 trillion government ministry with criminal enforcement couldn’t move the needle -What happens when women do the math on motherhood and walk away -The 1975 quote from a feminist architect who said out loud what the system was designed to do.

Footnote 5

In this provocative conversation, Dikötter challenges the prevailing narrative about China’s rise. Drawing from his latest book, China After Mao: The Rise of a Superpower, Dikötter argues that the Chinese Communist Party has masterfully projected the image of a powerful, modern, and economically dominant nation—but says that image is largely a façade.

Footnote 6

China expert Frank Dikötter, a senior fellow at the Hoover Institution, discusses the unique value of the diary of Li Rui and its contribution to understanding the history of the Communist Party in China, and in particular the Tiananmen Square massacre of June 4, 1989. Li Rui was a longtime Chinese Communist Party (CCP) insider and historian who witnessed the violent crackdown in 1989 and became a reform advocate interested in stemming authoritarianism in the CCP.

Cutting To The Chase

1. Christ told us to separate Caesar’s things from God’s. Two thousand years later, it is getting remarkably difficult to work out where one ends and the other begins.

2. Governments, corporations, churches and international institutions increasingly overlap. At the same time, collapsing trust in those institutions is producing an enormous political backlash.

3. The old labels aren’t helping. Capitalism, socialism, fascism, stakeholder capitalism, Hamiltonian economics. Everyone is arguing about the system, but where exactly is the free market?

4. Money is central to the confusion. Central banks, fiat currencies, bank created money, government guarantees and bailouts are hardly the foundations of laissez faire capitalism.

5. Richard Poe, in an extraordinary book, traces a hidden British financial and imperial hand through the French Revolution, Karl Marx, the rise of communism and ultimately the Russian Revolution, which he argues British interests then helped blame on the Jews. No joke.

6. His claim is that British power repeatedly fostered revolutionary movements abroad to advance its own financial and geopolitical interests. Some argue that it hasn’t disappeared, but has morphed into today's British/WEF/globalist agenda, complete with continued behind the scenes shenanigans. Suddenly the MAGA versus WEF/globalist ‘box on’ starts to look like another round of a very old fight.

7. The battle lines are now being drawn. The Churches, WEF, Chatham House, Charles, Carney and the globalist order face a Trump administration led challenge drawing heavily on working and middle class discontent.

8. And America has actually told us what it intends to do. Its strategy explicitly turns towards the Western Hemisphere and a “Trump Corollary to the Monroe Doctrine.”

9. Then along come the Churches. Leo condemns “usurious financial systems”. Francis attacked the free market. Neither adequately defines the economic system he is condemning. Charles? Well, see next point.

10. Their solution increasingly looks like greater central direction. Francis wanted institutions with “real teeth”. Charles wants the private sector “all pulling in the same direction.” The WEF calls it public private cooperation. I call it economic fascism.

11. Here is the great irony. Christianity spent centuries working its way towards private property, legitimate profit, voluntary exchange, subjective value, sound money and limits on Caesar. Augustine, Aquinas, Buridan, Oresme and Olivi understood things their modern successors appear to have forgotten.

Government Work Is God’s Work

A friend and former fund management colleague sent me the photo below. I won’t name him because I don’t want to destroy his reputation by associating him with a raving radical crazy man like me.

On Bangalore’s Vidhana Soudha, the seat of the Karnataka government, are the extraordinary words: “GOVERNMENT WORK IS GOD’S WORK.” The phrase was associated with Kengal Hanumanthaiah, Chief Minister of Mysore State and driving force behind the building in the 1950s, who conceived it as something approaching a “temple of democracy.” The inscription was intended to express the idea that public service was a sacred duty.

See end of article for full footnote.

Admirable perhaps, but it raises a more difficult question: when did doing God’s work become the government’s job?

Jesus Weighs In On the Debate

Christ appeared to draw a distinction: “Render therefore unto Caesar the things which are Caesar’s; and unto God the things that are God’s” (Matthew 22:21). Two thousand years later that boundary looks considerably less clear.

Popes pronounce upon banking, markets and the distribution of wealth; King Charles, Head of the Church of England (apparently), calls for “a paradigm shift”, action at “revolutionary levels and pace” and a “vast military-style campaign to marshal the strength of the global private sector” to achieve “fundamental economic transition.” Meanwhile we have the WEF, best described economically as fascist.

Who Exactly Is Caesar

The old question needs updating: what belongs to Caesar and, when governments, corporations, religions and international institutions increasingly overlap, who exactly is Caesar?

There is an echo here of the Divine Right of Kings. Nobody (at least as far as I know) is claiming governments rule by divine appointment, but once economic outcomes become moral questions, political intervention can acquire moral authority. Suddenly “Government Work Is God’s Work” sounds rather less quaint.

Don’t Shoot Me, I’m Only the Messenger

Some of what follows will be labelled conspiracy theory. Perhaps some is wrong. But people with considerable political power increasingly believe at least some of it is true, and they are acting accordingly.

To begin, the increasing distrust in our institutions didn’t come from nowhere.

Finally, the Gutenberg Press Moment

Controversies surround the U.S. three letter agencies, Five Eyes and what emerged from COVID and the U.S. electoral process. Revelation after revelation has led increasingly to questions being asked about relationships between governments, the financial industry, scientific institutions, technology and other companies and especially the media.

This has made the shout of “conspiracy theory” rather less convincing.

The corruption now being exposed across governments, NGOs, corporations and the media is highly disturbing to say the least. Maybe the internet is finally performing its Gutenberg Press function? One thing seems certain: we are entering a period of seismic change.

The Labels Are Becoming Almost Meaningless

Communism is again openly discussed in America while some of the world’s wealthiest people support supposedly anti-capitalist movements. Corporations, NGOs and religions embrace the WEF’s public private stakeholder totalitarian economic model.

The Trump administration whilst more pro market than any of its predecessors in decades is hardly full on laissez faire either. Economically it looks more Hamilton than anything else. Capitalism, fascism, socialism and third or whatever way are supposedly competing.

But where is the free market?

Or Outright Misleading

You may be asking: aren’t Trump’s tariffs anti free market, while the globalists are supposedly the great defenders of free trade? Indeed, both sides are routinely characterised that way. I have dealt with these issues in many previous essays. The bottom line is that the monetary system distorts the entire argument and, in the most important respects, makes the reality almost the reverse of the labels.

Indeed, What Exactly Is the “Free Market”?

The free market gets blamed for all our troubles, especially by the Churches, as we are about to see.

Money is central to the confusion. But we already have fiat currencies, central banks, bank created money, government guarantees and financial rescues. Yet economics debates competing systems while failing even to agree on how money and credit are created and how they allocate resources.

See what I mean about defining exactly what we mean by a free market when we criticise the current system.

Perhaps the real distinction is between decentralised and concentrated economic power. It might also explain why the ultra-wealthy sometimes support apparently anti-capitalist movements. Do they really want a decentralised system they cannot control?

This Isn’t New Either

That is what makes Richard Poe’s How the British Invented Communism interesting. Poe argues that powerful financial and geopolitical interests have historically supported revolutionary movements apparently hostile to themselves, running through British imperial networks, the French Revolution, Marx and revolutionary Russia to the modern global system.

Readers don’t need to accept his entire thesis, or indeed any of it. It is so contrary to what those of us in the Anglo West have traditionally been taught that you need to do your own research, which I am doing.

But powerful interests secretly financing movements for imperial, power or monetary motives is hardly inconceivable. It certainly makes some of today’s strange alliances look rather less strange.

The Forward Was By Who…

Oh, and the foreword is by Noor bin Ladin. If that surname rings a bell, it should. She is Osama bin Laden's niece. At this point even I am beginning to think the conspiracy theorists are overdoing the script.

A Conspiracy Theory To Debunk a Conspiracy Theory

Do yourself a favour and watch the six minute video on the book’s main thesis below. It is mind-blowing.

Poe puts Britain and its historic attempts to contain rival powers, especially Russia, at the centre of his story. More interestingly, parts of the Trump aligned movement now interpret Britain and Russia through a similar lens and some explicitly recommend Poe’s book.

One of Poe’s claims is that the widely accepted conspiracy theory that it was the Jews that were behind the Russian revolution was really a conspiracy theory invented by the British to cover their own conspiracy fact (I really had to think about that sentence).

The video explores the thesis that communism is a tool of the state, developed by British intelligence for the cynical purpose of subverting governments and controlling populations. See bottom of article for full footnote.

Whether every claim is right is not the immediate point. If people influencing American policy believe the old Atlantic establishment does not necessarily serve American interests, they will act on that belief. America did, after all, twice whip Britain’s butt.

Throwing a Brigade Of Light On a Serious Charge

I have found some reactions to the Ukraine/Russia war rather strange. Poe’s argument would presumably be that for some countries this is simply another chapter in the centuries long struggle to contain Russia.

Also, Australians might remember Gallipoli. Poe’s argument is that it was part of a ruse to keep Russia at bay, supposedly Britain’s ally at the time. If he is correct, Australians and New Zealanders supplied most of the bodies for hidden imperial objectives determined elsewhere.

Who knows but it sure is worth finding out, especially if your ancestors were involved in Gallipoli.

After the institutional revelations of the past decade, claims once dismissed out of hand receive a rather different hearing. The ‘masses’ seem to be highly suspicious now, with parents across the West increasingly reluctant to send their children to fight wars determined by opaque institutions.

The Battle Lines Are Being Drawn

America Turning Back To Its Own Hemisphere?

You don’t have to guess what the Trump administration intends to do. The remarkably little discussed 2025 National Security Strategy says explicitly that America “cannot afford to be equally attentive to every region and every problem in the world.”

Its first regional priority is headed “Western Hemisphere: The Trump Corollary to the Monroe Doctrine” and declares that the United States will “reassert and enforce the Monroe Doctrine to restore American preeminence in the Western Hemisphere.”

That is a major strategic reorientation, written down in an official US government document for anyone who cares to read it.

But First, Some Tidy-Up In the Middle East

The video below is a great demonstration of: 1) That Poe’s Thesis may have some real substance, and 2) the New World Order Emerging.

Boy, do we live in interesting times.

Treasury Secretary Scott Bessent says the U.S. is escalating economic isolation measures against Iran and forecasts the Strait of Hormuz will become “irrelevant” within two years, while Energy Secretary Chris Wright argues shipping continues under escorts and rerouting, citing 8–9 million barrels/day still moving through the strait plus 6 million diverted via expanding pipelines. The episode frames this as part of a broader strategy since March 2025 targeting Iran’s financial networks while expanding alternative energy supplies, including increased U.S. production, changes in Venezuela, UAE production outside old OPEC quotas, and Iraq pipeline deals to bypass Hormuz, alongside a nuclear power “renaissance.” It highlights remarks at Chatham House by Lebanese adviser Jean Aziz blaming Henry Kissinger’s 1976 actions for decades of conflict and IRGC entanglement, and Qatar’s Majed Al-Ansari describing a regional Gaza “20-point plan” leading to a Washington-based Board of Peace meeting on Feb. 19, 2026.

UFC Freedom 250 Wasn’t the Only Wrestling Match Going On At the White House

On One Side

Is the globalist institutional model represented in different ways by the WEF, assorted NGOs, Chatham House, Charles, Carney and much of the established Atlantic political, financial and foreign policy network.

The WEF’s own Great Reset called for governments and business to act jointly to reshape economic and social systems, while Charles helped launch it. Carney’s 2026 Davos response is different in important respects but still looks towards coalitions of middle powers and international cooperation as the response to the breakdown of the old order.

And In the Other Corner...

Is a Trump movement drawing much of its political strength from working and middle-class voters who believe that this very global order hollowed out American industry, weakened national sovereignty and enriched institutions increasingly detached from them.

Look at the video above (fast forward the first two minutes) where conservative historian Victor Davis Hanson gives a side of the issue that you rarely, if ever, hear in the mainstream press or many think tanks.

Like it or not, the Trump administration is now explicitly prioritising borders, domestic manufacturing, strategic resources and its own hemisphere.

The Elites Feel Their Power Being Threatened

Chatham House plainly recognises the scale of the break: its analysis of the new strategy concludes that “the US is headed away from the Atlantic.” Quite. The administration says it is doing it; its Atlanticist critics say it is doing it.

We hardly need to speculate.

Perception Itself Becomes Policy

And this is where Poe’s extraordinary historical argument becomes relevant again. Perhaps his interpretation of British imperial networks, Russia, finance and revolutionary movements has some currency after all. Perhaps parts of it are wrong.

But if people around the Trump movement increasingly interpret today’s struggle through that historical lens, while institutions associated with the old Atlantic order actively oppose the direction in which Trump is taking America, the perception itself becomes politically consequential.

Poe’s larger question suddenly looks remarkably contemporary: are we witnessing an entirely new struggle, or another version of a very old struggle over who controls the economic and geopolitical order?

The Free Market Is Being Thrown Out With the Bath Water

And underneath much of this confusion sits the failure of economics to provide a coherent theoretical framework, especially when it comes to money. The “free market” is being blamed for a system that is very difficult to describe as free in the first place.

This is a critical time in world history. We sorely need a theoretical and philosophical framework that justifies free markets and human freedom in general.

And That Brings Us Directly To the Christian Churches

At precisely the moment when the economic system is being questioned from almost every direction, they seem to have forgotten something rather important: Christian thinkers themselves spent centuries wrestling with these questions and eventually developed much of the intellectual justification for the free market.

I examined the role of Church and State in both the East and the West and the beginnings of the philosophical justification for a free economic order in the essay below.

In this period of extraordinary economic and political change, all this matters enormously. The point is that the debate has been going on for thousands of years. At times it seems we have gone backward.

Now would be a good time to examine all this against the rather extraordinary backdrop of what today’s Church leaders are saying.

Didn’t We Handle All This Centuries Ago?

Pope Leo XIV has recently rediscovered one of Christianity’s oldest economic concerns: usury. In October 2025 he declared that “the phenomenon of usury points to the corruption of the human heart”, described it as “a grave sin, at times very grave” and warned that “usurious financial systems can bring entire peoples to their knees.”

My essay above goes through some of the issues which the Church eventually came to terms with. The Pope seems unaware of this.

Fine, Your Holiness. Define It Please.

But what exactly is a usurious financial system? The interest rate? Bargaining power? Money creation? Debt? Inflation? Asset inflation? Redistribution of purchasing power? Leo gives us the moral condemnation without the economic definition necessary to determine who is committing the sin.

The guy in the video below address the Popes views on Usury. It is good and he even gets FRB. Worth a look.

Hold the Phone…Was He Joking?

Seven months later, addressing Italian bankers in May 2026, Leo sounded remarkably comfortable with the financial system he had warned could bring entire peoples to their knees. Banking institutions, he said, demonstrate “the complementarity between saving and investment, private and public” and contribute to “the realization of the common good and for sound economic growth.” He even credited them with “a just sharing and redistribution of wealth among individuals, businesses and institutions.”

He Cannot Be Serious

He is starting to sound like that WEF captured totalitarian, King Charles.

Which banking practices produce this wonderful redistribution and which create the “usurious financial systems”? Leo never says.

Are We Living In the Same Moral Universe?

So, who receives that new purchasing power first? What happens to asset prices and to people whose wages and savings have not risen? What happens when credit creation drives up housing prices, forcing the young to borrow ever larger amounts for the same house?

Look at analysis of some of the Church greats in my essay below on the moral aspects of banking to get some idea of how intellectually shallow the current Church leaders are.

If Leo wants to discuss financial systems bringing “entire peoples to their knees”, these questions surely come before congratulating bankers for the “just sharing and redistribution of wealth.”

What On God’s Earth Is He Talking About?

The same problem appears in Dilexi Te. Leo attacks “pseudo scientific data” supposedly showing that “a free market economy will automatically solve the problem of poverty.”

But what free market? Before blaming the free market, establish which part is actually free and identify the mechanism causing the problem.

For Goodness Sake Leo, Think Clearly

Agree with Aquinas and some of the Scholastics or not, especially on the Usury issue, but at least they defined their terms. They asked what a loan was, who owned deposited money, why interest might constitute usury, when profit was legitimate and when one person’s gain became an injustice to another. The Salamancans went further into value, exchange, money, scarcity and commercial profit.

Leo has revived their language of usury without their economic analysis. Until “usurious financial system” is defined, we cannot know whether the banking system he simultaneously praises is one of them.

Pope Francis Started Well

Leo’s language is not new. At Davos in January 2024, Pope Francis warned that less developed countries “should not be at the mercy of abusive or usurious financial systems.” As regular readers know, I would thoroughly agree.

But Francis did not define it either. In Evangelii Gaudium (2013), he condemned “an economy of exclusion and inequality” that “kills” and attacked “trickle-down theories” based on growth “encouraged by a free market”, saying this “has never been confirmed by the facts.”

Oh No

Francis blamed “ideologies which defend the absolute autonomy of the marketplace and financial speculation” for “a new tyranny” which “unilaterally and relentlessly imposes its own laws and rules.”

But where was this “absolute autonomy of the marketplace”?

We already had fiat currencies, central banks, bank created money, government guarantees, regulation, sovereign debt and governments rescuing financial institutions during the GFC. Francis blamed markets without separating them from the monetary and governmental architecture surrounding them.

His Totalitarian Instincts Emerge

Francis wrote that “we can no longer trust in the unseen forces and the invisible hand of the market” and demanded “decisions, programmes, mechanisms and processes specifically geared to a better distribution of income.”

That simply transfers decisions from dispersed buyers, sellers, workers, savers and entrepreneurs to institutions deciding what distribution is preferable.

But Francis Has Nothing On King Charles

Charles takes it considerably further. At Davos in 2020 he called for “a paradigm shift” requiring action at “revolutionary levels and pace.” At COP26 he called for a “vast military-style campaign to marshal the strength of the global private sector” to achieve “fundamental economic transition.” Most revealingly: “how do we get the private sector all pulling in the same direction?”

But markets work precisely because everyone does not pull in the same direction. Getting them to do so requires somebody to decide the direction. Charles’s “military-style” analogy captures it perfectly: armies have objectives determined from above and a command structure for achieving them.

None of Them Understand Economics Or Even Christianity

In Fratelli Tutti (2020), Francis attacked belief in “the marketplace, by itself” as “this dogma of neoliberal faith”, arguing that “neoliberalism simply reproduces itself by resorting to the magic theories of ‘spillover’ or ‘trickle’.” Again, neoliberalism goes undefined and the existing state dominated monetary system gets called a free market.

He clearly was ignorant of his own religion and its rich history in addressing these very issues.

Economic Fascism To the Rescue

Immediately after rejecting the “unseen forces and the invisible hand of the market” and calling for mechanisms to redistribute income, Francis turns to the question of who should exercise greater economic power. In Fratelli Tutti he calls for “stronger and more efficiently organized international institutions” with officials “empowered to impose sanctions”, and for international institutions with “real teeth.”

His alternative to supposedly excessive market power is stronger supranational political power.

What Exactly Do You Mean?

That makes Francis’s and Charles’s relationship with the WEF particularly relevant. The WEF calls itself the “International Organization for Public-Private Cooperation” and says it brings leaders together to “shape global, regional and industry agendas.”

This Manifesto Would Be Right At Home In…

The Davos Manifesto 2020 says a company is “more than an economic unit generating wealth” and multinational corporations should operate “together with governments and civil society.” The WEF also promotes “structured public-private initiatives.”

This is not decentralised market coordination. Major corporations, governments and organised stakeholders cooperate in establishing and pursuing wider economic and social objectives.

The Nazis Had Something to Say About Usury As Well

Point 11 of the NSDAP’s 1920 programme demanded the “banning [of] income not earned by work and personal effort” and the “breaking [of] the interest bondage.” Point 17 demanded abolition of land interest, while Point 18 grouped “usurers” with profiteers supposedly damaging the common interest.

Gottfried Feder (1883–1941), whose ideas influenced the early programme, put the principle bluntly: “The financial system stands in the service of the state, the financial powers may not form a state within the state.”

The similarity in language is striking. Francis warned against “abusive or usurious financial systems.” Leo called usury “a grave sin, at times very grave” and warned that “usurious financial systems can bring entire peoples to their knees.” Feder similarly moved from individual interest charges to an attack upon the wider financial system.

Yet the same question remains: where does legitimate interest end and usury begin?

Francis and Klaus Schwab

Francis’s engagement with the WEF began early. In 2014 he acknowledged the “fundamental role” of modern business. In 2018 he thanked Schwab for including “the perspective of the Catholic Church and the Holy See”, insisted that “the market must not be absolute” and called for “a firm resolve shared by all economic actors” to “give a new direction to the destiny of our world.”

Francis distrusted decentralised market coordination but endorsed major economic actors coordinating to “give a new direction to the destiny of our world.”

By 2024 the WEF Relationship Was Explicit

Francis told Schwab: “Your Forum, which aims to guide and strengthen political will and mutual cooperation, provides an important opportunity for multi-stakeholder engagement to explore innovative and effective ways to build a better world.” He called on “states and businesses” to promote acceptable models of globalisation.

He then demanded “international political action”, “coordinated measures” and “intergovernmental structures” exercising “control and guidance in the economic sector.”

That is public and private economic power being brought together, not dispersed.

Then He Condemns the Financial System at Davos. The Vatican Bank?

In the same message Francis warned against “abusive or usurious financial systems” without identifying what makes them usurious.

Oh, there is the small matter of the Vatican Bank as addressed in my essay below.

All this takes us straight back to Leo. Both attack the free market without disentangling it from the state dominated monetary system surrounding it, while supporting powerful institutions within that system. Neither supplies the missing economic analysis.

How the Church Came to Justify Capitalism

So how did we get from the early Church to a Christian tradition defending private property, voluntary exchange, merchant profits, market prices and limits on political power?

Regular readers know much of the background. I have previously traced the revolt against absolute state power, the early Christian beginnings of subjective value, Byzantium’s monetary institutions (see below) and the Church’s struggle with usury, banking and debasement.

The point here is simple: none of this suddenly appeared with Adam Smith.

What Is the World’s Oldest Uni?

By the twelfth century Europe was becoming richer and more commercial. The rediscovery of Justinian’s Corpus Juris Civilis at Bologna confronted Christianity with Roman law’s strong presumption that voluntarily agreed bargains should stand.

Rufinus argued that merchants could legitimately profit from labour, expense and risk. Huguccio strengthened the defence of private property. The distinction between the external forum of contracts and the internal forum of conscience also allowed a transaction to be legally valid without claiming every legal transaction was charitable.

The question was shifting from whether commerce was inherently suspect to whether the merchant provided something of value.

The Just Price Starts Looking Suspiciously Like the Market Price

The deeper problem was value itself. Did goods possess an objective value, or did value depend upon the people doing the valuing?

I outlined in the essay below how St. Augustine really solved that way back in the fourth century with his early formulation of the basics of the theory of utility.

Even if they had forgotten Augustine’s great works on economics, in practice commerce was already answering the question. Medieval merchants developed exchange rates, bills of exchange, credit and private commercial rules. Money changers valued competing coins according to metal content and market acceptance rather than simply accepting the value proclaimed by rulers.

The intellectual world was catching up with the commercial one.

Enter the Christian G.O.A.T

Thomas Aquinas (1225–1274) married Christianity with reason and natural law. If justice exists independently of rulers, political authority itself is subject to a higher standard. That matters enormously to property and contracts.

He also defended private ownership and legitimate merchant profit. Merchants moved goods, stored them, bore risks and incurred expenses. Profit could therefore represent payment for a genuine economic service.

Aquinas remained much less convincing on usury, as I have discussed elsewhere. But the ground had shifted: property, merchant profit and voluntary exchange could all be legitimate.

Then the State Gets Involved

As I discussed in The Black Death of the 14th Century, increasingly sophisticated commercial institutions collided with rulers desperate for revenue. Philip IV taxed, confiscated, attacked financiers, destroyed the Templars and used monetary debasement as a fiscal tool.

The practical question became unavoidable: what happens to property, contracts and commerce when rulers manipulate the money itself?

You Heard of This Bloke?

Jean Buridan (c. 1300–c. 1361) recognised that voluntary exchange occurs because the parties value things differently. The buyer values the good more than the money; the seller values the money more than the good. Both expect to gain.

That destroys the idea that commerce is inherently zero sum.

Buridan also pushed the just price towards the market price and argued that money did not acquire value merely because a king stamped his image upon it. Government might certify money, but it did not create its underlying value.

The King’s Money Is Not the King’s Money

Buridan’s pupil Nicole Oresme (c. 1320–1382) went considerably further. Money fundamentally belonged to the community using it, not to the ruler whose mint produced it.

A ruler could protect the coinage but debasing it for fiscal advantage transferred wealth from the public to himself. Oresme therefore treated debasement not simply as bad policy but as injustice.

He also understood the mechanism later called Gresham’s Law: impose an official relationship between coins whose underlying values differ, and people spend the overvalued money while hoarding or exporting the undervalued.

Private property cannot really be secure if rulers can alter the unit in which property and contracts are measured. Sound money therefore becomes part of the defence of property itself.

John Duns Scotus Complicates Things

John Duns Scotus (c. 1265–1308) emphasised labour, costs and risk more heavily and does not fit neatly into a straight line towards subjective value.

But even within this competing framework the argument had shifted. The question was increasingly how markets worked and how legitimate returns should be understood, rather than whether commerce and profit were intrinsically suspect.

Pierre de Jean Olivi Picks Up Where St. Augustine Left Off

Pierre de Jean Olivi (1248–1298) is where it becomes interesting.

Olivi argued that economic value depended upon utility and scarcity. Enormous labour did not itself make something valuable. Value depended upon its usefulness to people and its scarcity relative to their wants.

That takes us back to the water diamond paradox. Water is vastly more useful than diamonds, yet where water is abundant an additional amount can have little value. A scarcer good can command a much higher price.

That is getting remarkably close to marginal utility.

Centuries before Smith, Menger, Jevons or Walras, a thirteenth century Franciscan was moving towards ideas at the centre of modern microeconomics. Augustine had already recognised that value could not simply reside in an object’s intrinsic physical importance. Olivi took the insight considerably closer to a theory of price.

They Were Building the Foundations of Capitalism

By the end of this period Christian Europe had assembled an extraordinary collection of ideas. Private property had a moral and practical defence. Merchants could legitimately profit from services and risk. Voluntary exchange could benefit both parties. Market conditions entered the just price, while value itself was increasingly connected to human wants, utility and scarcity.

At the same time natural law stood above rulers, contracts-imposed obligations upon them and money was not simply the property of the prince. Debasement could therefore constitute injustice or theft.

None of this was a smooth march towards laissez faire capitalism. The same Europe produced usury prohibitions, banking evasions, fractional reserves, debasements and confiscations.

They Need To Go Back To School Or Seminary

But neither was the Church simply standing in capitalism’s way until the Renaissance and Reformation supposedly rescued Europe. Long before Adam Smith, Christian thinkers were asking questions later claimed by economics. Buridan explained why both parties gain from exchange. Oresme attacked monetary debasement and anticipated Gresham’s Law. Olivi connected value to utility and scarcity and moved remarkably close to marginal analysis.

Most people have never heard of them. Perhaps modern Church leaders should have.

Footnote to Richard Poe Video

Key Revelations and Historical Figures The Invention of Revolutionary Ideologies: Learn how British secret services harvested ideas from early English socialists and weaponized them, transforming them into destructive ideologies suitable for destabilizing nations. This dark art of disguising foreign-sponsored coups as spontaneous uprisings—what we now call “color revolutions”—dates back centuries. Share The Russian Revolution (1917) Exposed: Dive deep into the Russian Revolution, where the hidden hand of British intelligence manipulated events. Lord Alfred Milner: Discover the central role of Lord Alfred Milner, who was called the “wicked genius of Russia” by Alexander Kerensky. Milner praised socialism as the British Empire’s greatest secret weapon and traveled to Petrograd in February 1917 to deliver a final ultimatum to Tsar Nicholas II before the monarchy fell. Leon Trotsky, British Agent: Explore the mysterious ties of Leon Trotsky to British intelligence, including his release from a Canadian internment camp in 1917 on the orders of MI6’s US station chief, William Wiseman. Trotsky, who later led the Red Army to victory, was suspected of being a British asset by 1924. The Cover-Up: Understand how British War Secretary Winston Churchill spearheaded the propaganda campaign in 1920. In his Illustrated Sunday Herald article, Churchill accused a “worldwide conspiracy” of “International and for the most part atheistical Jews”—naming figures like Trotsky, Litvinoff, Zinoviev, and Radek—of masterminding the revolution. This was allegedly done to deflect attention from British complicity. Britain’s War Prize: See how Trotsky’s revolutionary actions—unilaterally repudiating Tsarist secret treaties like the Constantinople Agreement—directly enriched Great Britain by clearing the way for the Anglo-Persian Oil Company (APOC) (later British Petroleum) to acquire a de facto monopoly over vast Persian oil fields. The Roots of Communism (18th-19th Century): Trace the origins of communism to the French Revolution, orchestrated in part by intelligence operatives infiltrating French liberals. French Revolution: Learn how the hidden hand of British intelligence influenced the Jacobin radicals who brought down King Louis XVI. Thomas Jefferson accused Britain of using “hired pretenders” to subvert the French Revolution and blamed Danton and Marat by name of being on the British payroll. Early communists like Gracchus Babeuf derived ideas from British mentors, including figures connected to a British intelligence front newspaper, the Courrier de l’Europe. Karl Marx and the Aristocracy: Examine the unexpected alliance between communist ideologue Karl Marx and arch-reactionary Scottish aristocrat David Urquhart. What united them was a shared hatred for the middle class or bourgeoisie. This “natural alliance” between nobility and peasantry against the chaotic “middle” originated with the aristocratic Young England movement, which sought a return to feudalism. From the Round Table to Globalism: See how this aristocratic agenda was carried into the 20th century by the Round Table movement. Cecil Rhodes and Alfred Milner‘s movement, rooted in the doctrine of “liberal imperialism” (or “socialist imperialism”), sought a worldwide federation of English-speaking countries and the “ultimate recovery of the United States”. Modern Globalism: Follow the direct line of influence connecting Milner to William Yandell Elliott (recruited at Oxford’s Balliol College), Elliott to Henry Kissinger (Kissinger’s Harvard mentor), and Kissinger to Klaus Schwab, founder of the World Economic Forum (WEF). This network continues to pursue centralized power and the goal of global governance, fulfilling the prophecy of a “new form of stealth communism” called globalism.

Footnote to Bangalore'‘s Vidhana Soudha building picture

The inscription “GOVERNMENT WORK IS GOD’S WORK” on Bangalore’s Vidhana Soudha has an interesting history. The phrase was associated with Kengal Hanumanthaiah, Chief Minister of Mysore State and the driving force behind the construction of the building in the 1950s. Hanumanthaiah conceived the Vidhana Soudha as something approaching a “temple of democracy”, deliberately using Indian architectural traditions for the new institutions of government after independence. The inscription was intended to express the idea that public service was a sacred duty: those exercising political power should approach service to the people with the moral responsibility associated with service to God. Curiously, although the idea dated from Hanumanthaiah’s time, the inscription apparently did not appear on the building until 1980. Shortly before his death, Chief Minister R. Gundu Rao reportedly asked Hanumanthaiah whether he had any remaining wish. He replied that he wanted to see “Government’s Work is God’s Work” inscribed on the Vidhana Soudha. Hanumanthaiah died on 1 December 1980 and the words appeared shortly afterwards in both Kannada and English. The result is a fascinating feature of what is formally a secular democratic state: its great legislative building uses explicitly sacred language to describe the responsibility of government.

Cutting To The Chase

1. Are we headed for another GFC? Of course we are, I just don’t know when. Bubbles can start for all sorts of reasons. What turns them into monsters is the ability of money and credit to expand with them. That is what the current system does in spades.

2. More credit pushes up asset prices, higher prices support more collateral and more collateral creates more credit. Round and round we go.

3. Central bankers now largely recognise the problem. Credit, leverage, collateral and asset prices keep appearing in their own explanations of financial crises.

4. So why don’t they stop the credit? Because they can’t. The system is not ultimately under their quantitative control. Banks create money when they lend and, if expanding credit remains profitable, demand for more money and credit can create its own supply.

5. China actually tried to control money and credit. It still ended up with the mother of all credit bubbles.

6. AI and Data Centres may be the latest manifestation. Even the BIS and Bank of England are getting nervous. When even they start giving warnings, you know it is getting late.

7. Nobody knows when the tipping point arrives. What looked like extraordinary money and credit growth before the GFC now looks positively modest. This growth has gone on for many years now. You could have predicted a crash at any time over the past decade. Yet it has kept on tucking along.

8. The crash isn’t even the greatest economic cost. The real damage is done as the bubble distorts prices and the Allocation of Resources on the way up. The poor, of course, suffer the most both on the way up and down.

9. My Unified Theory of Money shows that a free market in money stops the process at its source. Give money a genuine cost of production and the system cannot manufacture the ever increasing credit needed to turn the latest enthusiasm into a self-reinforcing bubble.

They Agree It Is Money and Credit? So Why Not Control It?

Have a look at the money and credit charts. Regular Readers (RRs) will know that I am building up the analysis of my Unified Theory of Money (UTOM) over our journey.

One of the conclusions so far is that you don’t need money and credit to grow at all for the economy to grow. The pricing mechanism will handle the Allocation of Resources (AOR).

Where Did the Money Come From?

The Ginormous growth in money and credit therefore raises the interesting question of how that happens and what is the impact on markets and the economy. Look at the absolute numbers!

Total credit in the U.S. has grown to $77 Trillion from around mid $30’s Trillion pre GFC and less than $5 Trillion when the U.S. went of the gold standard in 1971. Obviously, you can see why I started the Charts when I did.

Welcome To Complexity Theory

Notice the Pre GFC growth in money and credit. They seem positively modest by the standards of the growth in money and credit since then.

If you knew nothing else, then you would conclude from these charts that we are headed for a catastrophe. If the extraordinary money and credit growth can go on for this long without another GFC, then why not a few more years?

Why not indeed. Welcome to Complexity Theory where tipping points are impossible to predict. I mean you could have picked any point along the curves as “enough is enough” and that must be the tipping point.

But the growth continued.

If ‘A’ Causes An Undesirable ‘B’, Then Do Something About ‘A’. If You Can.

We haven’t been operating in an analysis vacuum since the GFC. There seems to be increasing recognition even maybe consensus that the growth in money and credit causes Asset Bubbles.

Because They Can’t

Then why don’t Central Banks stop it? Good question. It is time we started serious discussions on exactly this issue. What I will argue here is that the Central Banks can’t stop it even if they wanted to. They don’t really control the system.

What? How come? Read on.

Don’t Ask!

A good question is what is the relationship between money and credit. Don’t ask! I will get there in the future. For now, we can go with that fact that they are two sides of the same coin. Sort of.

Why Are We Even Talking About Credit Bubbles and Another GFC?

Didn’t the great and the good fix all that? Wasn’t the bailout of the Gazillionaires and the resultant historic widening in the distribution of income since the GFC justified on the basis that the alternative of letting the whole system melt down would have been worse.

My essay below gives you a backdrop to the sorry state of central banking and economic theory today. We are entering dangerous territory, and this sorry state is the culprit in my view.

If You Think the Communists Are Dangerous Now, Wait Until the Next GFC

Why don’t we ask all the pertinent questions before the crash this time. How can asset bubbles even form? Are they just a fact of life. The Communists now trying to take over the U.S. would claim that they are a feature of the Capitalist system and that is one reason why Communism needs to replace it.

Think of how another GFC is going to change the politics of everything. So, the topics discussed in this essay are more than important in my view.

Here is the question. Will they bail out the Gazillionaires this time around? Will they get away with it? Or here is an even bigger question: Will the system implode and what if they cannot save the system even if they wanted to?

Now that is an essay in itself.

If I Was a Betting Man…Wait I Am by Definition

Shall we focus first on what an Asset Bubble does to the financial markets. But always keep in mind the main game which is what they do to the AOR in the economy.

Looking at the fundamentals of a company or sector are and remain important but the credit induced bubble changes those very fundamentals. Not only that, Bubbles also change the whole macro ‘asset class’ scene as well. Everything is distorted and investment skill starts giving way to luck.

But the Fund Managers Still Get Paid. Ugh?

It is the worst of feelings as a fund manager. I know I have been there many times. The credit induced prelude to the Mexican and Asian Crises and of course the GFC. It is one of the reasons I got out. And I am glad I did.

This is no way to run a financial system. Or a society for that matter. But it is a first world problem for a fund manager. Somehow, they still get paid fortunes whatever happens.

For the average citizen though, it is devastating.

Are We Watching It Happen Again With AI?

All this has led to increasing fears about whether we are headed for another GFC. The Bubbles tend to get manifested in one sector in particular. This time it is AI and the Data Centres. The video below is a good example of the discussion

Even the BIS and Bank of England are already warning about the increasingly complex web of debt financing the AI and data-centre boom. They are always late to the party so once they start with the warnings you are probably getting close to D-Day.

In its latest annual report, the Bank for International Settlements (BIS) the “central bank for central banks”, warns that disappointment in AI investment returns could trigger a sharp pullback in financing, turning today’s AI capital spending boom into a prolonged investment bust. The report also raises concerns about increasingly complex “circular financing” arrangements linking AI companies, hyperscalers, chipmakers, cloud providers, and data-center operators. One of the world’s most influential financial institutions now believes investors should pay close attention to the systemic risk building beneath today’s AI investment boom.

We Have Seen This Movie Before

The comparison with the GFC is uncomfortable: a single project can support borrowing against the property, leases, GPUs, customer contracts and future revenues, creating several layers of credit against the same underlying economic value.

Rising expectations then support more credit, which finances more AI investment and reinforces those expectations, the familiar credit-bubble feedback loop.

Where Does the Credit Come From?

And that brings us directly to the question I want to investigate.

Where does all this additional credit come from? If demand for AI infrastructure suddenly requires hundreds of billions of dollars of additional financing, how can the financial system apparently produce it?

There was not some enormous pile of previously unused money sitting in a vault waiting for somebody to invent ChatGPT.

If banks and other financial institutions can respond to profitable demand for credit by expanding their balance sheets, then understanding bubbles requires us first to understand something much more fundamental: how money and credit are created, what limits their creation and whether the central bank really controls either of them.

And Even More Important

If trillions of investments is in AI, then what use would those resources have been put to in the absence of AI. The Allocation of Resources (AOR) in the economy is now vastly different. The question is this: Are the price signals that direct this investment consistent with an efficient AOR?

It is the AOR issue that rarely, if ever, gets discussed. RRs will know already that an FRB Fiat System distorts prices signals and results in an inefficient AOR, even by mainstream economics standards. (By the way do you like all my Acronyms).

Yet they virtually never think about it in those terms. If all new money and credit created by a FRB fiat money system distorts AOR, then a credit bubble is distortion on steroids.

That is the real cost of Asset Bubbles.

How Do Bubbles Start?

There is no serious consensus about what initially starts every financial bubble. Mainstream pundits believe that technological breakthroughs, financial innovation, speculation, herd behaviour, irrational exuberance and government policy can all play a role in the catalyst.

But once we ask what allows an asset boom to become large enough to threaten the financial system, there is much more agreement. Central bankers, the BIS, the IMF and the historical literature repeatedly return to the same combination of credit growth, leverage, asset prices and collateral values.

Credit Bubbles Are Impossible In a Free Market Money Economy

If I invest $300,000 of my savings in a house and prices collapse, I lose money, but there is no necessary reason for the banking system to collapse with me. If I put in $300,000 and borrow another $900,000, the process is different.

The loan creates additional purchasing power, which can push house prices higher. Higher prices increase collateral values, making further lending possible, which creates still more purchasing power. Psychology may have supposedly started the boom, but credit is necessary to finance and magnify it.

In fact, my UTOM shows that bubbles are impossible in a free market money economy. Here is my essay explaining that (in part).

Because people and businesses would not be able to obtain the leverage and hence draw resources away from more efficient uses. My UTOM theory shows that a true free market for money puts paid to any self-fulling catalyst before it can form into a bubble.

Ask the Central Bank and Fund Managers To Define a “Bubble”

In our current system the great and the good talk about what is to be done after the system endogenously creates the bubble in the first place.

You are also probably asking how do they know they are even in a bubble? They don’t. Ask any fund manager to define when they are in a bubble. That is the point. You don’t even know you are in the bubble until after the crash that confirms it for sure. Until then you are only guessing and “feeling” it.

Central Banks Have Known This For A Long Time

Central bankers have understood the connection between credit and financial bubbles for decades.

In 2002, Claudio Borio and Philip Lowe at the BIS concluded that “sustained rapid credit growth combined with large increases in asset prices appears to increase the probability of an episode of financial instability.”

The warning was particularly important because credit and asset prices could boom while CPI inflation remained subdued. Raghuram Rajan added another part of the mechanism in 2006, arguing that “low rates will increase fund manager incentives to take on risk” and that cheap borrowing allowed managers to “goose up returns by adding leverage.”

Federal Reserve Governor Frederic Mishkin described the feedback mechanism particularly clearly in May 2008: “a credit boom begins, increasing the demand for some assets and thereby raising their prices.” Rising prices increase collateral values, supporting still more lending and higher prices.

Oh, I See. The System Causes It But You Can’t Do Anything About It

Peter Praet of the ECB later explained how financial intermediaries turn optimistic expectations into current purchasing power “through credit creation.” Yet having described the mechanism, Mishkin concluded that monetary policy “should not try to prick” such bubbles, while Ben Bernanke famously compared doing so with performing “brain surgery with a sledgehammer.”

The GFC rather brutally tested that approach. Afterwards, Borio and Piti Disyatat blamed the “excess elasticity” of the international monetary and financial system and observed that “Credit creation, a defining feature of a monetary economy, plays a key role.”

The historical evidence subsequently became even stronger: Schularick and Taylor described financial crises as “credit booms gone wrong,” while Jordà, Schularick and Taylor concluded that “what makes some bubbles more dangerous than others is credit.”

By 2010, ECB Executive Board member Lorenzo Bini Smaghi was already referring to a “broad consensus” that excessive credit growth had characterised the period preceding the GFC.

Yet the Basic Policy Framework Survived

Regulation became much more elaborate, but monetary policy remained primarily focused on inflation and economic activity.

Fed Vice Chair Randal Quarles said in 2019 that a “general consensus has emerged” around precisely that approach, despite acknowledging that accommodative monetary policy could encourage over-borrowing, speculative bubbles and the search for yield. Philip Lowe was still warning in 2023 that “monetary policy can’t ignore credit growth and asset prices.”

The details differ, but the recurring ingredients are remarkably consistent: credit, leverage, collateral and asset prices. There is no consensus that credit starts every bubble, but there is broad agreement that it can fuel them, make them self-reinforcing and make their collapse vastly more dangerous.

That Leaves a Rather Obvious Question

If credit is so central to the bubbles that central bankers themselves worry about, how can the financial system create so much of it in the first place? What creates the corresponding money, what constrains its quantity and how much control does the central bank have?

Before worrying about how to restrain credit bubbles, we need to understand how money and credit is created.

Types Of Money Systems

There are only a handful of ways to run a monetary system, and everything we observe is some variation or combination of these.

Well, you can:

1. Let the market determine money. No government. No FRB. History shows this is not theoretical. Variants of it have existed before.

2. The government can control money and either make it itself or have the market make it under their control. No FRB. This can apply to metal and/or paper.

3. The government can do 2) and have banks create money through FRB

4. Central banks facilitating the whole 3) process. Especially the government printing money and backing up banks when they get into trouble. Basically, 3) on steroids.

Each of these has enormous implications for the AOR and income distribution in the economy. The earlier you are in the chain of money creation, the more you benefit.

The later you are, the more you pay through higher prices and distorted markets. You would think the economics profession would hinge around a deep examination of these four types, but it does not.

The Worst Of All Worlds

We currently live in type 4, and it is complex beyond belief when you look at the institutional detail. I have spent around one thousand pages in Volume 1 of my Treatise going through how it works for the U.S., the Euro, China and Japan and it physically hurts your brain.

But at the core, the principles are simple and the conclusions are clear.

We live in a system where many, not all, of the wealthy get Money From Nothing and the Sweat of the Poor For Free. That is not a slogan, it is the mechanical outcome of how the system is structured and how new money enters the economy.

