Front Matter.qxp 8/4/2008 11:37 AM Page i The Mystery of BANKING Front Matter.qxp 8/4/2008 11:37 AM Page ii The Ludwig von Mises Institute thanks Mr. Douglas E. French and Ms. Deanna Forbush for their magnificent sponsorship of the publication of this book. Front Matter.qxp 8/4/2008 11:37 AM Page iii The Mystery of BANKING MURRAY N. ROTHBARD SECOND EDITION Ludwig von Mises Institute Auburn, Alabama Front Matter.qxp 8/4/2008 11:37 AM Page iv Copyright © 2008 by the Ludwig von Mises Institute All rights reserved. No part of this book may be reproduced in any manner whatsoever without written permission except in the case of reprints in the context of reviews. For information write the Ludwig von Mises Institute, 518 West Magnolia Avenue, Auburn, Alabama 36832. Mises.org. ISBN: 978-1-933550-28-2 Front Matter.qxp 8/4/2008 11:37 AM Page v To Thomas Jefferson, Charles Holt Campbell, Ludwig von Mises Champions of Hard Money Front Matter.qxp 8/4/2008 11:37 AM Page vi Front Matter.qxp 8/4/2008 11:37 AM Page vii CONTENTS Preface by Douglas E. French . xi Foreword by Joseph T. Salerno . xv I. Money: Its Importance and Origins. 1 1. The Importance of Money . 1 2. How Money Begins . 3 3. The Proper Qualities of Money . 6 4. The Money Unit . 8 II. What Determines Prices: Supply and Demand . 15 III. Money and Overall Prices . 29 1. The Supply and Demand for Money and Overall Prices . 29 2. Why Overall Prices Change . 35 IV. The Supply of Money . 43 1. What Should the Supply of Money Be? . 44 2. The Supply of Gold and the Counterfeiting Process . 47 3. Government Paper Money . 51 4. The Origins of Government Paper Money . 55 vii Front Matter.qxp 8/4/2008 11:37 AM Page viii viii The Mystery of Banking V. The Demand for Money . 59 1. The Supply of Goods and Services . 59 2. Frequency of Payment . 60 3. Clearing Systems . 63 4. Confidence in the Money . 65 5. Inflationary or Deflationary Expectations . 66 VI. Loan Banking . 75 VII. Deposit Banking . 85 1. Warehouse Receipts . 85 2. Deposit Banking and Embezzlement . 90 3. Fractional Reserve Banking . 94 4. Bank Notes and Deposits . 104 VIII. Free Banking and the Limits on Bank Credit Inflation. 111 IX. Central Banking: Removing the Limits . 125 X. Central Banking: Determining Total Reserves . 141 1. The Demand for Cash . 141 2. The Demand for Gold . 148 3. Loans to the Banks. 149 4. Open Market Operations. 153 XI. Central Banking: The Process of Bank Credit Expansion . 161 1. Expansion from Bank to Bank . 161 2. The Central Bank and the Treasury . 170 XII. The Origins of Central Banking. 177 1. The Bank of England . 177 2. Free Banking in Scotland . 183 3. The Peelite Crackdown, 1844–1845 . 186 Front Matter.qxp 8/4/2008 11:37 AM Page ix Contents ix XIII. Central Banking in the United States I: The Origins. 191 1. The Bank of North America and the First Bank of the United States. 191 2. The Second Bank of the United States . 198 XIV. Central Banking in the United States II: The 1820s to the Civil War . 207 1. The Jacksonian Movement and the Bank War . 207 2. Decentralized Banking from the 1830s to the Civil War . 214 XV. Central Banking in the United States III: The National Banking System . 219 1. The Civil War and the National Banking System . 219 2. The National Banking Era and the Origins of the Federal Reserve System . 229 XVI. Central Banking in the United States IV: The Federal Reserve System . 235 1. The Inflationary Structure of the Fed . 235 2. The Inflationary Policies of the Fed . 241 XVII. Conclusion: The Present Banking Situation and What to Do About It . 247 1. The Road to the Present . 247 2. The Present Money Supply . 252 3. How to Return to Sound Money . 261 Appendix: The Myth of Free Banking in Scotland . 269 Index . 293 Front Matter.qxp 8/4/2008 11:37 AM Page x Front Matter.qxp 8/4/2008 11:37 AM Page xi PREFACE lthough first published 25 years ago, Murray Rothbard’s The Mystery of Banking continues to be the only book that Aclearly and concisely explains the modern fractional reserve banking system, its origins, and its devastating effects on the lives of every man, woman, and child. It is especially appro- priate in a year that will see; a surge in bank failures, central banks around the globe bailing out failed commercial and invest- ment banks, double-digit inflation rates in many parts of the world and hyperinflation completely destroying Zimbabwe’s economy, that a new edition of Rothbard’s classic work be repub- lished and made available through the