Funding political ambitions

Alasdair Macleod – 23 May 2010

The Pandora’s Box of modern economic evils was opened in the nineteenth and early twentieth centuries. Two of the better known Troubles which escaped are communism and socialism. Karl Marx blazed the anti-capitalist trail for communism and was followed by his intellectual catamites, who condemned tens of millions to poverty and death. Socialism is the same as communism, if less strident, differs principally in its methods of coercion, and as a creed still plagues us in the West.

Communism and socialism are about physical control of the means of production, which is easy to understand and even attractive to the masses. Less discussed is the financing of socialism, and this was the third Trouble that escaped Pandora’s Box, with pernicious consequences and is at least as evil as the other two. It settled on the shoulder of a German economist, Professor Georg Friedrich Knapp.

Knapp was a respected teacher and economist in the early years of the twentieth century, and he was the moving light of a forgotten economic theory, Chartalism. This theory proposed replacing the gold standard with a government-issued fiat money, whose purchasing power was regulated through taxation. Knapp proposed his theory in Germany before the First World War, and when he said something, it was taken to be true. Knapp basically preached, “Money is what government says it is. Money is a government product. The government is sovereign and free to do what it wants with money”[i].

In this post-Keynesian world, this would not be controversial, and is taken as evidently true. But a hundred years ago, it was revolutionary, because to be acceptable money had to be fully convertible into gold or silver. Knapp, this respected professor and teacher, said in effect that government was entitled to ignore the constraint of gold and could monopolise money. This was the true birth of monetarism.

The first consequence was Germany was able to finance its armaments, and then the First World War, without resorting to unpopular levels of taxation. The inflationary process was well advanced by the time the Reichsbank suspended convertibility into gold on 31 July 1914, the outbreak of war. In the two weeks surrounding that date the Reichsbank increased its paper note issue by two billion marks, which raised the equivalent of about US$450 million at the prevailing exchange rate, an incredible sum for those days[ii]. The Reichsbank was able to perpetrate this fraud on the German people, because the exchange rate had been stable for as long as anyone could remember – thanks to convertibility of both currencies into gold. They were simply not aware of the debasement until much later, well after the war was lost.

Loosing the war closed off any imagined exit plan, and hyperinflation of prices followed; but Knapp’s theories were indirectly responsible for five years of fruitless slaughter, because he had unlocked its funding. The financial cost, as with all inflations, was borne by the middle and working classes, who were subsequently utterly impoverished. Despite this unhappy result, all western governments have persisted in trying to apply Knapp’s dictum, which he was still promoting in the 1920s.

Without Knapp, Keynes’s New Economics would not have been possible, and he acknowledged Knapp’s contribution to monetary theory in A Treatise on Money. Keynes saw gold convertibility as the principle impediment to the application of his own theories, and it is no wonder that he denigrated gold as the barbarous relic. Today, there is developing a belated understanding of the shortcomings of Keynesianism which so far only encompasses actual spending. This is yet to be translated into an understanding that the root of the problem is its financing through the unlimited availability of money and credit by printing.

There is no clearer example today of the separation of a desired economic outcome from its funding, than the euro-bloc’s rescue package for Greece. It is a fair bet that none of this money will be raised through taxation, because it would be as unpopular as being taxed only to be killed at the Somme. The money will be raised through inflation and through government debt that will never be repaid.

This is merely the latest development in a chain of events triggered by Knapp a century ago. There has not been a true gold standard since the advent of fractional reserve banking. The sole purpose of central banks is to print money, surreptitiously enough not to raise suspicions. They are very good at it, and to describe it as quantitative easing is just the latest stroke of Mephistophelean genius.

Fiat money is so ingrained that economists know no other system, and they even advocate monetary inflation as a beneficial tool, the ultimate confusion of good and evil. The effect of this cumulative monetary inflation to date is to tax current and future savings almost to extinction. The long-term habit of this legalised robbery is now entirely natural to politicians who benefit today, while leaving their electors’ future poverty to their successors.

What started as a crackpot theory from a forgotten German professor of economics is now the principle salvation, if money debasement can be so described, for all our ills, and a perfect illustration of the dangers of modern economics. It provided the finance for the war to end all wars, and it has allowed politicians to finance socialism to the point where global economic collapse is the only possible outcome.


[i] This summation of Knapp’s Chartalism is Ludwig von Mises’s.

[ii] This is the equivalent of $1 trillion in today’s money.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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