Let’s Get Down and Dirty Into Weeds

Two questions on UTOM may stand out.

1) If money is the key to inflation, then how does money get created under the current system? Surely it is just a matter of the Central Bank controlling the money supply growth. Pick a growth rate and Bob’s your Uncle, problem solved.

2) Interest Rates seen to play no role in UTOM as explained so far. How is it that interest rates don’t seem to matter for inflation in UTOM, yet Central Banks use them as the solution to inflation. How does all this fit in with the many historical essays I have done where interest rates are not set by any central bank, yet we still have inflation and deflation.

There are many essays in these questions alone. As we go through all this it may be worth keeping in mind this question: How come Central Banks and the economics profession don’t have the answers and haven’t properly examined these questions themselves.

The fact that they largely have not tells you everything, doesn’t it.

A Recap On Money Creation Under a Free Market

Remember, for most of the history we had specie as currency with paper notes used to transfer deposits playing a relatively minor role. Paper money changed all that with its invention in China in the later 10^th century and was used there until the mid-seventeenth century. They only started using paper money again in the 19^th century following the British victory in the Opium wars.

In the West, paper money wasn’t used until the mid seventeenth century.

Interest Rates Played No Role in Policy

There was no ‘interest rate’ monetary policy as such when specie was the currency. In both the East and the West even when there was paper money, interest rates were not used as a tool of monetary policy.

It was the government printing money to finance their activities. Interest rates were normally left to the market with the government often putting caps on the level of rates.

Central banks such as the Bank of England had administered discount rates from the seventeenth century and increasingly manipulated them, particularly under the nineteenth-century gold standard but largely to manage gold reserves, convertibility, liquidity and credit conditions.

We can conclude then that for most of monetary history, interest rates were set by market interactions sometimes with Government caps rather than as an instrument of macroeconomic monetary policy.

It was during the twentieth century that administered interest rates evolved into the principal instrument for managing aggregate economic activity and, eventually, inflation.

Begs the Question. What Was the Theoretical Discovery?

What determined the interest rate when the Central Bank was not setting it? What changed in economic theory in the early twentieth century such that interest rates became the prime instrument set by the Central Bank to control the economy.

I mean there must have been some major ‘discovery’ or insight by economists to justify such a monumental change in the economic system which was so different to literally thousands of years of operation in both the East and the West.

To recap, even when the Chinese invented paper money back in the later 10^th century they didn’t have an ‘interest rate’ macro policy. They simply decided how much to print. Likewise with the West from the mid seventeenth century unit the twentieth century.

And Money Supply?

Add to all this Fractional Reserve Banking (FRB). Now that has been around in some form since the invention of money. How does the government controlling the supply of money fit in with RFB? At stages through history Governments banned FRB and at other stages they set rules to limit it.

Often there were complex relationships where Governments used the FRB system to fund deficits as well as printing money themselves.

In other words is is complex. But mostly before the twentieth century there was no such thing as ‘macro’ policy when it came to money supply. Money supply control was normally seen as an inflation control tool and not a demand side tool.

We Need To Revisit the Nature Of FRB

So here are the two previous articles that are prerequisite reading for those that are new to my essays.

The Puzzle So Far

We have:

1) History where interest rates don’t really feature in “monetary policy” until really the 20^th century. Then it somehow morphed to be the prime instrument of policy.

2) How then did interest rates get formed when there was no central bank determining them? Is there is some underlying force behind this (economists call it the natural rate) which there much be because interest rates did exist.

3) Given that, then how does that ‘natural’ interest rate relate to the central bank determined rate. Does it even still exist once the central bank sets rates?

4) These are completely different economic models so what is the theoretical difference between the two. Obviously, the current one must be better otherwise we would go back to the old ways that existed for thousands of years.

5) What exactly determines money supply growth and do governments control it? What is the relationship between money supply and credit? How do the interest rates set by the central bank affect money and credit growth?

6) How does money supply, credit and interest rates all fit in with UTOM and the conventional economic theory.

You Would Be Wrong

You are probably thinking that conventional economic theory has all the questions well settled. I mean there are literally thousands of central bank economics walking around as if they do have the answers to those questions. We are talking about billions of people affected by their decisions, so they surely, they have all that settled.

Right? Nup. Not even close.

Where Do We Start?

For now, shall we deal with the money supply and credit growth.

As we have already explained it finally seems to be recognised that money and credit growth do have something to do with the credit bubbles. Mind you, this took decades of in-your-face experience for this to be recognised.

If you go back to the early 1980s most central banks used some sort of check list of economic indicators to determine what to do with monetary policy. Often this involved using the money and credit aggregates in that list. Often, they used interest rates to try and reach targets on money and credit growth.

As You Can Imagine This Was a Very Inexact Science

Sometimes Central banks set reserve ratios to restrict money and credit growth and that was the main instrument to control money and credit. At times some central banks were using both interest rates and reserve ratios to control money and credit.

Apart from China, as time went on the whole thing morphed into interest rates controlling economy growth and money and credit were not even a factor at all? Why?

The reason commonly given was that deregulation distorted the money and credit aggregates so much that they became relatively meaningless. It depends upon which central bank we are talking about but as a generalisation it was never totally clear whether the interest rates were to control both the economy through demand or through their effects on money and credit.

It would be fair to say that the majority of Central Banks were trying to control demand through the impact of interest rates on demand rather than through the money and credit aggregates.

Even those central banks that paid attention to the money and credit aggreges it was often only as an afterthought.

What About China. They Tried But Couldn’t Control It.

China is illustrative of the confusion here. See my previous essay on Chinese banks.

The point is that China looked a Japan and though we don’t want to go down the credit bubble track and they purposedly, and alone amongst central banks, tried to explicitly control money and credit. Maybe not actual targets but certainly they were a major aspect of their policy.

Here is the thing. Even though they tried to control money and credit and it got out of control anyway and they got the mother of credit bubbles.

You Mean Money and Credit Growth Can Be Out Of Their Control

There are so many questions to answer so perhaps a good place to start is can Fractional Reserve Banking and the structural set up with the Central Bank mean that the Central Banks can’t even control money and credit even if they wanted to.

A.K.A the China over the past 30 odd years.

Let’s keep sight of the big picture through all this. We now have recognition that money and credit do have something to do with bubbles even though money and credit were largely ignored for decades.

But nowhere along the way was there a new theoretical discovery suggestion that we now don’t need to worry about money and credit and interest rates should be the prime instrument of monetary policy and that operated mostly through the demand side of the equation.

What Happens When a Bank Makes a Loan

The essay below shows that the banks don’t even know they are creating money. The point is that the Central Banks don’t control the system itself. Take the example in the essay where the bank creates a new loan and a corresponding deposit. They will change at the margin lots of ratios that a central bank may have that they bank must comply with.

Often this will mean that they must get more Central Bank money to comply with the ratios. Where does that come from? Well, the central banks of course. You may well ask couldn’t the central bank just say no when the bank goes to the central bank to get the needed liquidity.

That Is Not How It Works

The central bank has systems in place where that liquidity that is requested by the banks is automatically applied but at a cost. Sometimes the cost increases the more they want. Sometimes the central bank can look at it after the event and try and tighten things up.

It all varies depending upon the central bank. But in practice, in all cases if the system ‘wants’ to expand money and create credit then it does. Maybe the central bank tries to tighten things up after the event. And even if it tries to do that, if the banking system deems it still profitable to keep expanding then it does.

In fact, the very act of expanding credit creates the self-fulling prophecy by causing asset prices to rise which in turn makes it profitable to keep expanding credit, despite the increased costs associated with doing so.

Increasing Cost of Finance May Not Matter

Even if the cost of increasing money and credit increases to the bank as the central bank makes it more expensive to comply with the various ratios, it may still be worth it and profitable for the banks to continue the credit expansion.

You can see how a self-reinforcing bubble can occur. The banking system starts expanding lending for property as in our example earlier. The increase money and credit in the economy drives up property values.

Even if it becomes more expensive for the banks to comply with all the various ratios it may still be worth to continue lending. Property values are going up in this self-reenforcing cycle so the banks can charge a higher interest rate on the loans to compensate for any increase in the cost of their loans because it becomes somewhat more expensive to comply with all the ratios.

I Won’t Torture You With the Exact Mechanics

Now I could go through exactly how all the ratios work for each central bank, but I am guessing you’re thinking: please don’t. I trust you. You are the only one who have been crazy enough to do 800 pagers on the details of this for the U.S., the Euro, the Peoples Bank of Chian and the Bank of Japan.

Different structures in each case but the same outcome in all cases. Demand for more money and credit can create its own supply.

That Everyone, Is How Bubbles Get Formed

A question that may be on your mind is do the central banks know that the system is sometimes beyond their control.

A very good question indeed. I reckon in most cases no. Certainly not until recently although there are increasing signs that they may be realising it now. The question is what they can do about it. The answer is not a lot. We have a system where the banks don’t even know they are creating money and the central bask mainly don’t either, neither can explain how it fits in with any economy theory at all: Keynesian, Monetarist, Austrian or any combination of the three.

But all seem to now agree that bubbles are not good things.

What About the Allocation of Resources (AOR)

Notice in UTOM that a bubble is impossible. That is because there is a cost of production to money. This means that whatever starts a bubble cannot morph into a credit fuelled bubble. It is impossible.

Note also that all the babble from economists and central bankers you virtually never hear them talk in AOR terms. Yet AOR is the whole purpose of economic analysis.

Cutting To the Chase

1. Our major institutions increasingly seem incapable of logic, reason and genuine debate. Mass Formation Psychosis (MFP) may help explain why.

2. The Iranian oil shock exposes that problem perfectly. Modern central bankers often appear not to understand, or at least cannot explain, the very inflation process they claim to manage.

3. At their best, they distinguish between a one-off price shock and sustained inflation. At their worst, they simply say higher oil prices keep inflation high. They cannot even tell a consistent story.

4. Even when they invoke second-round effects, wage pressures and inflation expectations, they never explain the mechanism by which sustained inflation actually occurs.

5. A simple free-market model with a constant money supply suggests a very different conclusion. Supply shocks change relative prices and the Allocation of Resources, but they do not generate sustained inflation.

6. Even allowing for changes in the velocity of money does not rescue the orthodox explanation. Sustained inflation still requires continuing growth in money expenditure.

7. Next time we remove the final assumption. What happens when money itself is produced by the market? The answer, I believe, overturns much of modern monetary economics.

Cognitive Dissonance, Central Bank Style

The recent Iranian oil shock provides a rare opportunity to observe how modern central bankers think about inflation. Their statements reveal two distinct strands of reasoning.

At times they draw a very careful distinction between a one-off increase in energy prices and a genuine inflationary process driven by changing expectations, wages and broader pricing behaviour.

This very short clip from former Fed head Powell is a good example. It seems expectations are important. You are probably asking how does it work from an oil price shock to continued inflation through an expectations channel?

At other times they simply state that higher energy prices are keeping inflation elevated, without explicitly explaining how the transition occurs.

It is all very confusing.

Waiter, Hmm… I Think I Will Have the ‘Word Salad’. Thanks.

I don’t want to torture you but at least watch the first few minutes of this video with Christine Lagarde, President of the European Central Bank. If anyone can decipher it, please let me know. And how about the Bobble Head Sycophantic Interviewer, she becomes important in this whole story to follow.

Lagarde, as she kindly reminded us in the video, was also a former head of the IMF.

The Sorry State of Our Institutions

Everyone, this is the sorry state of our economic and financial institutions. That includes the mainstream financial press who refuse to ask any challenging questions of the demigod Central Bankers, even when they are talking complete undecipherable gibberish.

The problem goes well beyond central banking. Across public health, the media, politics and economics, our major institutions increasingly seem unable or unwilling to subject their own assumptions to logic, reason and genuine debate.

Mass Formation Psychosis (MFP)

The recent Senate hearing have highlighted the sorry state of our institutions in another field. There has been lots of analysis as what to the hell happened back you know when.

Some interesting theories have emerged.

You have probably seen the resurgence of MFP recently bought back into focus by Dr. Mattias Desmet

Beside an explanation of the events during COVID, MFP has also been given as an explanation of why and how the Nazis in Germany and the Communists in Russia and China were able to come to, and stay, in power.

I Can’t Work It Out, Can You?

I’m still trying to figure all this out myself and have a very open mind. I reckon there may well be something to MFP.

Here’s a two-minute summary for the time deficient.

Did the 20^th Century Horrors of Hitler, Stalin and Mao Not Happen?

This is all very relevant to today given the rise to power of what can only be described as Communists in some States in the U.S. and now the mainstream of their politics.

Who would have ever believed that this was possible. But then again, who would have believed the events of COVID were possible. Maybe it is worth watching yet another take on MFP. It took over a year to make and is really good.

It was an honor to collaborate with Academy of Ideas. Their content is incredible. This video has been over a year in the making. I can honestly say I put every ounce of energy I had into this one. After completing this, I am mentally, physically and emotionally exhausted, but...this may be the most important message of our time. I think we can all feel that we are at a very pivotal point. The fate of our world runs along the edge of a knife. If we falter, we may descend into a nightmare. I enjoy exploring positive, enlightening ideas, but it is just as important to explore the dark side as well. Please, if you can, share this video far and wide.

The Money System Has To Be Involved In All This

Personally, I think the widening distribution of income caused by the monetary system and the (partly related) decline in the integrity of our institutions may have something to do with it.

It is not the whole story of course and maybe not even the main actor.

Being Of Sound Mind

I wish there was a conversation at this week’s hearing that went like this: Senator X: “Dr Fauci, do you have a functioning mind or any mind at all”. Dr Fauci: “On the advice of Counsel, I respectively….”

I’m only half joking here. There is a very serious issue here. I think we must demand logic, reason, debate and transparency from all our Institutions. Also, we must have rigorous questionings of these institutions and their actions by the fourth estate. In my view this applies especially to economic institutions, and we are certainly not getting it.

Where was I? Oh, that’s right on Lagarde.

Back To Lagarde

In a keynote speech entitled “Navigating Energy Shocks: Risks and Policy Responses”, delivered at the ECB and Its Watchers Conference in Frankfurt on 25 March 2026, ECB President Christine Lagarde set out how the ECB believed central banks should respond to the Iranian oil shock.

It is one of the clearest official explanations (pun intended) of modern central bank thinking that I have found.

Before discussing interest rates, she stressed that policymakers must first understand “the nature, size and persistence of the shock.” She then acknowledged the obvious limitation of monetary policy itself:

“Monetary policy cannot bring down energy prices. But we must identify when higher energy costs risk spilling over into broad-based inflation – be it through indirect effects or through second-round effects via wages and inflation expectations.”

A One-Off Shock Is Not Yet Continuing Inflation

The higher oil price itself is not described as inflation. Rather, the ECB’s concern is whether the initial increase in energy prices spreads throughout the economy by altering inflation expectations, wage bargaining and firms’ pricing behaviour.

Lagarde immediately strengthened that argument:

“Because the effects of significant price shocks on inflation can be non-linear, we need to work with scenarios and pay close attention to early warning signs that the shock is embedding in broader inflation dynamics.”

She then concluded:

“Small, one-off and short-lived supply shocks can be looked through. But as expected deviations from our inflation target grow larger and more persistent, the case for action becomes stronger.”

They Are Big on Scenarios, Size of Shocks, Blah Blah Blah

Later in the same speech she expanded the point even further by explaining that the appropriate monetary policy response depends not simply on whether the shock is a supply shock, but also on its magnitude and persistence.

There Are Those Three Bears Again

She outlined three different cases. If the shock is “limited in size and short-lived,” the classical response is to look through it. If it produces a larger but temporary overshoot of inflation, a measured policy response may be appropriate.

If the shock becomes sufficiently large and persistent, then a much stronger monetary response is justified. She concluded that the ECB would not act until it had “sufficient information on the size and persistence of the shock and its propagation.”

Ah, Here Is the Central Bank Hymn Book

Piero Cipollone, another member of the ECB Executive Board, expressed almost identical concerns in a later speech. Discussing the ECB’s scenario analysis, he explained that the Bank’s adverse scenario assumed:

“...stronger indirect and second-round effects, as well as greater uncertainty and heightened adverse international spillovers...” The ECB’s severe scenario went further still, assuming: “...an even stronger and more persistent energy price shock...” together with: “...greater uncertainty and even stronger indirect and second-round effects.”

Cipollone then explained why these distinctions mattered:

“The significant difference between the adverse scenario and the severe scenario highlights the importance of the intensity, duration and propagation of the shock as we seek to assess its impact on the inflation outlook.”

Trust Me, I’m a Central Banker

Finally, he described precisely what the ECB would be monitoring:

“We are nevertheless paying attention to possible signs of a de-anchoring of medium to long-term inflation expectations. In particular, we will be looking at the indirect pass-through of higher energy costs to the broader consumption basket prices and possible second-round effects.”

The Fed, the ECB…They’re All the Same

Federal Reserve officials expressed remarkably similar ideas. Governor Lisa Cook warned:

“Nonetheless, even temporary and short-lived shocks could influence inflation over the medium term. Firms may embed these shocks into their pricing decisions, and workers may incorporate them into wage negotiations.”

Likewise, Governor Michelle Bowman argued: “It is appropriate to look through temporarily elevated inflation readings largely due to higher energy prices...”

She then added an important qualification:

“In particular, the more persistent higher oil prices are—or if we start to see broader effects of higher energy prices on PCE inflation—the more likely I will consider shifting my approach to thinking about the balance of risks.”

Wait a Minute. What Happened to All Those Mechanisms.

The June 2026 minutes of the Federal Open Market Committee reveal the same emphasis. They observed:

“More broadly, most foreign central banks emphasized the risks of higher inflation leading to second-round effects and the need to mitigate these risks, despite prospects of weaker output growth, and signaled either policy rate hikes or a slower pace of easing going forward.”

Yet having explained the transmission mechanism so carefully, official central bank publications do not always maintain that distinction.

The ECB’s July 2026 monetary policy statement simply declared: “The energy shock continues to feed into higher prices.” It also observed: “It is becoming more expensive for firms to source inputs, and they therefore expect to put up their selling prices.”

Finally, it concluded:

“While energy price inflation declined in June, its rise since the start of the conflict – and its impact on food, goods and services price inflation – is likely to keep inflation well above target into the first half of 2027.”

It’s a Dog Breakfast of An Analysis

At their most careful, central bankers distinguish between an initial relative price shock and a continuing inflationary process. They repeatedly refer to “second-round effects”, “inflation expectations” and “wage pressures” as the transmission process by which an oil shock supposedly becomes broader inflation.

At other times, however, official publications simply state that higher energy prices are keeping inflation high, without even mentioning those intermediate mechanisms. Whether these later statements are merely shorthand for the more detailed explanation, or whether they reflect a subtly different conception of inflation, is left unexplained.

But There is an Even More Fundamental Problem

Even when central bankers provide their most detailed explanations, they still never explain the actual causal mechanism. How do changing expectations or higher wage demands generate the additional spending necessary to sustain a continuing rise in prices? Naming a “second-round effect” is not the same as explaining how that second round occurs.

That is the question we must now answer.

Take This Logic

The oil price rise slows economy but if it initiates wage pressures and inflation expectations then the Government, through the central bank needs to step in give it another kick in the guts by raising interest rates.

To the ordinary person out there this can seem a bit counterintuitive. They could well ask if the oil price rise slows the economy why then do we get inflation?

Please Explain?

I mean how does it all work?

Why does the same type of oil shock supposedly generate second-round effects on some occasions but not on others? What determines when the tipping point has been reached?

But here is an even more fundamental question. Assume that the magical tipping point occurs, what is the process where the now in play wage pressures and increased inflation expectations lead to actual increased inflation?

How Do I Get Some Of Them Mystical Powers

While we are at it, how does raising interest rates solve everything. Think about it.

An oil price shock causes changes in wage pressures and expectations of inflation and yet raising interest rates which had nothing to do with the increased inflation in the first place is the solution.

Not only that, the great and the good confidently assures us (watch the videos above) that they are ready to act when the signals go green. It seems that they have some mystical power to know when the green light goes on.

They also have the mystical power to know by how much to increase the interest rates which had nothing to do with the increased inflation in the first place.

Shall We Begin At the Beginning

I have mentioned in previous essays how my Treatise took fifteen years partly because I encountered illogical nonsense built on illogical nonsense to the power of about ten layers. The whole “what really causes inflation” is but one example of the layered illogical nonsense.

I will need to move slowly here so we will begin at the beginning.

UTOM. Pronounced “You-TOM”. Well, Are You?

I have described my Unified Theory Of Money (UTOM). It is really the Austrian theory, but I reckon UTOM goes some way to solving some of the fundamental issues with the Austrian theory to call it my own. For the enthusiast out there, UTOM deals with the seeming dilemma of the Evenly Rotating Economy and Money.

Here is the big question: Can you get inflation in a free-market model where money is created by the market and there is no Fractional Reserve Banking?

What Is Inflation? How Do You Measure It?

It is a rate of increase in prices not a one-off rise in the price level. The oil price shock is, in the first instance, a one-off rise in prices. Once that filters through everything then things could settle down. It is only inflationary if prices keep rising.

The measure of inflation is itself problematic. We obviously need to assign weights to each good to get an overall index measure. It is possible that a price shock causes some prices to rise and some to fall. That is, relative prices change as well as the measure of overall prices.

Remember the measure is not just some sort of interesting statistic. It is important because the behaviour of economic agents responds to it. Also contracts and financial market instruments including the stock market itself respond to it.

Money Wasn’t Important for Decades. How Come?

Most economists will know Friedman’s famous comment that “Inflation is always and everywhere a monetary phenomenon”.

Yet the discussion above from Central Bankers doesn’t mention money at all. In fact, we went for decades where money and credit didn’t feature in central bank and mainstream economic thinking at all. Except for the People’s Bank of China.

A Bit Of a Comeback

Recently money does get mentioned a bit in some research papers emanating from the Central Banks. Nearly always in the context of credit bubble talk.

But money is rarely mentioned in the Friedman sense. The discussion still almost always centres around raising interest rates to slow inflation? How do we square that circle with Friedman’s statement? To begin to answer this we need to build up the analysis over a few essays.

Here we start with assuming that money supply is constant. If Friedman is correct, then that has big implications for inflation.

Meet Our Fruit Case Economy

Take a simple economy of 100 each of apples, oranges and pears. For money say there 300 ounces of gold or to give it a modern perspective $300 one-dollar notes.

The prices of our goods will of course depend upon the relative demand and all sorts of factors. I can show that ultimately, prices, costs, and profits, will depend upon consumer preferences and the amount of money in the economy.

There is a certain intuition to this especially the ultimate price of the goods. Anyway, for our purposes here doesn’t really matter what the relative prices are, just that they exist.

An Apple Shock

Say there is an “apple shock”.

The supply of apples is hit hard by perhaps a crop failure. This initially sets off a rise in the relative prices of apples. This cascades into changes to consumer preferences. This in turn affects the demand and supply situation of all goods in the economy.

Basically, there are feedback effects on feedback effects and so on.

It is important to note the change in consumer preferences affects not just the demand for our apples, oranges and pears (and importantly money as well). They also affect the supply dynamics and cost situation of all goods in the economy.

To repeat: changes in consumer preferences affect not just demand but supply through changes in the cost structures of the whole economy. Most economists don’t realise this because they are stuck in either macro world or the Neo-Classical world.

Is Your Brain Already Starting To Hurt Yet

Think of it this way: the number of apples has fallen, and the price of apples has risen.

So far so good. But this change causes us to rethink lots of things. Each of us now adjusts our preferences of how many apples, oranges and pears and dollar bills we want to hold with the new apple situation.

The apple shock has caused us to adjust our preferences for all goods including apples and importantly how much money we want to hold once we have adjusted all of our purchases under the new apple regime.

This is the important point. The apple shock has been transmitted through the entire structure of the economy.

Off We Go To Market

These preference changes are expressed when we ‘go to market’ to make out purchases. That feedback gives information to the suppliers of the apples, oranges, pears and wait for it, money as well.

The suppliers of all the goods change their demand for resources (labour, capital, land) in their next production run. This in turn affects the prices of all those inputs.

With apple prices now higher the apple producers will want to increase production and try and draw resources away other producers. These other producers will be facing a new situation because of the changed demand for their products. The price of all the inputs will therefore be changing.

In some cases, there will be downward pressure in others upward pressure.

But What About the Overall Price Level?

I know what you are probably thinking what about overall prices? Ahh, then we get to money. Read on.

Hopefully you can see how the change in consumer preferences set off by the apple supply shock has affected both the demand and supply (i.e. cost of production) side of all goods in our economy.

But there is no reason whatsoever (so far) for the inflation impulse. None. In the first instance there are less goods in the economy due to the apple supply shock but the same overall money so the price level however defined will have risen.

The Market Reacts

The second-round impact is that there is likely to be more resources devoted to apple production because of the price rise and less resources devoted to the production of oranges and pears (again we will leave money to later).

The costs and price changes driven by the change in consumer preferences has set in train the cascading feedback effects which mean at the end of the day when things settle down to what economist call the new equilibrium, the allocation of resources has changed.

By round two we now have a different mix of goods than before the apple shock. Much will depend upon the nature of the apple shock and whether there is anything that can be done about it by devoting more resources to replacing the lost production (think oil).

Lots Of Complications but Here Is the Important Thing

Exactly where the measured price index ultimately settles is almost beside the point. It may finish above its original level, below it or somewhere in between depending upon how production adjusts and how the index is constructed.

What matters is that once the economy has absorbed the original shock, there is no remaining force causing the price level to keep rising. The one-off shock has worked its way through the system.

Government: Keep Out Of It

By round 2 (assuming all the adjustment has taken place) we will have the resources of the economy being put to producing a different mix of goods directed by the new consumer preferences.

There is no economic reason for a government to interfere with this process. The economy has adjusted to the change in consumer preferences and the reality of the apple supply shock.

You Rarely Hear the Great and the Good Speak In These Terms

Keep all this in mind when I refer to the Allocation of Resources (AOR) which I often do.

AOR is simply what uses land, labour and capital are put to. You know, what job do people go to what they get up in the morning. What uses are machines put to. Indeed, what machines are made. What is land used for. How do all these factors interact with each other.

It is the price mechanism directed by consumer preferences that direct all that activity.

It All Comes Down to the Consumer

Think of how the preferences cause the price and costs changes in apple, oranges and pear economy redirecting resources, after the shock, probably directed to restoring the apple production and less oranges and pears.

It all depends upon the nature of the shock, but the point is that a change in consumer preferences sets in train a series of price and cost signals that cause land, labour and capital to be put to different uses than previously.

Why Would You Want To Interfere?

The question is why on earth would you want to interfere with that adjustment. Also, shouldn’t every policy by the government start with asking what impact that policy will have on consumer preferences, knowing that it will change the AOR. The obvious follow up question is: is it worth doing?

Economists rarely address the AOR issues when they talk in macro terms like changing interest rates and fiscal policy on the ‘economy’. Hopefully you can now see that all these ‘macro’ policies change the AOR and interfere with consumer preferences.

What About Money: Setting the Scene

Now we get to see how money fits into all this.

Start with an economy where money supply is constant. This can be a fiat currency with no printing and no Fractional Reserve Banking or a specie economy, say gold, where supply is fixed.

The important point here for our analysis is that the money supply is fixed.

Important Lessons From a Simple World

Imagine that there is a market place every week where everyone gets one hour to trade their goods. We are deliberately simplifying the world so we can isolate the role of money.

Everyone starts with some combination of apples, oranges, pears and dollars. We all then have a choice to make as to what combination we want to end up with at the end of the hour?

At the end of all this the producers get their new price signals, so they know what to produce for next week’s market and how much labour etc. to demand for their production activities and so on.

Scenario One: Instantaneous Outcomes? Don’t Ask: Think Quantum Entanglement.

All the trades happen in everyone’s first trade once the hour starts. That is, magically the prices are set considering all the consumer preferences and everyone does their trades to get set for the week.

Think of it perhaps as everyone seeing the new prices on their screen then in on their computer their desired outcome and it magically produces the end result.

I know, you are asking how that could happen. Hey maybe AI could know all of our preference scales under all circumstances and work out the prices.

Rabbit Holes

In any event, welcome to one of my Rabbit Holes. There are lots of chapters in my Treatise on the formation of prices, but I ask you to trust me on a few of these perplexing issues in that it doesn’t change the principle I am trying to show here.

As an aside, most economists haven’t really gotten into the formulation of prices issues. They just draw their demand and supply schedules and somehow assume there is a lot of to-ing and fro-ing until equilibrium is reached. In reality, there are numerous preference feedback issues across products into preferences which complicate things. Believe me, the whole thing drove me bananas for a couple of years.

The Point Is?

The point of Scenario 1 is to show that the money goes around once. Everyone is happy with their new allocation of apples, oranges, pears and importantly money after this first magical trade.

For instance, I might start with 10 apples, 5 oranges and 3 pears and 10 dollars. On seeing all the prices, I might now want 5 apples, 7 oranges, 4 pears and 6 dollars. The total volume of goods is unchanged except for the apples shock at the start where say there was previously 100 apples and now there are only say 70 apples following the shock.

Same Money Chasing Fewer Goods

Now remember that there is the same total amount of money. We therefore have the same money chasing fewer total goods than before so the ‘price level’ however you want to define it has risen.

The question is how is it possible that we now get a continued rise in prices? After all the adjustments we have new relative prices, and this causes a production response and so on as described above.

Then we get to the next week, and we have a different supply of goods and a corresponding change in preferences and our ‘one round’ happens again.

The Composition of Prices Has Changed

The composition of prices is different with all the new preferences considered but clearly the ‘price level’ this time might be higher or lower depending upon how you measure it.

This in turn elicits another response. Eventually everything settles down and there are no more forces causing any more change in the composition of production.

Inflation, as defined as a rate of increase in prices, in this world is impossible. Clearly any government that tries to interfere with this process is changing the final AOR. Remembered the unencumbered AOR is reflecting consumer preferences.

Scenario Two: A More Realistic Situation

The trading goes for an hour. Consumers get to trade lots of times in reaction to changing prices and react to the reactions etc. Now they end up with their desired balance of apples, oranges, pears and money at the end of the hour.

Note that in this round there is no change to supply of any goods or money apart from the apple shock at the very start.

Around We Go

Now we have a situation where the total money supply might change hands numerous times. We have the concept of the velocity of money. That is the number of times the money supply circulates in a set time period. In this case it is within the hour.

The question is: can the ‘price level’ however defined now rise?

Say that I sell my apples and buy some oranges and then sell some pears and buy some apples because the prices have changed. I might then decide to sell some oranges and so on.

In the place of the hour my money transactions might be numerous times more than in our scenario one. Multiply this across the whole economy and the money supply has been transferred many times more than previously.

It is like there has been an increase in the money supply. In these circumstances it may well be that there has been a general increase in the price level.

But Can It Continue?

In the next round you would need the velocity to remain at the elevated level to maintain the new higher ‘price level’. It may even be that the price level falls if velocity falls back in the next round.

Remember that in the next round we have a different mix of goods as producers respond to the price signals for the first round.

A Higher Velocity Is Not Enough

Either way, in a general sense you would need the velocity to continue to increase in order for the ‘price level’ to continue to increase.

Suppose for the sake of argument, that changing expectations did temporarily increase velocity. That still doesn’t solve the problem. A permanently higher velocity could support a one-off increase in the price level, but sustained inflation requires the price level to keep rising. That would require velocity itself to continue increasing over time. What is the mechanism for that? Central bankers never explain it.

There We Have It. Friedman Was Correct. This Is Seismic.

Folks do you realise what we have just shown:

1) You need the money supply to increase to get any sort of sustained inflation. This begs the question as to how does raising interest rates control inflation if not through controlling the money supply. Why not just control that directly?

2) Governments attempt to interfere with any price shock is hindering the natural adjustment of the economy to a new reality. It would also hinder the adjustment which might help mitigate the shock itself.

3) There is no reason for inflation targeting. It interferes with the natural working of the market in responding to consumer preferences.

4) Why would we have a fiat money system at all? How does that help in the allocation of resources?

So far, we have assumed money supply was constant. We needed to do that to show that sustained inflation is impossible with a constant money supply. We have also shown that a constant money supply is totally consistent with an efficient AOR as directed by consumer preferences.

What If Money Can Be Created?

You are probably already seeing how creating money out of nothing messes with all this.

For now, however, let us consider a different world. Money can be created, but only at a cost. Welcome to our gold economy.

Go back to Scenarios One and Two. The apple shock did not simply change the relative prices of apples, oranges and pears. It also changed the relative price of money itself.

What is the “price” of money?

It is simply what an ounce of gold, or a dollar, will buy. If money buys more goods than before, its purchasing power has risen. If it buys fewer goods, its purchasing power has fallen.

I’m Shocked. Shocked I Tell You.

We have already seen how difficult it is to define a single “price level” but let us continue using it as shorthand for the general purchasing power of money.

The apple shock may also change people’s desired money balances. Once everyone has adjusted their purchases of apples, oranges and pears, they may decide they now wish to hold either more or less money than before.

That changes everything.

For Every Reaction There Is a Counter Reaction

Suppose people collectively decide they wish to hold more money. Less money is now circulating through the economy. The purchasing power of money rises.

But unlike our constant-money thought experiment, money itself is now a produced good.

If the purchasing power of gold rises sufficiently, producing more gold becomes relatively more attractive, just as higher apple prices encourage additional apple production. Resources begin to move towards gold production, while rising input costs and the other forces discussed in my UTOM framework simultaneously begin working in the opposite direction.

Money is now behaving like every other commodity.

A Glimpse Of What Is To Come

This leads to what I believe is a remarkable conclusion.

If money itself has a genuine cost of production, then even major supply shocks should be incapable of generating sustained inflation. That sounds like an extraordinary claim, and it is. The next essay explains why the economics of commodity money contains its own self-correcting mechanisms.

For now, however, we have established something important. Sustained inflation cannot occur without new money, or the equivalent through continually rising velocity, entering the economy.

That raises a very uncomfortable question.

If that is true, why is raising interest rates the standard cure for inflation?

Cutting To The Chase

1. The Dark Ages? Really? While the Western Roman Empire collapsed, the Eastern Roman (Byzantine) Empire continued for almost another thousand years, preserving Roman law, commerce and one of history’s most successful monetary systems.

2. The Byzantines learned from Rome’s monetary collapse. Their monetary system was not based upon economic theory but upon centuries of institutional memory. They understood that the entire monetary system mattered and carefully managed coinage, fiscal policy, banking regulations, and legal institutions

3. The money system survived because governments exercised restraint. Despite plague, invasion, territorial losses and repeated military crises, the Byzantine Empire largely resisted the temptation to finance its problems through monetary destruction.

4. The Islamic world did not replace a failed Byzantine currency. The Arabs initially adopted the Byzantine monetary system because it already worked.

5. Christian writers said comparatively little about inflation because, for centuries, there was comparatively little inflation to explain. This was in contrast to China, where repeated monetary crises forced thinkers to analyse inflation.

6. Money was only one part of a much larger institutional framework. Roman law, Benedictine monasteries, property rights, commercial administration and stable government all reinforced one another.

7. History consistently underestimates the importance of money. Wars, dynasties and theology dominate most historical accounts, while the monetary system that underpinned them is often treated as an afterthought. Yet money stands on one side of every economic transaction.

8. By the time Charlemagne revived commerce in Western Europe, Christianity faced entirely new economic questions. It now had to determine how Christian morality should apply to trade, investment, partnerships, profit and interest.

9. Oh, the Irony. The Iconoclasts (AD 726–843) spent more than a century, often violently, attempting to eliminate religious images because they believed they had no place in Christianity. Yet it increasingly appears that all that violence was unnecessary. The greatest image in Christian history may never have been painted by human hands.

Remember the Old TV Test Patterns

I don’t know about you, but my recollection of school history, assuming I was paying attention and assuming there actually were history classes, is that the period between the fall of Rome and perhaps Charlemagne or 1066 was largely a blank.

It was rather like television in the old days. Late at night the transmission stopped, the test pattern appeared and nothing much seemed to happen until everything suddenly started again in the morning.

Rome Falls But Roman Civilisation Refuses to Die

That picture is almost entirely wrong. The fall of Rome was not a single catastrophic event but the final stage of a long decline. By the time the young Emperor Romulus Augustulus was deposed in AD 476, the Western Empire had already endured generations of civil war, invasion, economic contraction and political instability.

Only Half the Empire Had Fallen

Nor did Roman civilisation simply disappear. As imperial government collapsed across Western Europe, the Church increasingly filled the vacuum. Bishops became administrators, judges, diplomats and protectors of their communities. In many towns they were the last educated officials still standing.

The Eastern Roman Empire, governed from Constantinople and later known as the Byzantine Empire, continued for almost another thousand years.

Not So Dark?

That creates a rather awkward problem for the traditional story of the “Dark Ages.”

Half of the Roman Empire never entered them. While Western Europe fragmented politically, the East continued preserving Roman administration, law, commerce and one of history’s most stable monetary systems.

For anyone interested in the history of money, commerce and economic thought, Byzantium is not a historical footnote. It is central.

Who Were Their PR People

The Byzantines have not merely been forgotten. They have suffered one of history’s worst public relations disasters. Today the word “Byzantine” evokes endless bureaucracy, incomprehensible rules, palace intrigue and people arguing over obscure theology while the world burns around them.

Part Of That Reputation Was Deserved

The imperial court was extraordinarily elaborate, and Byzantine politics could resemble an episode of Game of Thrones. But much of the caricature came from later Western historians, especially Edward Gibbon, who portrayed the Empire as decadent while Western Europe supposedly marched towards modern civilisation.

Yet Stop and Think About That For a Moment

If Byzantium was so hopelessly dysfunctional, how did it survive for more than a thousand years? Empires do not endure for a millennium through incompetence alone. They require functioning institutions, capable administration and, above all, a stable monetary system capable of supporting trade, taxation and government century after century.

Why So Little Analysis Of Inflation

One final contrast between China and Christendom deserves attention because it helps explain why their economic thought developed along such different paths.

At first glance, the absence of any substantial Christian discussion of inflation before AD 900 appears surprising. After all, as outlined above in Want To Know the Real Reason Rome Fell, the Roman Empire had experienced one of history’s great monetary collapses during the third century as successive emperors repeatedly debased the silver coinage.

Surely such an experience should have produced a rich body of Christian monetary analysis comparable to that found in China.

We shall see that the reason Christian writers said comparatively little about inflation was not because they ignored money, but because for centuries the money system largely worked.

The Turning Point

The decisive turning point came under Constantine I (306–337). Around AD 312 he introduced the gold solidus, struck at seventy-two coins to the Roman pound of gold. The reform was not simply another monetary experiment.

It established a gold standard that would survive for roughly seven centuries and become the monetary foundation of the Eastern Roman Empire.

What if a single coin could destroy an entire empire? This is the untold story of how the Byzantine Empire collapsed from within — not by invasion, but by its own money. Discover how a tiny change in gold purity triggered one of the greatest economic disasters in history. This isn’t just about the past — it’s a warning for today’s world, where money and power still decide the fate of nations. 💰 Watch until the end — you won’t believe how one coin brought down a thousand-year empire.

Modern numismatist Cécile Morrisson concludes that the Byzantine monetary system owed its success to “its experience inherited from the Roman tradition and a degree of sophistication in its financial acumen.“

They Did Learn From History After All

While Western Europe was fragmenting after the fall of Rome, the Byzantine Empire preserved Roman law, maintained one of the most stable gold currencies in world history and quietly accumulated centuries of practical experience in governing a complex commercial economy.

Byzantine monetary policy was not built upon abstract economic theory. It was built upon institutional memory.

Ironically, what many people dismiss today as “Byzantine bureaucracy” may simply have been the administrative sophistication required to govern one of history’s longest-lasting empires.

Note the Usual Gold, Silver, Copper Hierarchy

The success of the solidus did not mean the work was finished.

Gold might dominate imperial finance, military salaries and international commerce, but ordinary people bought bread, vegetables and wine with copper. By the end of the fifth century those copper coins had become tiny, inconvenient and confusing.

Emperor Anastasius I (491–518) therefore carried out one of the most important monetary reforms in Byzantine history. In AD 498 he introduced large bronze coins carrying clear marks of value. A forty-nummus coin bore a large M, a twenty-nummus coin a K, and a ten-nummus coin an I.

It was an intensely practical reform. The government was not attempting to create money from nothing. It was making the existing monetary system easier for ordinary people to use every day.

The solidus or nomisma was a highly pure gold coin issued in the Later Roman Empire and Byzantine Empire. It was introduced in the early 4th century, replacing the aureus, and its weight of about 4.45 grams remained relatively constant for seven centuries.

The hexagram (Greek: ἑξάγραμμα, hexagramma) was a large silver coin of the Byzantine Empire issued primarily during the 7th century AD.

Justinian I. 527-565 AD. Æ Half Follis (11.19 gm, 7h). Constantinople mint. Dated RY 12 (538/9 AD). :D N IVSTINIANVS P P AVG, diademed, helmeted, and cuirassed facing bust, holding globus cruciger and shield; cross to right :Large K; cross above, ANNO XII across field; Γ. DOC I 62; MIB I 96; SB 165.

Oh, For the Days Of Fiscally Responsible Government

Anastasius also acquired an extraordinary reputation for financial prudence. Procopius of Caesarea (c. AD 500–565), despite later becoming one of Justinian’s harshest critics, wrote admiringly of Anastasius’ management of the imperial finances.

In his Secret History he stated that Anastasius “filled all the treasuries to overflowing with gold before he completed the term of his life.“ He even explained the emperor’s reasoning, writing that Anastasius feared “that if his successor should find the treasury empty, he would immediately plunder his subjects.“

Whether Procopius exaggerated the quantity of gold is less important than the principle. To a sixth-century Byzantine historian, a well-filled treasury protected the population from future fiscal desperation.

Monetary stability began with fiscal discipline.

Yet, They Still Couldn’t Help Themselves

The reign of Justinian I (527–565) demonstrates that Byzantine governments understood monetary abuse could occur without reducing the gold content of the solidus itself. Procopius complained that officials altered the official exchange relationship between gold and copper.

He wrote that “the money changers were formerly prepared to exchange... two hundred and ten folles for one gold coin,“ but that the authorities ordered only one hundred and eighty folles to be exchanged instead.

His conclusion was blunt: “In this way they shaved one seventh off the value of each gold coin of all men.“

This was a remarkably perceptive observation. The gold coin itself had not necessarily become lighter, yet every holder of gold immediately found it purchased less subsidiary currency. Purchasing power had been transferred without visibly debasing the principal coin.

The People Knew

The ordinary population understood the consequences immediately. John Malalas (c. AD 491–578) records that in AD 553 “there occurred a debasement of the coinage. There was a riot and uproar among the poor and it was reported to the emperor.“ Justinian’s response is particularly revealing. According to Malalas, “He ordered that the standard of the coinage should continue according to the old practice.“

Historians continue debating the precise relationship between Malalas’ account and Procopius’ complaint, but together they reveal an important principle.

Monetary innovation that reduced the purchasing power of ordinary people could provoke immediate political consequences, and the solution was to restore the older and trusted standard.

The Global Reserve Currency In the 6^th Century

Not all the evidence comes from emperors and historians. Some of the strongest testimony comes from merchants themselves.

Cosmas Indicopleustes, writing during the middle of the sixth century after travelling extensively through the Red Sea and Indian Ocean trading networks, observed that Roman gold enjoyed an international acceptance unmatched by the currencies of neighbouring kingdoms.

His evidence is especially valuable because foreign merchants were under no obligation to accept Byzantine money. Imperial law stopped at the empire’s borders. If traders in India, Arabia and East Africa willingly accepted the solidus, it was because long experience had convinced them that its weight and purity could be trusted.

Reputation had become one of Byzantium’s greatest economic assets.

It Can and Needs To Be Done. Are You Listening Governments

The empire’s greatest test arrived during the seventh century.

Beginning in the 630s, Byzantium lost Syria, Palestine and Egypt to the Arab conquests. These were among its richest provinces and major sources of taxation. At the same time the empire was still recovering from the Plague of Justinian, which first struck in AD 541, and from decades of exhausting warfare.

Many states would have responded by abandoning monetary discipline altogether. Instead, the Byzantines contracted the scale of government, reorganised the army and preserved the integrity of the gold solidus despite enormous fiscal pressure.

