Money and Free Markets: A Summary
JANUARY 01, 1966 by V. ORVAL WATTS
Dr. Watts is Chairman of the Division of Social Studies at Northwood Institute, a private college dedicated to the philosophy and practice of free enterprise. This article is from lecture material for his course: Survey of American Life and Business.
Life is purposeful and creative action by individual creatures showing infinitely great ranges of variations in structures and capacities. The basic purpose of living action seems to be that of achieving greater awareness and understanding of the environment and increased power to organize it so as to make it more favorable to the preservation of higher forms of life. In such achievement we find the meaning of "welfare," "prosperity," and "progress" for every living thing including man.
For man, as for all forms of life, therefore, progress requires individuals to exert effort and to take the risks inherent in experiment and invention.
It follows that human welfare, prosperity, and progress do not consist in escape from stress and strain, nor in mere abundance of the means of subsistence or entertainment. Instead, welfare, prosperity, and progress correspond to the level of creative activity and the rate of achievement in discovering and developing new abilities and instruments for making the environment more hospitable to higher levels of living. Prosperity is pursuit of a flying goal. It is pursuit of abundance that escapes our grasp because human aspirations and capacities for achievements appear to know no bounds.
In man, however, creative action has reached a new stage of evolution. In the human being the life force has become self-conscious, self-controlling, and self-directing.
The creature, man, can now help control and direct creation and humans progress only insofar as individuals become aware of this unique opportunity and take advantage of it. In other words, humans prosper and progress only as they become aware of their powers of choice, self-control, and self-direction, and as they learn to exercise these powers creatively.
This is what we mean by saying that the human individual must accept responsibility for his own acts. He must learn that he is responsible as the primary cause for what he does, and to survive and progress he must gain wisdom and take charge of the process of acquiring those habits we call "character," "virtue," "morality," and "personality."
The first condition for this learning process and development is private property, or, more simply, property, for all true property is private. Individual appropriation of standing room and of the means of subsistence is necessary for mere existence, and individual appropriation of land and tools is equally necessary for anything more than mere existence, that is, for any degree of prosperity and progress. The prosperity and progress of every human society correspond to its members’ respect for the right of the individual to own, control, and use land and the fruits of his labor, thrift, and enterprise in production and exchange.
This individual appropriation and responsibility for finding, devising, and employing the "means of production" (land, natural resources, tools, machines, and other forms of capital) is capitalism. It follows from freedom from violence and intimidation (threat of violence). Where such freedom, or peace, exists, individuals have property in what they find, produce, or obtain by voluntary gift or exchange.
Equally essential for human prosperity and progress is cooperation. Humans need one another. None is sufficient unto himself. One of the most critical problems of human progress, therefore, is to maintain and improve cooperation while individuals exercise and develop their powers of self-direction and invention. These powers are the most important of all qualities distinguishing humans from animals or beasts. They are the qualities which also make a human — at least potentially — far more useful than any domesticated animal or inanimate machine.
But the risks of depending on the cooperation of free persons correspond to the opportunities for progress. Fear of these risks — knowledge that our welfare and even our very lives depend on the work and service of other persons — tempts us to resort to violence or threat of violence to assure continued cooperation or to increase it or improve it. The result of such coercion, however, is increasing antagonism and conflict or irresponsibility and apathy, which reduce cooperation. We cannot get true cooperation by force or threat of force because humans are self-controlling and will exert their peculiarly human powers (e.g., initiative and inventiveness) only in pursuit of self-selected purposes.
In perfect freedom, or pure capitalism, an individual would try to get the help of his fellows only by offering in return an inducement — something which other persons want and which they do not have or do not have in sufficient abundance. This inducement might be merely expressions of gratitude. But since man does not live by gratitude or praise alone, inducements in capitalistic (free) societies include offers of relatively scarce and desirable services and commodities — economic goods. This is the Golden Rule as it applies in the business of making a living.
But how can an individual know what goods to produce in order to get what he wants from others who may be distant from him in space or tastes?