efforts of Lew Rockwell and the staff at the Ludwig von Mises Institute at an obtainable price for students and laymen interested in the vagaries of bank- ing and how inflation and business cycles are created. In the absence of central-bank intervention, the current finan- cial meltdown could be a healthy check on the inflation of the banking system as Rothbard points out in his scathing review of Lawrence H. White’s Free Banking in Britain: Theory, Experience, and Debate, 1800–1845 that first appeared in The Review of Aus- trian Economics and is included as a part of this new edition to correct Rothbard’s initial support of White’s work in the first edi- tion. There have been virtually no bank failures in the United xi Front Matter.qxp 8/4/2008 11:37 AM Page xii xii The Mystery of Banking States since the early 1990s and as Rothbard surmised during that period where there was “an absence of failure” that “inflation of money and credit [was] all the more rampant.” Indeed, from Jan- uary 1990 to April 2008, the United States M-2 money supply more than doubled from $3.2 trillion to $7.7 trillion. Bankers were living it up, “at the expense of society and the economy far- ing worse” (Rothbard’s emphasis). Although ostensibly it is dodgy real estate loans that are bring- ing the banks down this year, in the seminal book that you hold, Rothbard shows that it is really the fraudulent nature of fraction- alized banking that is the real culprit for the bankers’ demise. But central bankers will never learn. “We should not have a system that’s this fragile, that causes this much risk to the econ- omy,” New York Federal Reserve President Tim Geithner said after engineering J.P. Morgan’s bailout of the failed Bear Stearns investment bank in the first quarter of 2008 with the help of the central bank. Of course the thought of dismantling his employer, the government leaving the counterfeiting business, and a return to using the market’s money—gold—didn’t occur to him. More government regulation in which “the basic rules of the game establish stronger incentives for building more robust shock absorbers,” is what he prescribed. Surely Murray is somewhere laughing. My introduction to The Mystery of Banking came in 1992 as I was finishing my thesis at UNLV under Murray’s direction. I found the book in the university library and couldn’t put it down. The book was long out of print by that time and being prior to the start of Amazon.com and other online used book searches, I was unable to find a copy of the book for purchase. Thus, I fed dimes into the library copier one Saturday afternoon and made myself a copy. When the online searches became available I waited patiently and bought two copies when they surfaced, pay- ing many times the original $19.95 retail price (as I write this AbeBooks.com has three copies for sale ranging from $199 to $225, and Bauman Rare Books recently sold a signed first edition for $650). Front Matter.qxp 8/4/2008 11:37 AM Page xiii Preface xiii When I discovered Rothbard’s great work I had been a banker for six years, but like most people working in banking, I had no clear understanding of the industry. It is not knowledge that is taught on the job. Murray may have referred to me as “the effi- cient banker,” but he was the one who knew the evil implications of the modern fractionalized banking system: “the pernicious and inflationary domination of the State.” DOUGLAS E. FRENCH LAS VEGAS, NEVADA JUNE 2008 Front Matter.qxp 8/4/2008 11:37 AM Page xiv Foreword v6.qxp 8/4/2008 11:37 AM Page xv FOREWORD ong out of print, The Mystery of Banking is perhaps the least appreciated work among Murray Rothbard’s prodi- Lgious body of output. This is a shame because it is a model of how to apply sound economic theory, dispassionately and objectively, to the origins and development of real-world institu- tions and to assess their consequences. It is “institutional econom- ics” at its best. In this book, the institution under scrutiny is cen- tral banking as historically embodied in the Federal Reserve System—the “Fed” for short—the central bank of the United States. The Fed has long been taken for granted in American life and, since the mid-1980s until very recently, had even come to be ven- erated. Economists, financial experts, corporate CEOs, Wall Street bankers, media pundits, and even the small business own- ers and investors on Main Street began to speak or write about the Fed in awed and reverential terms.