Monetary stability was not maintained because circumstances were easy. It was maintained despite circumstances being extraordinarily difficult.

Note the Quality Aspect

The clearest surviving statement of Byzantine monetary thinking appears much later under Emperor Leo VI “the Wise” (886–912). Around AD 900 he issued Novel 52, addressing a problem that seems surprisingly modern. Earlier emperors had attempted to remove older coins from circulation simply because they bore the portraits of previous rulers. Leo immediately identified the danger.

He wrote, “If a large amount of money of good quality and weight imparts great power to the State, the ancients were perfectly right in providing against its scarcity; just as if they would avoid a dangerous illness which would tend to deprive them of all their strength.“

The wording deserves careful attention. Leo did not praise abundant money in the abstract. He praised abundant money “of good quality and weight.“

Quantity mattered, but only when accompanied by integrity.

The Emperors Ego Be Dammed

Leo then explained why the earlier policy had been so damaging. Rejecting perfectly good older coins had produced, in his words, “confusion“ and “losses... especially among the poorer classes, who are more in need of assistance and protection than others.“

He became even more specific, warning that “traders of small resources, and those who only live by manual labor, as well as all peasants,“ would be unable to purchase “the necessaries of life“ with money that had previously been perfectly acceptable.

His solution was to restore continuity rather than innovation. He therefore ordered that “every kind of coins... whether they bear the effigy of an ancient or a recent sovereign, shall be equally good and current in business transactions.“

The legitimacy of a coin depended upon its weight and integrity, not the age of the emperor whose portrait it carried.

Some Handy Laws

If Leo’s legislation explains imperial thinking, the Book of the Eparch, compiled in Constantinople during the reign of Leo VI and expanded during the tenth century, shows how those principles worked in everyday commercial life.

Anyone seeking admission to the profession of money changer required guarantors who would swear “that he will not sweat (file) or clip either nomismata or miliaresia, that he will not coin...“

The punishment for violating that oath was uncompromising: “he shall have his hand cut off.“ The law recognised that monetary stability depended not merely upon the imperial mint but upon the integrity of the people handling coins every day in the markets of Constantinople.

The Regulations Became Even More Detailed

Money changers “shall not discount the miliaresia if the same are of good alloy and bear for authenticity the Emperor’s effigy.“

Notice that two conditions had to be satisfied. The coin required both good alloy and imperial authentication. The emperor’s portrait alone did not make bad metal valuable, while good metal without recognised authority could still create uncertainty.

Today The Bankers ARE the Counterfeiters. And It’s Legal

The regulations also required every banker to report counterfeit currency immediately. “Every money-changer who does not declare to the eparch that he has received counterfeit nomisma or miliaresion... shall be flogged, shaved and banished.“

The money changer was therefore not merely a businessman. He had become one of the principal guardians of the empire’s monetary system.

Forget Warsh. Put These Guys In Charge of the Fed

Taken together, these sources reveal something far richer than the simplistic claim that Byzantium merely “maintained sound money”:

1) Anastasius accumulated reserves because he believed an empty treasury tempted governments to oppress their own people.

2) Procopius recognised that governments could transfer wealth simply by manipulating exchange relationships between denominations.

3) Malalas recorded the political consequences when ordinary people suffered the effects of those changes.

4) Leo VI insisted that money must remain “of good quality and weight“ while refusing to destroy perfectly good coins for reasons of imperial vanity.

A Bedtime Reading Book

The Book of the Eparch then carried those principles into the marketplace, regulating the conduct of every licensed money changer in Constantinople. Across six centuries the message remained remarkably consistent. Trust in money did not arise from imperial decree alone.

It had to be earned, protected and defended every day through honest weights, reliable metal, prudent finance and institutions that punished those who sought to corrupt the currency.

Speaking Of Institutions, I Wonder How Many Lawyers Know This

Emperor Justinian I (c. AD 482–565) undertook one of the most ambitious legal projects in history. Between AD 529 and 534, his jurists collected, organised and systematised centuries of Roman legal thought into what became known as the Corpus Juris Civilis, or Body of Civil Law.

I discussed the extraordinary sophistication of Roman law in What Have the Romans Ever Done for Us? so I shall not repeat the details here.

What matters for our story is that Justinian preserved legal principles governing property, contracts, inheritance, partnerships, deposits and banking that might otherwise have disappeared forever.

Medieval Europe would eventually rediscover these texts and build much of its legal system upon them. Christianity therefore inherited not only the Scriptures and the writings of the Church Fathers but also a legal tradition that remained alive in the Eastern Empire long after imperial government had disappeared in the West.

Benedict Saves More Than Souls

If Augustine became the great intellectual architect of Western Christianity, Benedict of Nursia (c. AD 480–547) became its great practical organiser. His Rule of Saint Benedict, founded on ora et labora (”pray and work”), transformed disciplined labour into part of the Christian vocation, while Benedictine monasteries preserved agriculture, literacy, Roman law and classical learning through the chaos that followed Rome’s collapse.

They were not capitalist institutions, but by preserving order, property and administration, they helped lay the foundations upon which Europe’s later commercial civilisation would be built.

This Happened and Then That Happened…

It is incredible how mainstream historians have so little recognition of the money systems.

Look at the video above. A terrific “this happened and then that happened” account with the occasional analysis but through it all only an occasional fleeting reference to the money system.

As I keep saying, it is one side of every transaction, so it IS the economic system. It determines wars, government survival, poverty or wealth etc. Yet historians so often bypass it completely or mention it only in passing.

The Arab Conquests

The video below argues that declining confidence in Byzantine coinage encouraged the Arabs to replace it with their own stable gold currency, the dinar. That is only partly right.

When Arab armies conquered Syria, Palestine and Egypt during the seventh century, they inherited economies in which the Byzantine solidus remained the principal gold currency.

They continued using it for decades and even issued early Islamic coins modelled closely upon Byzantine originals. The problem was not that the solidus had already suffered the great debasement that would come centuries later.

It was that the new Islamic Empire remained dependent upon the money, symbols and monetary machinery of the empire it had just defeated.

Note the Gold, Silver, Copper Hierarchy (Again)

Caliph Abd al Malik (AD 646–705) finally broke that dependence. After first issuing transitional coins based upon Byzantine designs, in AD 696–697 he introduced the fully Islamic gold dinar: a carefully standardised coin bearing Arabic religious inscriptions rather than the image of a Byzantine emperor and the Christian cross.

The reform was monetary, political and religious at the same time.

Gold dinar Silver dirham Copper fals

Are You Noticing a Pattern Here

The caliphate had created its own reliable gold standard, unified a vast empire stretching across former Byzantine and Sasanian territories and provided the monetary foundation upon which trade with the Mediterranean, India and Central Asia could expand.

The dinar eventually became one of the great international currencies of the medieval world, but it did so by adapting the strengths of the solidus rather than rescuing commerce from its collapse.

The later Persian resistance to Mongol paper money belongs to a very different period, more than five centuries afterwards. By then merchants in the Islamic world had experienced generations of metallic money and were understandably suspicious when rulers attempted to replace it with compulsory paper currency.

Hundreds Of Years of Stable Currency

The creation of the dinar should not be confused with the later collapse of Byzantine gold. During the seventh, eighth and ninth centuries the solidus, increasingly known as the nomisma, remained an exceptionally reliable currency and continued serving as one of the Mediterranean’s premier gold coins.

The Arabs created their own money because they wanted monetary independence from Constantinople, not because Byzantine gold had already become worthless.

Hello Finance Enthusiasts

I have heard of motoring or horse racing enthusiasts. But “finance enthusiasts”? The heading above is the opening line of the following must watch video on Byzantine.

I Am Not Alone

You will not be surprised to find that it describes how the money system was central to it serving so long. But it is the last few lines that are key. They are points I have been making throughout my entire Treatise:

1) A stable of strong currency is the foundation of any stable economy

2) Fair taxation preserves both revenue and social balance

3) Balanced Trade Policies are the key to independence and resilience

The Lessons For Today Are Compelling

Note the third one. It is exactly what is going on now with the U.S. trying to do something about their persistent trade deficits.

As I keep saying, no and I mean no, civilisation goes on for that long with a persistent trade deficit without doing sonneting about it. Normally it doesn’t end well with wars and disruption and money debasement. The end can be complete collapse.

Economics fails us in its analysis of this at the nation-state level. Anyway, for anyone interested in economics, the real surprise is not that the Byzantines survived for another thousand years.

It is that economists and historians have paid so little attention to how they managed it.

Of Course, Water Eventually Flowed Downhill

The first sustained debasement of the Byzantine gold currency did not begin until the eleventh century, particularly under Constantine IX Monomachos (AD 1042–1055), and accelerated under his successors.

That was more than three centuries after Abd al Malik introduced the dinar. Contemporary observers such as Michael Psellos (AD 1017–c. 1078) witnessed the consequences, but by then we have moved far beyond the period covered in this essay.

Ironically, Byzantium’s greatest monetary achievement may also help explain why Christian monetary theory developed so slowly. Because the system generally worked, there was comparatively little pressure to investigate the mechanics of inflation itself.

When prices rose, the obvious explanations appeared to be war, plague, taxation or harvest failure. Few writers felt compelled to ask whether the quantity of money, its circulation or the quality of the coinage might themselves be driving changes in the general price level.

An Interesting Aside: The Divine Right of Kings Issue, They Took It Very Seriously

To modern readers, one of the strangest episodes of Byzantine history is the Iconoclast Controversy. Between AD 726 and 843, the Empire came close to tearing itself apart over the use of religious images. At first glance the dispute seems almost incomprehensible. Why would an empire spend more than a century fighting over paintings and mosaics?

I mean, it makes the Wars of the Reformation look almost sensible. As an aside to this aside, Murray Rothbard has a fascinating interpretation of those wars. It is well worth looking up.

The icons themselves, however, were only the surface issue. The real question was authority. Did the Emperor possess the right to determine religious practice, or did that authority ultimately belong to the Church?

Byzantine emperors regarded themselves as God’s representatives on earth, responsible not only for defending the Empire but also for protecting the purity of the Christian faith. When Emperor Leo III (c. AD 685–741) ordered the removal of icons, many Christians saw the decision not simply as bad theology but as an emperor overstepping his rightful authority.

Politics Made the Dispute Even More Explosive

The Byzantine Empire had just lost Syria, Palestine and Egypt to the rapidly expanding Islamic Caliphate, where religious images played little role in worship. Some historians believe these military disasters convinced Leo that God was punishing the Empire for venerating icons.

Others argue that he was also attempting to weaken the great monasteries, many of which were wealthy, influential and among the strongest defenders of icon veneration.

How Iconic

The ‘Debate’ Lasted More Than a Century. The Violence Lasted Almost As Long.

Whatever his motives, the controversy quickly became a struggle over far more than theology. It was about imperial power, Church authority and, ultimately, who ruled Christian society. The crisis lasted for more than a century before the restoration of icons in AD 843, remembered in the Eastern Church as the “Triumph of Orthodoxy.”

Did Jesus Take a Selfie At the Moment Of His Resurrection?

I cannot resist one final historical curiosity.

I often wonder what the participants in the hundred-year Iconoclast Controversy would make of the renewed scientific debate surrounding the authenticity of the Shroud of Turin.

There is now an enormous amount of more recent scientific analysis available (using the latest technology) for anyone wishing to investigate the evidence, and I will leave readers to draw their own conclusions.

But if the Shroud really is authentic, then history has a wonderful sense of irony. The opponents of icons may have spent more than a century trying to eliminate religious images, only to discover that Christ Himself left behind one of the most remarkable images in history.

Meanwhile Over In the Wild West

The seventh century transformed the Christian world. Arab armies swept across Syria, Palestine, Egypt and North Africa, permanently reshaping Mediterranean commerce and leaving the Byzantine Empire smaller but still economically formidable, its gold solidus remaining the region’s premier trading currency. Christianity now faced a new commercial and political rival in Islam.

Meanwhile, in Western Europe, another transformation was beginning.

Charlemagne (AD 742–814) sought not merely to preserve the Roman inheritance but to rebuild it. Crowned Emperor by Pope Leo III on Christmas Day AD 800, he restored political order across much of Western Europe, introduced a standard silver currency, promoted consistent weights and measures, strengthened administration and encouraged the revival of learning now known as the Carolingian Renaissance.

Commerce slowly revived, markets expanded and merchants once again travelled greater distances.

Still Many Unanswered Questions

That success reopened questions the early Church had never been forced to answer. The Council of Nicaea had restricted usury by clergy. Pope Leo I extended the prohibition more broadly, while Charlemagne incorporated it into secular law and the Synod of Aachen (AD 789) declared the ban applied to laypeople as well.

Yet as trade, partnerships and commercial investment expanded, Europe increasingly confronted a question that neither Scripture nor the early Fathers had fully resolved: when capital is employed productively and genuine commercial risk is taken, is every return on that capital really usury?

The medieval Church would spend the next several centuries trying to answer that question. It would produce one of the most remarkable bodies of economic thought in history.

Audio

Cutting to the Chase

1. Christianity inherited a difficult question from the ancient world. Could commerce, wealth and profit be reconciled with a life devoted to God?

2. For four centuries the early Church wrestled with that question. Jesus, St. Paul and the Church Fathers gradually built one of history’s richest traditions of commercial ethics.

3. They did not reject commerce. They rejected greed, fraud, exploitation and the abuse of financial power.

4. Along the way Christianity made another, largely forgotten contribution. It transformed the way people thought about economic value itself. That transformation reached its peak with St. Augustine. His insights would eventually change the history of economics.

5. Why is water cheaper than diamonds? Adam Smith made the paradox famous, but Augustine had already pointed towards its solution almost 1,400 years earlier.

6. Augustine argued that value depends upon “the utility each man finds in a thing.” Value exists in the mind of the individual, not in the object itself.

7. That simple insight makes Augustine far more than one of Christianity’s greatest theologians. It arguably makes him the philosophical father of economics.

8. Long before Adam Smith and Carl Menger, Christianity had already laid the intellectual foundations for subjective value. The Austrian School would later develop those ideas into a complete economic theory.

9. This essay tells that forgotten story. It argues that Christian theology helped lay the foundations of modern Austrian economics while simultaneously demolishing many of the core assumptions of modern classical and neoclassical economics.

10. Folks, don't send your kids to University to study economics. It's Un-Christian.

Adam Smith Didn’t Know But St. Augustine Did

I have already shown that by around AD 900 Chinese scholars had already developed an extraordinarily sophisticated understanding of money, debating inflation, deflation, debasement, hoarding, counterfeiting and the role of the state in managing the currency.

Christianity followed a very different path. Rather than asking how money should function, its leading thinkers asked whether wealth was being used justly. Was the merchant honest? Was the lender exploiting the vulnerable? Did rulers respect property and justice, or abuse their power?

The result was one of history’s richest traditions of commercial ethics, but comparatively little analysis of money itself.

This Lot Are Connected? This Will Be Good.

This essay traces an intellectual journey from Jesus through St. Paul, the Council of Nicaea and the early Church before culminating in Augustine’s extraordinary insight into value. From there the trail leads directly to Adam Smith’s famous puzzle, the Austrian School and one of the greatest debates in modern economics.

He inadvertently answered the Water/Diamond paradox that so eluded Adam Smith. In doing so he anticipated the central insight of Austrian economics. In the fifth century!

Just extraordinary but hardly anyone knows this.

How Christianity Tried To Justify Economic Life

Earlier in this series I argued that Jesus did not walk into an ordinary place of worship. He walked into one of the largest financial institutions in the Roman world.

The Temple functioned as a treasury where wealth accumulated, foreign currencies were exchanged and enormous trust had been placed in those responsible for administering those resources. His decision to overturn the tables of the money changers was therefore far more than an attack upon greedy merchants.

It was a direct challenge to the moral responsibilities accompanying financial power. Readers wanting the full argument can read Is the Pope a Catholic?

Yet once we leave the Temple courts, something remarkable becomes apparent.

Jesus Left Behind No Economic Treatise

Jesus never wrote an economic treatise. He left no systematic discussion of banking, merchants, prices or private property. Instead, he left behind a movement that within a few decades had spread across the greatest commercial empire the world had yet known.

Christian merchants traded in Roman markets beside pagans. Christian landowners collected rents and Christian sailors crossed the Mediterranean carrying valuable cargoes.

Jesus’ parables assumed this economic world was familiar to everyone listening. They featured vineyard owners hiring labourers, stewards managing estates, creditors settling accounts, merchants searching for pearls and servants entrusted with capital. Commerce was not treated as something alien to everyday life. It formed part of the ordinary fabric of society.

That immediately created a tension Christians would debate for centuries.

So, Which Is it

The Parable of the Talents presented one picture and would later cause Christian thinkers’ particular trouble because its commercial imagery was so direct.

The master condemned the servant who buried the money: “You should have put my money on deposit with the bankers, so that when I returned I would have received it back with interest” (Matthew 25:27).

That immediately raises a question familiar to readers of last week’s essay. For centuries Chinese scholars also debated whether hoarding money damaged the wider economy, condemning those who withdrew currency from circulation.

But Then There Is This…

Yet Luke’s Gospel appeared to point in a very different direction. Jesus instructed His followers: “Lend, hoping for nothing thereby; and your reward shall be great” (Luke 6:35).

The first passage employed banking and commercial gain as an illustration of faithful stewardship. The second warned against turning another person’s hardship into an opportunity for personal enrichment.

Neither passage condemned productive economic activity itself, but together they posed a difficult question. How could Christians distinguish legitimate commerce from exploitation?

The answer was not immediately obvious, and the Church would spend centuries attempting to reconcile those two passages.

Unlike Much Of Today’s Catholic Debate, Faith and Commerce Coexisted

You might think the headline is a little harsh. Have a close look at some of the economic nonsense coming out of sections of the Church today, all while leaving the Vatican Bank firmly in place (again, see Is the Pope a Catholic?).

If they refuse to go back and revisit their own history, I will do it for them.

On the Road Again

No one encountered that problem of justifying commerce sooner than Paul of Tarsus (c. AD 5–c. AD 64 or 67).

When Paul arrived in Corinth around AD 50, he entered one of the busiest commercial cities in the Roman Empire. Ships arriving from east and west unloaded cargoes from Egypt, Syria, Italy and Spain. Merchants crowded the markets and bought and sold goods arriving from every corner of the Mediterranean.

Money circulated constantly, fortunes were made and lost, and immense wealth existed beside desperate poverty. If Christianity was ever going to discover whether faith and commerce could coexist, Corinth was the ideal testing ground.

Leading From the Front

Paul’s own conduct established an important precedent. Rather than demanding financial support from the new congregation, he worked alongside Aquila and Priscilla as a tentmaker. Later he reminded the Ephesian elders:

“You yourselves know that these hands have ministered to my necessities, and to those who were with me” (Acts 20:34).

The ‘Protestant Work Ethic’ Isn’t Protestant. It’s Christian.

He immediately added:

“By working hard in this way we must help the weak and remember the words of the Lord Jesus, how he himself said, ‘It is more blessed to give than to receive’” (Acts 20:35).

Paul therefore treated honest labour not simply as a way of earning a living, but as the means by which Christians maintained their independence while acquiring the ability to help others. Work itself carried moral significance.

Would St. Paul Get Elected Today With These Comments?

That became even clearer when some believers abandoned ordinary employment because they expected Christ’s return within their own lifetime. Paul responded with striking bluntness:

“If anyone is not willing to work, neither should he eat” (2 Thessalonians 3:10).

He followed this with the instruction that they should:

“work quietly and earn their own living” (2 Thessalonians 3:12).

Honest labour was therefore not an unfortunate necessity forced upon fallen humanity. It formed part of responsible Christian living. Individuals were expected to support themselves where possible rather than unnecessarily burdening their neighbours.

Missing Words That Change Everything

Paul’s most famous teaching on wealth has suffered from centuries of careless quotation. He did not write that money itself was evil. Instead, he warned:

“The love of money is a root of all kinds of evil” (1 Timothy 6:10).

Only a few verses earlier he had explained why:

“Godliness with contentment is great gain, for we brought nothing into the world, and we cannot take anything out of the world” (1 Timothy 6:6–7).

The Distinction Is Fundamental

Money itself was not the enemy. The danger arose when accumulation became life’s ultimate purpose.

Paul therefore did not command every wealthy Christian to abandon property. Instead, he instructed Timothy:

“Charge the rich in this present age not to be haughty, nor to set their hopes on the uncertainty of riches, but on God.”

They were:

“to do good, to be rich in good works, to be generous and ready to share” (1 Timothy 6:17–18).

He Should Present To a Hedge Fund Convention. Now I’d Like To See That.

The emphasis consistently fell upon stewardship rather than possession. Wealth could finance commerce, support families, care for widows, feed the hungry or become an idol around which an entire life revolved.

Christianity’s earliest writers therefore focused less upon ownership itself than upon the purposes for which wealth was ultimately employed.

Risk and Reward: It’s Not Easy

That distinction proved easier to state than to apply.

The Roman economy contained merchants accepting enormous risks on dangerous voyages, contractors supplying armies, wealthy landowners leasing farms and money lenders financing commercial ventures. It also contained families borrowing because harvests had failed, taxes were due or food had run out.

Outwardly, the transactions could look similar. Morally, they were very different. One loan might finance production and involve genuine risk; another might allow a creditor to seize the land of a desperate farmer.

Christianity therefore faced a problem that would occupy its thinkers for centuries. The outward form of two transactions could appear identical while their moral character was completely different.

The central question became how to distinguish productive commerce from exploitation.

They Thought the End Of the World Was Nigh. Sound Familiar, Just Different Religion?

The earliest Christian communities did not initially develop a comprehensive economic philosophy because many believed history itself was drawing to a close.

The Book of Acts describes believers selling possessions and distributing the proceeds according to need:

“There was not a needy person among them” (Acts 4:34).

This was not yet a programme for governing an empire or a blueprint for running a civilisation. It reflected the solidarity of a relatively small community expecting Christ’s return within its own generation.

History Refused To Co-operate

History, however, had other plans.

Christ did not return during the lifetime of the Apostles. One generation became two, then three. Congregations gradually became permanent institutions. They acquired meeting places, received gifts, cared for widows and orphans, supported clergy and collected charitable funds.

You’re Now In Charge.

Time For Consequential Decisions. It Is Not So Simple.

Almost without noticing it, the Church itself became an economic institution.

It now faced precisely the same challenge Jesus had confronted in the Temple. Once again, people were placing both money and trust into the hands of religious leaders.

That institutional transformation fundamentally altered the economic questions Christianity had to answer. It was one thing to encourage generosity within a small community expecting the imminent end of the world.

It was quite another to administer land, buildings, charitable funds and property across an empire that continued year after year. Christian ethics now had to confront not only individual behaviour but also institutional responsibility.

Talk Is Cheap. We Need Action.

Clement of Rome (fl. c. AD 96) solution was neither forced equality nor the abolition of private property. Instead, he emphasised reciprocal obligation within the Christian community. He wrote:

“Let the strong not despise the weak and let the weak show respect unto the strong. Let the rich man provide for the wants of the poor; and let the poor man bless God, because He has given him one by whom his need may be supplied.”

He immediately added:

“Let the wise man display his wisdom, not by mere words, but through good deeds” (First Clement, 38).

This passage captures one of the defining characteristics of early Christian economic thought. Clement did not deny that some Christians were rich and others poor, nor did he demand that every difference be eliminated by institutional command.

Instead, he insisted that position created responsibility.

A Moral Law For Everyone

Roman society sharply distinguished between citizens and non-citizens, insiders and outsiders.

Christianity did not.

Moral responsibility extended wherever genuine human need existed. Long before the emergence of the modern welfare state, the Church had begun constructing one of history’s largest voluntary charitable networks.

The Source Of the Church’s Wealth

It Was To Help the Poor; They Were the Welfare State.

Christianity continued spreading through the commercial cities of the Empire during the second and third centuries. Congregations appeared in Antioch, Alexandria, Ephesus, Carthage and Rome, travelling along many of the same roads and sea lanes used by merchants.

Wealthy converts donated houses and estates, poorer Christians contributed what they could, and repeated waves of persecution periodically stripped the Church of its property. New donations rebuilt what had been lost.

By the beginning of the fourth century, Christianity possessed buildings, charitable funds and a recognisable administrative structure across much of the Empire despite never having enjoyed secure legal standing.

Wow. The State Gave the Church Its Property Back.

Everything changed in AD 312.

Constantine I (c. AD 272–337) defeated Maxentius at the Battle of the Milvian Bridge, and the following year Constantine and Licinius issued the agreement traditionally known as the Edict of Milan. Christians received legal toleration, and confiscated Church property was restored.

The implications reached far beyond religious freedom. The Church that had spent generations protecting its assets from imperial officials now found the state returning land, financing churches and granting privileges to the clergy.

Bishops who had stood outside political power increasingly found themselves advising the very rulers who exercised it. Christianity had moved from persecution to influence with astonishing speed.

Now Things Get Interesting

The Church’s new position immediately produced practical questions that scarcely existed while it remained poor and persecuted. Could bishops lend money to members of their own congregations? Could priests use spiritual authority for financial advantage? Could someone entrusted with caring for the vulnerable simultaneously become their creditor?

The New Testament repeatedly condemned greed, exploitation and avarice. It had not, however, provided a detailed financial code for a wealthy institution that now owned estates throughout an empire.

Those questions therefore had to be answered by the Church itself.

A Committee Made the Decision

Those issues reached the Council of Nicaea in AD 325.

The Council is remembered primarily for confronting Arius (c. AD 256–336) and defining orthodox teaching concerning the nature of Christ. Yet alongside those theological debates sat a practical question concerning money.

The Usury Issue: It’s Complex

Canon 17 declared:

“Forasmuch as many enrolled among the Clergy, following covetousness and lust of gain, have forgotten the divine Scripture, which says, ‘He has not given his money upon usury,’ and in lending money ask the hundredth of the sum, the holy and great Synod thinks it just that if after this decree any one be found to receive usury, whether he accomplish it by secret transaction or otherwise … he shall be deposed from the clergy and his name stricken from the list.”

The language is striking. I deal with Usury in the essay below. It is complex everyone.

The bishops condemned not merely interest but “covetousness and lust of gain” and warned against disguising exploitation through concealed arrangements. Their concern extended beyond the stated rate to the temptation for spiritual authority to become a source of personal profit.

But It Appears the Merchants Were Supposed To Be Exempt

Importantly, the canon applied to clergy rather than every commercial transaction undertaken by Christians.

A merchant financing a voyage entered an ordinary business arrangement involving risk and reward. A priest lending money to someone seeking pastoral assistance occupied an entirely different position.

The possibility for coercion, even if subtle, was obvious. Nicaea therefore recognised an institutional conflict of interest long before that expression entered the modern vocabulary.

The decision also illustrates the continuing pattern running through early Christian economic thought. The Church showed enormous concern for justice in exchange, the abuse of power and the ethical responsibilities accompanying wealth. Yet it still devoted comparatively little attention to developing a broader theory of money itself.

That task would largely await the medieval period.

The Merging Of Church and State

The next generation of bishops inherited Church rich enough to be tested by its own success. Basil of Caesarea (c. AD 330–379), Gregory of Nazianzus (c. AD 329–390), John Chrysostom (c. AD 347–407) and Ambrose of Milan (c. AD 339–397) preached to congregations containing merchants, landowners and imperial officials.

Churches received estates, bishops administered large charitable funds and Christianity had become closely entwined with Roman political power. The question was no longer whether a persecuted Christian could survive honestly, but how a Christian should behave while possessing land, grain, money and authority.

A Crisis Crystallises the Issue

Basil confronted the question during the famine that struck Cappadocia in AD 368 and 369. Failed harvests sent grain prices higher while some owners withheld stocks in anticipation of still better prices.

Basil addressed them directly:

“But whom do I treat unjustly, you say, by keeping my own? Tell me, what is your own? What did you bring into this life?”

He compared the wealthy owner to someone taking the best seat in a theatre and then claiming the whole performance simply because he arrived first.

Humanity Still Struggles With All This

His best-known attack was aimed at accumulation while others lacked necessities:

“The bread which you keep belongs to the hungry; the cloak in your chest belongs to the naked; the shoes mouldering in your possession belong to the barefoot; the money which you hide away belongs to the poor.”

The force of the argument came from the emergency before him. Basil was not writing a general theory that every stored loaf was theft. He was addressing grain withheld during famine while neighbours starved.

This Is All Happening Today Writ Large. Blame the Money System.

Basil also attacked the endless logic of accumulation. In his homily on the rich fool who proposed pulling down his barns to build larger ones, he asked:

“What am I to do? The answer was close at hand: I will fill the bellies of the hungry; I will open my barns and call in all the needy.”

Instead, the rich man’s only plan was to preserve still more for himself. Wealth had ceased to be a means of meeting human needs and had become an end in itself.

Gregory of Nazianzus returned to the same subject in his Oration on the Love of the Poor. He warned:

“The poor and the rich have met one another, and the Lord made them both.”

He added:

“Let us not labour to heap up and hoard riches while others remain in need.”

Gregory’s target was not exchange between individuals but the belief that prosperity proved superiority.

Chrysostom Confronts Hypocrisy

John Chrysostom (c. AD 347–407) carried the argument into Antioch and later Constantinople, where the contrast between wealth and poverty was impossible to ignore.

He asked:

“Do you wish to honour the body of Christ? Do not ignore him when he is naked. Do not pay him homage in the temple clad in silk, only then to neglect him outside where he is cold and ill clad.”

He reduced his argument to a sentence he urged Christians never to forget:

“Not to share our own wealth with the poor is theft from the poor and deprivation of their means of life; we do not possess our own wealth but theirs.”

He Was Not Condemning Material Things

Like Basil, Chrysostom was speaking about superabundance beside unmet need. His sermons treated almsgiving not as optional generosity but as one of the purposes for which wealth had been entrusted.

Yet he did not condemn material things in themselves. He praised labour, generosity and careful stewardship while attacking avarice and conspicuous luxury. The question was not whether a Christian possessed money but whether money possessed the Christian.

That distinction would later be expressed with remarkable clarity by Maximus the Confessor (c. AD 580–662):

“It is not food that is evil but gluttony, not material things but avarice, not esteem but self-esteem. It is only the misuse of things that is evil, not the things themselves.”

Ambrose Confronts the State

Ambrose of Milan (c. AD 339–397) brought the argument into the imperial court. In his treatment of Ahab and Naboth he defended a small landowner against a king who wanted his vineyard.

He began: “There was a king in Israel named Ahab and a poor man named Naboth. The former abounded in the wealth of a kingdom while the latter possessed a tiny plot of land.”

The king’s greater wealth did not create a greater claim. Ambrose then challenged the rich directly: “How far, O rich, do you extend your mad greed? Shall you alone dwell upon the earth?”

He continued: “The earth was established in common for all, rich and poor. Why do you alone, O rich, demand special treatment?”

The story only works because Naboth genuinely owned the vineyard. Ambrose was not denying private property. He was insisting that ownership carried moral obligations and that political power could not simply absorb the property of weaker owners.

The Divine Right Of Kings Debate Begins

His confrontation with Theodosius I (AD 347–395) after the massacre at Thessalonica in AD 390 carried the same principle into politics.

Ambrose wrote: “You are a man, and temptation has come upon you; conquer it. Sin is not removed except by tears and penance.”

The constitutional principle later associated with him captured the revolution: “The emperor is within the Church, not above the Church.”

For economic thought this was revolutionary. If the emperor remained subject to a higher moral law, then taxation, confiscation, debasement and regulation could all be judged morally rather than accepted simply because the state commanded them.

Government itself was not above the standards it imposed upon everyone else.

St. Augustine: The Philosopher’s Philosopher. Or Aquinas?

What truly guides human understanding—faith that transcends logic, or reason that demands evidence? In this intense philosophical clash, *Augustine* represents the power of inner belief, divine trust, and the idea that truth begins beyond human reasoning. On the other side, *Aquinas* builds a structured bridge between faith and logic, arguing that reason itself can lead us toward understanding God. This isn’t just a historical debate—it’s a mirror of your own inner conflict. Every decision you make quietly sits between belief and logic, intuition and proof. The question is not who is right… but which voice dominates your life. Faith or reason—what defines you?

If Basil, Gregory of Nyssa, John Chrysostom and Ambrose established Christianity’s moral framework for wealth, charity and commerce, Augustine of Hippo (AD 354–430) took Christian thought in a profoundly different direction.

Augustine is usually remembered as one of Christianity’s greatest theologians and one of history’s greatest philosophers. He and Aquinas compete for the Christian philosopher G.O.A.T.

That is the Augustine most people know.

Or the Economist’s Economist?

If you would like a little background on the man himself, these two short videos provide an excellent introduction. Fascinating though it is, I’m skiing off piste. Let’s get back to the reason we’re here.

Almost nobody knows the Augustine who made one of the most profound observations ever written about economic value.

Journey through the life and legacy of St. Augustine, the brilliant philosopher and theologian whose ideas reshaped Western civilization. From his early struggles with desire and meaning to his profound conversion and towering works like Confessions and The City of God, Augustine's insights on grace, free will, time, memory, and the self laid the foundation for modern notions of identity and individualism. Discover how his thought influenced Christianity, existentialism, political theory, and psychology across centuries.

Was Augustine the Real Father of Economics

But it is very difficult to find economists discussing him at all.

Rather than simply asking whether wealth was used justly, Augustine asked far deeper questions. Why do human beings value one thing more than another? What makes a society truly just? How does God’s objective order relate to the countless choices individuals make every day?

In searching for answers, he produced insights that would not become central to economic theory for another fourteen centuries. Remarkably, he did so while writing theology rather than economics.

The City of God

Augustine lived through one of the greatest crises in Roman history. Born in North Africa in AD 354, he watched the Western Roman Empire weaken under political instability, economic decline and repeated barbarian invasions. Then, in AD 410, Alaric (c. AD 370–410) and the Visigoths entered and sacked Rome.

For almost eight centuries Rome had appeared invincible. Its fall shook the ancient world and many concluded that Christianity itself was responsible.

Augustine’s answer was The City of God.

This Is Very Libertarian: When the Government IS the Bandit

Instead of defending Rome, he challenged the very assumptions upon which Roman power had been built. Military success, political authority and imperial splendour, he argued, proved nothing about the justice of a nation. A kingdom could conquer the world and still be fundamentally corrupt if it abandoned moral law.

His most famous judgement remains one of history’s greatest condemnations of arbitrary state power:

“Justice being taken away, then, what are kingdoms but great robberies?” (The City of God, Book IV, Chapter 4)

To make the point unforgettable, Augustine recounts Alexander the Great’s encounter with a captured pirate. Asked what gave him the right to terrorise the seas, the pirate replied:

“Because I do it with a petty ship, I am called a robber, while you who do it with a great fleet are styled emperor.” (The City of God, Book IV, Chapter 4)

The Point Is Devastating

Scale does not change morality. Theft committed by an empire is no less theft than theft committed by a single criminal. Governments therefore stand beneath justice, not above it.

Their economic actions, whether taxation, confiscation of property or interference with commerce, remain subject to the same moral law that governs every individual.

Trust: Christianity’s Great Commercial Advantage

Having placed rulers beneath moral law, Augustine turned to another misconception: that Christianity condemned commerce itself. Like the earlier Church Fathers, he attacked greed, dishonesty and exploitation, but he refused to confuse those vices with trade.

Speaking of merchants, he observed:

“The greedy tradesman blasphemes over his losses; he lies and perjures himself over the price of his wares. But these are vices of the man, not of the craft, which can be exercised without these vices.” (Sermon 178)

This Was An Important Distinction

Commerce itself is morally neutral. The evil lies not in buying and selling but in the character of the buyer or seller. Trade, like politics or farming, can be practised honestly or corruptly.

Augustine reinforced the point with another commercial illustration:

“For you commend the merchant who sells lead and gets gold, and will you not commend the merchant who lays out money and gets righteousness?”

The comparison works only because Augustine assumed profitable exchange was perfectly rational. Everyone understood why a merchant would exchange lead for gold. Augustine simply redirected that familiar reasoning towards spiritual ends.

Yet hidden within the example is a deeper economic insight. Read on.

Augustine Discovers Subjective Value

It was while explaining God’s created order, rather than commerce itself, that Augustine made his greatest contribution to economic thought. In The City of God, he distinguished between two completely different ways of judging the same object:

“Of the Ranks and Differences of the Creatures, Estimated by Their Utility, or According to the Natural Gradations of Being.” (The City of God, Book XI, Chapter 16)

Those final words, “or according to,” are crucial. Augustine recognised two separate standards of judgement. One ranks things according to God’s created order. Human beings stand above animals, animals above plants and plants above inanimate objects.

The Other Asks An Entirely Different Question

How useful is this thing to the individual?

The first is objective. The second depends upon the circumstances of the person making the judgement.

He then summarised the principle in one remarkable sentence: “According to the utility each man finds in a thing, there are various standards of value.” (The City of God, Book XI, Chapter 16)

That Is An Astonishing Observation For the Fifth Century

Augustine is not saying that reality itself is subjective.

Bread still nourishes, gold remains durable and a horse still possesses the same physical characteristics regardless of who owns it. Rather, he is saying that value depends upon “the utility each man finds” in those objective characteristics. Different individuals therefore place different values upon the same good because they seek different ends.

He illustrates the principle with a series of memorable examples: “Who would not rather have bread in his house than mice, gold than fleas?” (The City of God, Book XI, Chapter 16)

According to the natural order, mice and fleas are living creatures while bread and gold are inanimate objects. Yet everyone would choose bread over mice and gold over fleas because usefulness, not metaphysical rank, governs practical decisions.

Market Versus Moral Value

He immediately follows with an even more striking comparison:

“More is often given for a horse than for a slave, for a jewel than for a maid.” (The City of God, Book XI, Chapter 16)

Augustine is not suggesting that horses possess greater dignity than human beings. His point is that market value and moral value are not the same thing. A horse may command a higher price because it better serves the buyer’s immediate purposes.

A rare jewel may be worth more in exchange than a servant. Prices therefore reflect the usefulness individuals attach to goods, not their place in God’s created order.

The Famous Water-Diamonds Paradox

Adam Smith identified one of the greatest problems in economics, but he could not answer it. If the founder of classical economics could not explain the most fundamental question in value theory, then classical economics was built on an incomplete foundation until Menger.

Why is water, essential for life, usually worth so little, while diamonds, which are largely ornamental, command enormous prices?

This became known as the water-diamond paradox. Smith recognised the contradiction, but his labour theory of value could not resolve it. Without an explanation, the very foundation of classical economics remained incomplete.

If economics cannot explain why one good commands a higher price than another, it has not yet explained value itself.

It Now Seems Obvious, But It Was Unresolved For a Long Time

The paradox remained unanswered until Carl Menger’s Principles of Economics appeared in 1871. Menger showed that goods are not valued in the abstract. They are valued according to the importance of the next available unit to the individual making the choice. That insight transformed economics.

Astonishingly, Augustine had come remarkably close nearly fifteen centuries earlier. Explaining God’s created order rather than commerce itself, he wrote:

“The reason of one contemplating nature prompts very different judgments from those dictated by the necessity of the needy.” (The City of God, Book XI, Chapter 16)

Needs Change Value

Bread means something different to a starving man than to someone who has just eaten. Water is valued differently in the desert than beside a river. The object has not changed; the circumstances of the individual have.

Augustine had therefore recognised one of the central insights of economics: value does not reside in the object itself but in the relationship between the object and the needs of the person evaluating it.

This Is One of History’s Great Coincidences

Remarkably, Augustine’s discussion was translated into English using the word ‘utility’ in Marcus Dods’ influential 1871 translation, the very same year that Jevons and Menger launched the Marginal Revolution.

Augustine never developed a complete theory of markets, prices or marginal utility. Nevertheless, he had crossed an intellectual frontier. More than fourteen centuries before Carl Menger, he recognised that economic value does not simply reside within objects themselves.

Humans Act To Achieve Desired Ends

It depends upon the utility that each individual finds in them.

From there it was only one further step to ask an even deeper question. If people value goods because they help achieve desired ends, what are those ends, and how do human beings choose the means to achieve them?

Augustine turned to that question in On Christian Doctrine.

This Sounds So Much Like Mises In ‘Human Action’

Having explained why people value the same goods differently, Augustine asked a deeper question. “What is it that people are trying to achieve when they value anything at all?” His answer came in On Christian Doctrine, where he distinguished between ends and means.

He begins with a simple distinction: “There are some things…which are to be enjoyed, others which are to be used.” (On Christian Doctrine, Book I, Chapter 3)

He then defines both terms: “To enjoy a thing is to rest with satisfaction in it for its own sake.”

“To use…is to employ whatever means are at one’s disposal to obtain what one desires.” (On Christian Doctrine, Book I, Chapter 4)

These few lines contain one of the earliest descriptions of purposive Human Action.

Take Me Home Roman Roads

People first decide what they want and then select the means they believe will achieve it. Food satisfies hunger, ships carry travellers, houses provide shelter and money purchases other goods.

Their value lies not in themselves but in the ends they help accomplish.

Augustine illustrates the point by comparing life to a traveller returning home. Roads and ships are valuable because they bring the traveller to his destination. No one mistakes the ship for home itself. Likewise, wealth, property and money are ordinarily means rather than final ends.

A Moral Dimension

Yet Augustine also recognised an important moral distinction. Means can be used rightly or wrongly. The fact that someone values an object explains his actions, but it does not prove those actions are morally good.

In this respect Augustine appears to differ from modern economics. He accepted subjective value while insisting that objective moral standards still governed how those values ought to be pursued.

He then asked what ultimate end every human being seeks. In The Morals of the Catholic Church, he answered: “We all certainly desire to live happily.”

He continues: “What do we call enjoyment but having at hand the objects of love?”

Finally, he summarises the sequence that lies behind all human action: “Love... yearning to have what is loved, is desire; and having and enjoying it, is joy.”

This Is going To Get a Bit Technical But Stay With Me

In a handful of sentences Augustine describes the progression from desire to action, to satisfaction. Human beings act because they seek to improve their condition. Although his purpose was theological rather than economic, the logic is unmistakable.

The comparison with the Austrian School is remarkable. Carl Menger would later explain that goods acquire value because individuals believe they can satisfy particular wants.

Ludwig von Mises would build economics upon the proposition that human beings act purposefully, selecting means in an attempt to move from a less satisfactory condition to a more satisfactory one.

Augustine developed neither a complete theory of prices nor a formal theory of marginal utility. Yet more than fourteen centuries earlier, he had already recognised the philosophical foundations upon which both would rest.

Goods derive value because they serve human purposes. Individuals desire particular ends, judge the available means and choose those they believe will best achieve what they seek.

He Demolishes Modern Neoclassical Microeconomics

Read closely, Augustine comes remarkably close not merely to subjective value but to the logic of marginal utility itself. Human action begins with dissatisfaction. The individual ranks possible ends, chooses between competing means and acts upon that preference.

The choice itself reveals that one available course was preferred to another.

That Creates a Fundamental Problem for Modern Neoclassical Microeconomics

Its central apparatus of indifference curves assumes that an individual can be indifferent between two different combinations of goods. Yet genuine indifference cannot generate purposeful choice. The moment the individual chooses one combination rather than another, the action demonstrates preference.

If the two alternatives were truly equal in the mind of the person acting, economics could not explain why either was selected.

Mathematics Destroyed Economics

Indifference curves therefore do not extend marginal utility theory. They contradict its essential logic. Marginal utility is ordinal: individuals rank alternatives.

Indifference curve analysis invents collections of alternatives supposedly ranked equally, then uses those imaginary equalities as the foundation of modern consumer theory.

Augustine begins where economics must begin not with a mathematical curve drawn by an outside observer, but with the acting individual who desires an end, evaluates the available means and chooses.

The Contradiction

Physics can be described mathematically because the same conditions produce the same physical response. Economics studies people who choose, and choice cannot be reduced to equations in the same way.

Once economics abandons the acting individual for mathematical curves, it ceases to explain human choice and begins describing an imaginary world instead.

Far from merely anticipating modern microeconomics, Augustine’s analysis exposes the contradiction at its heart.

I’m Thirsty

I need a marginal glass of water after writing this. It’s free!

Righto everyone. Pour yourself a glass of red, or whatever takes your fancy.