The answer is to be found in the operation of the market place. Exchange values — wages, interest rates, rents, profits, and losses — act as signals and incentives to producers. A relatively high price is more than a "trumpet call to production." It provides also an increased opportunity to those getting it to increase the supply of the relatively scarce service or commodity.
For efficient marketing, or exchange, both money and credit are essential. Money is necessary as a measure of values and a medium of exchange. Credit is necessary whenever it takes time to complete an exchange.
In contrast with economic goods, money is useful only when scarce. Air and water are still useful even when they are so abundant that no one will pay anything to get more, but money becomes useless when everyone has all he wants of it. Gold would still have a use for filling teeth or for plating a manmade satellite if we had all we wanted of it, but it would no longer have use as money, because no one would give anything in exchange for it.
Credit and money are often confused with one another, but they are actually as different as day and night. Money is a means of payment, credit is only a promise to pay. It arises in connection with an incomplete exchange.
Except in the case of simple barter, it is seldom possible or economical to make a simultaneous and complete exchange of services between two persons or to complete payment at the same instant each unit of services is performed. Most exchanges in all societies except the most primitive take time to complete, and while incomplete, credit is given and received.
From the lender’s standpoint, credit involves trust that the borrower (the person who gets goods or money on credit) will complete the exchange (pay later). From the borrower’s standpoint, credit involves a promise to pay — a promise to complete the exchange at some future time by giving value in exchange for the goods or money presently received.
To repeat, credit arises in an incomplete exchange.
The borrower may give the creditor a written promise to pay, but such records, or credit instruments, are not credit, and the number or face value of such instruments has only a loose and indirect relation to the volume of credit in actual use.
Neither are such instruments money even though they pass from one person to another in settlement of obligations. Circulating credit instruments, such as private bank notes or bank checks, are a form of currency, but they are promises to pay money rather than money itself. Their usefulness as a medium of exchange, or currency, depends on creditors’ confidence in the maker’s ability and willingness to pay the money promised when due or to deliver claims of equal value against other credit-worthy producers or property owners.
When a debtor promises to pay in gold or some other commodity, he accepts the value of this commodity as the standard (measure) of value for his payment. He does not always or necessarily deliver the standard money (e.g., gold) in payment, but to avoid doing so and yet satisfy his creditors he must deliver goods or claims on goods which the creditor prefers to gold. This means that the debtor must price his goods (or those assets he liquidates in order to get the wherewithal to pay his debt) low enough so that buyers will prefer them to gold and give him gold or its equivalent for them.
In this way, a standard money, such as gold, exerts constant pressure on individuals to use credit productively and to keep their prices in line with the value of the standard. If the standard commodity, e.g., gold, becomes abundant and cheap, sellers may correspondingly raise their prices. But gold has become the generally accepted standard in free markets precisely because—although widely distributed in nature — it has not come on the market faster than the demand for it has increased, except for comparatively brief periods.
The specialists in credit (e.g., bankers, savings institutions, insurance and investment companies) record the values advanced as loans, or "credits," act as producers’ agents in making advances and collections, and serve as clearing-houses for drafts, orders, and other forms of credit currency used as evidences of loans and payments, exchanges, and repayments.
Since a borrower commonly uses a credit from one producer (or from the financial agent of a producer, such as a bank) to make full and satisfactory payment to another producer, it is easy to confuse credit (especially bank credit) or the evidences of this credit (currency) with money, and to believe that the demand for goods and the supply of credit depends on the amount of borrowing and the spending of borrowed funds. In this limited view, the borrower is a public benefactor merely because he borrows, buys, and consumes. When this limited and fallacious view of credit and of credit currency dominates political policy, it leads to waste of productive resources and to statism (governmental restriction of freedom).
In freedom, the borrower is expected to repay the loan, and lenders who fail to collect payment suffer losses and find themselves correspondingly deprived of their credit and lending power. To repay the loan, however, the borrower must either reduce his later spending by the amount of the loan (in which case there is no net increase in demand or spending for goods), or he must produce and sell more goods to get the means of payment. Since lenders usually charge interest for their loans, thus requiring repayment of more than was originally loaned, borrowers have a corresponding incentive to use their borrowings to maintain their earning power or to increase it. Hence, in freedom, borrowers and lenders tend to use credit economically and productively.
