Wednesday, September 2, 2009

How the central bank concentrates wealth in the hands of a few

Let's start with the criminal counterfeiter. A criminal counterfeiter creates new money. He spends that money in his local community. As he does so, the prices of things he buys will tend to go up (because he is increasing the demand for them). Those he buys from will then have the newly counterfeited money and they, in turn, will spend it, driving up the prices of the things they buy. And so on. Over time, the money spreads out through the community and the prices of everything are a bit higher. A fraction of the wealth of the community has been stolen and transferred to the counterfeiter and those who got early use of the new money (before prices rose, generally) by diluting the purchasing power of everyone's savings. To paraphrase Hoppe, inflation (counterfeiting) transfers wealth from the later users of new money to the early users of new money.

Kings and emperors have been doing this through the debasement of coins for millenia. They take in a batch of 10,000 coins of purity X and dilute them and spend back 11,000 coins of some purity less than X but force merchants to sell at the prices that obtained with the older, purer coins (hence, price controls). With the advent of paper money - whether under Kublai Khan in China or John Law in France - a new and easier means of diluting money emerged. Governments found it difficult to restrain themselves in the debasement of paper money and many economies have been crashed by out of control printing-press inflation.

In the central-banking/fractional-reserve model, it is no longer necessary to print physical banknotes to inflate, you just make "loans" on the books of non-existent money or, at least, money that the vast majority of the public believes to be far more liquid than it actually is. Through interbank loans, the money multiplier allows a reserve ratio of X to result in an expansion of the money supply up to 1/X its original size (i.e. 10% reserve ratio allows up to 10x expansion of the money supply).

You can think of the Federal Reserve as a kind of "money fountain" that sucks money out of the hands of the public (and not just the American public, a large part of the world's population is directly plundered by Fed inflation) and pours it out upon the politically-connected in Washington, DC. The wealthy are more politically connected than the poor. So, the poor get regressively taxed by Fed inflation and the politically well-connected rich in Washington, DC make off with the loot. It should be obvious how this concentrates wealth in the hands of the few.

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