You are about to read the heart of my Treatise. Fifteen years in the making. I will not pretend it is the easiest or shortest essay I have written. So before we dive in, I have included another Cutting to the Chase for those who want the destination before the journey.

If you are still with me after that, put your thinking cap on.

We are about to travel from Ancient China to the inside of your own mind. Part I of the journey is history. Part II is pure thought. That’s where things get interesting.

You're probably thinking, "Maaate, this is a bit long. I might be drunk as a skunk by the time I finish."

To which my reply is: "You might need to be. We're about to challenge two thousand years of monetary thinking."

Folks, this isn't my usual weekly essay. It's the main article I'll be pointing people to for years whenever they ask how a free market monetary system would actually work.

Audio

Cutting To The Chase

1. Who should control money? Ancient Chinese thinkers believed the State should control the monetary system. Two thousand years later, modern economics still reaches essentially the same conclusion.

2. In fact most today believe it should be ruled by a few unelected people independent of elected and legitimate representatives. Even the Ancient Chinese didn’t go that far, at least their rulers had the Mandate of Heaven hanging over them.

3. The debate is no longer mainly about controlling the money supply but about controlling interest rates to influence inflation, the money supply and the wider economy.

4. But why should anyone control the money system at all? Why not allow the market to determine both the quantity of money and interest rates? Now that would be a totally different economic structure than the one that exists today.

5. In a genuine free market, the money supply in circulation is not fixed. It expands and contracts automatically as economic conditions and consumers’ demand for money change.

6. The market discovers the quantity of money society wants. No government, central bank or committee needs to estimate it. The market also discovers the whole spectrum of interest rates.

7. This essay argues that money possesses three self correcting mechanisms, only one of which exists for every other good. Money is therefore fundamentally different from every other good in the economy.

8. The first mechanism is simply the ordinary forces of supply and demand that apply to all goods. The other two are unique to money: a valuation effect operating through demand and a supply side cost effect operating through production.

9. Together, these three mechanisms give commodity money its own natural stopping mechanism. As more money is produced, the incentive to produce still more progressively disappears. Once producing additional money is no more profitable than producing any other good or service, labour, capital and natural resources automatically flow back into the wider economy.

10. Economic growth driven by a greater quantity of labour, capital and natural resources naturally requires more money. A free market monetary system automatically accommodates that demand. Growth driven by higher productivity, however, requires no additional money. Society simply enjoys lower prices and higher living standards.

11. Inflation targeting is a disguised form of money debasement. It is immoral because it prevents the benefits of higher productivity from flowing equally through lower prices. Those who receive the newly created money first benefit at the expense of those who receive it later, or not at all.

12. Money hoarding is not necessarily a market failure. It is another expression of consumer preferences that a free market automatically accommodates.

13. Neither the quantity of money nor interest rates should be policy variables. Like every other price and quantity in a free market, they should emerge from voluntary exchange, consumer preferences and profit rather than government decree.

Part 1: The Journey From Ancient China

Who Should Control Money?

For most Chinese thinkers the answer was simple: the State. For most modern economists the answer is central banks, assisted by commercial banks.

Same thing really.

Yet I keep banging on about abolishing Fractional Reserve Banking (FRB) and getting governments out of the money business altogether. I can almost hear the question.

“O.K. smarty pants. What replaces it?” Fair question.

What Is a ‘Good’ Money Structure?

For readers who want the background, in the essay below I have written about how money emerges naturally from barter and why, across almost every civilisation, copper became the money for small transactions, silver for medium-sized transactions and gold for large ones.

The essay also explains why those metals repeatedly emerged through market forces rather than government design.

More importantly, it leaves us with a much bigger question. Should governments control money at all, or should the market?

And What Exactly Do We Mean By “The Market”?

The easiest way to answer those questions is to remove one of the biggest complications in modern monetary debates: paper money and FRB.

Doing so does not in any way change the conclusions from this analysis. It just makes the underlying principals easier to see. We therefore need to return to a world where money itself was a commodity, there was no paper money and FRB was minimal.

Fortunately, no civilisation left richer records of monetary debates than China.

From roughly the beginning of the Han dynasty (206 BC) through to the late Tang dynasty (907 AD), Chinese officials, philosophers and historians produced what is probably the greatest continuous discussion of money in the ancient world.

The East Believed the Government Should Control It All

Perhaps no one summarises that tradition better than Richard von Glahn (1959 – still going). Reflecting on the Guanzi (compiled c. seventh to third centuries BC), he writes:

“In contrast to Western monetary thought, which derived from the moral question of determining a ‘just price’ in individual transactions, Chinese monetary theory, as exemplified by the Guanzi, was conceived as a set of methods whereby the ruler can ensure an equitable (though not equal) distribution of goods and wealth in society.”

That Distinction Is Profound

Where Western thought gradually became preoccupied with private property, voluntary exchange and the justice of individual transactions, Chinese monetary thought generally approached money as an instrument of statecraft.

The central question was not simply how markets worked, but how rulers could use markets to preserve political order, economic stability and ultimately their own legitimacy.

He Ain’t Heavy, He’s My Currency

The Guanzi itself contains one of the most remarkable passages in the history of economic thought:

“Now grain is heavy in our state, and light in the world at large. Then the other lords’ goods will spontaneously leak out like water from a spring flowing downhill. Hence if goods are heavy, they will come, if light they will go.

If the other lord’s grain is priced at ten, and if we price our grain at twenty, then their grain will flow to our state. If a fu of grain is selling for a hundred in Teng or Lu, then we make our price for a fu of grain a thousand, and the grain of Teng and Lu will flow through the four channels to us as though into a deep ravine.”

Here “heavy” and “light” refer not to physical weight but to relative prices. The authors understood that goods naturally flow towards higher prices just as water flows downhill.

In modern language, they were describing price arbitrage and recognising that prices direct the flow of trade, resources and wealth between competing states.

That Is An Astonishing Insight For Its Age

The remarkable point is not simply that the authors understood markets. They understood them extraordinarily well.

Their conclusion, however, was very different from that reached by later free-market economists.

Rather than allowing markets to operate freely, they believed the ruler should deliberately harness those market forces in pursuit of political objectives. That assumption, that money should ultimately remain an instrument of government, would dominate Chinese monetary thought for centuries.

But They Were Still Wary of State Power

Yet the Chinese tradition was never blind to the dangers that accompanied such power. After surveying centuries of monetary history, the great Chinese economic historian Peng Xinwei (1907 to 1967) reached a conclusion that still resonates today:

“Ever since the authority to make and issue money first fell into the hands of rulers, it has been an instrument for oppressing the people by the rulers.”

It is difficult to imagine a more succinct warning about monetary sovereignty. The same authority that promises order can also become an instrument of extraction. The same power that stabilises society can, when abused, undermine the very legitimacy it was meant to preserve.

The Crypto Debate Began 1,300 Years Ago

These tensions became especially vivid during the Tang dynasty. Faced with chronic shortages of coin, the great statesman Zhang Jiuling (673 to 740 AD) proposed relaxing the state’s monopoly on coinage.

It was a bold suggestion because it implied that the market might help solve a problem the government itself had failed to resolve.

His opponents, however, saw the issue very differently. To them, allowing private coinage was not merely an economic reform. It challenged the very relationship between sovereignty and money.

People Would Leave Productive Work

Among the most thoughtful critics was Liu Zhi (eighth century AD), whose objections reveal an extraordinary appreciation of the social consequences of monetary policy. His first concern was that profit would lure people away from productive labour:

“If it is profitable, then masses of people will leave the field... if masses leave the fields of the south, then the sod will not be broken, and as a consequence cold and hunger will approach.”

The Sweat Off the Poor Man’s Brow

His second concern was even broader. He feared that changing who created money would fundamentally change the structure of society itself:

“Some people’s wealth will be excessive, and thus it will not be possible to exhort them through the prospect of rewards. Some will be poor and hungry, and thus it will not be possible to awe them with prohibitions. As a consequence, the laws will not be observed, and human rationality will be disjointed by both wealth and poverty.

If assent is given to their casting of coins, then the poor will not be able to get by, and I fear that they will become still poorer, and be reduced to the status of servants in the households of the rich. The rich households will take advantage of this to become still more licentious.”

The Best Minds Follow the Money. Unfortunately.

Those same concerns have echoed throughout history, both in the East and the West. They form one of the major themes running through my Treatise. The creation of money distorts incentives. Those who receive the new money first benefit at the expense of those who receive it later.

In modern economies that often means fund managers, investment bankers and others employed in finance and the industries that surround it. Higher rewards in those sectors attract talented labour that might otherwise have been devoted to producing other goods and services.

Notice how similar that is to Liu Zhi’s concern about people abandoning productive work because money itself had become the source of profit.

I Can Personally Attest To Liu Zhi Concerns

That is very similar to what has happened over the past fifty years since the world abandoned the gold standard.

Throughout my career I repeatedly found myself hiring extraordinarily talented people, and more than once I caught myself wondering whether they should have been applying those talents somewhere more productive.

At the time I was still under the illusion that we lived in something approaching a free market. Most economists would simply argue that the higher wages, to put it mildly, in finance and related industries merely reflected the pricing mechanism directing resources towards their most productive use.

But that conclusion assumes the monetary system itself is not distorting the very price signals it is supposedly revealing. As we shall see, that assumption lies at the heart of the entire debate.

They Understood Monetary Theory Too

Liu Zhi (eighth century AD) then turned directly to monetary theory itself. His discussion would not sound entirely out of place in a modern economics seminar:

“Goods are cheap because coins are few. If few in number, they are heavily demanded. If they are heavily demanded, then increase the number minted and distribute them, causing them to be lightly demanded. If goods are expensive, it is owing to an abundance of coins.”

He continued:

“If abundant, they are lightly demanded. If they are lightly demanded, then work out methods for gathering them in, causing them to become heavily demanded. The prices of goods are linked to the numbers of coins. The number of coins depends on the officials’ constrictive or expansionary policies.”

Lecture Over. Tutorial Time.

Translated into modern language, Liu Zhi was saying that if there are fewer coins in the economy, goods become cheaper. Put another way, each individual coin buys more goods and services. Likewise, if there are too many coins, prices rise and each coin buys less.

Goldilocks Scenario

His proposed solution was equally clear. If there were too few coins, mint more. If there were too many, gather them back in. In other words, increase or decrease the money supply until you arrive at what we would today call the “Goldilocks” outcome.

It is at this point that I part company with Liu Zhi.

I greatly admire both his logic and his understanding of monetary theory. What I cannot accept is the assumption that anyone, whether an emperor, a treasury or a central bank, somehow possesses the knowledge to determine what the “just right” quantity of money should be.

One can easily imagine Liu Zhi being perfectly comfortable with the idea of a modern central bank attempting exactly that.

Did You Notice One Other Thing?

There is something else that is striking about Liu Zhi’s analysis.

Interest rates do not feature at all.

His entire discussion revolves around the quantity of money. Even if one accepts that governments should control the money system (which of course I don’t), modern economists still need to explain why interest rates have become the primary policy instrument rather than the money supply itself.

Hoarding: Take 1

Nor did Liu Zhi stop there. He immediately connected monetary policy with sovereignty, inequality and political power:

“If the officials lose control, the initiative will fall to the people. If the people do not get to cast coins but are constrained by edicts to pay them in taxes, this will cause the poor to lose their property and falsely assign their wealth to rich households.

If the rich store up commodities and usurp the sovereign right to circulate light or heavy coins, then below men will be placed in difficulties, and above they will usurp the means to profit. What we now suffer from is precisely this.”

This was not a hypothetical concern. Liu Zhi believed it was already happening. Wealthy households were hoarding commodities and had begun to “usurp the sovereign right to circulate light and heavy coins.”

The Real Source of the Problem

In other words, they were increasingly determining which coins circulated, whether coins with higher or lower metallic content dominated the market and, therefore, who gained and who lost from the monetary system.

Meanwhile, ordinary people still had to pay their taxes in the official currency and were often forced to surrender land and property to wealthy households in order to obtain it.

In Liu Zhi’s view this was not merely an economic problem. It represented one of the sovereign’s most fundamental powers passing into private hands.

An Example

Imagine there are two copper coins. One contains ten grams of copper. The other contains only five grams. Yet both are declared by law to have the same value.

If wealthy merchants can influence which coins circulate, they naturally keep the heavier coins with the greater intrinsic value and spend the lighter coins instead.

They also determine who receives the scarce full weight coins and who is left holding the debased ones. Ordinary people, meanwhile, still must pay their taxes in whatever currency the government demands.

Wealth and purchasing power gradually flow towards those who control the money itself.

Just Like Today’s Banks

That broader point is just as relevant today.

Ironically, the modern banking system has recreated almost the same debate, only under a different institutional arrangement.

Today commercial banks create the overwhelming majority of the money supply through fractional reserve banking whenever they extend credit. My essay below explains exactly how the process works.

Banks therefore exercise powers that Liu Zhi believed belonged exclusively to the sovereign. The mechanism has changed from minting bronze coins to creating bank deposits, but the underlying issue remains remarkably similar.

Whoever possesses the power to create money receives it first. Whoever receives it first allocates purchasing power. Whoever allocates purchasing power inevitably influences the distribution of wealth throughout society.

Liu Zhi regarded that as an argument for a state monopoly over money.

Right Concern, Wrong Conclusion

The Austrian School reached almost exactly the opposite conclusion.

If the power to create money inevitably redistributes wealth and invites abuse, perhaps neither governments nor commercial banks should possess that power.

That question is every bit as relevant today as it was in Tang China.

But What If the State Abuses the Power?

If Liu Zhi (eighth century AD) feared that private control over money concentrated wealth and power in the hands of wealthy households, Kong Yi (753 to 833 AD) approached the problem from the opposite direction.

He accepted that the State should control money.

His concern was what happened when the State itself abused that privilege. In his view, governments could hardly condemn counterfeiters while simultaneously debasing their own coinage. The two behaviours differed only in scale. One was official. The other was private.

When the Ruler Cheats First

In one of the most perceptive observations of the period, Kong Yi argued that counterfeiting was often the predictable consequence of government policy rather than simply the work of dishonest citizens:

“The reason why people engage in counterfeiting despite the stringent laws outlawing the practice is that the ruler, in coining money, cherishes copper and begrudges the expenditure of labor.”

It is a remarkably modern insight. If the government reduces the quality of its own money to save costs, why should anyone else respect the standard? Once the ruler begins cheating, the public simply follows his example.

Counterfeiting becomes not merely a criminal act but a symptom of a monetary system whose own integrity has already begun to collapse. I go through how the modern banking system is essentially a counterfeit operation in the essay below.

There only difference between today’s system and the Tang dynasty is that the counterfeiting operation undertaken by the banks is sanctioned by the government.

He Thought a Full Weight Coin Was the Solution

It was for that reason that Kong Yi looked back to the old Wuzhu coin as the benchmark of good money:

“This shows that the weight and quality of the Wuzhu coin was in proper proportion to the requirements of a medium of exchange, and thus the Wuzhu coin stands as a model deserving emulation.”

Du You Know Why Money Exists

The Tang period also produced one of the finest descriptions of why money exists in the first place.

Du You (735 to 812 AD), whose Comprehensive Statutes became one of the great reference works of Chinese statecraft, explained why different forms of wealth were inferior to good coinage:

“Gold and silver are worked into utensils and articles of adornment, which inhibits their circulation. Grain is too bulky, and silk too fragile to transport over considerable distances. Coin alone meets the needs of commerce.

It puts forth and flows freely like a fountain. Not only are grain and silk bulky and fragile, but they also cannot be easily divided into fractional units. Of all monetary instruments, the Wuzhu coin alone has served as the only practical currency throughout successive dynasties.”

Sadly, Du You Didn’t Connect the Dots

There is an elegance to that passage that transcends its age. Du You instinctively understood the characteristics that make good money good. It must circulate, be portable, divisible and hard to counterfeit. Above all, it must facilitate exchange rather than obstruct it.

His image of money flowing “like a fountain” remains one of the most beautiful descriptions of liquidity ever written.

The essay above Why Are Crpytocurrencie So Popular goes through the characteristics of good money in detail. Du You was spot on.

What he did not do, and in fairness almost nobody did until the Austrian School, was connect those characteristics with a coherent theory explaining how money itself emerges and how its supply and demand are regulated by the market.

Theory Meets Reality

Elegant monetary theory has an unfortunate habit of colliding with political reality.

The An Lushan Rebellion (755 to 763 AD) devastated the Tang economy and forced the government into extraordinary fiscal measures. The consequences were catastrophic. As Peng Xinwei records, “the price of rice” rose “to between 300 to 400 times the prewar prices.”

My essay below goes through the whole episode, but regular readers know the drill by now. The government debased the currency and the rest, as they say, is history.

Hoarding Take II

The question of hoarding occupied Chinese monetary thinkers constantly.

In their view, and I might add in the view of most economists throughout history, money was meant to circulate. A coin buried in a cellar performed no monetary function at all. Think of money hidden under the mattress as the modern equivalent.

The interesting side question is whether money sitting on deposit in a bank is really hoarding.

The Tang reforms unintentionally demonstrated the problem. The Double Tax Reform required taxes to be paid in cash, yet, as Peng Xinwei records, “the supply of coins advanced into the state treasuries to stay there and rich men hoarded coins. Naturally prices fell and peasants were forced to sell off even more agricultural products to pay the same money amount of tax.”

There Is a Cost To Adjustment

This highlights something that economic theory often glosses over. On paper the adjustment appears seamless.

In the real world someone bears the cost of that adjustment. In this case it was peasants who were forced to surrender increasing quantities of their produce simply to obtain the increasingly scarce coins needed to meet their tax obligations.

Money had not disappeared, it had simply stopped moving. The result was deflation, falling prices and a transfer of wealth towards those fortunate enough to possess the increasingly scarce coins.

Later Thinkers Made the Point Even More Explicitly

Zhang Fangping (1007 to 1091 AD) argued that money was meant to circulate continuously between the Treasury and the people. Government spending released money into the economy, taxation returned it and the process then began again.

But if taxes simply accumulated in the Treasury, “the normal flow of money would be impeded, which would give rise to money shortage.”

This was another remarkable insight.

Monetary shortages could arise not merely because too little money had been coined, but because governments themselves prevented existing money from circulating.

The Velocity Puzzle

Shen Kuo (1031 to 1095 AD) took the analysis even further.

He identified numerous causes of monetary shortage, including that “a large amount of metal money was hoarded because people did not have confidence in ‘salt notes’,” while separately observing that “hoarding money was a prevalent practice.”

His conclusion is extraordinary:

“Money benefits from circulation. If a city of ten households has a hundred thousand unit of money, which is accumulated in one household, its total value will remain unchanged in a hundred years. But if the same amount of money is circulated among ten households...its total value will be a million. If it is perpetually circulated, then its total value will be incalculable.”

Six Hundred Years Before Their Time

Six centuries before William Petty and long before modern economists began discussing the velocity of money, Chinese scholars had already recognised that the effectiveness of a monetary system depended not merely on the quantity of money but also on how rapidly it circulated.

In almost everyone’s view, money was not meant to sit idle in treasuries or private hoards. It was meant to move. That belief eventually became one of the intellectual foundations upon which Flying Cash and, ultimately, paper money would be built.

As we shall now see, however, there is another side to the story. The free market reaches a very different conclusion.

Part II: From Ancient China to Your Own Mind

It’s Time to See How a Free-Market Money Would Work

Let’s briefly recap the four qualities that make an intermediate good suitable as money.

1. Divisibility and consistency. Any portion is the same as any other and it can be divided into smaller parts or combined for larger transactions.

2. Durability. It holds its substance over time.

3. Transportability. It contains a high value in a small quantity, making it practical to move between markets.

4. Difficulty to counterfeit together with sufficient rarity so it cannot simply be produced at will and lose its value.

For the sake of argument, going forward I will use gold, although copper and silver satisfy the same principles for different sized transactions.

The first three characteristics above are reasonably obvious. The fourth is the crucial one.

Money Needs to Have a Cost of Production

A free-market money must have a real cost of production. Otherwise, it could be created by anyone at virtually no cost.

Ahh, like today’s system. Think banks.

In the extreme, the inevitable result would be hyperinflation and the collapse of the monetary system. Scarcity is therefore not an accidental characteristic of good money.

It is one of its defining features.

Is Satoshi Nakamoto An Austrian Economist?

That is simply another way of expressing point four above. Yet it is remarkable how many textbooks happily list these four characteristics while simultaneously defending a fractional reserve banking system that creates money at almost no cost.

The two ideas are fundamentally inconsistent.

It is one of the reasons I strongly suspect that Bitcoin’s mysterious and anonymous founder, Satoshi Nakamoto, had more than a passing background in Austrian economics.

Economics 101: Increase Supply and the Price Falls

Let us begin with something completely uncontroversial.

Every good in the economy is subject to the ordinary forces of supply and demand.

If car manufacturers suddenly double the production of cars, the price of cars falls. If farmers produce twice as much wheat, the price of wheat falls. If advances in technology make televisions cheaper to produce, television prices fall.

While these changes have indirect effects throughout the economy, the adjustment is largely confined to the markets directly connected with those goods.

There is nothing unusual about this. It is simply Economics 101.

A Free-Market Money Behaves the Same Way

If more gold is produced, the purchasing power of gold falls. Like every other good, increasing supply reduces the value of each additional unit and therefore reduces the profitability of producing still more of it.

Up to this point, money behaves exactly like every other commodity.

But This Is Where the Similarity Ends

Money is unlike every other good because every price in the economy is expressed in units of money. Increasing the supply of money therefore changes not just one price.

It changes the purchasing power against which every other good and service is measured.

That means commodity money adjusts through three separate mechanisms.

Mechanism 1: The Usual Produce More and the Price Falls

The first adjustment is the ordinary supply and demand process that applies to every good in the economy. We discussed that process above. More money reduces the value of an additional unit and therefore reduces the profitability of producing more of it. Up to this point there is nothing special about money at all.

But money does not stop there.

Mechanism 2: The Valuation Effect

Because every other price is measured in money, two additional powerful economy wide feedback mechanisms immediately begin operating.

The first additional mechanism is what I call the valuation effect. At first glance this might appear to be nothing more than the familiar downward sloping demand curve taught in every introductory economics course.

It is not.

An Apple a Day...

Suppose I offer you a whole apple. Then suppose I offer you another whole apple.

Standard economics says you will generally value the second apple less than the first because of what economists call diminishing marginal utility. Your willingness to work or sacrifice other goods to obtain another identical apple falls because your wants are becoming progressively more satisfied.

That is the traditional downward sloping demand curve. That is Mechanism 1 above.

Just Like They Keep Giving You Less Chocolate in Your Chocolate Bar

Now consider a completely different situation.

Instead of another whole apple, suppose the additional apple is only half an apple. Clearly you would not be willing to work as many hours to obtain it.

But notice why. It has nothing whatsoever to do with diminishing marginal utility.

You value it less because the unit itself has become economically smaller. In a sense, it has become a different product. The reason your willingness to work for it has fallen is therefore completely different from the standard downward sloping demand curve.

That Is Precisely What Happens With Money

The additional ounce of gold is still physically one ounce. Nothing has changed about the gold itself. But if that ounce now purchases fewer goods and services than the previous ounce, then economically it has become the equivalent of the half apple.

You are therefore no longer willing to work as many hours, or sacrifice as many other goods as possible, to obtain another ounce because the real reward from obtaining that ounce has fallen.

When millions of individuals make the same decision, the demand for money itself changes.

Here's a Technical Point

For the economic purists, this is more than a simple movement along the conventional demand curve. The purchasing power of the monetary unit itself has changed. That changes an individual’s willingness to acquire that same physical unit of money because it now delivers fewer monetary services than before.

Unlike the traditional downward sloping demand curve, this reduction in demand is not driven by diminishing marginal utility.

It is driven by the deterioration in the purchasing power of the monetary unit itself. The physical unit is unchanged, but the economic services it provides have diminished.

Economically, the monetary unit has become the equivalent of "half an apple". The physical unit is unchanged, but the economic product it represents is different.

Conventional Analysis Doesn’t Apply Here

Traditional demand and supply diagrams are not particularly well suited to illustrating this mechanism because money is unlike every other good. The demand for money contains several dimensions, including an important time element, which makes the analysis considerably more complicated than the standard textbook treatment.

For present purposes, however, the key point is much simpler. Even from the demand side alone, money possesses a self-correcting mechanism unlike that of any other good.

Before we even consider the cost of producing additional money, the adjustment process has already begun.

But there is more.

Mechanism 3: The Supply Effect

The second additional mechanism is a cost effect, and it is much simpler to understand.

As the larger money supply works its way through the economy, wages, machinery, fuel and every other input used in gold mining also become more expensive. The cost of producing additional money therefore rises, reducing profitability even further.

The Automatic Stopping Mechanism

Again, no other good generates these economy wide feedback effects.

Taken together, these three mechanisms create one of the most remarkable properties of commodity money. Every increase in the money supply automatically sets in motion forces that progressively reduce the incentive to produce still more money. Commodity money therefore contains its own stopping mechanism.

An Example: There’s Gold In Them There Hills

Suppose a major gold discovery or a technological breakthrough suddenly makes gold mining far more productive.

Initially, mining becomes unusually profitable. Labour, capital and natural resources are temporarily drawn away from producing ordinary goods and into producing gold. More gold is produced and the money supply expands.

At that point the three mechanisms we have just examined begin operating simultaneously.

Mechanism 1 Kicks In

Mechanism 1 operates exactly as it does for every other good. As with any good, an increase in supply requires a fall in price if the market is to clear the additional output. Economists describe this as a movement down the demand curve. There is nothing unusual about it. It is simply the ordinary operation of supply and demand.

Money behaves the same way. The only difference is that the “price” of money is its purchasing power. As more money is produced, the purchasing power of each additional unit falls. Equivalently, the overall price level rises.

That adjustment alone creates a disincentive to procure additional money. If money were just another commodity, the story would end there.

But Money Is Not Just Another Commodity

Mechanism 2 also immediately begins operating. As each additional ounce of gold purchases fewer goods and services than before, individuals become less willing to work or sacrifice other goods to obtain another ounce of gold. The purchasing power of the unit itself has fallen and so has the reward from obtaining it.

At the same time, Mechanism 3 comes into play. As the larger money supply works its way through the economy, wages, machinery, fuel and every other input required to produce gold become more expensive. The cost of producing additional money therefore rises.

Together, these three mechanisms progressively reduce the profitability of producing additional money. Eventually the abnormal profits disappear and labour, capital and natural resources flow back into producing the consumer and capital goods that people want.

The Conclusion That Turns Two Thousand Years of Monetary Thinking on Its Head

The long run result is not a permanently enlarged mining industry, nor a permanent diversion of resources away from productive activity.

Instead, the economy settles into a new equilibrium with a larger stock of money and a higher general price level.

I have built a model that demonstrates this adjustment process in detail. Even without working through the mathematics, however, the implications are enormous.

The Price Level Is Irrelevant

The ultimate price level is largely irrelevant from the perspective of resource allocation. Once the adjustment has run its course, labour and capital once again produce the mix of goods and services consumers value most highly.

There is also no reason to fear a permanent diversion of resources into producing money or speculating in money, the very concern that preoccupied Chinese monetary thinkers and, indeed, many economists right up to the present day.

The principal economic cost is therefore the transition itself. During that adjustment period, labour and capital are temporarily diverted into producing additional money rather than the goods and services that directly satisfy consumer wants.

It Is a Different System Entirely To a Fiat Money System

This automatic adjustment is precisely what distinguishes commodity money from fiat money.

Commodity money contains its own stopping mechanism because additional money creation progressively destroys its own profitability through ordinary market forces.

The market itself determines when enough money has been produced.

Fiat money contains no equivalent discipline. Since it can be created at virtually zero cost, there is no objective economic test telling governments or central banks when enough money has been produced.

Not only that, I have shown that zero cost money creation is largely out of their control anyway. See the two previous essays above: What Happens When the Bank Robs You and Bills Bank, How the System Was Rigged From the Start.

Gold Discoveries Do Not Increase Overall Wealth

Under a commodity standard, the market itself answers that question through ordinary profit and loss.

This also explains why major gold discoveries, despite permanently increasing the money supply, do not permanently alter the structure of production. Once prices have fully adjusted, labour and capital return to producing the goods and services consumers value most highly.

Apart from the temporary adjustment process, the legacy of the gold discovery is not greater real wealth. It is simply a larger stock of money and a correspondingly higher general price level.

Falling Prices Are Not All the Same

Modern economics often treats all falling prices as though they were symptoms of the same disease.

They are not. The economic consequences depend entirely upon why prices are falling.

Why Prices Can Fall

1. An Increase in Overall Productivity

Suppose productivity throughout the economy increases.

There has been no increase in the demand for money at all. Society is simply producing more goods and services with the same quantity of labour, capital and natural resources.

The greater abundance of goods naturally causes prices to fall.

That is not a sign of economic weakness. It is the very mechanism through which the benefits of higher productivity are shared across the whole community. Lower prices mean that everyone’s money now buys more goods and services.

Real incomes have risen.

Think About Computer Technology

Computer technology provides an obvious example.

Over many decades computers have become dramatically more powerful while becoming progressively cheaper. Very few people regard this as a problem. Quite the opposite.

The falling price of computing has allowed the entire community, not merely computer manufacturers, to share in the enormous productivity gains generated by the industry.

The same principle applies throughout a free market economy. Whenever one industry becomes more productive, lower prices spread those gains to every consumer.

A Simple Example Illustrates the Point

Suppose an economy produces only apples, bananas and gold, with gold serving as money. Initially there are one hundred ounces of gold, fifty apples and fifty bananas.

Now suppose improvements in farming suddenly double banana production while the quantity of gold remains unchanged.

Bananas obviously become cheaper.

Society is now wealthier because it enjoys twice as many bananas while sacrificing nothing else. Even people who never worked in the banana industry benefit because lower banana prices increase their real purchasing power.

In short, everyone can continue consuming the same number of apples while enjoying more bananas.

But Prices Need To Fall

This is one of the great strengths of a free market.

Falling prices are the mechanism by which productivity gains in one part of the economy become higher living standards for everyone else. The market automatically spreads the benefits of innovation without requiring redistribution or government planning.

Inflation Targeting Is Immoral

Attempts by governments or central banks to prevent this process by creating additional money or targeting inflation interfere with that natural transmission mechanism.

Instead of allowing consumers to receive the full benefit of higher productivity through lower prices, monetary expansion keeps prices artificially higher than they otherwise would have been.

This Is Seismic: It Has Income Distribution Effects

Purchasing power is then redistributed according to where the new money enters the economy.

It is impossible to overstate that importance of this. Yes there are still more bananas and the same apples but who ends up with them is now different.

What appears to be economic stabilisation is often the suppression of one of the market’s greatest strengths.

This is one reason inflation targeting rests on such questionable foundations.

Greed Is Not Good. Deflation Is.

If productivity is continually increasing, then a stable or gently falling price level is the natural outcome of a healthy economy.

To insist upon positive inflation is to prevent the wider society from fully enjoying the benefits of rising productivity. Or rather, it redistributes who benefits, normally into a few hands that get early access to the newly created money.

The widespread belief that all deflation is dangerous stems largely from analysing fiat money systems, or systems heavily influenced by government intervention, rather than a genuine free market monetary system.

2. Hoarding Is Not a Problem. In Theory!

A very different situation arises when prices fall because people voluntarily choose to hold larger cash balances. The demand for money has increased relative to other goods.

As explained earlier, the purchasing power of money rises becaseu there is less money in circulation.

That higher purchasing power makes the production of additional money more profitable. The market therefore begins supplying the additional monetary services consumers are demanding.

Hey Government: Keep Out Of It

Apart from the temporary adjustment process, there is no market failure requiring government intervention. Within a genuine free market monetary system, hoarding is simply another expression of consumer preferences.

In that sense hoarding is not a market failure at all. It is an efficient market outcome because it reflects what consumers themselves have chosen.

That is why, at least in theory, hoarding is not the economic bogeyman it is so often portrayed to be.

You will not find that argument in too many economics textbooks.

See the Difference With Mainstream Economics

The entire modern monetary debate begins from the assumption that someone must determine the correct quantity of money or manipulate interest rates.

Keynesians generally believe central banks should manage the economy primarily through interest rates and government spending. Monetarists generally believe they should manage it through monetary aggregates. Modern central banks generally attempt to manage it through inflation targets.

These are, of course, broad generalisations. What matters is what they all have in common.

Every one of these approaches begins with the assumption that government should somehow determine the quantity of money, interest rates or both.

Free Market Money Is a Totally Different Economy

A genuine free market reaches a completely different conclusion. The quantity of money is not a policy variable. It is simply another market outcome.

Just as markets determine the quantities of wheat, housing, labour and every other good through prices, profitability and consumer preferences, they also determine the quantity of money.

There is no separate monetary problem requiring a monetary planner.

This Is the Greatest Misconception in Modern Economics

Economists have spent centuries debating how governments should determine the correct quantity of money or interest rates when the more fundamental question is why governments should be involved in such decisions at all.

Once money is treated as another market good, the problem largely disappears.

The market continuously discovers both the purchasing power of money and the quantity of money that consumers are willing to pay society’s scarce resources to produce.

The quantity of money therefore ceases to be an object of policy and becomes, like every other quantity in a market economy, the outcome of voluntary exchange.

All This Raises Even More Questions

If the theory is correct, exactly how does the economy adjust? Does the adjustment process to any disruption in money supply leave permanent scars or does the economy simply settle into a new equilibrium?

To that end, what do the great gold and silver discoveries of the sixteenth and seventeenth centuries tell us?

What about cryptocurrencies? Have we finally created the perfect money, or do they suffer from an entirely different set of problems?

Where do interest rates fit into all this? Can inflation occur under a genuine free market money? How would governments fund their activities? How do you change from the current system to a free market system?

They are all good questions. In fact, they are the obvious questions.

Stay tuned.

Cutting to the Chase

1. A new Hamiltonian revolution is taking place in America. The Neo-Hamiltons have correctly identified that something is fundamentally broken in the current global financial system. Where I part company with them is over the money system solution.

2. On the surface the debate appears to be about the return of tariffs and industrial policy. But really it is about the broken global monetary system. The Founding Fathers understood that. Modern economics largely does not.

3. The American Revolution was never simply about tea or taxation. It was fundamentally about money, debt, trade deficits and monetary sovereignty.

4. Britain’s trade deficit with China, the bailout of the East India Company and a collapsing imperial monetary system helped trigger the Revolution. America now confronts remarkably similar monetary contradictions.

5. The Founders concluded that bad money eventually destroys good politics. Inflation does not solve problems. It merely changes who eventually pays.

6. The Constitution’s monetary clauses were written to stop another monetary disaster. Hamilton, Jefferson and Madison then immediately reopened the argument over how the new republic should organise its monetary system.

7. The military revolution ended. The political revolution largely succeeded. The monetary revolution never did.

8. For two hundred and fifty years America has continued arguing over the same monetary questions through the First Bank, Jackson, the Federal Reserve, Bretton Woods and now today’s debates over debt, trade deficits and the dollar.

9. The real question this Independence Day is not what the Founders achieved in 1776. It is whether we have forgotten what they were trying to prevent.

Are We In Another Revolution Right Now?

It certainly feels that way.

Across the West, political movements are emerging that would have seemed unimaginable only a decade ago. The post-war economic consensus is fracturing and ‘free trade’ is being challenged. Tariffs and Industrial policy are back.

Governments are once again talking about production rather than consumption. National resilience rather than global efficiency and rebuilding domestic industry rather than simply importing more from abroad are in vogue.

Something Profound Is Changing

Whether you support or oppose the current U.S. administration is almost beside the point. There is plenty in its programme that people across the political spectrum will both like and dislike.

What matters is understanding why this shift is happening. If you want to understand the ideas driving it, the following video is essential viewing.

On America’s 250th Independence anniversary, Susan Kokinda argues that this moment is more profound because Donald Trump and his administration are reviving the “American System” of political economy—tariffs to promote domestic industry, manufacturing, and internal improvements—after it was suppressed following President William McKinley’s assassination in 1901. She contrasts the American System with the “British System,” citing Henry Carey’s warning of two opposing systems, and says the nation’s economic heritage was replaced by free trade, consumerism, and institutions like the Federal Reserve. Kokinda connects the Declaration’s appeal to the Laws of Nature and Nature’s God to economics, quoting Lyndon LaRouche on a state shaping a nation’s relationship to the physical universe. She highlights speeches by Jamieson Greer and Scott Bessent on production over consumption, and J.D. Vance’s call for a Hamiltonian approach grounded in human dignity, linking it to the Declaration’s “pursuit of happiness” over “property.”

You Can’t Hollow Out Your Industrial Base Without Consequences

The more I have studied monetary history, the more convinced I have become that none of this should surprise us.

History repeatedly shows that societies cannot hollow out their productive base through persistent trade deficits, allow wealth to become increasingly concentrated through the financial system, and expect political stability to continue indefinitely. Eventually the politics changes because the economics has become unsustainable.

That is exactly what happened before the American Revolution. Only then, it was Britain running the great trade deficit with China.

The similarities are extraordinary.

Enter the ‘Neo-Hamiltons’

One of the most interesting developments has been the emergence of what I call the ‘Neo-Hamiltons’.

Hamilton became something of a hero for many on the political left through the blockbuster musical that bears his name. Yet today it is the Trump administration that is reviving many of Hamilton's economic philosophy of tariffs, industrial policy and national development, while many of Hamilton's loudest admirers seemingly now oppose precisely those policies.

History can be wonderfully mischievous sometimes.

But Their Real Enemy Is the Global Financial System

Above almost everything else, the Neo-Hamiltons are united by a deep hostility towards the Federal Reserve, Wall Street and what they regard as an international financial system that has enriched finance while hollowing out productive America.

Regular readers will know that I have more than considerable sympathy for that diagnosis.

Where I Part Company Is Over the Money System Solution

Hamilton’s answer to America’s monetary problems was a system centred on national banking, public credit and a close relationship between finance and the state.

Yet that looks remarkably similar to the architecture that eventually evolved into the modern financial system the Neo-Hamiltons now criticise.

In my view, he fundamentally misdiagnosed the problem. The Revolution had exposed the dangers of bad money, excessive debt and financial privilege. Hamilton's solution institutionalised all three. Rather than completing the monetary revolution, he quietly began rebuilding the very architecture the Revolution had been fought to escape.

That apparent contradiction lies at the heart of this essay. But I don’t blame the Neo- Hamiltons for it.

Blame the Economics Profession

Modern economics still has no coherent theory explaining how a fiat money system fits within genuinely free markets or how free market economics should deal with competing nation states operating under entirely different monetary systems.

That is why today’s debates over tariffs have become so confused.

We Are talking About Different Economic Systems

As I have argued before, once you leave a commodity money system and enter a fiat money world, the theory changes fundamentally.

Policies that would clearly reduce prosperity under a genuine free market monetary system can produce very different outcomes once governments possess the power to create money, manipulate exchange rates, subsidise credit and run persistent trade deficits without immediate settlement.

Both Sides Are Talking Past One Another

Those defending “free trade” are often not defending free trade in the classical sense at all.

They are defending a global trading system built upon fiat money, reserve currencies, central banks and international financial institutions. Those are not neutral market conditions. They are institutional arrangements that profoundly influence trade itself.

Equally, many of the Neo-Hamiltons are not really arguing against free trade. They are arguing against the monetary architecture that sits beneath today’s version of globalisation.

Whether they know it or not, the main issue implicit in their objections is not to voluntary exchange between nations. It is to a fiat money system that has enabled persistent trade deficits, deindustrialisation and growing income disparity.

It Depends Upon What You Mean By Free Trade

Until economics distinguishes between free trade under sound money and “free trade” under fiat money, both sides will continue arguing past one another because they are debating different systems while using the same language.

That is why debates over tariffs have become so confused.

Which Brings Us Back To the Founding Fathers

They disagreed passionately about the solution to the money system failures.

Hamilton, Jefferson, Madison and the others fought some of the greatest constitutional battles in American history over what monetary system the new republic should adopt.

But they agreed on one thing: The money system was the problem.

Everything that follows begins there.

The Revolution Didn’t Begin With Tea. It Began With War Debts and Financing Trade Deficits.

Every schoolchild is taught that the American Revolution began because Britain imposed taxes on the colonies. There is truth in that, but it is only part of the story. Governments rarely wake up one morning and decide to tax people for the sheer enjoyment of it.

They do it because something has already gone badly wrong with their finances. That is exactly where Britain’s story begins.

Did you know the American Revolution was actually sparked by a massive corporate bailout? Most history books teach that the Boston Tea Party was simply a colonial protest against a three-pence tax. But the real story is much darker and spans across the globe. By the 1770s, the British East India Company—a heavily armed corporate monopoly—was on the verge of bankruptcy. After violently taking over the Bengal subcontinent, the company prioritized aggressive tax collection and shareholder profits over human lives, contributing to a devastating famine that killed 10 million people.

To save this "too big to fail" corporation from collapse, the British Parliament passed the Tea Act of 1773. This bailout allowed the company to bypass merchants and dump its massive 18-million-pound surplus of tea directly onto the American colonies duty-free.

The colonists saw right through this corporate rescue plan. When those tea chests hit the water in Boston Harbor, it wasn't just a tax revolt—it was a direct strike against a destructive global monopoly. That single act of sabotage linked a humanitarian disaster in India to the 13 Colonies, setting off a chain reaction that united the continent and birthed the United States.

The Seven-Year Itch That Destroyed an Empire

The Seven Years’ War left Britain not simply victorious but financially exhausted. It had defeated France, expanded its empire and become the world’s dominant military power, but it had also accumulated an enormous mountain of debt.

Interest payments alone consumed a staggering proportion of government revenue, and every minister in London understood that the bills eventually had to be paid.

Victories are wonderful things, provided someone else pays for them. Britain discovered, as so many great powers have before and since, that the celebration eventually gives way to the accountant.

The financial pressures extended well beyond Europe.

Eventually It Always Comes Down To Trade Deficits

Britain also faced a chronic trade deficit with China, purchasing vast quantities of tea, silk and porcelain while having almost nothing that the Chinese wished to buy in return, except silver. That is, money.

Britain therefore found itself caught in an uncomfortable arithmetic. Silver flowed relentlessly east while government debt continued rising at home.

The empire looked magnificent on a map, but beneath the surface the monetary foundations were becoming increasingly fragile.

For a time, the East India Company managed to hold this extraordinary system together. Revenues extracted from Bengal helped finance the purchase of Chinese tea, while London’s financial markets convinced themselves that the whole arrangement could continue indefinitely.

Time For a Tea Break

The Tea Act of 1773, conceived as a lifeline for the Company’s drained coffers, was meant to restore its finances as the video above shows. It triggered the Boston Tea Party that same year and the American Revolution soon after. The chain of causation ran from Chinese demand for silver to British taxation in Bengal to colonial rebellion in North America.

It is a tale that begins in Canton moves through Bengal and ends in Boston Harbour.

The Bengal Crime. And You Thought the GFC Bailouts Were Bad.

The extortion system worked for a while. Then reality intervened. Bengal suffered catastrophe, Company revenues collapsed, warehouses filled with unsold tea, and one of the largest corporations in the world suddenly found itself staring into the abyss. Parliament was not simply confronting a tea problem.

It was confronting a financial crisis that threatened an entire imperial trading system.

What? You Mean the Locals Weren’t Impressed? You Don’t Say.

Seen in that light, the Tea Act of 1773 looks very different. It was not an isolated piece of tax legislation dreamt up by an unusually vindictive Parliament. It was an attempt to rescue an empire whose finances were beginning to unravel.

Britain hoped that by allowing the East India Company to sell its surplus tea directly into the colonies it could generate desperately needed cash, stabilise the Company and keep the entire imperial monetary machine functioning for a little longer. Tea was merely the vehicle. Money was the destination.

The full story behind that bailout deserves is outlined in the above essay on Death in Bengal. For readers new to this series, here is the argument in brief.

The Argument In Brief

1. The United States is trying to fix its trade deficit, but the cause lies deeper. Every world order begins with faith in its money and ends when that faith fails.

2. Governments’ fear of their country running out of money, literally, and their refusal to let trade deficits correct naturally have been the root cause of much human suffering. Economics has much to answer for on that front.