We should note, too, that creditors and sellers of goods in free markets tend to reject or discount inferior currencies, i.e., currencies that are inferior in convenience and intrinsic worth. Consequently, in freedom, good money drives out bad money. Or, more precisely, among private currencies in free markets, more trustworthy and convenient forms of currency tend to replace inferior currencies.¹
Governments, and only governments, may declare certain credit instruments (usually government IOU’s or the IOU’s of banks controlled by government) to be full legal tender. This means that creditors can legally demand nothing better or more valuable in payment of debts owed to them. This legal tender act by government transforms the credit instruments into "fiat money," or "paper money." The purpose of this act is commonly to increase the means for paying debts (including the government’s own debts) and thus make them easier to pay. It thereby aids debtors at the expense of creditors.
It is to such legal tender money that Gresham’s Law applies. Governments compel creditors to accept all legal tender money at face value. Yet they sometimes issue new kinds of money having less intrinsic worth than coins of the same stated legal tender value still in circulation. This was the case when the Tudor monarchs were debasing the coinage during the lifetime of Sir Thomas Gresham, London merchant and government financier. Gresham then noted (as Oresme and Copernicus had before him) that "bad money drives out good money." That is, debtors and buyers of goods make their payments in the money of less intrinsic worth, while they hoard, melt down or ship abroad the coins having greater intrinsic worth.²
When the fallacious view that borrowing per se is a public service prevails in politics, the government is likely to manufacture "lawful money" (legal-tender paper, or fiat money) to permit the borrower to avoid a cut in his future spending as he pays his debt. It may then issue paper money to lend or give to "needy," or "deserving," spenders, or to buy the products of favored producers regardless of the economic value or usefulness of these goods. Such policies waste labor and capital which might otherwise increase the supply of goods (and of credit) in the free markets, and they encourage unproductive borrowing and consumption of goods.
Furthermore, when government gets the authority to print legal-tender money, it is likely to use this easy method for increasing its own spending for political purposes, as, for example, for molding public opinion to support its expansion of power, for hiring police, spies, soldiers, and tax collectors to enforce its multiplying rules and levies, or for buying votes, wholesale or retail.
But as government thus expands its activities beyond those necessary to establish freedom (i.e., to suppress private coercion, such as banditry, assault, and stealing), it takes from individuals a corresponding amount of freedom to use their energies and capital according to their own best judgment. It thereby restricts their opportunity to develop their most important powers — those powers which most of all distinguish humans from animals; and so it restricts human progress. This encroachment of government on individual freedom is commonly called "statism."
Political constitutions are systems of rules by which freedom-seeking humans have tried to restrict government activities to those believed necessary for welfare. In this sense, the state and Federal constitutions of these United States were originally the most restrictive constitutions of which we have record, and until about 1898 they served as effective barriers to the advance of statism in this country.
¹ Since, so far as I know, this law is my own discovery, stated in my classes and public lectures nearly 20 years ago, friends have named it "Watts’ Law of Money." Long study of banking and monetary history, as well as economic analysis, convinces me that it is a valid observation of an economic uniformity, or law. Therefore I am willing to accept responsibility for putting the statement of it into circulation.
2 We have seen this verified in the United States for two years or more as paper dollars replaced silver dollars and half dollars in circulation, as wartime nickels of higher silver content disappeared from circulation, and now as the new "sandwich" quarters and dimes replace coins of much higher silver content.
Opportunities to "Do Good"
Too many of us get it into our heads that to "do good" we must go far outside our daily routine interests.
Glenn Frank once said: "The rich man’s greatest opportunity for public service lies inside his private business. That is to say, statesmanship in business is of greater social value than philanthropy outside business."
A man with the genius for successfully running a business is right where he belongs; the opportunities to "do good" are greater in business than outside business.
WILLIAM FEATHER, in The William Feather Magazine, July, 1965