3. America sustains its deficits with paper promises, just as Britain once did with tyranny in Bengal to obtain silver and with opium to send that silver back to China.

4. Markets can correct deficits if left alone, but that would also mean surrendering control of the money system itself and no government has ever had the courage to do that.

5. The story begins in China. Its hunger for silver set the world’s standard of value and drained Europe’s supply.

6. Europe’s scarcity of silver forced invention. Banks, credit, and paper notes were born not from genius but necessity. Paper then multiplied what metal remained, but the flow of bullion still ran east to China, where only silver by weight would do.

7. John Locke gave that scarcity a philosophy. He argued that value lay in silver itself, not in the king’s command.

8. To keep tea and porcelain coming, the East India Company found a cheaper source of silver: Bengal. The right to tax became the right to drain. Between 1769 and 1773, Bengal starved while London’s accounts balanced. Ten million died so that China’s merchants could still be paid.

9. The same system financed the Tea Act of 1773 and helped ignite the American Revolution. The silver that passed through Calcutta and Canton ended up shaking London and Boston alike.

10. The same mechanism linked empires from Istanbul to Canton. The Ottomans, short of silver, saw their coinage debased and their sovereignty eroded.

11. When Britain reversed the silver flow through opium, China’s dominance ended. Gold replaced silver, and paper eventually replaced both.

12. The deaths in Bengal were the price of one imbalance. The next reckoning is already in the works.

The Colonists Rebelled Against the Global Financial System

The colonists instinctively understood that something much larger was taking place. They were not simply being offered cheaper tea. They were being asked to become participants in a financial system over which they had virtually no control.

Parliament determined taxation. London controlled credit.

The Bank of England enjoyed privileges that the colonies themselves were denied, while the Currency Acts had already stripped the colonies of much of their monetary flexibility.

They were expected to trade, borrow and pay, but not to control the money upon which their own economy depended.

Money Control Without Representation

That is why I have increasingly come to regard the Boston Tea Party as one of history’s great monetary protests rather than merely a tax protest. The tea itself was almost irrelevant.

The real issue was whether Americans would continue financing an imperial financial system that appeared increasingly incapable of financing itself.

The famous cry of “taxation without representation” was therefore only part of the argument. Beneath it lay another complaint that receives far less attention today: monetary control without representation.

This matters because it completely changes the way we understand the origins of the Revolution. Britain was not simply an arrogant imperial power imposing unpopular taxes.

It was also a heavily indebted state trying to preserve an increasingly unstable monetary order. The colonists were not merely demanding political liberty.

Just Like the Occupy Wall Street and Tea Party Today

Whether they fully appreciated it or not, they were also demanding the right to escape a financial system whose contradictions were becoming impossible to ignore.

Once you see that, almost everything about the Revolution looks different.

The Stamp Act, the Townshend Duties and even the Tea Act cease to look like isolated acts of imperial arrogance. They become increasingly desperate attempts by a heavily indebted government to hold together a monetary and financial system that was beginning to unravel.

The Revolution was not simply a political crisis. It was also a monetary crisis.

What We Have Learned So Far

1. Britain won the Seven Years War (1756-1763) and bankrupted itself. The map got bigger. The balance sheet died. The war doubled Britains debt and the interest bill alone threatened to sink the state. A revenue source had to be found and fast.

2. America’s deficit fed Britain. Britain’s deficit fed China. Silver drained east in one unbroken stream. One global pipeline. One point of failure.

3. Bengal’s silver kept that stream alive until famine of 1769-1770 killed millions and wiped-out East India Company revenue. Britain needed more silver. America was the answer.

4. Mercantilism was not a theory. It was a panic. Manage trade. Control colonies. Ban their money. Pretend arithmetic no longer applies.

5. Britain forbade America from printing its own money while the Bank of England printed credit freely at home. The colonies literally ran out of money. Taxation without representation became taxation without currency.

6. The Tea Act of 10 May 1773 was the last gasp of a dying system. Tea was irrelevant. The goal was to keep the bullion circuit running. Bengal’s taxes filled London, London’s silver paid China, China’s tea was dumped on America, and Americas cash was meant to refill the East India Company’s coffers so the loop could continue.

7. Buying the tea meant surrendering monetary autonomy. It meant agreeing that Parliament controlled taxation and London controlled money.

8. The colonists already had cheaper Dutch tea. The Dutch sailed to Canton, loaded their ships with better tea, and sold it in America untaxed and cheap. It was everything British tea was not which made the Tea Act look like a trap rather than a bargain.

9. The Boston Tea Party of 16 December 1773 was therefore the refusal to be shackled into Britain’s collapsing silver pipeline from Bengal to Canton.

10. Every empire collapses the same way. The currency cracks before the army does. Britain mistook paper for power and paid the price.

11. The American Revolution was triggered by British trade deficits with China. That is not a metaphor. It is the ledger truth.

12. Today the United States runs the same deficits with the same country, only bigger.

13. The last revolution began when the money broke. The next one will start the same way. The World Economic Forum believes policy can defy arithmetic. It cannot. Trade imbalances are created by the money system, not by ministers. When the money system fails, every plan fails with it.

Well, That's Just Dandy

And here we arrive at one of history’s more delicious ironies.

The United States today finds itself running persistent trade deficits with China, financing enormous public debts and wrestling with questions about tariffs, banking and the international monetary system.

Think about the symmetry.

Two hundred and fifty years ago Britain found itself running chronic trade deficits with China, financing an ever-growing public debt and desperately trying to preserve a world order built upon its monetary system.

Today the United States finds itself confronting remarkably similar questions. The reserve currency and financial instruments are different and the geopolitical players have changed.

But the Underlying Arithmetic Looks Uncannily Familiar

If the American Revolution was, in part, born out of Britain’s monetary contradictions, what should we make of a world in which America now occupies Britain’s position?

That is the question that should trouble all of us.

History never repeats itself exactly, but it has an uncanny habit of asking the same questions in different centuries.

They Won the War. Then Lost Control of the Money.

Winning a revolution and building a functioning monetary system turned out to be two very different things. It is one thing to throw off imperial rule. It is quite another to construct a financial system capable of surviving peace.

The irony is almost unbelievable.

Having spent a decade rebelling against Britain’s monetary failures, the revolutionaries almost immediately found themselves making many of the same decisions. Different flag, government and printing press. The monetary dilemma, however, was exactly the same.

The explanation was understandable enough. Wars are expensive, governments need resources, and the Continental Congress possessed almost none of them. It had no established taxation system, little gold or silver, limited foreign borrowing capacity in the early years and no central treasury capable of financing a prolonged conflict.

More Dangerous Than the Continental Plate Boundaries

Like countless governments before it, Congress reached for the printing press. The Continental Dollar became not merely a means of payment but a declaration of nationhood itself. Printing money appeared to solve the immediate problem.

As so often happens throughout history, it merely postponed the real one.

For a While the Illusion Worked

Soldiers accepted the notes and merchants and farmers traded with them. The new currency carried a powerful symbolism because it represented the birth of an independent America. Patriotism itself helped sustain confidence.

Unfortunately, patriotism has never proved an adequate substitute for monetary discipline.

Congress continued issuing more paper while the individual states did the same. Before long the supply of promises was expanding far faster than the supply of goods those promises were supposed to purchase.

Who’d Have Thought

The consequences were entirely predictable because they have accompanied almost every major paper money experiment in history.

Prices accelerated. Savings evaporated. Speculation flourished. Honest production increasingly gave way to financial opportunism as everyone attempted to spend depreciating notes before they lost still more purchasing power.

By 1781 the Continental Dollar had effectively collapsed.

The expression “not worth a Continental” entered the American language for a reason. It was not a clever saying. It was an accurate description of monetary failure.

The Great Monetary System Debate: At Least They Had One

Here’s the Cutting to the Chase section of the Founders Warned Us About Inequality essay attached above.

1. The American story starts with a money problem, not a philosophy seminar. In the colonies, money was whatever people could trade, until war pushed governments toward paper promises.

2. Every paper money experiment ran the same cycle. Issue notes to fund war. Declare them legal tender. Watch specie disappear. Watch prices rise. Watch trust collapse.

3. Britain banned colonial paper money not because paper money was immoral, but because monetary privilege was imperial power. Britain kept the privilege. The colonies were denied it.

4. The Revolution was about monetary sovereignty. The colonies were expected to pay debts and taxes in a standard of value they could not control, while trade deficits and bullion drains did the quiet damage in the background.

5. Congress reached for the printing press first. The Continental Dollar asserted national legitimacy, then collapsed under over issue and war realities, leaving ordinary people holding the loss.

6. The Founders treated that collapse as a national trauma because they had lived through it. They argued that inflation was not merely an economic mistake but a moral and political crime that corrupted law, rewarded fraud, and punished honest labour.

7. This is the missing modern intuition. To the Founders, fiat style paper money and the banks’ ability to create money were worse than war. They dissolved trust inside society, turned citizens into speculators, drove booms and busts, and made property and contracts arbitrary.

8. France financed American independence by borrowing, not by producing or reforming. In helping America win, France set fire to its own fiscal structure and handed itself to a crisis its monarchy could not survive.

9. Britain lost territory but kept its credit by institutionalising permanent debt and a deeper bond market. America copied the architecture, beginning the shift from independence as hard money discipline to independence as managed credit.

10. Jefferson and Madison came up against Hamilton in a constitutional fight over the establishment of the First Bank of the United States, a struggle over whether the new republic would be governed by hard money discipline rooted in production, or by managed credit justified by convenience, precedent, and state necessity.

That unresolved choice would shape the dollar’s evolution from the very beginning.

The Founding Fathers Knew

The remarkable thing is that the Founders understood exactly what had happened. They did not describe inflation as an unfortunate side effect of wartime finance or as an unavoidable inconvenience.

They described it as something far more serious. George Washington warned that paper money would “ruin commerce, oppress the honest, and open the door to every species of fraud and injustice.” James Madison wrote of the “pestilent effects of paper money on the necessary confidence between man and man.”

Thomas Jefferson believed banking institutions themselves posed dangers greater than standing armies. These were not academic observations written centuries later. They were conclusions reached by men who had just watched their own monetary system collapse before their eyes.

The Constitution they would soon write reflected those lessons on almost every page dealing with money.

The ‘Something Bad or Something Worse’ Aftermath Choice

Perhaps the greatest misconception about inflation is that the damage ends when the printing stops. That is often when the real pain begins.

Inflation rearranges wealth, distorts contracts and encourages people to take on obligations that appear manageable while money remains plentiful. Once discipline returns, those same debts become crushing.

Creditors demand repayment in money that has become scarce, while debtors discover that the prosperity inflation seemed to promise was largely an illusion.

Franklin Was Prophetic: They Almost Didn’t Keep It

That is precisely what unfolded across the young republic after the war ended.

Farmers who had borrowed during the inflation suddenly faced repayment in hard money. Courts reopened. Taxes were collected in specie. Sheriffs began seizing farms. Families who believed they had survived the war now discovered they faced financial ruin in peacetime.

For those who are time constrained, here’s the summary of the Bad Money Makes Bad Politicians above essay.

This Is What Happens When You Get Inflation

1. The American Revolution ended with a monetary collapse, not a clean victory. The Continental currency hyperinflated, debts survived, and a second conflict, a monetary one, began after the war.

2. Inflation created debts that appeared manageable while paper was plentiful, then turned those same debts into impossible burdens once discipline returned.

3. Once inflation has occurred, there is no fair way out. Losses must fall either on creditors through depreciation or default, or on debtors through violent enforcement carried out by courts, seizures, and imprisonment. Politics can only choose the loser.

4. Shays’s Rebellion showed what happens when post-inflation discipline is enforced through courts, seizures, and imprisonment. Rhode Island showed what happens when relief is enforced through courts, tender laws, and judicial coercion. One produced armed resistance. The other destroyed credit, contracts, and the trust essential to a market economy.

5. These were not anomalies. Together they revealed the endpoints of every inflationary system. Relief wins votes. Discipline restores contracts. Neither can avoid conflict once inflation has done its work.

6. The Founders drew a hard conclusion. Money could not safely be left to state politics. That is why the Constitution banned state paper money and state legal tender laws.

7. The Constitution did not attempt to balance debtors and creditors. It attempted to prevent the conditions that force society to choose between them.

8. The lesson the Founders learned, and we forgot, is simple. Inflation, whether goods or asset-based, is not an economic inconvenience. It is a political trap. Once entered, there is no just exit, only a fight over who pays.

Shays’ Rebellion was not simply a revolt against government authority. It was the social and political aftermath of a monetary collapse. Rhode Island travelled down the opposite path, attempting to solve the problem by printing still more paper and coercing its acceptance through legal tender laws.

One state embraced harsh monetary discipline. The other embraced renewed inflation. Both ended in crisis because both were trying to solve problems created by the same monetary disaster.

A Big, Big, Teachable Moment

I believe this is one of the most important lessons the Founders learned, and perhaps the one modern economics has done the most to forget.

Once a society embarks upon inflation there is no painless exit. Someone ultimately bears the losses. Either creditors lose through depreciation or debtors lose through enforcement. Politics cannot eliminate those losses.

It merely decides who will suffer them. That is why inflation is never simply an economic phenomenon. It eventually becomes a political one.

It Shaped the Constitution

It was this painful experience, rather than abstract political philosophy, that shaped the Constitution itself.

The monetary clauses were not decorative legal language inserted by theoretical lawyers. They were the direct product of lived experience. The delegates had watched paper money destroy trust, contracts and social stability. They had seen both inflation and deflation tear communities apart.

Their response was remarkably simple. Prevent governments from creating the conditions that made those tragedies possible in the first place.

The Revolution Wasn’t Over. It Had Simply Changed Battlefields.

By 1787 the Founders believed they had learned one of the harshest lessons in political history. Britain’s debt problems had helped produce the Revolution. The Revolution’s paper money had produced inflation.

Inflation had produced Shays’ Rebellion in Massachusetts and monetary chaos in Rhode Island.

Every path seemed to lead back to the same uncomfortable conclusion.

Bad Money Eventually Destroys Good Politics

The Constitution was their attempt to break that cycle. Its monetary provisions were among the clearest anywhere in the document.

The states were forbidden from issuing bills of credit. They were forbidden from making anything but gold and silver coin legal tender. Congress was granted the power to coin money, not simply manufacture promises.

These clauses were not legal curiosities. They were the product of bitter experience. The men who drafted them had spent more than a decade watching one monetary disaster after another tear apart both the British Empire and the infant American republic.

A Human Nature Moment. Maybe That Is the Real Teachable Moment

It is therefore remarkable how quickly the debate returned. The Constitution had barely come into operation before the argument over money erupted all over again. Only this time there were no British soldiers, no harbour full of tea and no imperial Parliament.

The battlefield had shifted from Boston Harbour to the Cabinet table, from Lexington to Congress.

The Revolution had changed its form, but not its subject.

This Debate Has Massive Significance Today

Alexander Hamilton believed the young republic needed something different.

In his view America required a permanent financial system capable of funding government, supporting commerce and establishing public credit. War debts would be consolidated. Federal bonds would become the foundation of national finance.

A national bank would sit at the centre of the system, linking government and private finance in ways the United States had never previously experienced. To Hamilton this was modern statecraft.

To many of his contemporaries it looked disturbingly familiar.

Jefferson and Madison immediately recognised what was at stake. Their objections were never simply technical arguments about constitutional wording or administrative efficiency. They believed something much more fundamental was occurring.

The Revolution had been fought, in large part, to escape a political economy built upon public debt, privileged finance and concentrated monetary power. Hamilton appeared to be rebuilding many of those same institutions under an American flag. The uniforms had changed.

The Architecture Looked Remarkably Similar

This is the point that often disappears from modern discussions.

Today’s debate is frequently reduced to Hamilton, supposedly the financial genius, versus Jefferson the romantic agrarian. That caricature misses the far larger question confronting the new republic.

What kind of monetary system had the Revolution been fought to create? Was America supposed to become a nation whose prosperity rested primarily upon production, saving and hard money?

Or would it gradually evolve into a society where government debt, banking and expanding credit became the organising principles of economic life?

Same Old, Same Old

My own reading of the period leaves me with an uncomfortable conclusion.

Hamilton did not complete the monetary revolution. He redirected it.

Many of the institutions that had dominated British finance before the Revolution gradually reappeared in American form. Permanent public debt became respectable. National banking returned. Government credit increasingly became the foundation upon which the financial system rested.

The monetary argument that many believed had been settled in Philadelphia was reopened almost immediately, and in truth it has never been settled since.

Seen From This Perspective, American History Begins To Look Rather Different

The First Bank, the Second Bank, Andrew Jackson’s banking war, the Civil War greenbacks, the creation of the Federal Reserve, the abandonment of gold, Bretton Woods and today’s debates over central banking and the dollar no longer appear as isolated episodes.

They become chapters in one long constitutional argument that has continued, with brief interruptions, since the ink dried on the Constitution itself.

That is why I have come to think of the American Revolution as unfinished. The military revolution succeeded beyond anyone’s expectations. The political revolution established history’s greatest constitutional republic.

The monetary revolution, however, never truly reached its destination. It merely entered a new phase, one that Americans are still debating two and a half centuries later.

So, What Exactly Are Americans Celebrating Today?

That is the question I have found myself asking as I worked through this seismic period of history.

Every Fourth of July Americans rightly celebrate the extraordinary courage, both moral and physical, of the generation that founded their great republic. They overthrew the most powerful empire on earth and produced arguably humanity’s greatest constitutional achievements.

But In the End, It Was About Much More Than British Rule

Yet I also wonder how many Americans appreciate that the Revolution was never simply a revolt against British rule.

It was also a revolt against something much deeper. It was a revolt against the political consequences of bad money, excessive debt, financial privilege and governments that had gradually lost control of their own finances.

The Founders experienced first-hand how monetary disorder corrupts politics, divides communities and eventually threatens liberty itself.

They did not learn those lessons from books. They buried friends, watched savings disappear, saw farms confiscated and lived through the social upheaval that followed monetary collapse.

That experience shaped almost everything they did afterwards.

The Formative Years

It shaped: 1) the Constitution and the debates between Jefferson, Madison and Hamilton. 2) the suspicion that many of the Founders held towards permanent public debt, banking privilege and paper money. 3) Above all, their conviction that sound money was not simply an economic preference. It was one of the foundations upon which constitutional government itself depended.

Whether they ultimately succeeded is another question entirely.

As I argued in the previous essays, Britain’s debt problems helped produce the Revolution. The Revolution itself produced inflation. Inflation produced Shays’ Rebellion, Rhode Island and the constitutional settlement.

The Names Change: But That Is About It

Almost immediately the country reopened the same monetary questions through the banking debates of the 1790s.

Since then, America has returned to these arguments repeatedly. The names change. The arguments never really do.

Groundhog Day

Once again, the United States finds itself carrying enormous public debts, questions are being asked about banking, money creation, trade deficits, tariffs and the future of the international monetary system.

Politicians are again promising the clever policies can postpone arithmetic indefinitely.

History offers very little comfort for that belief. Every society eventually discovers that monetary reality is remarkably patient.

It always waits.

Which Brings US Back to Independence Day

Perhaps the greatest tribute we can pay the Founders is not simply to celebrate what they achieved in 1776.

It is to remember what they were trying to prevent.

They understood that republics are not usually destroyed overnight. They decay slowly as financial discipline gives way to political expediency, as governments substitute promises for production, and as citizens gradually come to believe that prosperity can be printed rather than earned.

Will We Get It Right This Time?

Whether you ultimately agree with my interpretation or not, I hope these essays encourage you to reread the American founding with fresh eyes. I have certainly done so.

I began this long many year journey thinking the Revolution was about independence from Britain. I finished it realising it about the monetary questions that still confront America and the world two hundred and fifty years later.

The muskets have long since fallen silent. The monetary revolution, however, is still ongoing.

See bottom of the essay for detailed description of video.

Audio

Cutting To the Chase

1. China developed sophisticated monetary theory nearly two thousand years before economics became a formal discipline. Its scholars debated inflation, deflation, purchasing power, money supply, monetary circulation and the role of government centuries before many of these ideas appeared in the West.

2. The central Chinese monetary debate was never simply about inflation. It was about who should ultimately control money: the State or the people. That question remains largely unasked today.

3. Despite this sophisticated debate, Chinese dynasties repeatedly financed wars, grandiose projects and political promises by debasing the currency. History showed that governments can decree the value of money for a while, but they cannot decree confidence in it. Trust has to be earned.

4. Money debasement was a major, if not the major, factor in the downfall of successive Chinese dynasties, from the Han dynasty (206 BC–220 AD), through the Period of Disunion (220–589 AD), to the Sui dynasty (581–618 AD) and the Tang dynasty (618–907 AD).

5. Whenever governments failed to provide reliable money, ordinary people created alternatives. Grain, cloth and silk then. Cryptos now. Governments can create money. Markets create trust. Commerce has always found a way around bad money.

6. Monetary crises repeatedly reshaped Chinese political thought. Inflation and debasement came to be seen not merely as economic failures but as evidence that rulers were losing the Mandate of Heaven.

7. The Tang dynasty (618–907 AD) produced one of the most sophisticated monetary debates in history. Thinkers such as Zhang Jiuling, Yuan Jie, Du You, Liu Zhi and Li Ao examined inflation, purchasing power, wealth redistribution, deflation and monetary confidence at a level that still surpasses most modern discussion.

8. The shortage of money proved to be just as important as its debasement. Chinese thinkers recognised that an expanding economy required not merely sound money but enough money in circulation to support trade and taxation.

9. Flying Cash represented one of the greatest conceptual breakthroughs in monetary history. For the first time, purchasing power could move independently of the metal that represented it, paving the way for true paper money.

10. Perhaps the greatest lesson of two thousand years of Chinese monetary history is that human nature never changes. Governments continually face the temptation to finance wars, grand projects and political promises through the monetary system.

    The challenge is not simply to design good money, but to design institutions that limit that temptation.

Is Chinese New Year Really the Jewish Passover?

In the first of this series of essays on how ideas about markets and money developed throughout history, we met the man you probably wouldn’t ask to deliver the pre-World Cup motivational speech.

Let’s call him Motivation Man.

Well...he’s back. Only this time he has outdone himself.

He is claiming that the Chinese New Year may actually have begun as the Jewish Passover.

What?

Have a look at the video below or at least read the footnote in small print below.

Did you know that the Chinese New Year began as the Israelite Passover? Did you know that the red on the door posts and lintels of Chinese homes (now red paper) used to be blood-soaked paper, soaked with the lamb’s blood of the Passover Sacrifice? Did you know that Israelites settled in China shortly after the 10 Tribes were exiled by the Neo-Assyrians in year -721 (or 722 BCE)? Did you know that scattered Israelites also settled in Japan and Korea? Yes it is true. The Israelite Passover New Year combined with the seven-day Feast of Unleavened Bread became part of Chinese culture anciently, and today it is known as Guò Nián (過年). Now Guò Nián (過年) has been interpreted for centuries to mean “The Chinese New Year.” However, anciently it referred to these Israelite holidays. Notice how Guò (過), in Guò Nián (過年), in Chinese, means: “Passover.” And Nián (年) is the name of the destroyer that passed over at midnight the Chinese homes. Notice how the chief characteristics of “The Chinese New Year” and the Israelite holidays are very much the same. Notice how each takes place during the same time of the year. Notice how each has a ritual, thorough cleansing of the home the day before the holiday begins. Notice how both holidays go for seven days. Notice how each family has a special feast, with special foods, including unleavened cakes. But most remarkably, notice how both believe in a destroyer that passes by at midnight that night which killed their children and livestock. How did the ancient Chinese protect themselves from this destroyer? They put lambs blood from a sacrifice on their door posts and lintels of their homes. Later it became blood soaked paper, and today it is blood-red paper. They believed that a destroyer called Nián (年) passed by at midnight. And they needed to protect their children from that destroyer. Later they added firecrackers that they set off at midnight. But all these things point to the same foundational holiday. This ancient Chinese tradition was coined “The Chinese New Year” by foreigners who misinterpreted the observance and the Chinese character Nián (年). These foreigners assumed that the Chinese were speaking of the “passover” of the year, instead of the “passover” of the Destroyer. Over the many centuries, the Chinese had forgotten their Israelite heritage and the true meaning of the observance... BOOK LINK: https://a.co/d/gjHHXSO

Now, before everyone starts firing off emails, I should say that I genuinely have no view on whether this is true or not. I simply haven’t gone deeply enough into the evidence.

But Motivation Man has a habit of doing his homework, so I think it is worth investigating properly before dismissing it.

After fifteen years researching the historical part of my Treatise, I have accumulated a growing collection of these “that can’t possibly be right...but if it is, it changes everything” moments. Most turn out to be dead ends. A few don’t. But they all force you to think.

How Is This Relevant

You are probably asking what any of this has to do with the topic at hand.

The answer is...

Absolutely nothing. Well...almost nothing.

This essay is about Ancient China, and I thought I would share one of the more extraordinary rabbit holes I have stumbled across. Besides, there is some fairly heavy monetary lifting ahead, so why not begin with something that gets the brain working?

We Have Much To Learn From Chinese History

Whether Motivation Man is ultimately right or wrong is almost beside the point.

The deeper lesson is that ancient China still contains enormous areas that most of us in the West know almost nothing about.

The more I research it, the more I realise that China was debating questions about philosophy, government, commerce and money that would not appear in Europe for another thousand years.

Which brings us to the real subject of this essay.

China Was the First Civilisation To Develop a Theory of Money

While the West was still centuries away from developing anything resembling systematic monetary theory, Chinese scholars had already spent hundreds of years debating the origins of money, the nature of money, inflation, deflation, monetary circulation, state monopolies, private coinage and the proper role of government in the monetary system.

The fact is that Ancient China developed theories of money that, in many respects, surpass anything produced by modern economics.

They Avoided the Mathematics

I suspect one reason is that they never mathematised economics in the way the modern profession eventually did. Instead, they relied heavily on observation, logic and plain common sense.

Yet despite all this intellectual sophistication, it still didn’t prevent them from making exactly the same catastrophic monetary mistakes that brought down dynasty after dynasty.

Should Governments Be Involved At All

This is the heart of the debate in China for the past three thousand years. It really began in the Guanzi as the video correctly notes.

In China despite all the debate it was the state that was considered to be the rightful custodian of money.

Ironically, that is where the whole world is at right now but hardly anyone questions this. The debate, such as it is, hovers around the edges of central bank independence blah blah blah.

The real question is: shouldn’t the thousands of years of debate in the East, along with disaster after disaster in both the East and the West, lead people to ask the simple question the ancient Chinese asked: “what should be the role of the State when it comes to money”

The Question Nobody Asked

One aspect of the NBER paper that the opening video examines that struck me as particularly revealing, not because of what it says, but because of what it quietly assumes.

Throughout the paper, the authors catalogue the long history of Chinese debates over government monopolies, monetary management, state control of coinage, paper money and the unification of the currency.

These are all treated as competing schools of monetary thought.

Yet almost nowhere do they ask the prior question that later became central to Carl Menger and Ludwig von Mises: why should the state control money at all? The debate begins only after government authority over money is already taken for granted. The real question becomes not whether the state should manage money, but how it should do so.

Has Money Theory Regressed

Ironically, Peng Xinwei’s monumental Monetary History of China is, in one important respect, closer to the Austrian tradition than the NBER paper itself.

Peng repeatedly argues that money emerged naturally from expanding trade and exchange, with commodities such as cowry shells gradually acquiring monetary functions before rulers institutionalised them.

That sits remarkably close to Menger’s explanation of the spontaneous emergence of money and, ultimately, Mises’ Regression Theorem. The divergence comes later. Once money already exists, Chinese thought increasingly shifts its attention to how the ruler should regulate, standardise and control it.

In that sense, the great divide between the Chinese and Austrian traditions is not over inflation, paper money or monetary mechanics, Chinese thinkers understood many of these issues centuries before the West, but over a much deeper philosophical question: does money ultimately belong to the market or to the state?

Governments Wanted Decree But the People Wanted Trust

Remember the Guanzi. The Guanzi tradition, strongly associated with state management, treated money as a lever of rule. The ruler was to manage the balance between money and goods, stabilise prices and preserve order.

Yet the experience of debasement pushed many Chinese thinkers toward practical metalism. Full bodied coins with reliable metallic content came to be seen as the sign of prudent rule.

The state claimed authority over money, but the people still trusted metal.

This May Be a Touch Presumptuous Of Me

I am going on the assumption that there might be one or two of you out there who may need a little brushing up on your Ancient Chinese history. So, I will post short historical videos when we get to the various dynasties.

What is notable about the videos is that they rarely mention money. In my travels and research on the historical part of my treatise it is impossible to not cover the whole of society.

Money is one side of every transaction, so the money structure is the societal structure. Yet this is rarely acknowledged in normal historical accounts.

Where We Left Off

In the previous essay we left both Rome and Han China standing at the height of their power. Both would eventually collapse. The video above gives an excellent overview of the Han dynasty and even notes the remarkable Roman embassy that reached China.

I couldn’t help wondering whether they discussed their monetary systems.

Money in Han

The contradiction between the State and the people in regard to money became especially visible during the Han dynasty.

Emperor Wu of Han (156 to 87 BC), who ruled from 141 to 87 BC, restored the imperial monopoly over coinage and introduced extraordinary monetary devices, including deer hide money valued at 4,000 cash.

Kites Were the First Drones

Will the U.S. Dollar Last 700 Years

Emperor Wu issued the Wuzhu coin in 118 BC, which became one of the great standards of Chinese monetary history. It lasted for 700 years.

Not in the video below that Leo talks about the hole in the coin representing the unity between heaven and earth.

See what I mean about the connection of currency with the Mandate of Heaven.

The Salt and Iron Debate. It Is Exactly the Same Today. Ask New York.

Wu’s policies became central to the famous Salt and Iron debates of 81 BC, held under Emperor Zhao of Han (94 to 74 BC), who ruled from 87 to 74 BC.

This above video is good, but it missed one of the major issues in the debate: money.

Who Should Control Money? The State? Or the People?

In the Salt and Iron debate more than sixty Confucian literati challenged the state monopolies and argued that market discipline could maintain proper standards of weight and purity.

Their complaint was devastating. Officials and artisans stole from the profits of the mint. Coins were too thin or too thick, too heavy or too light. Farmers could not distinguish good coins from bad. Merchants passed off debased coins in exchange for good ones.

Trade was harmed, consumers suffered and the literati lost. Sadly, that might be the most familiar sentence in monetary history.

From then on, the principle of sovereign currency was rarely seriously challenged in China.

The state’s right to issue and manage money remained central. Even when critics attacked debasement, they usually did not break entirely from the assumption that the ruler had a duty to manage the monetary order.

The Han Fell. The Mandate Remained.

The defeat of the Confucian scholars in the Salt and Iron Debate (81 BC) did not end China’s monetary arguments.

It merely settled them for the Han dynasty (206 BC–220 AD).

By the final decades of the Eastern Han (25–220 AD), confidence in the monetary system had been badly shaken. The state’s monopoly over coinage increasingly concealed its own debasements while critics blamed private coiners instead.

They Debated Reducing the Money Supply

Wang Mang’s (c. 45 BC–23 AD) disastrous monetary experiments had demonstrated how quickly confidence in money could collapse, and although the Eastern Han restored the wuzhu coin, the monetary economy never fully regained its earlier strength.

Peng Xinwei even describes the monetary economy of the Eastern Han as appearing to be “in decay”, with cloth and grain once again assuming monetary functions as confidence weakened.

This deterioration profoundly shaped Chinese monetary thought. Debate increasingly shifted away from whether money mattered to how much money should circulate and who should control it.

Zhang Lin argued that money had become too plentiful because of its “cheapness” and proposed that taxes and market transactions should instead be conducted in cloth to withdraw coins from circulation.

Xun Yue (148–209 AD), by contrast, defended the continued importance of money, opposed abandoning coinage and argued instead for restoring a sufficient supply of sound currency.

At Least They Had a Debate

By the time the Han collapsed in 220 AD, China was no longer merely suffering political fragmentation. It was engaged in an increasingly sophisticated debate over inflation, money supply and the proper role of the state in monetary affairs, a debate that would continue for the next two thousand years.

The collapse of the Han dynasty marked one of the great turning points in Chinese history. For more than four centuries the Han had provided political unity, administrative coherence and a monetary framework that allowed trade, taxation and government to function across much of China.

Ideas Are Memes And Travel Through Time

The dynasty had inherited the intellectual legacy of Confucius (551–479 BC), the practical statecraft of the Guanzi (compiled c. 7th–3rd century BC), the standardisation efforts of the Qin dynasty (221–206 BC), and centuries of debate over the proper relationship between rulers, markets and money.

Yet when the Han finally disintegrated, those ideas did not disappear with it. Armies marched, warlords fought and kingdoms rose and fell, but the deeper assumptions of Chinese civilisation endured.

The Mandate of Heaven survived. So too did the belief that rulers were responsible for maintaining order and that economic stability formed part of legitimate government. The dynasty had fallen, but the intellectual framework that justified political and economic life remained remarkably intact.

Period of Disunion

The four centuries that followed became one of the most turbulent periods in Chinese history. Historians call it the Period of Disunion (220–589 AD), encompassing the Three Kingdoms (220–280 AD), the Western Jin (266–316 AD), the Eastern Jin (317–420 AD) and the Northern and Southern Dynasties (420–589 AD).

Rival courts competed for legitimacy, populations migrated, frontiers shifted and warfare repeatedly disrupted normal life. Political unity disappeared and, with it, the monetary stability that had gradually emerged under the Han.

Same Old, Same Old

Different kingdoms issued different currencies, regional rulers experimented with varying weights and denominations, and the temptation confronting every government was as familiar then as it is today.

Armies had to be paid, officials required salaries and ambitious public works demanded resources. Raising taxes was politically difficult so manipulating the currency seemed the easier solution.

Some rulers simply produced overvalued money. During the Three Kingdoms period, the Wei kingdom issued the daquan wushi, the “large coin of fifty”, whose official value bore little resemblance to the copper it contained. Similar experiments appeared in Shu and Wu.

Governments could proclaim what a coin was worth. Convincing the public was another matter altogether.

Cryptos Are Not a New Idea

Throughout Chinese history, ordinary merchants, farmers and craftsmen repeatedly demonstrated a practical understanding of money that often exceeded that of their rulers.

When official currencies became unreliable, people quietly searched for alternatives. Grain, silk and cloth increasingly assumed monetary functions alongside coinage.

This was not a sign of economic backwardness. It was evidence of economic adaptation. If governments failed to provide trustworthy money, society created substitutes.

Governments could issue money, regulate money and monopolise money, but they could not simply command trust into existence.

Trust had to be earned. The modern fascination with cryptocurrencies is simply another chapter in that very old story.

The Greatest Monetary Historian You’ve Never Heard Of

The great Peng Xinwei (1907– c.1967), referred to earlier whose Monetary History of China remains one of the great works on the subject, describes a monetary system slowly disintegrating alongside the political order.

It is about 1000 pages and very heavy going. I have gone through every word, and it features extensively in my Treatise.

It is a work of greater significant than anything that Friedman or Keynes ever produced.

Yet hardly any economist has ever heard of him.

The Cloth Crypto

During long stretches of the centuries during the period of disunion, official coin production virtually ceased altogether. In many parts of China, copper coins gave way once more to commodity money as confidence evaporated. As Peng observed:

“The land tax, bribes, relief of the distressed, salaries, loans, measures of value and instruments for making purchase and rental for carts were done in cloth.”

That quotation deserves to be read twice. Not just taxes or wages but even bribes were being paid in cloth.

Cloth had ceased to be merely another commodity. It had become the economy’s money.

Taxes were paid in it, salaries were paid in it, loans were denominated in it and commercial contracts increasingly relied upon it. The market had not stopped functioning.

Ordinary people had simply abandoned unreliable money and adopted something they trusted more.

They Even Debased the Silk and Grain. Ingenious When You Think About It.

Yet commodity money proved no more perfect than metallic money.

Peng records one of the most wonderfully human observations in the entire history of money when he notes that “people watered down grain and made thin silk for use in the market.”

Human nature had not changed.

Debase bronze coins and people clip the coins. Replace them with grain and they dilute the grain. Replace them with silk and they weave thinner silk. Every monetary system creates opportunities for fraud.

Human ingenuity simply adapts to whatever form money happens to take.

The Mandate of Heaven and Money Took Centre Stage

These centuries transformed the relationship between money and political legitimacy.

The Mandate of Heaven had always implied that rulers were responsible for maintaining order, but monetary stability increasingly became recognised as part of that responsibility. Inflation, debasement and monetary confusion were no longer merely technical failures.

They became signs that government itself might be failing. Earlier generations had emphasised morality, ritual and political virtue.

Increasingly, economic competence joined that list.

A ruler who could not maintain a trustworthy monetary system risked appearing incapable of fulfilling the duties that Heaven had entrusted to him.

The Lesson Became Unmistakable

Bad money produced social disruption. Social disruption weakened legitimacy. Legitimacy and monetary stability became inseparable. The state could proclaim the value of its currency, but it could not proclaim confidence. That had to be earned.

By the time China was reunited under the Sui dynasty (581–618 AD), four centuries of monetary experimentation had taught a profound lesson. Or did it?

Emperor Wen of Sui, Yang Jian (541–604 AD; reigned 581–604 AD), inherited an economy fractured by inflation, commodity money and competing regional currencies. His achievement was not simply military.

Step into the story of the Sui Dynasty, a brief but transformative period in Chinese history. After centuries of division following the Han Dynasty’s fall, Emperor Wendi reunited China in 589, bridging the north and south. Discover the Sui’s groundbreaking achievements, including the construction of the Grand Canal—a 1,000-mile waterway that revolutionized trade and unified the economy. Though short-lived, the Sui Dynasty laid the foundation for China’s future prosperity and global influence. Join us as we uncover how this pivotal era shaped the nation’s path to greatness!

According to Peng, by reducing palace expenditure and restoring fiscal discipline, he stabilised the currency after centuries of disorder. Contemporary accounts celebrated the recovery, declaring that “granaries and treasuries were overflowing” and textiles had accumulated until they “could have encircled the southern walls.”

The Grandiose Grand Canal (And Other Assorted Wars)

Yang Jian’s son, Emperor Yang of Sui, Yang Guang (569–618 AD; reigned 604–618 AD), embarked on, wait for it: 1) vast construction projects, including expanding the Grand Canal, 2) costly military campaigns and 3) extravagant public spending that overwhelmed the state’s finances.

Peng’s verdict could almost describe countless governments throughout history: “Naturally prices shot up... the higher went prices, the heavier became the people’s burden... there was nothing else for many people to do but go into the hills as ‘bandits’... later their numbers grew to several tens of thousands and then to over 100,000... they could no longer be defeated, and the dynasty subsequently fell.”

The Sui ruled for barely four decades, but their historical importance cannot be overstated.

They reunited China politically, rebuilt the imperial administration, restored communications between north and south and completed the Grand Canal, reconnecting the economic heart of the empire.

More importantly, they reunited the monetary system.

Once again there was a realistic prospect that a single government could oversee trade, taxation and coinage across the whole of China.

Tang Dynasty. What Glass Ceiling.

Again, in the short historical video below money doesn’t feature.

But It Was About Money

The Tang dynasty (618–907 AD) inherited far more than a reunited empire.

It inherited nearly a thousand years of monetary debate, four centuries of hard lessons about inflation, political fragmentation and fiscal collapse, and a rapidly expanding commercial economy.

The question confronting Tang officials had haunted China since the Warring States period (475–221 BC): if the state was responsible for preserving monetary order, how far should it intervene in the economy?

Who Needs Modern Theory

As we have seen, Chinese thinkers had been wrestling with the nature of money since at least the Warring States period.

One remarkable observation from the Mozi (c. 4th century BC) had already recognised that changes in prices could reflect changes in the value of money itself rather than changes in the underlying commodity:

“The (weight of the) King’s knife does not change, but the price of grain does. In a year when prices of grain change, it means a (corresponding) change (in the value) of the knives.”

Nearly a thousand years before Yuan Jie (719–772 AD) examined candidates on inflation, Chinese thinkers had already recognised one of the central relationships in monetary economics.

The Continuity Is Remarkable

If the commodity itself had not fundamentally changed, why had its price changed so dramatically? Chinese monetary thought had been building layer upon layer of practical observation for centuries.

Few dynasties have enjoyed a more glittering reputation than the Tang.

Poetry flourished under Li Bai (701–762 AD) and Du Fu (712–770 AD), Chang’an became perhaps the largest and most cosmopolitan city on earth, trade stretched along the Silk Road from Japan to Persia, and the imperial bureaucracy attracted some of the finest scholars in Chinese history.

A Revolution In Monetary Thought

Yet beneath that cultural brilliance lay an equally remarkable revolution in monetary thought.

Unlike earlier dynasties, the Tang left us not merely coins and official edicts but an extraordinary collection of essays, memorials, debates and examination questions.

For the first time we can watch identifiable individuals wrestling with inflation, taxation, money supply, credit and commercial development almost in real time.

The discussion becomes far more engaging because we know the names of the participants and can hear many of their own words.

Can We Reincarnate This Bloke Today

One of the first great voices of the Tang was Zhang Jiuling (678–740 AD), the distinguished chief minister under Emperor Xuanzong (685–762 AD). Zhang is remembered as a statesman of unusual integrity who repeatedly warned the emperor against corruption, extravagance and complacency during what later generations would regard as the high point of Tang prosperity.

His career illustrates an enduring feature of Chinese monetary history. Economic questions were never neatly separated from questions of political morality.

He Said What

For Zhang Jiuling, good government required restraint. Officials who spent recklessly or pursued personal enrichment weakened not merely the treasury but the moral authority of the dynasty itself.

Although his surviving writings ranged far beyond monetary affairs, they reflected the same conviction that had animated Chinese political thought since the Zhou dynasty (1046–256 BC): sound administration could not be separated from sound money because both ultimately depended upon the character of those entrusted with power.

They Held Those Ideas To Be Self Evident. Until…

Those ideas seemed almost self-evident while prosperity continued. During the early eighth century, the Tang Empire appeared stronger than ever. Agricultural production expanded, cities grew, domestic commerce flourished and international trade reached extraordinary levels.

Merchants carried Chinese silk, ceramics and metal goods across Asia while foreign traders brought horses, precious stones, spices and new ideas into the empire. The monetary system functioned so successfully that many officials regarded it as one of the dynasty’s greatest achievements.

History Has a Habit Of Exposing Complacency

In 755 AD, General An Lushan (703–757 AD), one of the empire’s most powerful frontier commanders, launched a rebellion that almost destroyed the Tang dynasty. The conflict lasted until 763 AD and ranks among the deadliest wars in human history.

Whether the death toll reached the highest modern estimates or not, there is little doubt that the rebellion shattered one of the world’s greatest civilisations and transformed China’s monetary debates from theoretical discussions into urgent practical problems.

Armies had to be supplied, cities rebuilt and refugees supported while tax revenues collapsed. Like governments throughout history, the Tang faced the same familiar choices: raise taxes, borrow or manipulate the currency.

Of Course, Make More Money

In 758 AD, while the rebellion still raged, new coinage was issued in an attempt to finance the war. Inflation followed, prices rose sharply and confidence in the monetary system weakened.

The episode became one of the defining monetary crises of Chinese history and is examined in much greater detail in the accompanying Substack essay, Want to Take an 8th Century Chinese Civil Service Exam?

One of the most remarkable responses came from Yuan Jie (719–772 AD), who had lived through the rebellion and its economic consequences firsthand. Rather than asking candidates to memorise doctrine, he required future officials to explain the mechanics of inflation itself.

In the 766 AD imperial civil service examination he posed the following question:

“Why if in past years a hu of grain was considered expensive at 400, has it been considered cheap at 500 cash in recent years? Why if in past years a bolt of cotton was considered expensive at 500 cash was it considered inexpensive in recent years at 2,000 cash?”

The brilliance of the question lies not simply in recognising inflation, but in recognising that different prices move by different amounts. Candidates were expected to think about purchasing power, monetary depreciation and relative prices rather than merely observing that everything had become dearer.

They Realised This a 1,000 Years Earlier

Nearly a thousand years earlier, the Mozi had already asked a remarkably similar question:

“The (weight of the) King’s knife does not change, but the price of grain does. In a year when prices of grain change, it means a (corresponding) change (in the value) of the knives.”

The Continuity Is Striking

From the Warring States period to the high Tang, Chinese thinkers repeatedly returned to the same fundamental question: if the commodity has not changed, what has happened to the money?

Long before economics became a formal discipline, Chinese scholars were already analysing inflation through changes in purchasing power rather than simply changes in prices.

Revisiting the Salt and Iron Debate

The monetary disorder following the An Lushan Rebellion also revived arguments that stretched back almost seven centuries to the Salt and Iron Debate (81 BC).

The Confucian scholars had warned:

“Officials and artisans alike steal from the profits of the mint. Some coins are too thin or too thick, too heavy or too light. Farmers cannot distinguish good from bad. Merchants pass off debased coins in exchange for good. Trade is harmed, and consumers suffer.”

The complaint sounds surprisingly modern. Monetary disorder rewarded dishonesty, undermined confidence and disrupted ordinary commerce.

Du You Get It

Among the greatest Tang officials was Du You (735–812 AD), who spent more than three decades compiling the Tongdian, one of China’s greatest institutional histories.

Unlike a chronicler interested simply in recording events, Du You examined how governments worked. Taxation, administration, military organisation and monetary policy formed parts of a single system because he understood that changing one inevitably affected the others.

His most famous observation captures that insight perfectly:

“Money is the fountain of all commodities.”

The Metaphor Is Powerful

A clean fountain nourishes everything flowing from it; pollute the fountain and every stream is contaminated. For Du You, sound money encouraged commerce to flourish naturally, while monetary disorder spread disruption throughout the economy.

Earlier writers, particularly those associated with the Guanzi (compiled c. 7th–3rd century BC), had emphasised the ruler’s power over money, arguing that he should possess “the sole authority over the ratios of exchange” and recognising that money “possesses no intrinsic value and cannot by itself satisfy wants and needs.”

Ask Not How But Should

Du You shifted the emphasis.

Rather than asking how governments could use money as an instrument of power, he argued that their first responsibility was to preserve confidence in the monetary system itself.

You Rarely Hear This Perspective Today

Liu Zhi (d. 659 AD) approached the problem from a different perspective. He was less interested in institutions than in how monetary policy affected ordinary people. His conclusion remains strikingly relevant:

“When money is plentiful, the rich grow richer. When money is scarce, the poor grow poorer.”

In a single sentence Liu Zhi recognised that monetary policy redistributes wealth.

Inflation, deflation and monetary scarcity do not affect everyone equally.

Long before economists began analysing the distributional effects of monetary policy, Tang thinkers understood that every monetary decision created both winners and losers, making money not merely an economic question but a profoundly moral one.

Fed Chairman Warsh Makes Exactly This Distinction

The Tang debates also recognised that inflation was only half the story. Li Ao (772–841 AD) argued that falling prices were not automatically beneficial. If prices fell because productivity increased, society became wealthier. If they fell because money itself had become scarce, the consequences could be severe.

Merchants delayed purchases, farmers struggled to sell their produce and economic activity slowed despite abundant goods.

It is one of the earliest sustained discussions of deflation anywhere in the world. Note the distinction between what causes the falling prices: productivity increases or declining money supply.

This is exactly the argument that the new Fed Chairman is making.

Few Monetary Debates Have Reached This Level Of Sophistication

Taken together, Du You, Liu Zhi and Li Ao demonstrate just how sophisticated Tang monetary thought had become. The debate had moved well beyond whether governments should mint more or fewer coins.

It had become a discussion about confidence, wealth distribution, inflation, deflation and the relationship between monetary stability and good government, the very issues that would shape China’s next great monetary innovation.

The Availability Of Money Was a Real Issue Though

The final great monetary reform of the Tang came under Chancellor Yang Yan (727–781 AD). His Double Tax Reform of 780 AD replaced the increasingly unworkable equal-field system with taxes assessed primarily on land and property and, crucially, payable in cash.

The reform recognised that China had become a far more commercial society than the institutions inherited from earlier centuries. At the same time, it tied the fiscal health of the state more closely than ever to the availability of money. A shortage of coin was no longer simply an inconvenience. It could determine whether farmers could meet their tax obligations at all.

The reform also exposed a problem that would dominate the remainder of the Tang dynasty. As commerce expanded, the demand for money grew far faster than the supply of bronze coins.

A Circulation Issue

Officials increasingly realised that the issue was not simply how many coins existed, but whether they continued circulating through the economy. Merchants, meanwhile, responded in the most practical way possible. Whenever official coinage proved inadequate, private alternatives emerged. Governments condemned them as challenges to imperial authority; traders regarded them as commercial necessities.

The tension between state control and market innovation became one of the defining characteristics of late Tang monetary history.

Long-distance trade revealed the problem most clearly. Transporting large quantities of bronze coins across China was expensive, cumbersome and dangerous. A successful merchant might need to move tonnes of coin merely to settle accounts in another city. As commerce flourished, the physical nature of money itself became an obstacle to further economic growth.

Markets Solved the Problem Before Governments Did

Merchants increasingly deposited coins with trusted agents in one city and received written claims redeemable elsewhere. Instead of transporting metal, they transported paper claims to metal. Contemporary observers identified four reasons this innovation spread so rapidly: chronic shortages of coin, local restrictions on exporting currency, the need to transfer tax revenues across the empire and the rapid growth of long-distance commerce.

This system became known as Flying Cash. The name itself captured its genius. Money no longer crawled across mountains in heavily guarded caravans; it appeared almost to fly. As one contemporary observer remarked, “goods flowed like water from a spring flowing downhill.”

Commerce had found a way to move purchasing power as easily as it moved goods.

The Law Of Unintended Consequences

Flying Cash was not yet paper money in the modern sense. It remained a remittance system backed by deposits of real coin. Yet the conceptual leap was enormous. For the first time, economic value could travel independently of the metal that represented it. After centuries spent debating coins, weights, debasement and inflation, China had taken the first decisive step towards an entirely new monetary age.

The next step would change not merely Chinese history, but the history itself in both the East and eventually the West.

It was the invention of true paper money.

Perhaps This Is the Real Lesson

Human nature is such that we organise ourselves into societies where those in control eventually need to extract the ‘sweat off the poor people’s brow’ for...well, you know the drill by now: wars, grandiose projects and looking after their own constituencies. Raising taxes is always unpopular. Manipulating the money is usually easier.

To do that, government will eventually need to resort to money debasement whatever form money takes.

This is why I reckon any monetary system worth having should be designed to limit that temptation. In my view, the only durable way to do that is to take the creation of money out of the hands of government altogether.

Footnote to opening video

THE CHINESE MONETARY REVOLUTION While Europe was largely operating on barter and rudimentary coinage, ancient China was developing a complex, multi-layered monetary system. By the 8th or 9th century, China had invented “flying money”—the world’s first paper currency, so light it could blow out of your hand. This wasn’t just a convenience; it was a state-controlled mechanism for revenue and taxation that eventually spread as far as Persia. KEY THEORIES EXPLORED: 1. The Quantity Theory of Money (800 Years Early) Western textbooks often credit Jean Bodin or later figures like Marshall and Fisher with the Quantity Theory of Money. However, Chinese scholar Lu Zhi (794 A.D.) clearly presented this version 800 years before Bodin. He argued that when the quantity of money is large, goods become “light” (cheap) and money becomes “heavy” (expensive), suggesting the government must expand or contract the supply to stabilize prices. 2. The Velocity of Circulation The scientist Shen Kuo (1077 A.D.) observed that the “benefits” of money come from its circulation. He calculated that if money stays in one household, its value is static, but if it circulates among ten households, its “total value” effectively multiplies. This insight preceded William Petty’s Western version by roughly 600 years. 3. Ancient Gresham’s Law Two thousand years before Thomas Gresham proposed that “bad money drives out good,” the Han Dynasty poet Jia Yi observed that debased, private coinage was causing undebased money to disappear from the market. 4. Nominalism vs. Metallism The sources reveal a sophisticated debate on the nature of money. The Guan Zi (c. 645 B.C.) argued for a nominalist view: money has no intrinsic value (you can’t eat it or wear it), but it is a “symbol of kingship” and a tool for the state to regulate the economy. THE BANKING PARADOX If China’s monetary thought was so advanced, why didn’t it produce the world’s first modern banks? The research suggests several cultural and structural factors: Family as Finance: The traditional Chinese family provided reciprocal economic aid, functioning as a “mini-bank” that reduced the demand for public financial institutions. Hoarding Culture: In an agricultural society, wealth was often hoarded in cellars as a “preference for fluidity,” which prevented the capital accumulation necessary for large-scale banking. State Monopoly: The government often kept a tight grip on coinage and loans, leaving little room for private financial innovation. GLOBAL IMPACT & THE MARX CONNECTION The influence of Chinese thought may have traveled the Silk Road. The original Hamburg and Swedish banks were actually modeled after Chinese systems, and the first Western paper money appeared in Sweden in 1661—centuries after China’s “precious notes.” Perhaps most surprisingly, Karl Marx explicitly cites the Qing Dynasty finance minister Wang Maoyin in Das Kapital. Wang’s theory on “token money” being backed by “real money” (convertible paper) remains a significant contribution to monetary history. SOURCE: This video is based on: Zheng Xueyi, Yaguang Zhang, and John Whalley. “Monetary Theory from a Chinese Historical Perspective.” NBER Working Paper 16092, National Bureau of Economic Research, June 2010.

Audio

Cutting To The Chase

1. The Iranian crisis marks the final end of the geopolitical order created after the collapse of the Ottoman Empire and later absorbed into the Anglo-American Rules Based International Order.

2. The debate over the Iranian MOU is really a debate about what kind of world comes next and who gets to shape it.

3. The Iranian Revolution started before the war. Iran’s crisis began before the war with hyperinflation, food pressures, severe water shortages and declining legitimacy. Hyper-inflation eventually results in a change to the political structure.

4. Those pre-war conditions are now far worse. That fundamentally changes how the MOU should be interpreted.

5. The real strategic consequence of the war may be that the world is now investing heavily in alternatives to the Strait of Hormuz.

6. Iran cannot rebuild its war economy and rebuild its society at the same time.

7. The MOU matters because it potentially offers a path away from war, inflation, shortages and economic collapse.

8. Any Iranian government that fails to fix money, food and water is unlikely to survive for long.

9. Beneath the geopolitical arguments lies the deeper issue of the monetary system that underpins the entire post-war order. The global monetary system is in a pre-collapse stage. Eventually everything built upon it changes as well.

10. The globalist world is collapsing before their very eyes. The Iranian crisis is therefore about much more than Iran.

Why Was James Bond British and Not American?

I know what you’re thinking.

“You idiot. Because Ian Fleming was British.”

Fair point. But there is something deeper going on.

Fleming (1908–1964) served in British Naval Intelligence during the Second World War and drew heavily on those experiences when creating Bond. Yet by the time the first Bond novel appeared in 1952, Britain was no longer the dominant power it had been when Fleming was born.

The United States had become the world’s leading economic and military power, while the old European empires were beginning to unravel.

Yet Bond’s world often suggested otherwise.

A Product Of His Time

In the Bond novels, Britain frequently appears far more influential than it really was.

But maybe not?

Bond operates at the centre of world affairs, British intelligence drives events and British officials are portrayed as indispensable.

The Americans are allies, but rarely the senior partner. The best example is Felix Leiter, Bond’s CIA counterpart. Leiter is capable, brave and likeable, but he is usually cast as Bond’s helper rather than his equal.

This was not how power was actually distributed during the Cold War. In reality, the CIA dwarfed Britain’s intelligence services in budget, manpower and global reach.

Perhaps that was part of Bond’s appeal. He represented a world many Britons wanted to believe still existed.

A world in which Britain remained at the centre of events.

Did Bond Reflect Reality?

The reason this matters is that we may be witnessing something similar today.

Many of the institutions, assumptions and power structures that emerged during the twentieth century are now being questioned.

Some may survive. Some may not.

But as with Bond’s Britain, there appears to be a growing gap between how some people imagine the world works and how power is actually being exercised.

When Did Bond and Leiter Go Rogue?

One of the more curious developments of the past decade has been the rise of the term Deep State.

Depending on who you ask, it has been linked to everything from COVID (see the extraordinary releases from a couple of days ago regarding Fauci and the intelligence agencies), to U.S. election interference, to intelligence operations in Ukraine and political warfare, particularly in the United States.

The Epstein affair has only intensified these suspicions, with many pointing to evidence of cross border intelligence connections, elite networks and unanswered questions that remain unresolved to this day.

There’s Something Deeply Disturbing About All This

What makes the discussion especially interesting is that this alleged Deep State appears to be cross-border.

British and American intelligence agencies seem to appear repeatedly in many of the claims, often alongside their Five Eyes partners.

In other words, Bond and Leiter are not operating on opposite sides of the Atlantic. They appear to be working together, as if they belonged to one organisation, just like in the movies.

But if such networks exist, who ultimately controls them?

Were They The Baddies From The Get Go?

The problem for ordinary observers is that we simply do not know where the truth begins and the conspiracy theories end.

There is enough public information, contradictions and unanswered questions floating around to leave many people deeply suspicious, but perhaps not enough to settle the debate conclusively.

What matters is not whether every claim is true. What matters is that trust in many of the institutions that underpinned the old order is deteriorating at exactly the same time as the geopolitical order itself appears to be changing.

Maybe the bigger question is not whether or when Bond and Leiter became the baddies.

It is whether the old order is prepared to go quietly.

The Empire That Drew the Map Is Gone

One of the most extraordinary aspects of the Iranian crisis is that it may mark the final end of the geopolitical order created after the collapse of the Ottoman Empire in 1918.

For more than a century, the modern Middle East has operated within a framework largely designed by Britain and France after the First World War.

He Even Looks a Bit Like Peter O’Toole

T E Lawrence 1888-1935 A portrait of T. E. Lawrence taken while serving as British Liaison Officer to Emir Feisal at the Versailles Peace Conference.

The borders of Iraq, Jordan, Syria, Lebanon and much of the wider region were drawn by imperial officials, diplomats and soldiers operating in the shadow of figures such as T. E. Lawrence.

For decades, Britain remained one of the central outside powers shaping events in the region, directly or indirectly.

Today, as one of the most significant crises in modern Middle Eastern history unfolds, Britain is not merely absent from the decision-making process.

Britain Is Now Barely Relevant To the Middle East

That is a remarkable historical reversal.

The British Empire helped create the modern Middle East yet now has almost no influence over its future direction.

The negotiations, power struggles and strategic decisions surrounding Iran involve the United States, regional powers, Pakistan, Russia, China and the Gulf states. London is largely a spectator.

In a deeper sense, this is also the final burial of the post-Ottoman settlement itself. The Ottoman Caliphate, which had dominated much of the Islamic world for centuries, disappeared in 1924.

What replaced it was an Anglo-French imperial order that shaped the region for the next hundred years.

That Order Is Now Breaking Down Before Our Eyes

Whether what emerges next is better or worse remains to be seen, but it will not be the world of Lawrence of Arabia, Sykes–Picot Agreement, or imperial Britain.

One suspects this reality is deeply uncomfortable for many of the foreign-policy establishments that grew up around the old order. Institutions such as Chatham House spent decades analysing, advising and often helping manage a Middle East whose basic structure emerged from the age of empire.

Britain Has Left the Arena

Yet the Iranian crisis demonstrates that the centre of gravity has shifted elsewhere. The map may still bear the fingerprints of the British Empire, but the empire itself has left the stage. What we are witnessing is not merely a crisis in Iran.

It is the final fading of a geopolitical architecture that has dominated the region for over a century.

Yet Britain’s decline in the Middle East is only part of the story.

The British Empire did not simply disappear and leave a vacuum behind. Leadership of the Western world gradually shifted from London to Washington. The institutions, alliances and assumptions that governed the post-war world were no longer British but Anglo-American.

If Lawrence of Arabia represented the creation of one order, then the Rules Based International Order (RBIO) represented the creation of another.

Why Does This Matter

RBIO is a term used to describe the system of institutions, agreements, norms and rules that emerged after the Second World War.

It includes bodies such as the United Nations, International Monetary Fund, World Bank and later the World Trade Organization, together with principles such as freedom of navigation, state sovereignty, international trade, treaty obligations and the peaceful resolution of disputes.

In theory, all countries operate under the same rules regardless of size or power.

The term is often contested because critics argue that the “rules” were largely designed and enforced by the Western powers, particularly the United States and its allies, after 1945.

Supporters view it as a framework that helped produce decades of relative stability and economic growth. Critics see it as an order that reflected the interests of the post-war Anglo-American establishment.

As a result, when people talk about defending or challenging RBIO they are often debating not just international law or institutions, but the broader distribution of power within the international system.

Whether one sees this as the decline of a Western-dominated system or simply the evolution of the international order depends largely on how one interprets the history of the last eighty years.

Cranks No Longer

The reason all of this matters is that even many of the people who helped build and manage this system are beginning to admit that it is under strain.

For years critics of globalisation, endless wars and the post-war order were dismissed as cranks, conspiracy theorists or extremists. Yet increasingly it is establishment figures themselves who are talking about rupture, fragmentation and the breakdown of old assumptions.

Carney, Mark Carney

This video below gives a terrific explanation of the state of affairs today. You will not see this type of analysis in the mainstream press. Now you don’t have to agree with them, but it does give a realistic explanation of what is happening.

It explains why so many from all sides of the political fence are hysterical.

Ahead of the G7 in Evian, Canadian Prime Minister Mark Carney warned of a “global rupture” as the post–Cold War rules-based order breaks down, a claim the episode argues was underscored by Donald Trump’s summit remarks suggesting Syria should handle Hezbollah if Israel cannot without “killing everyone else,” and criticizing Israel’s actions in Lebanon. The script says Trump’s approach reflects a sovereignty-based foreign policy that bypasses imperial proxies and multilateral institutions, highlighted by direct engagement with “the full spectrum” of the Iranian system to secure an Iran memorandum of understanding and by prioritizing Gulf leaders in public time. It argues the real target is dismantling the “terror premium” on oil tied to Strait of Hormuz threats, and portrays Europe’s Ukraine pledges as unfunded, citing Britain’s defense leadership resignations over lack of money, fueling Carney’s alarm.

You and Whose Army

Carney has basically conceded that the old order is dead. He admits that the RBIO is breaking down.

He even claims that some new G-something is emerging as a replacement world order. They still seem obsessed with confronting Russia. Talk about the Black Knight in Monty Python and the Holy Grail. Half the limbs are gone and he's still shouting, "Come back here and take what's coming to you."

But there is an even bigger question lurking beneath all of this.

Empires, alliances and international institutions do not float in the air. They are built upon economic and monetary foundations. If the post-war order is genuinely entering a period of decline, then we need to ask what made that order possible in the first place.

That takes us back to James Bond.

The Real Death of James Bond

The world is changing and basically James Bond is dead. I wrote a couple of weeks ago about the Death of Globalisation.

It is impossible to untangle the monetary and economic factors from the geopolitical “James Bond” globalisation issues.

This is because the monetary system sits underneath all of it.

The U.S. dollar as the world’s reserve currency is not merely a financial arrangement. It underpins trade, debt markets, military spending, sanctions, international institutions and much of the geopolitical architecture that emerged after 1945.

If that monetary foundation begins to crack, it should not surprise us that the geopolitical structure built upon it also begins to wobble.

Global Monetary System and Geo-Political Collapse

The monetary side is in collapse as I have pointed out on many occasions.

Coinciding with this is the growing strain on the geopolitical structure that has dominated the last eighty years. This does not mean the system disappears overnight.

It does mean that events which might once have been viewed as routine suddenly take on much greater significance because people begin interpreting them as evidence of either the old order’s survival or its decline.

That is why the reaction to the Iranian MOU has been so fascinating.

It’s No Longer Left Versus Right

But what is perhaps even more interesting is how different groups have reacted to it. Increasingly, the dividing line does not appear to be the traditional left-versus-right framework that dominated much of the twentieth century.

Instead, many of the arguments seem to reflect a deeper disagreement about whether the existing international order should be preserved, reformed or replaced.

For those still committed to the assumptions of the RBIO, the MOU often appears as a dangerous retreat from the responsibilities of the old order.

Putting the Kids In Harms Way

For others, particularly those with more nationalist sympathies, the question is much simpler: why should their sons and daughters be sent halfway around the world to fight and die in conflicts that appear to offer little benefit to their own country?

Why should taxpayers continue carrying the costs? And why should ordinary people be expected to sacrifice for a system that many increasingly believe no longer serves their interests?

That disagreement sits beneath many of the reactions we are witnessing.

This Brings Us To Iran

Check these essays I wrote on Iran before the war to get some perspective that I think many pundits are missing.

The note above contains the two pre-war essays.

They matter because they were written before missiles started flying and before the current crisis dominated headlines.

The central argument was that Iran already faced profound structural problems. The war did not create those problems. It merely accelerated them.

Here is the Cutting to the Chase section of the first.

Cutting to the Chase

1. From the outside, Iran’s unrest looks like a sudden reaction to currency depreciation. It is not.

2. The crisis is monetary and systemic. States resort to printing money when they can no longer fund war, grandiose projects, and elite protection openly.

3. Debasement looks painless at first, but inflation destroys purchasing power, erodes wages and savings, and distorts prices so badly that markets stop coordinating production and distribution.

4. Food shortages follow not because food disappears, but because inflation breaks price signals. Producers pull back, merchants hoard, imports stall, and shelves empty.

5. Grandiose projects lock in hidden costs. In Iran, massive dam building and water mismanagement turned drought into a water crisis and pushed food shortages into everyday life.

6. When prices lose meaning, production falters, shelves empty, and access to money, food, and water becomes uncertain.

7. When money, food, and water fail together, politics ends. What follows is survival, legitimacy collapses, and revolt becomes inevitable, as in France in 1789 and Persia in 1294.

This Changes Any Interpretation Of the MOU

The reason these pre-war conditions matter is that they fundamentally change how one interprets the MOU.

If Iran were a healthy, stable and prosperous country, many of the current arguments would look very different. But Iran entered this crisis carrying the burden of inflation, food pressures, water shortages and declining legitimacy. Any assessment of the MOU must therefore be viewed through the lens of those realities.

This also helps explain why reactions to the agreement have been so varied. People are not really arguing about the same thing. They are looking at the same event through completely different worldviews and arriving at completely different conclusions.

Which Category Are You In?

One pundit explained the array of reactions like this:

Israel: The regime should have been removed entirely. The MOU allows Iran to rebuild its war machine. It is a sell-out.

One Section Of The American Right: America is abandoning its responsibilities. If you start the job, you finish the job.

One Section Of The Left: America has failed once again. The MOU is simply evidence of that failure.

The Globalists: This was too important to leave to regional players and bilateral deals. The established international institutions should have been involved. The MOU demonstrates why the old system is still needed.

The American Working Class: Why should America’s kids be sent halfway around the world to finish the job? The nuclear issue appears to have been addressed. The oil can flow. Let the countries of the region sort out the rest. And by the way, the recent track record of “finishing the job” has been, to put it politely, mixed. A sizeable number in this group do not believe America should have attacked Iran in the first place.

The Countries Of The Region: The message is fairly simple. The future of the Middle East will increasingly be determined by the countries that actually live there. Not by London. Not by Brussels. And not necessarily by Washington either.

What is fascinating about all this is that each group can look at exactly the same MOU and reach a completely different conclusion. Some see weakness. Some see restraint. Some see failure. Some see opportunity.

That is why the debate has become so heated. People are not merely arguing about Iran.

They are arguing about what kind of world comes next.

The First Casualty of War: Reason

They say the first casualty in war is truth. Maybe in the age of the internet, we should change that to reason.

I do not think I have ever seen anything quite like the fact-free and often reason-free reactions to both the MOU and the events leading up to it.

What is fascinating is that each group is interpreting events according to its own view of how the world works. Some see a betrayal. Some see a retreat. Some see a victory. Some see the beginning of a new order. Others see the end of an old one.

But the Reactions Matter Even More Than the MOU

They reveal a world that no longer agrees on who holds power, how power should be exercised, what the international system should look like, or even whether the existing system deserves to survive.

And that takes us back to James Bond.

The old order still has its defenders. The question is whether they are defending a living system or merely a memory of one.

All They Are Saying Is Give the MOU a Chance

Emotions are quite high at the moment with each of the groups mentioned above going at it big time.

Things are very fluid but watch this interview with Vice President J.D. Vance.

He makes the obvious point that if the Iranians do not play ball with the MOU, then the Americans can go back at it.

Importantly, they will not get investment. They will not get money released. They will not get access to the economic benefits that would come from normalisation.

There Will Be Consequences. Apparently.

In other words, if they try and rebuild their war economy it is game over.

It is difficult to overestimate the importance of this point. Much of the current debate assumes the MOU somehow gives Iran a free pass.

Vance’s argument is the opposite. The agreement only works if Iran changes course. If it does not, then the economic consequences remain.

The Iranian People Might Get There First

As you will see below, I reckon that if they try and rebuild their war economy, they may not even need the Americans to step in.

The people might do it for them. Things are extremely dire on the economic front.

History is littered with examples of regimes discovering that hungry and thirsty populations eventually lose patience.

The Most Important Ship Of All Has Already Sailed

For almost five decades now the Iranians have held the world hostage to closing the Strait of Hormuz and choking the world economy.

Well, you only get to play that ace in the pack once and they have done it.

Regardless of whether they can do it again (and it increasingly appears they cannot), the really important point is that the rest of the world has now received a very powerful incentive to make sure they never have to worry about it again.

Iran and its proxy forces have successfully paralyzed the global supply chain, trapping thousands of cargo ships and creating a devastating geopolitical chokehold across the Strait of Hormuz and the Bab el-Mandeb strait. But the world is fighting back, not with weapons, but with unprecedented mega-projects. A new “Era of Corridors” is beginning, designed to completely destroy Iran’s maritime blockade. Discover the staggering $300 billion masterplan to bypass the Strait of Hormuz, including a massive 32-kilometer engineering marvel: a mega-canal cutting directly through the rugged Hajar Mountains of Oman to give supertankers a safe exit to the Arabian Sea. But that’s not all. The Middle East is rapidly building alternative escape routes, from the $17 billion Iraq-Turkey “Development Road” railway juggernaut to the maximum-capacity pipelines of Saudi Arabia and the UAE. However, breaking the blockade comes with a deadly risk. As these massive overland corridors and canals take shape, the threat of Iranian asymmetric warfare, kamikaze drone strikes, and cyber sabotage looms larger than ever. Watch this full geopolitical and economic breakdown to see how the $300 billion race to end Iran’s Hormuz trap is reshaping the map of the Middle East!

Surrounding countries have been and are now accelerating alternative routes as the video shows.

Why Cant the Pundits See This

That is the part many commentators appear to be missing.

This is not really about what Iran can do tomorrow. It is about what everybody else does over the next five or ten years.

Once hundreds of billions of dollars begin flowing into pipelines, rail corridors, ports and alternative shipping routes, the strategic landscape changes.

Let’s say Iran tries to rebuild the capacity to threaten the Strait again. We are talking years. By the time they get there, many of the alternatives may already be operational.

It will all be for nought.

The real ship that has sailed is not the oil tanker. It is the assumption that the world will forever tolerate being held hostage by a single choke point.

It’s The Economy Stupid

What seems to be missing from much of the analysis is the economic reality. Yet the economic reality is central to everything.

It is as if everyone has forgotten that the revolution started before the war. The unrest was not created by missiles and bombs.

It was created by a dire economic situation that had already pushed large sections of society to breaking point.

I have written four previous essays on Iran. Importantly, two of these were written before the war and two after.

That distinction matters because the analysis did not begin with the conflict. The conflict merely reinforced many of the conclusions that were already becoming apparent.

My conclusions from those essays were the following:

Pre-War

1. Iran was a war economy. The proceeds of the oil largely went to weapons and regional influence. Oh, and by the way, also to the elite, mainly the IRGC, who enriched themselves in the process.

2. The corruption also resulted in grandiose projects. Hundreds of dams were built, contributing to the destruction of the water table and creating not merely a water shortage but a potential national catastrophe, particularly during the current drought.

3. The war economy, the grandiose projects and the need to keep key constituencies happy resulted in chronic deficits despite extraordinary oil revenues.

4. Those deficits resulted in money printing and near hyperinflation. Once that happens, shortages of food and essential goods inevitably follow. A hungry and thirsty population is not a stable population.

5. Is any of this starting to sound familiar to regular readers of the histories of both East and West?

6. Notice I have not even mentioned religion. These patterns appear throughout history regardless of religion, ideology or philosophy.

7. These circumstances were ripe for revolution. The only uncertainty was how long the existing regime could hold on as the economy deteriorated and how much force it was prepared to use against its own people. Bound up in that uncertainty was the inevitable splitting of the ruling class into competing factions with different interests and different visions of the future.

Remember, all of this was written before the war.

Then the War Came Along

Well, we got the answer to point seven: “pre war, they could have held out for a very long time”. And vicious. The very fact that over 12,000 targets were hit shows you the extent of the war economy.

You don’t need any more proof that the oil revenues were going to the things we speak about ad nauseam: war, grandiose projects and looking after your constituencies.

This Brings Us Back To the MOU

The debate is often framed as if the only question is whether Iran deserves another chance. That is not really the question. The more important question is whether Iran has any realistic alternative.

A country suffering hyper-inflation, food pressures, water shortages, economic stagnation and declining legitimacy has fewer options than many commentators seem willing to acknowledge.

That is why the MOU matters. Not because it magically solves Iran’s problems.

But because those problems already existed before the first shot was fired.

The Iranian Government Will Not Survive If They Don’t Do This

Now things get interesting.

In my “You’re the New President” essay I looked at the budgetary position facing a post-war Iranian government and reached what I think is a fairly straightforward conclusion.

Iran can rebuild itself.

More importantly, it may have no choice.

The economic situation is now so severe that any government which fails to address the monetary crisis is unlikely to survive for very long. The issue is no longer simply economic. It is political.

Hyperinflation eventually becomes a legitimacy crisis.

And Legitimacy Crises Eventually Become Regime Crises

Here are my main conclusions from the article. I outline in detail how Iran can rebuild itself with its own revenues.

Cutting To The Chase

1. Iran’s real revolution began when the money system collapsed, not when the latest headlines appeared.

2. Once money stops functioning, commerce breaks down, social order weakens, and political change becomes a matter of time.

3. A fiat money system is not just bad economics. It is a hidden transfer of wealth from workers and savers in bank deposits to governments, banks, and their allies.

4. The first duty of a new government is therefore to free the poor from the tyranny of the fiat money system.

5. Iran is unusually well placed to do this because it has household gold culture, significant official gold reserves, foreign currency assets, and large oil revenues.

6. The right solution is not another stabilisation program. It is a full monetary reset in which gold and silver become the money and fractional reserve banking is banned.

7. The arithmetic broadly works. Small and middle depositors can be protected, larger balances can absorb the haircut, and the transition can be funded without using a single barrel of oil.

8. Once money is fixed, resources are allocated through real market signals rather than through inflation and credit distortion.

9. The Peace Dividend: The budget can then be rebuilt around oil revenues, allowing zero domestic taxes for citizens while redirecting wasteful state spending toward infrastructure, water systems, agriculture, and productive investment.

10. Fix the water system as well as the money system, and Iran does not just stabilise itself. It becomes a model for other countries facing their own versions of collapse.

A revolution in money could change the course of human history. Iran may simply be the first place where it happens again.

China, facing its own revolutionary pressures, could be next.

A Couple of Scenarios

The question now becomes fairly simple.

Can Iran escape the logic of the pre-war crisis?

Everything I wrote before the war kept coming back to the same issue. Iran was already facing monetary collapse, hyperinflation, food pressures, water shortages and declining legitimacy.

The war did not solve those problems. It made them worse.

The MOU matters because it potentially offers a path out of that crisis. The question is whether the regime takes it.

Scenario One

Iran attempts to rebuild the old system.

I struggle to see how this works. The old war machine took decades to build and consumed enormous resources. Recreating it would require money, foreign suppliers and time.

More importantly, it would likely trigger the very sanctions, restrictions and investment withdrawals that Iran is supposedly trying to escape.

I keep hearing figures of around $300 billion in potential regional investment. Maybe that number is wrong. Maybe it is lower. Maybe it is higher.

But the exact figure is not really the point.

Investors generally do not pour hundreds of billions of dollars into countries rebuilding military capabilities, playing cat and mouse with nuclear programs and sponsoring proxy conflicts.

In short, Iran cannot simultaneously ask for reintegration into the international economy while rebuilding the very structure that caused its isolation in the first place.

But There Is An Even Bigger Problem

Would the population tolerate it?

Remember where we started. Hyperinflation. Food pressures. Water shortages. A population already revolting before the war.

Now add the destruction and disruption caused by the conflict itself. A government asking its people to sacrifice yet again in order to rebuild the old structure may discover that the public has other ideas.

Scenario Two

Iran uses the opening created by the MOU to rebuild the economy rather than the war machine.

This is broadly the path outlined in my earlier essays. A thirsty and hungry population living through hyperinflation does not care much about geopolitical grandstanding.

It cares about food, water, jobs and functioning money.

Any government that wants to survive will eventually have to confront those realities.

Scenario Three

Iran attempts reform but a revolution happens anyway.

Probably the most likely scenario.

History is full of examples where reform arrives too late to save an existing political structure. The old regime loses legitimacy faster than it can rebuild confidence.

Political change follows even if the economic direction itself is broadly correct.

All Scenarios Eventually Lead To the Same End Point

That is why I keep coming back to the same conclusion.

The real question is not whether the MOU is perfect. It is not whether the current regime survives. It is not whether every faction gets what it wants.

The real question is whether Iran can escape the cycle of war, inflation, food shortages, water shortages and political instability that was already consuming the country before the war began.

Everything else is secondary.

My decision tree keeps leading me back to the same destination: a changed Middle East.

One way or another, the hundred-year-old order that emerged after the collapse of the Ottoman Caliphate appears to be running out of road.

A Regime Change Equivalent To Bringing Down the Roman Empire

Now that is a very big statement.

To be clear, that comes from the video below, not me.

But it touches on a theme that has run through this entire essay.

We started with the decline of British influence in the Middle East, moved through the strain appearing in the RBIO and ended up at the Iranian MOU.

The question is whether these are isolated events or signs of something much bigger.

Maybe It’s Not Mainly About Iran

That is why I found the video interesting. Its argument is not really about Iran.

It is that a deeper struggle is underway over who controls the institutions that shape nations, economies and foreign policy.

In that sense, the Iranian negotiations are just one piece of a much larger puzzle.

What if the real regime change isn’t happening in foreign governments—but in the institutions that shape governments themselves? In this analysis, Mike examines the deeper geopolitical struggle unfolding behind the Iran negotiations, the war in Ukraine, the growing crisis within Europe’s political establishment, and the battle over the future of the Federal Reserve. While much of the media focuses on military conflicts and diplomatic headlines, a larger question is emerging: who actually controls the direction of nations? From the Middle East and Eastern Europe to Washington and Wall Street, competing visions for the future of the international system are colliding. Mike explores how President Trump’s foreign and economic policies challenge decades of assumptions about war, globalization, central banking, and national sovereignty. The breakdown: • The hidden battle behind the Iran negotiations • Why JD Vance says direct diplomacy changes everything • The future of the Abraham Accords • Trump’s strategy in the Middle East • Ukraine, NATO, and Europe’s political crisis • Why European elites are losing support • Trump’s conversations with Putin and Zelensky • The growing debate over the Federal Reserve • Kevin Warsh and calls for policy regime change • Jerome Powell and the future of monetary policy • Why economic growth challenges the Fed’s assumptions • Alexander Hamilton’s vision for national banking • The relationship between sovereignty, production, and prosperity • What America’s future may depend upon From geopolitics and monetary policy to economic development and national renewal, this analysis explores the forces shaping the next chapter of American and global history.

The MOU Is Pis@#$# Off All the Right People

One of the reasons I find the reaction to the MOU so fascinating is that it seems to be upsetting people from all corners of the political spectrum.

That should probably not surprise us.

If the old order really is under strain, then those most invested in it are naturally going to react strongly when events move in a different direction. What we are witnessing is not simply disagreement about Iran.

We are witnessing disagreement about what comes after the RBIO.

I could go on forever about all this, but ultimately, I want to focus on the economics because that is where I think the real story lies.

It All Boils Down To the Fed

If the post-war order is changing, then sooner or later we have to examine the foundations upon which that order was built.

That brings us back to a familiar theme for regular readers: the monetary system. Throughout history, political systems, military systems and geopolitical systems have rested upon monetary systems.

Change the money and eventually you change everything built upon it.

There is much to agree with and disagree with in the video. I largely agree with the diagnosis. The monetary system sits at the centre of the problem, and the Federal Reserve sits at the centre of that monetary system.

Hamilton Is Not the Answer

Where I part ways is on the solution.

They, and it seems much of the Trump Administration, are heavily influenced by Alexander Hamilton’s vision of national banking.

That is where I get off the train. I dont think you can reform the system whilst maintaining the Fed.

In my view, the proposed “Hamilton” solution is still a version of the same monetary architecture that created many of the problems in the first place.

You Can’t Blame Them

Economics has spent generations struggling to incorporate money properly into free-market theory.

It is therefore hardly surprising that when people witness the devastation caused by inflation, debt expansion, financial crises and endless wars, the proposed solution often ends up being more of the same.

The only monetary system that genuinely restrains governments from the three great temptations of history: wars, grandiose projects and looking after politically connected constituencies is one in which governments cannot create money from nothing.

That means gold. That means silver. And that means a ban on fractional reserve banking.

That, ultimately, is why I believe the monetary system remains the most important story of all.

Cutting To The Chase

1. The current global economic order is losing legitimacy and no consensus replacement has yet emerged. That means ancient debates about authority, money and economic order are likely to return.

2. Before societies can justify markets, property rights or profits, they must first answer a deeper question: who has the legitimate authority to make the rules?

3. Both China and the West concluded that political authority should not be the highest authority. Rulers themselves were subject to judgement.

4. In China, this principle emerged through Shang Di, Heaven and eventually the Mandate from Heaven. In the West, it emerged through the Hebrew tradition, Greek philosophy, Natural Law and later Christianity.

5. Both civilisations developed mechanisms through which rulers could lose legitimacy when they violated a higher moral order.

6. Rome’s great contribution was not economic theory but institutions. Property rights, contract law and voluntary exchange became embedded in a legal framework that outlived the Empire itself.

7. China developed a different tradition. Economic life became closely connected to statecraft, monetary stability and the moral responsibilities of rulers.

8. Rome increasingly moved toward the idea that value emerges through voluntary exchange. China increasingly moved toward the idea that economic order must be maintained by morally responsible government.

9. Both civilisations discovered that money is never merely a technical matter. Monetary stability became linked to legitimacy, trust and social order.

10. Both Rome and China eventually learned the same lesson: when governments corrupt the currency, the damage extends far beyond economics.

11. Capitalism did not suddenly appear with Adam Smith. Its intellectual foundations were laid over centuries by philosophers, theologians, jurists, rulers and civilisations wrestling with much older questions.

12. To understand where the next economic order may be heading, we first need to understand how previous civilisations justified economic life in the first place.

How Two Civilisations Tried To Justify Economic Life

Last week’s essay dealt with the Death Rattles of Globalisation. I mentioned that as of yet there is no consensus replacement. My view is that the replacement order, by definition, will have a new world monetary order.

Debates that have been dormant for centuries will resurface. So, I reckon to get ahead of the game we need to reexamine the role of the State or some overarching authority in economic affairs.

And to whom do they report? Now that might sound like a strange question. Not really when you think about it.

Some Important Questions

Ask yourself these questions: To Whom do the World Economic Forum and other Globalist organisations report? To whom do the rule makers of the precious “rules based international order” report?

To whom will the creators of central bank digital currencies report? Indeed, to whom do current Central Banks (i.e. the creators of money) report? I have shown in numerous essays that, in their own minds, they don’t think they should report to anyone.

See What I Mean

These questions weren’t strange to the Ancients in the West and the East for thousands of years. In the West, the pinnacle of the examination of such questions was probably the Medievals. In the East, well arguably in around 1000 B.C.!

In short, these questions centre around what economic order should govern society and on what moral basis do you justify that order?

This will take a few essays folks. But believe me, the world will be discussing all these things again in the coming years.

Is the State the Highest Authority

Humans have been grappling with that since we first started forming ourselves into tribes and settling in one place.

We had the Mandate of Heaven. We had the Greek Polis. We had the Divine Right of Kings. The Communists wanted to get rid of God and religion because the State needed to be the highest power. You don't want the people thinking there is something above the State.

Yet for thousands of years those pesky subjects thought differently. The relationship between God and the State and the “rules of the game” is quite a story in human history.

Maybe you could say it is the story.

The Catholic Church Today

How did an institution that spent centuries defending private property, voluntary exchange, merchant profits, market prices and limits on political power become associated in many people’s minds with hostility toward capitalism?

And if that is the Western story, what was happening on the other side of Eurasia in China, where rulers, philosophers and officials were wrestling with the same questions, but often reaching very different conclusions?

Somewhere along the way, either the history was forgotten or the story was rewritten. Or capitalism itself has mutated into a Frankenstein monster.

The Protestant Work Ethic Theory? Not So Fast.

In the West, the popular version of events is familiar enough. Christianity, we are told, was deeply suspicious of wealth. The medieval Church supposedly viewed commerce with distrust, condemned profit, looked down upon merchants and generally stood in the way of economic progress.

Then came the Renaissance, the Reformation, the Enlightenment and finally Adam Smith (1723 to 1790). Europe shook off its medieval inheritance, embraced markets and capitalism was born.

Like many popular histories, it has the advantage of simplicity. Unfortunately, it bears only a passing resemblance to what actually happened.

Sorry Scots, You Weren’t As Important As People Say

The reality is both more complicated and much more interesting. Capitalism did not suddenly emerge in eighteenth century Scotland. Nor was it invented by a handful of secular philosophers who rescued Europe from religious darkness.

Long before economics existed as a separate discipline, generations of theologians, canon lawyers, philosophers, bishops and jurists were wrestling with questions that lie at the heart of every market economy.

The questions date back thousands of years. So sorry Scots, you were but a bit player in the whole drama.

Some Big Questions

What is property? Can one person legitimately profit by serving another? Is voluntary exchange beneficial to both parties? Who determines a fair price? Can rulers confiscate wealth whenever they choose? Is there a law above the state itself?

These were not abstract questions.

They were practical questions that emerged from everyday life.

Merchants needed contracts. Farmers needed secure ownership of land. Towns needed functioning markets. Kings and Emperors needed revenue. Churchmen needed to decide whether particular activities were moral, immoral or somewhere in between.

Meanwhile, Over in China

In a very different civilisational setting, ancient China was wrestling with its own version of the same questions. What makes rule legitimate? What does a ruler owe the people? What happens when taxes become unbearable, money collapses, famine spreads or trade breaks down?

Is political authority absolute, or can Heaven itself withdraw its support from a failed dynasty?

That is where the comparison becomes fascinating.

The West eventually developed a language of natural law, property, contract and voluntary exchange. China developed a language of Heaven, harmony, money, grain, taxation and dynastic legitimacy.

Both civilisations understood that economic life was never merely economic.

It Was Moral, Political and Even Cosmic

The answers given to these questions gradually accumulated over centuries. In the West, they eventually formed part of the intellectual architecture upon which capitalism would later stand.

In China, they formed one of the most sophisticated traditions of monetary statecraft the world had ever seen.

The remarkable thing is that neither outcome was inevitable.

The First Christians

If one had surveyed the early Christian world in the first, second or third centuries AD, there would have been little reason to predict that Christianity would one day become associated with a defence of markets and private property.

The first Christians were not economists. They were concerned with salvation, morality and man’s relationship with God.

Many expected the imminent return of Christ. Wealth was often viewed as spiritually dangerous. Merchants were frequently regarded with suspicion because they appeared to profit from exchange rather than production. Commerce itself could seem morally ambiguous.

It is difficult to imagine a less obvious starting point for a civilisation that would eventually justify capitalism.

Yet that is precisely what happened.

Early China

If one had surveyed early China during the Shang dynasty, also known as Yin, from roughly the sixteenth to eleventh centuries BC, there would have been little reason to predict that China would develop one of the most remarkable traditions of monetary thought in world history.

Shang China was not yet a developed monetary civilisation in the way later China would become. Productive life was still heavily agricultural, and evidence for large scale trade is limited.

Yet China would eventually become obsessed with money, coinage, taxation, grain, price stability and the fiscal duties of rulers. Its thinkers would produce early theories about the relationship between money and goods that sound startlingly modern.

Who Owns and Controls Money: The Ruler or the People

They would debate whether money belonged to the ruler or the people. They would see debasement not merely as bad policy, but as a sign that the ruler had violated the moral order itself.

China moved toward the moral burden of political and monetary order.

China’s story also begins long before its mature imperial system.

Shang Di, the Lord On High

Long before the full doctrine of the Mandate of Heaven emerged under the Western Zhou dynasty from 1046 to 771 BC, the Shang worshipped Shang Di, the Supreme Lord or Lord on High.

Shang Di stood above spirits and ancestors as the ultimate heavenly authority governing harvests, war, weather and the fate of dynasties themselves.

That matters because the later Chinese emperor was not merely a political ruler. He eventually became the Son of Heaven. His legitimacy was tied to a cosmic order that stood above him. If he governed well, Heaven favoured him. If he failed, Heaven could withdraw its support.

Defence of Voluntary Exchange in the West

The West moved toward the moral defence of voluntary exchange and the story begins long before Christianity itself.

Christianity did not emerge into an intellectual vacuum. It inherited ideas from the Jewish tradition, from Greece and from Rome. Some of those ideas pulled in very different directions. The history of Christian economic thought is therefore not the story of a single idea developing smoothly through time.

It is the story of competing traditions struggling against one another for centuries.

The Greeks Invented the name Economics But That Was About It

The Greeks provided part of the Western inheritance. Their contribution to philosophy was enormous, but their contribution to economics was fragmentary. There was nothing resembling a modern treatise on economics.

Observations about property, exchange and money appeared scattered throughout works concerned primarily with politics, ethics and philosophy.

If we are trying to understand how capitalism was eventually justified, we need to begin with the people who asked the questions long before anyone had heard the word capitalism.

The Greeks did not build a theory of markets in the modern sense, but they did wrestle with some very big issues. What is the ideal society? Who should rule? What role should property play?

And should the individual exist for the State, or the State for the individual?

Was Plato the First Fascist or Communist?

Nevertheless, two figures towered above all others: Plato (c. 428 to 348 BC) and Aristotle (384 to 322 BC).

Plato’s vision of society would be familiar to anyone who has studied the great collectivist movements of the modern age. In The Republic, written around 375 BC, he imagined an ideal state in which society was carefully organised from above.

Individuals existed primarily for the good of the community.

The rulers ruled, the soldiers fought and the producers produced. The emphasis was always upon harmony, order and collective purpose. Personal freedom occupied a distinctly secondary place.

Or So Goes the Superficial Interpretation

The video above is great viewing and addresses the modern-day lens on Plato.

As always, things are more complex. But what this video does is give you some feel for the debate to come.

Plato Believed the Ruling Elite Should Own Nothing. I’m Starting To Warm To His Ideas After All

How do you reckon that will go down amongst the Gazillionaires and Royalty (i.e. King Charles) at the WEF.

Not only that he believed they should live in dormitories in communal living whilst the average punter could own property and conduct business.

This is a total inversion of the WEF philosophy where you own nothing and the elites own everything.

Plato Was Right About the Questions But Wrong About the Answers

Although separated from us by more than two thousand years, there is something surprisingly modern about the superficial interpretation of Plato’s instincts.

Again and again throughout history, intellectuals have imagined that society’s problems could be solved if only sufficiently wise people were granted enough power to organise everyone else’s lives.

China had no exact Plato, but it did develop a political imagination that often shared his concern for harmony, order and morally guided rule. The comparison must not be pushed too far, but the family resemblance is there.

Both traditions feared disorder. Both believed political life required moral direction.

Both were deeply uncomfortable with the idea that private appetite should simply run loose.

But the Very Ancient Chinese Were Wary of the State

By the Western Zhou period, from 1046 to 771 BC, China had transformed the older Shang belief in Shang Di into the broader moral force known as Heaven, or Tian. This was not merely a change in religious vocabulary.

It was one of the most important political ideas in human history.

An Astonishing Idea

Heaven could grant legitimacy, but it could also withdraw it.

The Zhou had overthrown the Shang and needed to explain why their rebellion was legitimate. Their answer was the Mandate of Heaven, or Tianming. The ruling house held power only so long as it governed with virtue, nourished the people and maintained order in the realm.

That was an astonishing idea. It meant political authority was conditional. It meant that a dynasty could lose the right to rule. It meant that famine, rebellion, crushing taxes, corruption or monetary disorder were not merely unfortunate events.

They could be signs that Heaven had withdrawn its favour.

The Genesis of the Mandate Of Heaven

For modern readers, the Mandate Of Heaven often appears uniquely Chinese.

Yet a growing number of historians, theologians and scholars of comparative religion have pointed to some intriguing similarities between the earliest Chinese conception of Heaven and ideas more familiar from the ancient Near East.

I’m Not Hiring This Guy For A Pre World Cup Match Motivation Talk

The above video gives you an overview. You will see what I mean by the heading.

Long before Confucius (551 to 479 BC), long before the emergence of Daoism and centuries before Buddhism arrived in China during the first century AD, the Shang dynasty worshipped Shang Di, the Supreme Lord or Lord on High.

Shang Di stood above earthly rulers, governed the fate of kingdoms and acted as the ultimate source of authority. The king ruled, but he did not rule absolutely.

He remained subject to a higher power.

Was It the Same God?

This is where the comparisons begin.

In the Hebrew tradition, the God of the Old Testament also stands above kings. Kings are not themselves divine. They are judged according to standards they did not create.

Prophets can condemn them. Kingdoms can be punished. Legitimacy depends not merely on power but on conformity with a higher moral order.

Ancient Israel and ancient China developed in very different cultural and historical environments. There is no consensus that Shang Di and the God of the Old Testament should be treated as identical concepts.

Yet the parallels are striking enough that they continue to attract scholarly interest and popular discussion alike.

Were Xi and Trump Standing Before the Old Testament God

If so, then that certainly throws a cat amongst the pigeons.

I’m not going to weigh into the debate about whether Shang Di and the Old Testament God were one and same. It is way, way above my pay grade.

I really don’t know, but I have to say, the facts are interesting.

You Don’t Have To Be Religious To Be Fascinated By This

In fact, you could believe that religion is an invention of the mind and still wonder about how there can be such similarities between two ‘made up’ Gods.

You could also have the view, like many I know do, that even if religion is made up it does perform the task of making the rulers and the people subject to a higher authority and that can at times be a good thing in itself.

The fascinating question then is how and why did both the West and the East “invent” a seemingly identical higher authority independently.

Anyway, back to the task at hand.

Nonetheless, the Same Moral Conclusion

If you are wondering what any of this has to do with capitalism, quite a lot as it turns out.

Long before people debated markets, profits and private property, they debated legitimacy.

Who has the right to make the rules? Who judges the ruler? What limits exist on political power?

The answers given by China and the West would differ in important respects, but both traditions began with the same assumption: economic life could not be separated from a larger moral and political order.

More importantly for our purposes, both traditions arrived at a conclusion that would shape their respective civilisations for centuries. Political authority was not the highest authority. Rulers themselves were subject to judgement. There existed a moral order above the state itself.

That idea may ultimately prove more important than the theological differences.

Where Does Authority Come From

Whether expressed through the language of Shang Di, Heaven, Natural Law or the Western God, both civilisations developed mechanisms through which rulers could be measured against standards beyond their own commands.

The king, emperor or ruler was powerful, but he was not ultimate. Not because it proves anything theological.

But because it helps explain why the comparison between the Mandate of Heaven and Natural Law feels so natural. Both emerge from cultures that believed moral authority exists above political authority.

It Does Feel ‘Natural’ Though. I Wonder What the Globalists Think Of It.

Once that foundation is established, it becomes much easier to understand why both civilisations eventually developed ideas that allowed rulers to lose legitimacy when they violated the moral order.

Are you starting to ask yourself how the Globalist philosophy fits into all this.

In particular, how does the trans-humanist philosophies which seem to be part of a large portion (but not all) of the Globalists fit in with the thousands of years of inquiry in both the West and the East.

Aristotle Was All Over the Place. But He Was the True Father of Economics.

Aristotle was a far more complicated figure than Plato. Many later writers have attempted to claim him either for the free-market tradition or for its opponents.

Neither interpretation is entirely satisfactory because Aristotle often contradicted himself.

In some passages he condemned monetary exchange and money making as unnatural. In others he praised the network of reciprocal exchange that binds society together. At times he appeared deeply suspicious of commerce.

At other times he recognised its importance.

But He Supplied the Building Blocks for the Free Market

Despite these inconsistencies, Aristotle developed several ideas that would later prove extraordinarily influential.

He defended private property. He recognised that human beings act purposefully to achieve desired ends. He understood that individuals make choices based upon their circumstances and desires.

Buried within his broader philosophy were intellectual tools that later generations would develop into far more sophisticated theories.

Aristotle did not create capitalism. He did not even create economics. Yet he supplied building blocks that future thinkers would use in ways he never anticipated.

China Took a Different Path

At roughly the same broad ancient period, China was moving in a different direction. During the Eastern Zhou period from 770 to 256 BC, including the Spring and Autumn period from 770 to 476 BC and the Warring States period from 475 to 221 BC, political authority fragmented.

The Zhou king retained ritual importance, but real power shifted to competing states.

This fragmentation mattered enormously.

Like the Greek world of rival city states, China’s divided world produced political experimentation, warfare and intellectual brilliance. Confucianism, Daoism, Legalism and the texts associated with the Guanzi tradition all emerged in this atmosphere of intense competition and crisis.

China was not yet producing Aristotle’s kind of theory about private property or voluntary exchange.

It was producing something else: a theory of order. Its central problem was not merely how individuals exchange, but how rulers hold the realm together when money, grain, armies, taxes and ambition are all pulling in different directions.

Greek Thought Fractures

After Aristotle, Greek economic thought largely stagnated. The great age of the independent Greek city states was ending. Conquest, political fragmentation and imperial rule transformed the Mediterranean world. The old polis that had shaped Greek political thinking gradually disappeared.

Many philosophers responded to this decline not by developing richer theories of economic life but by retreating from it.

Schools such as the Cynics, active from the fourth century BC, and Epicureans, beginning with Epicurus (341 to 270 BC), often emphasised withdrawal from worldly concerns, the reduction of desires and personal tranquillity. The practical problems of commerce, production and exchange became secondary.

The Discovery of Natural Law

It was during this period of political and cultural change that one of the most important intellectual revolutions in Western history occurred.

The Stoics, founded by Zeno of Citium (c. 334 to 262 BC) in Athens around 300 BC, began as an offshoot of earlier philosophical traditions.

Yet they gradually developed ideas that would have profound consequences far beyond anything their founders could have imagined. Their most important contribution was not economic.

It was the concept of natural law.

The Hebrews Were Already There

To modern readers, natural law can sound abstract or theological. In reality, it was one of the most revolutionary ideas ever introduced into political thought. The Stoics argued that there exists a universal moral order rooted in the nature of reality itself.

Human beings can discover this order through reason. Because it is universal, it applies everywhere. It does not depend upon membership in a particular city, tribe or empire.

Of course, the Hebrews were already there on this concept, but the rest of what was to become known as the West certainly were not.

The Implications Were Enormous

For the first time, rulers themselves could be judged according to a standard higher than their own commands. A law was not automatically just simply because it had been enacted by a king, emperor or assembly.

Political authority was no longer the ultimate source of legitimacy. There existed a higher law against which political power itself could be measured.

East Meets West, Philosophically

Here the parallel with China becomes impossible to ignore.

The Stoic natural law tradition, from roughly the third century BC onward, and the Chinese Mandate of Heaven tradition, first articulated under the Western Zhou from 1046 to 771 BC, were not the same thing.

They emerged from different cultures, different metaphysics and different political worlds.

Yet both did something extraordinarily similar.

Both Placed Rulers Beneath a Higher Order

In the non-Jewish West, that higher order was expressed through reason, nature and eventually law.

In China, it was expressed through Heaven, virtue, harmony and the visible condition of the realm. If rulers governed unjustly, they could be condemned. If they destroyed social and economic order, they could lose legitimacy.

The Individual Human Not the State At the Centre

This represented a profound departure from much earlier thinking. Plato and Aristotle had both been deeply tied to the world of the polis. The Stoics, by contrast, were free to think in universal terms.

Their philosophy shifted attention away from the city state and toward the individual human being.

Human nature, rather than citizenship, became the foundation of moral reasoning. In doing so, they created an intellectual framework that would later become central to both Roman law and Christian thought.

China’s Mandate of Heaven also became a framework that outlived every dynasty that invoked it. The Zhou used it against the Shang. The Han, ruling from 206 BC to 220 AD, used it against the Qin, which ruled from 221 to 206 BC. Later dynasties would do the same again and again.

The particular dynasty could fall.

The Mandate remained.

Cicero: Law Existed Independently of the State. It Came From God(s)

The most famous Roman representative of the Stoic tradition was Cicero (106 to 43 BC). Living during the final years of the Roman Republic, Cicero absorbed Stoic ideas and helped transmit them into Roman political and legal culture.

He viewed justice as something that existed independently of rulers and governments.

Political authority was legitimate only insofar as it respected higher principles. At times he spoke of states acting little differently from bands of robbers when they abandoned justice and pursued power for its own sake.

That is not a small point.

Once rulers can be compared to robbers, political power has lost its immunity. It must justify itself. It must answer to justice. It must answer to something above itself.

Same Judgement in China

In China, the same kind of judgement took a different form. A ruler who failed to nourish the people, maintain order, restrain corruption, preserve money and keep taxes bearable could be said to have lost Heaven’s favour. He might still have armies. He might still sit on the throne. He might still issue decrees.

But morally, he was already finished.

These ideas would prove remarkably durable.

Rome Picks Up the Ball

The civilisation that ultimately carried the Western inheritance forward was Rome.

Rome’s contribution to the development of capitalism is often misunderstood because the Romans produced relatively little original economic theory. They were not economists. They were lawyers, administrators and institution builders.

Their genius lay not in abstract theorising but in creating legal frameworks capable of governing a vast empire.

Maybe We Should Revert Back to Roman Law

Roman law developed some of the strongest concepts of private property the ancient world had ever seen. Ownership was treated as a serious and enforceable right. Individuals could use their property, transfer it, sell it and contract with others regarding its use.

Closely connected to this was the development of sophisticated contract law. Agreements voluntarily entered into by individuals acquired increasing legal recognition and protection.

The Romans might not have written economics textbooks, but they built the legal machinery without which a commercial society struggles to function.

It Wasn’t Baked In

These developments might seem obvious to modern readers because we live within the civilisation that inherited them. Yet they were far from inevitable.

The notion that individuals possess enforceable rights over property, and that voluntary agreements should generally be respected, represented a major step in the development of a commercial society.

Secure property and reliable contracts reduce uncertainty. They encourage investment. They make long term planning possible. Long before anyone explained why markets functioned effectively, Roman law was helping create the conditions under which markets could emerge and flourish.

China Was On a More Collectivist Track

China during the Qin dynasty from 221 to 206 BC and the Han dynasty from 206 BC to 220 AD was doing something quite different. The Qin unified weights, measures, script and coinage under Qin Shi Huang (259 to 210 BC), who became First Emperor in 221 BC. The aim was not Roman style private law. The aim was imperial unity.

That distinction matters.

Rome’s legal genius increasingly protected private property and contract between individuals. China’s imperial genius increasingly standardised the tools of rule. Measures, roads, writing, administration and coinage were instruments for holding the realm together.

Rome Got There On Voluntary Exchange

Perhaps most importantly, Roman law increasingly recognised the legitimacy of voluntary exchange itself. If a buyer and seller freely agreed upon a price, that agreement generally carried considerable weight.

Hidden within this principle was an idea that would become one of the great battlegrounds of medieval economic thought.

The value of a good was not necessarily determined by an official, a ruler or a bureaucrat. It emerged through the interaction of individuals engaged in exchange.

That principle would survive the collapse of the Roman Empire and eventually find its way into Christian civilisation.

China Didn’t

China did not develop the same presumption. In the Chinese tradition, especially through the Guanzi and later Pseudo Guanzi material associated with the Warring States and early Han period from roughly the fourth to second centuries BC, money and prices were deeply connected to statecraft.

The ruler was expected to manage the relationship between money and goods in order to maintain balance.

As Yogi Berra Said…

This is one of the great forks in the road.

Rome leaned toward the idea that value could emerge through exchange.

China leaned toward the idea that economic order had to be managed by morally responsible rulers.

How Do Ideas and Norms Travel Through Centuries

The story of how Roman ideas survived is one of the most important and least appreciated chapters in the history of capitalism.

The survival of Roman law turned out to be one of the great mysteries of Western civilisation. When the Western Roman Empire collapsed during the fourth and fifth centuries AD, much of the ancient world disappeared with it. Cities declined. Trade contracted. Literacy fell. Political authority fragmented.

Looking back, it is easy to imagine the legal achievements of Rome vanishing along with the Empire itself.

That did not happen.

Rome’s Legal Gift To the Future

Two great compilations of Roman law ensured that a substantial part of Rome’s legal inheritance survived the collapse.

In the West there was the Theodosian Code, promulgated in 438 AD under Theodosius II (401 to 450 AD). In the East there was the far more comprehensive Corpus Juris Civilis, issued under the Christian Emperor Justinian I (482 to 565 AD) in the sixth century AD.

These collections preserved not merely legal rules but an entire way of thinking about property, contracts and exchange.

This mattered enormously because ideas often survive political institutions. Empires collapse. Laws remain. Centuries later people rediscover them, reinterpret them and build upon them.

That is precisely what happened in medieval Europe.

China Offers a Remarkable Parallel

Dynasties fell, but the Mandate of Heaven endured.

The Qin fell in 206 BC. The Western Han ruled from 206 BC to 9 AD. Wang Mang’s Xin dynasty ruled from 9 to 23 AD. The Eastern Han ruled from 25 to 220 AD. Then came the long period of disunion from 220 to 589 AD.

Through it all, the underlying logic remained. A ruler had to preserve order. A ruler had to maintain the livelihood of the people. A ruler had to control disorder in money, taxation and grain.

If he failed, Heaven’s support could be withdrawn.

The Romans Justified the Theory Behind a Just Price

One of the most striking features of the Roman legal tradition was its attitude toward voluntary exchange. Both the Theodosian and Justinian traditions generally treated the agreed price between buyer and seller as legitimate.

If two parties freely entered into a transaction, the law was reluctant to interfere.

Mere ignorance about the value of a good was not normally sufficient reason to invalidate a contract.

In other words, Roman law leaned heavily toward the principle that adults should be free to make their own bargains.

Central Bankers Should Take Note

Modern readers may struggle to see why this was significant. After all, voluntary exchange appears entirely normal to us. Yet throughout history many societies have been deeply uncomfortable with the idea that prices should emerge through bargaining.

Again and again rulers, philosophers and religious authorities have been tempted to determine what they believe a good ought to be worth. The Roman tradition stood largely against this impulse.

It recognised that value emerges through exchange itself.

China’s Tradition Was More Complicated

It did not lack markets. It did not lack merchants. It did not lack money. By the Warring States period from 475 to 221 BC, spade coins, knife coins, ring coins and other bronze currencies were circulating in different regions.

But Chinese monetary thought developed under the shadow of political unity and disunity. Fragmented coinage mirrored political fragmentation. Monetary unity became part of political unity. Stable money became part of legitimate rule.

Money therefore occupied a unique position within Chinese civilisation.

Money Was a Moral and Political Issue

Unlike modern economists who often treat money as a technical subject best left to experts, Chinese thinkers increasingly viewed monetary stability as a moral and political issue. Stable money promoted trade, prosperity and social harmony.

Unstable money undermined all three. A ruler who corrupted the currency was not simply making a policy mistake. He was potentially violating the very order that justified his rule.

The Qin standardised coinage after 221 BC. The Han experimented repeatedly with coinage after 206 BC. In 182 BC, the Han debased the Banliang coin by reducing its weight while retaining its nominal value. In 175 BC, the court had to restore part of the metallic content.

The pattern is painfully familiar.

Governments Do What Governments Do

Interestingly, the Romans arrived at a similar practical observation, even though they interpreted it through a very different intellectual framework.

Rome did not possess a formal equivalent of the Mandate of Heaven. The Romans inherited ideas about higher law through the Stoics, especially Zeno of Citium (c. 334–262 BC), and later through Cicero (106–43 BC), who argued that rulers themselves were subject to justice and natural law.

Yet Rome never fully embedded these ideas into its political structure in the way China embedded the Mandate into its understanding of dynastic legitimacy.

The Romans understood the importance of money better than almost any earlier civilisation. The Temple of Juno Moneta, from which we derive the words money and mint, became one of the centres of Roman coin production.

Rome built what was arguably the first great empire organised around a money economy.

Secure coinage, extensive trade networks, property rights, contract law and commercial exchange became central features of Roman civilisation. Commerce flourished because people could trust the legal and monetary framework within which it operated.

Yet Rome eventually discovered the same temptation that would confront countless governments throughout history.

When military expansion slowed and new sources of tribute dried up, expenditure continued to grow. Armies expanded. Bureaucracies expanded. Welfare programmes expanded. Public works multiplied. The state wanted more resources than taxation alone could easily provide.

The Response Was Familiar

The currency was progressively debased.

Silver content was reduced while face values remained unchanged. More coins could be produced but trust gradually disappeared. Prices rose. Economic calculation became more difficult. Trade suffered.

Eventually the government responded with regulations, controls and coercion in an effort to suppress the consequences of its own monetary policies.

The Chinese Would Recognise This

A Chinese observer would likely have recognised the pattern immediately.

Although the language differed, the underlying lesson was remarkably similar. Monetary disorder reflected political disorder. A government unable to discipline itself eventually corrupted the currency. A corrupted currency eventually undermined society.

The difference was that the Chinese interpreted this through the lens of Heaven and legitimacy. The Romans increasingly interpreted it through administration, imperial authority and state power.

Both civilisations therefore arrived at one of the great lessons of history.

Money Is Never Merely Money

It reflects deeper questions about power, legitimacy and the relationship between rulers and the ruled.

The Chinese asked whether a ruler still possessed the Mandate from Heaven.

The Romans increasingly asked how the state could preserve order and maintain authority.

The answers were different.

But both recognised that when money begins to fail, something much larger is usually going wrong.

This is where we are at today.

Cutting To The Chase

1. There is a new world order emerging. Concurrently, economics is entering a period of intellectual upheaval because the dominant theories of the last fifty years are failing in front of us.

2. The globalist economic order is losing legitimacy because large parts of the working and middle classes now see the system as rigged, unfair and unsustainable. They are right.

3. The problem is not free markets. The problem is the managed fiat monetary system built around central banks, artificial interest rates, debt based growth and intervention.

4. For decades, the establishment treated the foundations of this system as settled and dismissed the gold and sound money proponent critics of central banking as cranks or extremists. Cancel culture was rampant in economics long before it emerged in wider society.

5. That strategy is now failing because the debate itself is changing. Ideas once pushed outside the gates are returning to mainstream discussion after nearly a century in exile. For the first time in generations, the foundations of the monetary system itself are being openly questioned.

6. The deeper problem is Keynesian economics itself, which supplied much of the intellectual justification for activist government, managed demand, central banking and the interventionist state.

7. Keynes’s own record should make people far more cautious. Eugenics, the German “total state” preface, Bretton Woods arrogance and his shifting views during the 1931 crisis all undermine the sanitised textbook mythology.

8. Hayek saw the problem clearly. He later regretted not attacking The General Theory more forcefully because he assumed its flaws would be obvious and its influence short lived.

9. Keynesian economics fails basic logic, cannot be reconciled with sound money or genuine free markets, and survives largely because its contradictions went unchallenged for generations.

10. The old Keynesian monetary regime is now facing the serious challenge it avoided for nearly a century. The old consensus is dying, but a new one has not yet emerged.

    That is why everything feels so confused. The debate has finally arrived. Bring it on.

Economics Has Failed

Get the feeling we are entering a new world order on a number of fronts. I will try and stick to the economics as much as possible, but everything is intertwined of course.

There is lots to agree and disagree with in the above video depending upon what angle you are coming from.

What is indisputable is that economics has failed.

But Not Free Markets

That is not to say that markets have failed. It is not to say that entrepreneurship has failed. It is not to say that technology has failed. Living standards have risen enormously (for some but not others), innovation continues at a breathtaking pace, and free people continue to create extraordinary things.

What has failed is the intellectual framework that has guided much of economic policy for the past half century.

The theories that underpin central banking, fiat money, debt based growth, perpetual intervention and increasingly managed economies are producing outcomes that fewer and fewer people regard as either fair or sustainable.

The System Isn’t Working For the Working Class

The globalist system or so called “Rules Based International Order” of the past fifty years is not working for large sections of the working class in many countries.

Indeed, one of the great ironies is that much of what is described as a free market system bears little resemblance to a genuine free market at all.

The System Seems Rigged: News Alert, It Is

There is a growing sense that the system is rigged. Bailouts appear to flow upwards whilst losses flow downwards. House prices and asset prices rise faster than incomes. Wealth concentrates. Younger generations find themselves increasingly locked out of opportunities that earlier generations took for granted.

Trust in institutions continues to erode.

Regular readers will know that my own view is that the fiat money system sits at the centre of much of this. We do not live in a genuinely free market system. We live in a system dominated by central banks, fiat currencies, managed interest rates and repeated interventions that distort price signals throughout the economy.

To that extent, I would agree with much, though not all, of the video.

The Problem Comes With Proposed Solutions

My own solution remains relatively simple. Return money to gold and silver. Ban Fractional Reserve Banking. Reintroduce genuine market discipline into the monetary system.

If you do that, many of the other problems become far easier to solve. You probably need fewer tariffs because much of the distortion in global trade originates in the fiat monetary system itself and in the peculiar privileges attached to the U.S. dollar’s role as the world’s reserve currency.

That does not mean abandoning national interests. You still need sensible policies regarding national defence, strategic industries and critical supply chains. But many of the symptoms people are trying to treat today originate in a deeper monetary disease.

They Shut Down Debate. It Is Backfiring

The real problem is that we were not even having a serious debate about these issues. Until now that is.

Instead of examining the foundations of the current system, the establishment often responds by dismissing or marginalising those who question it.

The economic equivalent of cancellation has become remarkably common. Certain assumptions are treated as settled. Certain institutions are treated as beyond criticism. Certain questions are treated as evidence of extremism rather than curiosity.

That is not healthy. More importantly, it is becoming increasingly counterproductive.

The world is changing whether the establishment likes it or not. Questions that were dismissed only a few years ago are now being openly discussed in financial markets, in politics and even within parts of the central banking community itself.

The Old Consensus Is Weakening

The question is whether the system can be reformed whilst preserving the central banking framework that sits at its core.

I do not think it can.

We are at the beginning of a period of significant change, and the establishment is already circling the wagons.

This essay introduces some of the reasons why.

Fed Independence

I have written several articles on the issue of Fed independence. It is often spoken about as though independence is an end in itself rather than a means to an end.

The deeper problem is that there is no coherent theoretical justification for many of the powers that modern central banks exercise. Indeed, many economists have never seriously examined those foundations at all.

What is extraordinary is not merely the confidence with which these institutions defend themselves.

It is the lengths to which they will go when somebody dares question the assumptions upon which the entire system rests.

The Curious Case of Judy Shelton

She Was An Insider

Judy Shelton became one of the most controversial attempted economic appointments in modern American history when President Donald Trump nominated her in 2019 to serve on the Board of Governors of the Federal Reserve.

The significance of the nomination had little to do with her qualifications. Shelton possessed establishment credentials that would normally have made her an uncontroversial choice.

She had served at the Hoover Institution, advised presidential campaigns, represented the United States at the European Bank for Reconstruction and Development, and spent decades writing about monetary policy and international finance.

She was not an outsider to the system. She was an insider who had become increasingly critical of the assumptions upon which the system rested.

But She Did Have a Mind Of Her Own

What distinguished Shelton from most modern economists was that she was willing to ask questions that many regarded as settled.

She questioned whether money should have some form of external anchor. She argued that gold deserved serious consideration as a monetary reference point. She questioned federal deposit insurance.

Most controversially of all, she openly questioned whether central banks should possess the extraordinary powers they exercise today. Watch the interview below. She makes exactly the same points I have been making on the Fed’s debasement of the currency.

Rather than debating where interest rates should be set, she questioned why a handful of unelected officials should be setting the most important price in the economy at all.

Remember the unanchored current system only began in 1971 and the Fed only in 1913. And someone comes along and starts asking some questions that had been asked for thousands of years in the both the East and the West, and what happened?

Tut Tut, We Can’t Have That

For supporters of the existing monetary order, this was deeply unsettling.

A critic of modern central banking was now being considered for a seat inside one of the most powerful central banks in the world.

The reaction was swift.

There’s Something Off Putting About A Public Letter

In August 2020, no fewer than 130 economists, including seven Nobel Prize winners, signed a public letter urging the United States Senate to reject her nomination.

I don’t know about you, but my “self-important, pompous ass” radar is on full alert when people do this. There are not always wrong, but they are nearly always wrong. Sometimes they have downright evil intentions as in the Hunter Biden Laptop fiasco.

I mean what are they saying when they do these public letters?

Hey, I’m important and my views matter so me and my other self-important pompous ass buddies need to inform the ‘people’ of our views on a matter of intergalactic significance?

It also has some totalitarian tones to it. An indeed, this letter sure did, as we will see.

Oh, The Humanity: She Has Different Views

The wording of that letter deserves to be quoted directly because it reveals far more than its authors probably intended.

The economists wrote:

“Ms. Shelton has a decades-long record of writings and statements that call into question her fitness for a spot on the Fed’s Board of Governors.”

They then explained the basis of their objection:

“She has advocated for a return to the gold standard; she has questioned the need for federal deposit insurance; she has even questioned the need for a central bank at all.”

Diversity Good. Unless You Disagree With US.

The letter concluded:

“While we applaud the Board having a diversity of viewpoints represented at its table, Ms. Shelton’s views are so extreme and ill-considered as to be an unnecessary distraction from the tasks at hand.”

Read that again carefully. Shelton was not accused of corruption. She was not accused of incompetence. She was not accused of dishonesty. She was not accused of lacking qualifications.

Her apparent offence was that she supported gold, questioned deposit insurance, and questioned central banking itself.

Even the Unions Opposed Her: It Was An Organized Hit Job

The American Federation of Labor and Congress of Industrial Organisations (AFL-CIO) strongly opposed here as this letter shows.

What exactly was one of America's largest labour organisations doing taking a public position on the gold standard, deposit insurance and the theoretical need for a central bank? These are not traditional labour issues. Yet they found themselves repeating almost exactly the same objections made by the economics profession.

“Our opposition to Ms. Shelton’s nomination is based on her lack of commitment to Federal Reserve independence, her decades-long advocacy of returning to the gold standard, her opposition to federal deposit insurance, and her questioning of whether a central bank is even needed.”

Notice the wording. Say no more.

Workers: You’re On Your Own

This is exactly what was meant earlier about shutting down debate. Instead of engaging with Shelton's arguments, large parts of the establishment seemed to instinctively rally to the defence of the existing monetary order the moment its underlying assumptions were questioned.

In the case of the AFL-CIO, the position is especially reprehensible. The very monetary order they were defending has done enormous damage to the workers they claim to represent.

While asset owners have prospered, many workers have found themselves increasingly locked out of housing, squeezed by inflation and left behind by a system that socialises losses and privatises gains. Yet here was one of America's largest labour organisations rallying to the defence of that very system.

Gold Was Kryptonite

That wording is extraordinary because it treats support for gold as if it were some sort of intellectual kryptonite.

Yet gold formed the basis of monetary systems for most of recorded history. The Roman Empire used gold. Byzantium used gold. The great commercial republics of Europe used gold. Britain operated under a gold standard.

China used gold, silver and copper on and off for thousands of years. When the paper money system failed, they went back to the metals.

The Bretton Woods system itself was built upon a dollar convertible into gold. For thousands of years, gold was not regarded as an extremist monetary theory.

Gold was money.

The Sheer Hypocrisy Of These People

The obvious question therefore becomes: if support for gold is so extreme, why do central banks still hold it?

The timing of that question could hardly be more relevant.

Just days ago, the European Central Bank published a remarkable finding. According to its latest analysis of global reserve assets, gold has overtaken U.S. Treasuries to become the largest reserve asset held by central banks worldwide.

Click on the photo to see the report.

Why Then Is Gold Over a Quarter Of Central Bank Reserves

Gold accounted for 27 per cent of global official reserves at the end of 2025, compared with 22 per cent for U.S. Treasuries. The ECB also noted that central bank gold holdings are now approaching the levels seen during the Bretton Woods era, when gold stood at the centre of the international monetary system.

The ECB attributed the shift partly to the sharp rise in the gold price, but it also highlighted something more important. Central banks themselves have been significant buyers. Christine Lagarde observed that geopolitical tensions continue to drive demand.

I’m Waiting For the Public Letter

In other words, the institutions responsible for managing the world’s monetary reserves are not treating gold as a museum piece or historical curiosity.

They continue to regard it as a strategic reserve asset during periods of uncertainty.

That finding creates an awkward problem for the economists and former Federal Reserve officials who opposed Judy Shelton’s nomination. One of the central themes of the criticism directed at Shelton was that her interest in gold reflected an outdated and discredited approach to monetary policy.

Yet while Shelton was being portrayed as a monetary eccentric for discussing gold, central banks themselves were accumulating it.

But They Were the System

Many of Shelton’s critics were not writing from outside the system. Some spent decades working within central banks, advising policymakers or helping shape modern monetary doctrine. Throughout that period, they argued that advanced economies had moved beyond gold and embraced a more sophisticated monetary framework centred on fiat currencies and central bank management.

Yet the institutions they served behaved rather differently.

The contradiction is difficult to avoid.

The Shelton controversy looks rather different considering the ECB’s findings. The criticism often carried the implication that serious monetary professionals had moved beyond gold altogether.

Yet at precisely the same time, those professionals were overseeing institutions that continued to treat gold as one of the most important reserve assets in the world.

Apparently, gold is irrational enough to disqualify someone from serving on the Federal Reserve Board, but rational enough for central bankers to hold in greater quantity than U.S. Treasuries.

No explanation is ever offered for that contradiction.

With a track Record Like This, I’d Lay Low

The irony becomes even greater when one examines the actual record of the institutions whose defenders signed the letter. The economists wrote as though the superiority of the current system had already been demonstrated beyond doubt.

Yet the period dominated by central banking has given us the Great Depression, the inflationary collapse of the 1970s, the Latin American debt crises, the Mexican Crisis, the Asian Financial Crisis, the Dot Com bubble, the Global Financial Crisis, the COVID monetary explosion, and the inflation surge that followed.

And now of course the Great China Bust.

Meanwhile the United States dollar has lost more than 95 percent of its purchasing power since the Federal Reserve was created in 1913.

Intellectual Straw Houses

What makes the Shelton episode particularly revealing is that the signatories were not merely disagreeing with a policy proposal. They were treating the questioning of central banking itself as evidence of unfitness for office.

In every other intellectual discipline, questioning foundational assumptions is regarded as healthy.

Scientists question theories (though even that has changed). Historians question orthodoxies. Lawyers question legal doctrines.

Yet here more than 130 prominent economists effectively argued that questioning the institution itself placed Shelton beyond the boundaries of respectable debate.

Her Real Crime

That may ultimately be the most important lesson of the entire episode. Judy Shelton’s real offence was not advocating gold. Her real offence was reminding people that central banking itself is a relatively recent historical experiment.

Gold has thousands of years of monetary history behind it. The modern fiat system does not. The reaction to Shelton suggested that many economists were less interested in debating that proposition than preventing it from being discussed at all.

That is not usually the behaviour of a confident intellectual tradition.

It is more often the behaviour of one that senses its foundations are weaker than it publicly admits. It is also a very much totalitarian instinct.

Who Are You Mr. Warsh?

Kevin Warsh occupies an unusual position in the current debate. Unlike Judy Shelton, he is not viewed as an outsider challenging the monetary system itself. Unlike many recent Federal Reserve leaders, however, he has become increasingly critical of the post 2008 era of quantitative easing, balance sheet expansion and perpetual monetary intervention.

The difficulty for investors is that there remains considerable uncertainty about what Warsh would do if given control of the Federal Reserve.

His speeches often sound far more hawkish than those of recent Fed Chairs. He has repeatedly criticised excessive monetary expansion, warned about the dangers of inflation and argued that central banks have become too interventionist.

Yet he remains fundamentally a creature of the existing system. He is not proposing a return to a gold standard, a fundamental restructuring of the monetary order or any radical departure from the current framework.

They Are Still Trying To Work Him Out

As a result, opinions on Warsh vary widely.

Warsh matters because he is not an Austrian economist, a gold advocate or an outsider critic of the system. He comes from inside the establishment itself. When someone with those credentials starts openly questioning the consequences of quantitative easing, perpetual intervention and balance sheet expansion, markets pay attention. The debate is no longer confined to the fringes.

It is moving into the centre of the policy establishment.

Supporters see him as a genuine reformer who recognises the failures of the post 2008 regime and wants a smaller, more disciplined Federal Reserve.

But Will the Institutional Reality Win Out

Critics argue that any Fed Chair, regardless of their rhetoric, will ultimately be constrained by the realities of a highly indebted financial system and government sector. The debate therefore centres less on what Warsh says today and more on what the system itself would permit him to do once in office.

For now, the most accurate description may be that Warsh represents dissatisfaction from within the establishment. He clearly recognises many of the problems created by modern central banking, but whether he intends merely to reform the existing framework or fundamentally challenge it remains one of the most important unanswered questions surrounding a potential Warsh chairmanship.

The Green Shoots

A few years ago, the idea of Judy Shelton appearing on CNBC and declaring Keynesianism dead would have been almost unimaginable.

Here is the CNBC Squark Box interview of just a week ago.

Not because Shelton has changed. She has been making variations of the same argument for years. What has changed is the willingness of the financial establishment to even entertain the discussion.

For decades, Keynesian economics and activist central banking occupied a position of intellectual dominance. The debate was largely confined to arguments about how much intervention was required, not whether the underlying framework itself was sound.

Questions about fiat money, central bank discretion, perpetual stimulus and the long-term consequences of monetary expansion were often dismissed before they were seriously considered.

Today that confidence appears far weaker. The Global Financial Crisis, quantitative easing, COVID, the largest monetary expansion in modern history, the return of inflation and exploding government debt have all taken their toll. Questions that once sat outside the mainstream are now being openly discussed on mainstream financial television.

A Turning Point?

The irony is that many of those now questioning the system remain products of it. Kevin Warsh criticises excessive monetary activism. Shelton challenges parts of modern monetary orthodoxy. Yet both remain, to varying degrees, within the existing framework. They recognise many of the contradictions, but they are still searching for solutions from inside the structure that created them.

That is what makes this moment interesting. The old certainties are fading. The authority of the Keynesian consensus is no longer unquestioned. Yet no replacement consensus has emerged. The result is a growing willingness to revisit ideas and assumptions that were declared settled generations ago.

To understand how we arrived at that point, we need to go back to the man whose ideas came to dominate economic policy in the twentieth century: John Maynard Keynes.

Hayek on Keynes: “A Man With A Great Many Ideas Who Knew Very Little Economics”

Well Hayek didn’t hold back in this interview. More on that later. But it does seem that the signatories of the letter had this in common with Keynes when it came to economics.

Extraordinary arrogance.

Or as the saying goes, ‘Often wrong but never in doubt’

For nearly a century Keynes has occupied a unique position in economics. He is not merely regarded as an important economist. He is often treated as one of the founding fathers of modern macroeconomics itself. Yet aspects of his record that would likely dominate discussion of almost any other economist are often treated as minor historical footnotes.

Keynes Was a Proud Eugenicist

This was not a man who merely brushed against the eugenics movement. Keynes served on the governing council of the British Eugenics Society and, shortly before his death in 1946, became its Vice President.

Nor did he hide his views. In a 1946 address to the Society, he described eugenics as:

“the most important, significant and, I would add, genuine branch of sociology which exists.”

Those words are his.

By modern standards, few public figures could survive such an association. Yet most economics students graduate knowing more about the multiplier than they do about Keynes’s leadership role in a movement now associated with some of the darkest intellectual currents of the twentieth century.

The German Version of The General Theory

The controversy deepens further when one examines the German edition of The General Theory published in 1936.

The famous passage reads:

“Die Theorie der Gesamtproduktion, die das folgende Buch zu geben beansprucht, lässt sich viel leichter den Verhältnissen eines totalen Staates anpassen als die Theorie der Erzeugung und Verteilung einer gegebenen Produktion unter Bedingungen freier Konkurrenz und eines großen Maßes von Laissez-faire.”

The standard English translation is:

“The theory of output as a whole, which is what the following book purports to provide, is much more easily adapted to the conditions of a totalitarian state than is the theory of production and distribution of a given output produced under conditions of free competition and a large measure of laissez-faire.”

Notice something important. The phrase “totalitarian state” was used by later critics.

The original German phrase was: “totalen Staates”. Literally:“total state.”

Keynes chose those words himself.

The significance of this passage is often understated. Keynes did not write that his theory was more adaptable to a democratic state. He did not write that it was more adaptable to a constitutional state. He did not write that it was more adaptable to a welfare state.

He wrote that it was more adaptable to a “total state.” And he specifically contrasted it with free competition and laissez faire.

What Did “Total State” Mean

That choice of language matters because, in 1936, the phrase was not politically neutral.

The concept of the “total state” had already become closely associated with Fascist Italy and with German political thought.

It referred to a state whose authority extended throughout economic and social life rather than being confined to the limited functions traditionally associated with classical liberal government.

Sort Of Like Our System Today

Whether Keynes intended the phrase as a technical description, a political observation or something more is a matter of debate.

What is not open to debate is that he chose those words himself. He was not writing for an English audience decades later. He was writing for a German audience in 1936, at a time when discussions about the role of the state in directing economic life carried very different political overtones than they do today.

At a minimum, the passage reveals something important about Keynes’s own understanding of his theory.

He openly acknowledged that the framework set out in The General Theory was easier to implement in a highly interventionist state than under conditions of free competition and laissez faire.

Readers can decide for themselves what conclusions should be drawn from that observation.

But That’s Not All, You Also Get

There is another passage from the same preface that receives far less attention.

Keynes wrote:

“Ich habe mit Interesse festgestellt, dass die deutsche Literatur der letzten Jahre zahlreiche Elemente enthält, die dem Gedankengang dieses Buches nahe stehen.”

Translated:

“I have noted with interest that German literature in recent years contains numerous elements close to the line of thought of this book.”

Again, critics have asked the obvious question.

What German literature of the preceding few years was Keynes referring to in 1936?

Why the Bait and Switch?

Germany had been under National Socialist rule since 1933. Economic debate was taking place inside an increasingly controlled political environment.

Keynes was effectively informing German readers that strands of contemporary German thought contained ideas like those developed in The General Theory.

The usual defence is that Keynes was merely making a technical observation about economic administration. Perhaps. But that explanation immediately raises another question.

If this was simply a technical observation, why did Keynes make it only in the German preface?

Why does the English edition contain no comparable discussion of the adaptability of Keynesian economics to a total state?

A technical observation is either true or false regardless of audience.

The fact that the statement appears only in a special preface written for a German audience is precisely why critics continue to debate it nearly ninety years later.

He Would Be Cancelled Today For this Comment

During the Bretton Woods negotiations Keynes privately referred to the conference as:

“the most monstrous monkey house assembled for many years.”

Elsewhere he described: “the vast monkey-house at Bretton Woods.”

He also complained that: “The delegates of many of them have nothing to contribute and will merely encumber the ground.”

Taken individually, each of these episodes might be explained away. Together they paint a picture rather different from the sanitised version of Keynes often presented in undergraduate economics courses.

Friedman Was Treated Differently

The economics profession frequently presents Keynes as one of its greatest intellectual figures while treating these aspects of his record as historical curiosities.

For decades Milton Friedman was subjected to relentless criticism because he visited Chile in 1975 and met with General Pinochet. Critics portrayed this as evidence that Friedman was somehow morally compromised by association with an authoritarian regime.

Entire books, documentaries and academic careers were built around the claim that free market economics was tainted by its alleged connection to the Chilean dictatorship.

Yet the treatment of Keynes could hardly be more different.

The real issue is not whether Keynes should be cancelled. It is whether the economics profession applies the same standards to its own intellectual heroes that it applies to those who challenge the prevailing orthodoxy.

On that question, the contrast is becoming increasingly difficult to ignore.

Remember Britain Going Off the Gold Standard

Keynes is often presented today as the economist who possessed clear answers while everyone else stumbled through the crisis.

The reality was far messier. During the lead up to Britain’s departure from gold in 1931, Keynes repeatedly shifted his position on balancing the budget, defending sterling, and preserving the gold standard itself. His views evolved so rapidly under the pressure of events that historian Philip Williams later described Keynes’s interventions as “hopeless as policy advice in an emergency.”

This uncertainty makes Keynes’s later comments about Bretton Woods all the more revealing. Many delegates, in his view, had little to contribute and merely complicated the task of designing the postwar monetary order.

The irony is difficult to miss.

The same economist who had repeatedly changed his own position during the greatest monetary crisis of his age now appeared frustrated that so many other nations wished to participate in shaping the new system.

The episode reminds us that Keynes was not the omniscient figure portrayed in many textbooks. He was brilliant, often insightful, frequently inconsistent, and at critical moments deeply uncertain about the correct course of action. As the events of 1931 demonstrated, even Keynes himself was feeling his way through the darkness.

That version gives you the connection between the “monkey house” remarks and the broader theme that Keynes was not the steady hand of later Keynesian mythology.

Don’t Throw the Baby Out With the Bathwater

In my research on the history aspects of my Treatise across all the cultures you come across many people who have highly dubious views and behaviour in some aspects of life but have something important to say in other aspects of life.

Maybe we should cut Keynes some slack when it comes to the Eugenics stuff. Maybe.

You are still left with the issue whether, at the very least, someone who proudly and openly holds those views does suffer from some form of ability to logically reason.

That should therefore mean that their writings on other stuff should, be very closely examined for logic and sense.

The ‘F” Word

But it goes much further here. Forget the conclusion that some might draw that Keynes had some fascist tendencies.

We still have come to terms with the fact that the hero of many or most modern-day economists, including many of the pompous letter signatories, thought his theories were more suited to a totalitarian state.

I Thought They Were Sort Of Free Market Types

Why don’t they come clean and put out an open letter saying the very basis of their economic theory is more suited to a totalitarian state.

At least Keynes was semi honest in claiming it, albeit in the German edition only.

Or at the very least, can they tell us what revisions to his theory make it now more suited to a market economy?

And Therein Lies the Problem: His Theory Was Gibberish

You see in my Treatise I prove, yes prove, that Keyes economic theory is total gibberish.

Exactly what you would expect from an arrogant the Eugenicist with strong “total state” sympathies.

His theory fails the laws of basic logic on numerous levels.

The Austrian of course have be pointing this out for over 100 years.

So How Did and Do So Many Follow Him

Hayek’s later reflections on Keynes are remarkable because they reveal not fear of The General Theory, but rather a profound underestimation of its eventual influence.

Keynes

Looking back decades later, Hayek openly admitted that one of the greatest mistakes of his professional life was failing to mount a comprehensive response when Keynes’s book appeared in 1936. As he later put it:

“I should have written a review of Keynes’ General Theory. I have never fully regained the ground which I then lost.”

The reason for his inaction was not that he found Keynes intellectually overwhelming. Quite the opposite.

Hayek Thought It Was Gibberish As Well

In a 1983 interview, Hayek reflected on the extraordinary success of Keynesian economics with a mixture of disbelief and regret, stating:

“I did not think that this nonsense would become accepted as it did.”

That single sentence captures Hayek’s attitude perfectly. He believed that the flaws in Keynes’s analysis would be obvious to professional economists and therefore assumed the book’s influence would be short lived.

Instead, The General Theory transformed economics, academia, central banking and government policy throughout much of the twentieth century.

Hayek later concluded that by failing to challenge Keynes more directly at the crucial moment, he had allowed an intellectual revolution to proceed largely unanswered, a decision he regarded as one of the greatest strategic errors of his career.

In this interview Hayek claims that he didn’t expect the theory to be so successful. In the interview he bluntly states that Keynes basic premise had been refuted in the nineteenth century and the measure of a good economist was someone who understood that.

There You Have It

We are in the midst of profound change not only in policy but in economic thought and theory.

I reckon we are at the stage where there is growing acknowledgment that the current system is not fair and is not working, that the globalists at the WEF, Central Banks and other national and international organisations not only don’t know what they are doing but the very theory underling their world views are fatally flawed.

It is about to get very interesting.

Cutting to the Chase

1. The depression of 1920/21 was every bit as brutal as the early years of the Great Depression.

2. In 1920/21 the government largely allowed wages, prices, and resources to adjust. It cut, yes cut, government spending by almost half. There was no monetary policy response. Zero.

3. In the 1930s Hoover and Roosevelt repeatedly intervened to prevent that adjustment. Large infrastructure projects, increased government spending, and efforts to “work with business” were all designed to prop up the economy.

4. The Federal Reserve did not “do nothing.” It injected reserves, expanded credit, supported banks, and attempted to hold the system together.

5. The government went even further. It confiscated citizens’ gold and fundamentally changed the relationship between money, banking, and the state.

6. Policies were designed to support wages, prices, and weak institutions. In doing so, they delayed many of the adjustments needed for recovery.

7. The result was two completely different outcomes: one depression lasted roughly eighteen months, the other more than a decade.

8. Delaying economic adjustment does not eliminate the pain. It merely spreads the pain across years, destabilises society, and risks changing the political order itself. Think China today. Think of the world's economies still struggling with the distortions created before, during, and after the GFC.

9. The Great Depression became the defining battleground of modern economics, shaping the Monetarist, Keynesian, and Austrian schools that still influence policy today.

10. The depression of 1920/21 was largely forgotten despite providing one of the closest comparisons available to the Great Depression.

11. The obvious question is why. Why did economists spend nearly a century debating one depression while largely ignoring the other?

A Fascist Coup?

It is a mostly forgotten period of American history. Was it for real? No one will ever know but it does appear that there was ‘something there, there’.

I have written about what happens when an economy enters a severe depression and the inevitable political reaction. Democracy or not.

This is why it is important to understand the Great Depression. There are so many dimensions to it that are very relevant to today’s global economic and political structure.

Bottom line is that economic depression inevitably brings political change. It is almost a law.

But you know what country I reckon should take the most notice of this phenomenon?

China.

A Clockwork Orange Treatment

Every economist should be forced to watch the 15-minute video below. We might have to resurrect Stanley Kubrick so he could get them “comfortable” to ensure they watch it.

The reason is simple.

The Great Depression was not merely an economic event. It reshaped political systems around the world. It changed governments, empowered extremists, altered institutions, and left an intellectual legacy that still dominates economics today.

Yet economists almost never compare it with the depression of 1920/21.

They should.

Moving On From a War Economy

The depression of 1921 was about as bad as you could get. It is one of the clearest examples in economic history of a resource reallocation problem.

The First World War had left the American economy on a war footing. Entire industries had been organised around military demand.

When the war ended, those industries suddenly found themselves producing goods and services that consumers no longer wanted in the same quantities.

It Was Brutal

Land, labour and capital all needed to move into different activities more consistent with peacetime consumer preferences.

The adjustment was brutal. Industrial production collapsed by almost 30 percent. Wholesale prices fell by nearly 40 percent.

Unemployment surged. Hundreds of banks failed. Thousands of businesses went under. Deflation swept through the economy. By almost any measure, the downturn was severe.

Yet what happened next is rarely taught.

They Did What? They Didn’t Do What?

The federal government cut spending dramatically, reducing expenditures by almost 50 percent over two years.

There were no large stimulus programs, no bailouts, no attempts to prop up failing industries, and no major efforts to prevent prices and wages from adjusting.

And wait for this: there was no monetary policy. Federal Open Market Operations didn’t begin until 1922.

A Teachable Moment

The monetary and banking comparison is particularly revealing. During the depression of 1920–21, the money supply contracted by roughly 14 percent, wholesale prices fell by nearly 40 percent, and approximately one thousand banks failed over several years.

Yet the banking system itself remained largely intact. There was no nationwide banking panic, no collapse of depositor confidence, and no destruction of the deposit structure comparable to the early 1930s.

By contrast, the Great Depression saw the money supply collapse by roughly one third and nearly 9,000 banks disappear.

It Was Not Only About Money

Money contracted in both episodes. The difference was that the later contraction became a systemic banking crisis that destroyed deposits, credit relationships and confidence throughout the financial system.

The depression of 1920–21 therefore demonstrates that monetary contraction alone does not automatically produce a decade long depression. Something more was required, and in the 1930s that “something more” was the collapse of the banking system itself together with the broader interventions that prevented rapid adjustment.

Why Do They Tee Off On President Harding

President Warren Harding famously spent much of his time playing cards and golfing rather than trying to manage the economy from Washington.

Enthusiasts will want to watch the whole hour of the video below from well-known Austrian economist Tom Woods on the 1920/21 Depression. The rest of you should at least watch from the 19 to 26-minute mark. He talks about President Harding’s speeches.

Incredible stuff.

Those Were the Days

This was all before Keynesian and Monetarism. The days before people expected the Government to solve all their problems. Modern minds like ours wonder how on earth did Harding ever get elected saying things like that.

In fact, the rot was already setting in.

Herbert Hoover unsuccessfully urged President Harding to expand credit and undertake public works, proposals that Harding largely ignored. The economy was therefore allowed to adjust.

When I get to the late nineteenth century gold standard, I will address how culture matters. Clearly there were some remnants of that culture in the early 20^th century.

O.K. Then, What Was the Outcome

Remarkably, the economy recovered in roughly eighteen months from peak to trough.

Prices adjusted. Wages adjusted. Resources moved. Factories that had served wartime demand shifted toward civilian production. Capital was redirected. Labour found new uses.

The painful adjustment was allowed to occur and, once it had occurred, growth resumed.

This creates one of the most important questions in economic history. If the United States could suffer such a severe downturn from 1920 to 1921 and recover in less than two years, why did the next major downturn turn into a depression that lasted more than a decade? What changed in just eight years between 1921 and 1929?

That question sits at the heart of the debate between Austrian economists such as Mises and Rothbard and economists such as Friedman and Keynes. The answer they give is very different.

The Great Depression was not simply a larger version of 1921. Something fundamentally different had happened to the monetary and financial system during the 1920s.

An Antigravity Event

But something happened to ‘thinking’ as well.

In a very real sense shouldn’t the 1920/21 Depression be the most studied economic event of the past century or two. I mean things happened that modern economic theory suggests is not possible.

It is like witnessing an antigravity event and yet for the next hundred years it gets totally ignored by all physicists?

The difference in thinking, action and outcome between the two close proximity depressions is mind-boggling.

Why Was There a Great Depression?

We have lived through depressions many times in all cultures with a money system.

So, why was the 1930s depression so vicious? What distinguished it from many of the others? Particularly the very recent 1920/1921 depression.

O.K. my view which is very Austrian (mainly), is that there was a credit bubble induced by the Fed (so what’s new) and this resulted in the breakdown of the banking system. Again, so what’s new. I would also claim that ‘fiscal’ policy was also a major factor (see below).

The Friedmanites claim that the depression was deep because the Fed failed to save the banks when they could and should have.

I have shown in the past two essays that this is demonstrably not true.

The Fed did try and save the system.

The Austrian view is that by not letting the system clean itself out the Fed prolonged the adjustment. In the Austrian world view when there is a credit bubble, resources are misallocated.

In other words, land, labour and capital are put to uses that they would not be put to if left to the demands of the consumers.

Completely Different Economic Systems

Regular readers will know that I go on and on ad nauseam about how the money system matters because of what it means for the allocation of resources which is what economics is supposed to be all about.

Money is one side of every transaction, so the money system is really the economic system. In effect, so called free markets economies with different money systems are different economic systems.

That is, one based on gold and one based on fiat money with exactly he same structure otherwise will have a completely different allocation of resources. Yet you rarely if ever hear about economists talking in those terms.

What We Have Here Is a Failure To Adjust

In the above short video Rothbard sums up the Austrian position and what to do (or more accurately what not to do) in a bubble economy.

Therefore, the beginning of the great depression was really about the economy trying to move towards an allocation of resources more commensurate with consumers demands or preferences as economists like to term it.

This is what the Austrians means by the depression/recession being the cleansing process.

Still Some Big Unanswered Questions

Now if the monetary authorities try to intervene in that process than the adjustment will delayed or maybe not occur at all as in the Post GFC era.

Fine, this may get you to a long depression, but a Great Depression requires further explanation.

So why didn’t the market self-correct as it has done many times.

The recovery was so quick in 1920 that they didn’t even have time to implement the government programs supposedly required to fix it!

Sadly, in the 1930s the government did have time to implement their programs. And that along with their monetary response is what caused the Great Depression to be the Great Depression.

Hoover Was Not Laissez Faire

One of the great myths of the Great Depression is that Hoover was a do-nothing president devoted to laissez faire. This is one of the most durable pieces of historical nonsense in the entire story.

As we have seen above, Hoover had been preparing for intervention for years.

Despite all the evidence from 1920/21, he rejected the old view that recessions should be allowed to liquidate unsound positions and permit prices, wages and costs to adjust. He believed government should coordinate business, labour and finance to prevent contraction.

In this sense, Hoover was not the last of the old order. He was a bridge to the New Deal.

Don’t Trust Business Leaders

Hoover called White House conferences of business leaders, construction firms, utilities and labour leaders almost immediately after the crash. The industrialists pledged not to cut wages and were encouraged to expand construction.

This was not laissez faire. It was coordinated intervention.

Whoops: “As Far As We Are Concerned, the Depression’s Over” Henry Ford 1934

Henry Ford even announced a wage increase. Representatives of business were organised into committees to coordinate industry cooperation with the Hoover program.

Have a look at him in this video announcing the depression was over. In 1934!

Wages Are Prices

Hoover’s central doctrine was that wages should not fall. He believed high wages sustained purchasing power and therefore recovery. This was the “new economics” of the 1920s, and it became one of the central errors of the Depression.

The problem is simple. Wage rates are prices. They are not moral ornaments.

If product prices fall and wage rates are held up, real wages rise. If real wages rise above the productivity of labour in distressed sectors, employers do not hire. They lay off workers or refuse to expand employment.

Well, That’s a Surprise

That is exactly what happened.

Hoover and his supporters thought they were preserving purchasing power. They were pricing workers out of jobs. The employed workers enjoyed artificially high real wages, while the unemployed paid the price.

By 1931 some observers were pointing out exactly this distinction. The buying power of wages does not come from wage rates held up by political pressure. It comes from production. If wage costs are held above market clearing levels while prices and output fall, unemployment rises.

They Bragged About It

The American Federation of Labor understood what Hoover had done for them. William Green praised Hoover for maintaining wage standards and preventing general wage reductions.

Hoover himself boasted that employers had maintained established wages and distributed work among employees.

But distributing work is another way of distributing unemployment. If firms are pressured not to cut wage rates and not to dismiss workers freely, they reduce hours, avoid hiring, delay investment, and retain workers whose productivity may no longer justify the wage. This does not solve unemployment.

It hides and worsens it.

This Was the Free-Market Guy. Sure.

Hoover also expanded public works and encouraged utilities and railways to increase construction. He supported farm programs and price support efforts. He attacked short sellers. He pressed for restrictions on immigration, which he believed would reduce labour market pressure.

In 1930 he effectively reduced European immigration by around 90 percent through administrative action, partly to prevent wage competition.

Hoover’s 1932 program went even further.

He supported the Reconstruction Finance Corporation, broader discount eligibility at the Fed, a Home Loan Bank system, aid to Federal Land Banks, a Public Works Administration, loans to states for relief, weakening bankruptcy laws and additional measures to protect railroads and restrict competition.

This was the Hoover New Deal before Roosevelt’s New Deal.

Anything But Face Reality

The purpose was explicit: cushion liquidation, prevent bankruptcies, maintain wages and support credit. But liquidation was precisely what the economy needed after the artificial boom.

Not liquidation for its own sake. Not cruelty. Not indifference. Adjustment.

Bad debts had to be recognised. Malinvestments had to be written down. Wages and prices had to adjust. Resources had to move from bubble sectors to sustainable sectors. Instead, policy attempted to freeze the old structure in place.

This is why the Depression persisted.

Political Nationalism Emerges

Once the banking and reserve system came under pressure, countries increasingly turned inward. Governments facing rising unemployment and collapsing industries attempted to shield domestic producers through tariffs, quotas, exchange controls and various forms of economic nationalism.

Virtually all economists agree that Smoot Hawley mattered.

The story goes that it was a serious policy error and it worsened the contraction of world trade. It raised tariffs, encouraged retaliation, damaged export industries, harmed consumers and weakened the international division of labour.

To some it was the main cause of the Great Depression. Rothbard would disagree. He and the Austrians claim it was not the root cause of the Great Depression.

That Distinction Matters

Many mainstream accounts treat Smoot Hawley as though it explains everything.

It does not.

It cannot explain the monetary inflation of the 1920s. It cannot explain the reserve pyramid. It cannot explain the gold exchange standard. It cannot explain the stock market credit boom. It cannot explain wage rigidity. It cannot explain why the Fed’s reserve injections failed to restart the banking system, nor can it explain why the Depression persisted long after the initial collapse.

Tariffs worsened an already deteriorating situation, but they did not create the underlying monetary fragility that had been building throughout the 1920s.

This Is Subtle But Vital

In the Austrian construct the trade collapse should instead be understood as part of a much broader breakdown in the international order.

As I explain in my earlier essay below, I reckon even the Austrians miss the point here. Once you have a fiat money system there is no way of determining what is the efficient allocation of resources.

Moreover, no economic school of thought adequately deals with efficient allocation of resources, tariffs and trade at the country level with a fiat money system or even a gold exchange system.

It is impossible to overstate the importance of this. I only address some of the issues in my essay above. In time I will get to the rest of them.

Tariffs Matter But Not In the Way Most Think

The bottom line is that not only have we taken the wrong lessons from the monetary side of things but also from the trade side.

This is not to say that the tariffs did not contribute to the depression. After all tariffs require an adjustment of resources in both countries. In other words, all countries involved produce different things.

Price signals and resource movements take time. But if this new resource allocation is hampered by wage restrictions and other interference than the adjustment to the new tariff structure is hampered.

Thus, even if the tariffs were to result in a more efficient allocation of resources which is possible by not certain (it is not possible to say either way), the adjustment mechanism itself could contribute to the depression.

It Was (And Is) All Interconnected

The gold exchange standard intensified the problem because the international system had become built on layers of claims rather than final settlement. Countries were not simply trading goods. They were holding sterling balances, dollar claims and various forms of reserve assets tied to the banking systems of other nations.

I dealt with all that last week.

When confidence weakened, countries no longer trusted these layered claims in the same way. They increasingly wanted gold itself or domestic monetary protection. The system therefore became vulnerable to a general scramble for liquidity and reserves.

This is one reason why the Depression spread internationally with such force. The interconnectedness created during the 1920s boom became a transmission mechanism during the collapse.

International lending dried up, trade finance weakened, reserve movements intensified and countries increasingly defended themselves at the expense of the broader system.

Smoot Hawley accelerated that fragmentation, but it was not the original disease. It was part of the desperate political reaction to a system already beginning to fracture.

The Roosevelt Family and the Chinese Drug Trade

Roosevelt was and is a hero to many. As an FYI, his family background is interesting. This is not to say he was in any way involved but he was the product of an entitled class, and he never really did a day’s ‘work’ in his life.

This perhaps helps explain his extraordinary lack of understanding of how the free market works. To be fair, he did have lots of partners on that front, then and now.

When Roosevelt entered office in 1933, the United States was facing an extraordinary collapse of confidence. Thousands of banks had failed; unemployment was catastrophic and depositors had increasingly withdrawn currency and gold from the banking system.

He Didn’t Mess Around

The old structure was visibly disintegrating, and Roosevelt responded with an intensity that permanently changed the American monetary and financial system. See the table below for the sequence of “policies” initiated.

The banking holiday temporarily stopped the run on the banks. Gold confiscation addressed a deeper problem. As long as Americans retained the right to convert paper claims into gold, confidence in the banking system remained vulnerable.

Roosevelt first closed the banks, then closed the public’s escape into gold. Only after control of the nation’s gold had been secured was the dollar devalued from $20.67 to $35 per ounce.”

He Went To Church. I’m Not Sure He Heard God Correctly.

There is something about the music in these propaganda videos that cheers you up despite the desperate measures.

The banking holiday was one of the most dramatic admissions in modern financial history. The federal government effectively shut down the banking system to stop the runs and reorganise confidence.

This alone revealed something crucial about fractional reserve banking.

Banks appear liquid during periods of confidence because depositors do not simultaneously demand redemption. Once confidence collapses, however, the mismatch between reserves and liabilities becomes painfully obvious.

The system can no longer function normally without political intervention.

Executive Order 6102. It Sounds Like Orwellian Fiction. It Wasn’t.

Roosevelt’s administration moved rapidly to centralise monetary authority and reshape the banking structure. Gold confiscation became one of the defining moments of the era.

By Executive Order 6102, Americans were ordered to surrender monetary gold to the government, after which the dollar was devalued against gold.

This was not simply an administrative detail. It marked a decisive break from the older monetary order in which citizens retained direct claims on gold through the banking system.

See What You See

Before 1933, the promise was not hidden away in some government document or economics textbook. It was printed directly on the money itself.

If you look at a U.S. Gold Certificate, the note explicitly states that a specific amount of gold coin had been deposited in the Treasury and was “payable to the bearer on demand.”

Before 1933 the note promised gold. Afterwards it simply declared itself legal tender. That single change marked the transformation of the dollar from a claim on gold into a fiat currency.

1922 gold certificate

In other words, the paper in your pocket was a claim on real gold. An ordinary citizen could walk into a bank or the Treasury and exchange the note for the metal.

After Roosevelt’s gold confiscation and the suspension of domestic gold redemption in 1933, that promise disappeared from the notes. The paper currency remained, but the right to demand gold did not. The words printed on the money tell the whole story.

1934 note

Before 1933 the note promised gold. Afterwards it simply declared itself legal tender. That single change marked the transformation of the dollar from a claim on gold into a fiat currency.

Why?

The purpose of these actions was clear.

The government wanted to stop gold hoarding, halt redemption pressure, recapitalise the banking system through devaluation and free monetary policy from the remaining constraints imposed by convertibility.

Under a gold standard, excessive monetary expansion risks reserve losses and external discipline. Once gold ownership is centralised and convertibility weakened, the state gains far greater discretionary control over money and banking.

This is one of the central ironies of the Depression. A crisis produced in part by excessive credit expansion and reserve pyramiding eventually led to a system with even greater centralised monetary management. The old discipline was weakened in the name of stabilisation.

It Worked! Until It Didn’t

The creation of the FDIC similarly transformed the banking landscape. Deposit insurance reduced the likelihood of bank runs because depositors no longer feared immediate loss from individual bank failures.

In the short term this stabilised confidence and reduced panic behaviour. But the longer-term implications were profound. Once depositors believed the state would protect them, they had less incentive to monitor the soundness of banks themselves.

Market discipline weakened, while banks gained greater freedom to take risks under the protection of federal guarantees.

This Was Not Market Economy

The banking system became more politically stabilised, but also more dependent on state backing and less constrained by depositor caution. The reforms solved one instability while planting the seeds of another.

The New Deal also expanded intervention far beyond banking.

The National Recovery Administration attempted to reorganise industry through codes, production controls and managed cooperation between business, labour and government. Competition increasingly came to be viewed not as a mechanism of adjustment but as a threat to stability.

Falling prices and wage competition were treated as destructive forces rather than necessary elements of correction after the boom.

A Major Shift In Economic Philosophy

Earlier depressions had generally allowed substantial price and wage adjustment.

The New Deal increasingly attempted to prevent those adjustments through political coordination and intervention. Industries were encouraged to maintain prices. Labour bargaining power was strengthened. Production controls and cartel like arrangements spread through parts of the economy.

The Wagner Act reinforced these tendencies by strengthening organised labour and collective bargaining. Real wages remained elevated relative to depressed market conditions, particularly in industries already weakened by falling profitability and overcapacity.

This became one of the least understood features of the Depression.

This Is Why Economic Theory Has Real Life Consequences

The issue was not simply that wages were “too high” in some moral sense. The issue was that wage rates are prices within the economy.

When product prices collapse while wage rates are politically supported, real labour costs rise. Employers facing falling revenues and uncertain demand become less willing to hire additional workers. The result is persistent unemployment.

This helps explain why unemployment remained extraordinarily high throughout much of the 1930s despite monetary easing, public works and repeated government intervention.

The system was not being allowed to clear. Prices, wages and resources remained partially frozen by attempts to preserve existing structures and living standards created during the boom years.

O.K. Then, Explain This

The recession of 1937 to 1938 is one of the most important episodes in the entire Depression era because it undermines several of the standard explanations simultaneously.

By that stage, the United States had already abandoned the old gold framework, confiscated gold, devalued the dollar and dramatically expanded monetary discretion. The banking system had been stabilised politically through deposit insurance and broader federal involvement.

Yet despite all of this, the economy suffered another severe contraction.

Industrial production collapsed by approximately 32 percent from peak to trough. Unemployment surged back toward 19 percent. Financial markets weakened and confidence deteriorated. The recovery that had appeared underway suddenly looked fragile and incomplete.

This episode matters enormously because it cannot easily be blamed on the gold standard. The United States had already moved far away from the old convertibility system by 1933.

Not So Fast

Nor can it be explained by a collapse in the money supply comparable to the early thirties. Between June 1937 and June 1938, M2 fell only modestly, by roughly 3 percent.

Yet industrial production collapsed by more than 30 percent.

That mismatch is one of the most important facts of the entire Depression. If a relatively small decline in the money supply was associated with such a dramatic collapse in economic activity, then the recession cannot be explained by money alone.

Unresolved Problems

Many of the deeper structural problems remained unresolved. The distortions created during the twenties had never fully liquidated. Regulatory uncertainty remained high. Business investment remained cautious.

Government intervention had repeatedly changed the rules of the system, making long term calculation more difficult. Most importantly, labour markets remained rigid.

The Economic Heavyweights Go Head To Head

This is where Rothbard’s interpretation differs sharply from Friedman’s. Friedman focused primarily on the monetary side of the downturn and argued that the Federal Reserve should have expanded more aggressively.

Rothbard argued that government intervention had repeatedly prevented markets from adjusting, particularly through policies designed to maintain wage rates above market clearing levels.

In his view, this was one of the principal reasons why unemployment remained persistently high throughout the Depression.

Look At the Wage Rate Increases

The wage issue became particularly important during 1937.

After the Supreme Court upheld the National Labor Relations Act, union power expanded rapidly and money wages rose sharply. Rothbard notes that money wage rates increased by approximately 13.7 percent during the first three quarters of 1937.

For businesses still operating in an uncertain environment, this represented a significant increase in labour costs at precisely the moment when the recovery remained fragile. Firms do not hire workers because reserves are abundant.

They hire workers when the expected return from employing labour exceeds the cost. When wage costs rise sharply while profits remain uncertain, hiring and investment become more difficult to sustain.

What Was the Fed Up To?

At the same time, Federal Reserve officials were becoming increasingly concerned about inflation. Massive gold inflows following Britain’s departure from gold and the continuing European monetary crises had created enormous excess reserves within the American banking system.

Policymakers feared that these reserves represented inflationary fuel waiting to ignite another speculative boom.

As a result, the Fed doubled reserve requirements in three stages during August 1936, March 1937 and May 1937.

For central reserve city banks, reserve requirements on net demand deposits rose from 13 percent to 26 percent. Reserve city banks saw requirements rise from 10 percent to 20 percent, while country banks rose from 7 percent to 14 percent. Time deposit requirements also increased from 3 percent to 6 percent.

At the same time, the Treasury sterilised gold inflows so that incoming gold no longer automatically expanded the monetary base.

But the Money System Was Now Different

Taken together, these measures undoubtedly tightened monetary conditions. Yet the effect was very different from what policymakers expected because the banking system of 1937 was no longer the banking system of 1929.

Before the crash, banks had operated with very small excess reserves and had attempted to remain fully loaned up. After the banking collapses, however, behaviour changed fundamentally. Excess reserves were no longer viewed as idle balances waiting to support expansion. They became protection against renewed withdrawals, loan losses, runs and uncertainty.

This Is Why the 1937 Episode Is So Important

Between June 1937 and June 1938, reserves rose while the money supply fell modestly. Banks were reducing lending, strengthening liquidity positions and holding reserves defensively rather than using them to support deposit expansion.

The relationship between reserves, lending, deposits and economic activity had fundamentally changed. The same reserve base that might once have supported a large multiple expansion of credit during the twenties no longer generated the same response after the collapse of confidence.

Once the Fed reversed the reserve requirement increases and the Treasury stopped sterilising gold inflows, monetary growth resumed. M2 rose by 5.7 percent in 1938, 10.1 percent in 1939 and 12.5 percent in 1940.

But the Broader Lesson Remained

The recession of 1937 to 1938 demonstrated that money still mattered, yet it also exposed the limits of purely mechanical monetary explanations. Monetary tightening, defensive bank behaviour, sharply rising wages, labour market rigidity, regulatory uncertainty and unresolved malinvestment all interacted simultaneously.

The episode therefore sits awkwardly with both simple monetarist explanations and simple gold standard explanations.

It suggests that the Depression was not merely a story of reserve shortages or liquidity shortages. It reflected deeper structural fragilities within a highly leveraged fractional reserve banking system and an economy whose adjustment mechanisms had repeatedly been obstructed.

Central banks could create reserves, alter reserve ratios and change discount rates, but they could not command confidence, force banks to lend, make businesses invest or make labour markets clear when policy itself was pushing wages and costs above sustainable levels.

What Made the Great Depression Great?

The answer was not simply the stock market crash, the gold standard, Smoot Hawley or even the banking panic.

The Federal Reserve helped create the boom. When the crash came, it repeatedly tried to save the system. At the same time Hoover and Roosevelt increasingly intervened to prevent the economy from adjusting. Wages were supported. Credit was supported. Prices were supported. Banks were supported. The old structure was repeatedly protected rather than allowed to clear.

The result was that a depression became the Great Depression.

Are You Listening China

Ideas matter because ideas drive policy. The policymakers of the 1930s increasingly rejected the approach taken during 1920/21 and embraced intervention instead. In doing so they fundamentally changed both the economy and the monetary system.

Depressions matter because they never remain purely economic events. Eventually they become political. They change governments, institutions and sometimes entire societies.

That is why understanding the Great Depression still matters today.

It is not ancient history.

It is a warning.

Cutting To The Chase

1. Milton Friedman understood something most economists and bankers still struggle with today: banks create money when they create deposits. When banks fail, money disappears.

2. The problem is that nearly all senior bankers do not fully understand how the system they operate actually works. The modern banking system evolved far beyond the simplistic textbook “money multiplier” story generations of economics students were taught.

3. Economists built entire theories around efficient markets and resource allocation while never properly explaining how fractional reserve banking and money creation from nothing fit into that framework in the first place.

4. The Fed did not simply “do nothing” during the Great Depression. It repeatedly injected reserves into the banking system. The problem was that reserves alone could not force frightened banks to lend or frightened depositors to stop withdrawing money.

5. In a fractional reserve system, money, lending, collateral, confidence, and asset prices become entangled. In a boom the system reinforces itself upward. In a bust the process works violently in reverse.

6. By the early 1930s the Federal Reserve was increasingly fighting contractionary forces it could not fully control. Banks became defensive, loans contracted, deposits shrank, gold flowed internationally, and confidence collapsed faster than policymakers could stabilise the system.

7. Friedman largely blamed the Fed’s failure to prevent monetary contraction. Rothbard went much further. He argued the deeper problem was the inflationary fractional reserve system and unstable gold exchange system built during the 1920s itself.

8. Britain had attempted to restore Sterling’s prestige without accepting the old discipline of the classical gold standard. Foreign central banks increasingly held Sterling balances rather than gold, creating a giant “double inverted pyramid” resting on confidence.

9. Once Austria, Germany, and eventually Britain itself came under pressure, the system began to reverse violently. Countries no longer wanted claims on claims. They wanted final settlement. They wanted gold.

10. Even Keynes himself was deeply uncertain during the crisis. Far from possessing the neat ready made solutions presented in later textbooks, his shifting positions on budgets, Sterling, and gold led one historian to describe his missives at the time as: “hopeless as policy advice in an emergency.”

11. The crisis revealed how far the interwar “gold standard” had drifted from the old automatic system described in textbooks. By 1931 the international monetary order increasingly depended on emergency credits, private conversations, political management, and confidence in central bankers themselves.

12. Britain abandoning gold in September 1931 was not merely a British event. It was the psychological breaking point of the entire interwar monetary order. If sterling could fail, then the entire structure of international confidence could fail with it.

And the worst was still to come. Stay tuned.

Banks Can Destroy and Create Money

The video below features Milton Friedman explaining the great depression and in particular Fractional Reserve Banking (FRB). Amongst other things, he addresses the global nature of the banking crisis.

There is a lot to unpack in all this.

One big issue was that Friedman understood something most economists still struggle with: bank failures destroy money because banks create deposits in the first place.

A Personal Experience

About a decade after the GFC, I was in a conversation with the very senior person at a big bank. And I mean very senior and a very big bank by global standards.

We will leave the identities at that.

Anyway, I was rabbiting on about my treatise and the evils of FRB. To cut a long story short, this person claimed that banks don’t create money.

He agreed that deposits were money but in broad terms, he claimed the banks need to fund their book of loans. They do this by competing for deposits and raising other debt in the markets. These funds are used to make loans and comply with all the ratios and risk regulations etc.

The Chicken Or the Egg

It didn’t matter whether the banks decided their level of loans first or whether they made the funding decision after. Either way they were in the market for funds. The balance sheet reflected the end result of all this funding and loans.

The banks compete for this pool of funds.

You can understand his thinking. After all there is no item for “money created by the bank” either in the Balance Sheet or the Cash Flow and P&L accounts.

Maybe They Should Hire Akio Toyoda

It was quite a long discussion, and it got interesting when I kept pushing back and then I hit him with some questions: “If bank competes for a pool of deposits, then how come the deposits in the whole system are about 10% higher than they were last year. Where exactly did they come from?”

He just looked at me for a bit and then walked away. I can understand the anger.

Imagine if you were the Chairman of Toyota and you couldn’t explain even in a very broad sense how cars were made. Imagine if you had no idea at all how those magnificent cars are produced.

Milton Nails It and He Was No Monster

Milton Friedman in the above video makes the same point. It is his quote from the video repeated below that is in the subtitle of this essay.

“If you ask an individual banker if he creates money, he will look at you as if you are mad”

Judging by the clothes this video was obviously made in the 1970s. Things haven’t changed much except the fashions.

The left like to paint Milton Friedman as some sort of demon but as you can see from the video his style is every enduring even if a touch arrogant. I almost feel guilty critiquing him. He is after all the bastion of free market economics.

But that is the point. Isn’t it.

Even the great free market economists haven’t connected the dots from the money system to the free market.

An Army Of Economists

All these big (and small) banks have teams of economists pontificating on all sorts of stuff. Every single one of them would have sat through the “money multiplier” lectures at Uni.

Why haven’t they explained it to their executives, most of whom would have sat through economics courses themselves. Were they down the pub during those lectures like I probably (certainly?) was.

Think about Friedman’s point.

We are now over 100 years since the Fed’s creation and yet, until very recently the vast majority of talking head economists at banks and virtually all their executives had no idea that they are creating money from nothing.

Raise the issue and they will probably think you are offering them tickets to a Dire Straits reunion concert.

Too Little Too Late

Now in the past few years we have seen the textbooks mutate a bit and they talk about central bank reserves and the relationship between the banks and the central bank in somewhat more realistic terms. We have also seen many papers from the central banks talking about money and money creation and so on.

But it is hardly a great awakening.

Part of this mini-awakening trend might have been because the “plumbing of the system” has changed so much and many central banks don’t really have reserve ratios anymore. So, the multiplier appears to be redundant. Part might have been due to the whole QE saga.

I think it was largely the belated response to the GFC where a trained monkey could see that there was a lot of things that didn’t make sense about the financial system and credit creation.

Economists Just Don’t Get It

To that end have a look at one of the world’s most popular economic textbooks, Harvard University’s Professor Greg Mankiw’s Principles of Economics now in its 10^th edition.

You will see what I mean.

At least it now addresses FRB in a more sophisticated way than the textbooks of thirty odd years ago. He now has the Fed’s open market operations and so on. Needless to say, he doesn’t understand the endogenous nature of the system where demand can create its own supply.

He was also a signatory on the petition for Fed independence along with a bunch of the other economists. I have written extensively about all that sad saga.

The fact that he is a signatory is proof itself that he doesn’t understand the system.

The Big Question: How Does FRB Fit In With Efficient Allocation Of Resources?

Do I need to say anymore on how the rest of economic theory fits in with money creation even as described in Mankiw’s famous textbook.

It doesn’t because it is theoretically impossible.

Remember money and credit disappeared as important factors in the scheme of things for about 50 years (except in China) only to now make some sort of comeback.

A good question would be: “so what changed in the theory to make them sort of important again?”

The Bottom Line

At the risk of repeating myself, the bottom line is that there is still the question that Friedman, Central Banks, Bankers, and Economists still refuse to address. How does the financial system and FRB fit into a coherent economic theory and into the efficient allocation of resources?

The reason they didn’t and still don’t answer that is because the answer is: “It Doesn’t”.

The Romans made FRB illegal not because of economics but because it was fraud. Dante and Milton and Aquinas thought the same.

Personally, I would use both the fraud and allocation of resources as reasons to ban FRB.

The Plumbing Is Different But IT Stills Flows To the Same Spot

Whilst the system’s plumbing is different to the 1930s and the Friedman’s 1970s videos (above and below), the problem is the same.

It still beggars belief that nearly all the bankers don’t understand they create money.

Even the very few that even address the issue as Jamie Damon from J.P Morgan has on occasions done, do so only in a superficial way. That is, even then, their comments show that they still don’t know exactly how money and credit is created. Furthermore, they certainly don’t know the economic rationale for the system.

Hey Milton, Why Didn’t You Tell Them

In the video Friedman claims: “It’s a Process that even today, few bankers understand.”

The layperson might watch Friedman’s video and simply ask: “then why didn’t you tell the bankers all this? After all you were arguably the most famous economist of your time?”

Maybe he tried to, I don’t know.

An Important Plumbing Change

The declining importance of reserve ratios became explicit in March 2020 when the Federal Reserve reduced reserve requirements on transaction deposits to zero.

Think about what that meant.

For decades, economics textbooks had taught reserve requirements as one of the central constraints on bank lending and deposit creation. Entire generations of students were taught versions of the “money multiplier” model built around those reserve ratios.

Yet the modern banking system kept functioning even after the formal reserve requirement disappeared.

Not So Helpful Mutations

That alone should have forced economists to ask some uncomfortable questions.

In reality, modern banking had increasingly evolved into a far more complex system driven by capital constraints, liquidity management, collateral requirements, treasury operations, funding markets, and central bank settlement mechanisms rather than simple reserve ratios.

Reserves still matter operationally for interbank settlement and financial stability, but the abandonment of formal reserve requirements further demonstrated that modern money and credit creation is an endogenous and system wide process rather than a simple mechanical “money multiplier” process driven directly by central bank reserve injections.

An Ingenious Study

Now you could argue chicken and egg stuff about whether the banks decide their loan first or deposits or even both concurrently. In fact, it is extraordinarily difficult to determine how the amount loans and deposits get decided in these very large organisations.

In 2014, Economist Richard A. Werner published an article titled, “Can banks individually create money out of nothing? – The theories and the empirical evidence”,

It was an ingenious study where he was able to mainly isolate one single loan at a small German bank to see how the bank behaves in granting a loan.

For instance, do they check reserves or total deposits etc. before granting a loan? Do they get a deposit and do the calculation on how much extra loans they give out as implied by the fractional theory? Or do they simply grant the loan by creating the deposit?

The Bank Officers Were Unaware

Werner went to great lengths to follow a single loan through the whole process.

What he found was that the banks simply granted the loans and simultaneously deposits to the borrower and no consideration was paid to attracting new deposits (or using previously arrived new deposits) or to the reserves held at the central banks. The bank’s balance sheet simply expanded by the size of the loan.

None of this means that as loans and deposits are granted that various regulatory or self-imposed ratios etc. do not come into play. The point is that no officers were aware of any of these factors in granting the loan.

The regulatory ratios and “funding of the loans” become part of the overall daily Treasury operations that are the amalgamation of all the bank’s operations.

The Textbooks Are Misleading

Werner’s study mattered for a deeper reason.

It was not simply that the bank created deposits when it made the loan.

It was that the real operational behaviour of the bank looked very different from the simplified textbook story that generations of students had been taught.

In practice, modern banking operates as a dynamic system wide process involving lending decisions, interbank payment flows, treasury management, reserve settlement, collateral movements, capital constraints, and central bank operations all interacting continuously. Individual banks do not mechanically decide in advance what their final level of deposits or lending will be.

Who Decides Then?

Those positions evolve through the aggregate behaviour of the banking system itself.

This is one reason why central banks often struggle to control money and credit in any precise way despite their enormous influence over the financial system.

With all this in mind, lets return to the depression. Just keep in mind that they didn’t understand the system then and they don’t understand it now.

For exactly the same reasons.

Back to the Depression

Remember last week we looked at controlled and uncontrolled reserves. We got up to just after the October 1929 crash. We showed how the Fed went to extraordinary lengths to inject reserves into the system.

Controlled reserves were rising because the Fed was intervening. Uncontrolled reserves were falling because confidence, gold movements, public behaviour and banking behaviour were moving against the system.

This is not a story of inaction. It is a story of policy fighting the structure and losing.

It Was Out Of Control

In early 1930, fears subsided somewhat. Unemployment averaged less than 9 percent during the year.

The Fed lowered the discount rate further to 2 percent in February 1930. Acceptance rates and call loan rates were also lowered. Member bank reserves rose by $116 million during the year, yet the money supply remained roughly constant because banks were already becoming more cautious.

That is another crucial point. As we have explained, reserves are not the same thing as lending. The Fed can add reserves, but it cannot make banks lend if banks are afraid, borrowers are impaired, collateral is falling, and the public wants currency rather than deposits.

Here is the summary table from last week that is useful for perspective.

This is where simple monetarism becomes too mechanical. It treats money supply as if the central bank can dial it up directly. But in a FRB system, deposits are created through bank lending, and bank lending depends on confidence, capital, collateral, risk appetite and expected repayment.

The Fed supplied reserves. The banks increasingly refused to pyramid new credit on top of them.

The machine was jamming.

Why the Rescue Failed

The rescue failed because the problem was not merely a shortage of reserves. The problem was the collapse of the credit structure that reserves had previously supported.

Here is another Friedman video on the Great Depression. He unequivocally blames the Fed and believes that they could have and should have prevented the decline in the money supply.

“There was never a moment during that period when the federal reserve didn’t have the power to prevent the decline in the quantity of money”

He Misses the Point

But what he misses is that in a boom, reserves support deposits. Deposits support loans. Loans support spending. Spending supports asset prices. Asset prices support collateral. Collateral supports more loans.

The process looks self-validating while it lasts.

In a bust, the same logic reverses. Asset prices fall. Collateral weakens. Loans become doubtful. Banks contract. Deposits shrink. Depositors become nervous. Currency demand rises. Reserves are drained. Banks contract further. The process becomes self-reinforcing in the opposite direction.

That is why a FRB system is so dangerous. It is not merely that banks lend too much. It is that the money supply itself becomes entangled with lending and confidence. When lending contracts, money contracts. When confidence fails, money disappears.