A Perfect Conterfeit; J. E. McAdoo

The potential loss inherent in counterfeit money seems almost self-evident. Yet, those who might accept it and spend it unknowing ly, before it was detected, would certainly feel no sense of loss. Ap parently, the entire loss would fall upon the unfortunate individual who happened to be last in line when it was detected and confis cated. But an interesting question arises: Where is the loss realized if the counterfeit money is never 1975 A PERFECT· COUNTERFEIT 723 detected? Does the potential loss simply remain potential, never to be realized? If no one is· fated to be "last in line," who can lose through the introduction and cir culation of a "perfece' counterfeit money? Someone Must Lose It might be argued that· there can be no such thing as a perfect, or undetectable counterfeit. Still, it is a safe bet that, at any given time, a certain amount of counter feit money is in circulation, and remains undetected. Even if that were not the case, it is possible to postulate a perfect counterfeit and to trace its economic significance.

We know, almost by instinct, that someone must lose. The coun terfeiters,who successfully intro duce their worthless facsimiles in to permanent circulation, have ob viously realized a fraudulent gain. But at whose expense? If the coun terfeit is never detected who loses? There can be only one answer: the counterfeiters gain, and everyone else loses. The character of the insidious loss inherent in a perfect counter feit money is confoundingly diffi cult to recognize. We know that the counterfeiter's gain is achieved at a loss to everyone else, but "every one else" feels no sense of loss. On the contrary: everyone else feels more prosperous. There is more "money" around. Retailers notice increased sales; they, in turn, must increase their purchases. Business activity picks up; people have more money to spend. Far from feeling a sense of loss, the victims of the counterfeiter's fraud enjoy a grow ing sense· of prosperity. As long as the quantity of counterfeit money introduced into circulation is held to an amount that in itself will not create suspicion, the victims will believe they've never had itso good.

The "prosperity" engendered by the introduction of a perfect counterfeit money is clearly a false prosperity. The increased tempo of sales and purchases· has been stimulated by a fraudulent increase in the supply of "money." The production and exchange of goods and services have been given a shot in the arm, but mon ey has been weakened by counter feit. The value which is unwit tingly given to the bogus "money" must inevitably be taken from the lawful money. In effect, the count erf eit steals its purchasing power from the lawful. The result is gradual, but in exorable: the purchasing power of all money is reduced. Prices rise. The counterfeit has undermined the value of the lawful; the poten tial loss inherent in a perfect counterfeit money has at last been realized!

724 THE FREEMAN December But it is not recognized. The victims, unaware of the existence of counterfeit money in their eco nomic bloodstream, are unable to identify the true reason why ris ing ... prices are eroding a prosper ity which they regarded as real. Understandably, they seek explan ations in visible symptoms of their problem: they blame those who raise their prices. The real villain, the counterfeiter, is immune to criticism; no one suspects his ex istence. But through the economic damage he has inflicted upon so ciety, he has created a cause for popular frustration and unrest that can be. expressed only in m-is directed social and political an tagonisms. The Better the Counterfeit, the Greater the Danger There can be no rational de fense for counterfeit money, even a "perfect" counterfeit. The false prosperity which would inevitably follow the introduction of a per fect counterfeit into circulation would just as inevitably be fol lowed by a collapse of that false prosperity under the weight of rising prices. The counterfeiter would gain, and everyone else would lose.

The crime of the counterfeiter is not that he has usurped a pre rogative which the government has taken unto itself; it lies in the grave damage he can inflict upon the economic, social, and political structure of the country whose money he counterfeits. The more successful he is, the more damage he does. A perfect counterfeit would eventually destroy the value of all money, including the count erfeit. In doing so, it would create a condition of social .and political chaos. It is with good reason that every person in the country should fear and abhor even the. idea of a perfect, undetectable counterfeit money. Bank-Created Credit By an incredible paradox, our official monetary policy supports a practice, the effects of which are precisely those of a perfect count erfeit money. That practice, de fended by economists, business men, bankers, and· government, is the creation of credit through the commercial banking system.

There can be no doubt that cred it plays an important role in di versified and specialized econo mies. Through credit, the entire economic cycle - from demand to production, distribution, exchange, and consumption - can be en hanced in function and effective ness. Legitimate credit has a legit imate place in the economic proc esses by which we survive and prosper. There is, however, a crucial dif1975 A PERFECT COUNTERFEIT 725 ference, in both nature and effect, between legitimate credit, and the credit created through the com mercial banking system. Legiti mate credit involves the temporary loan of existing money between one party and another. Bank cred it involves the creation of a sub stitute for money. This substitute, usually in the form of a demand deposit, is officially defined as mon ey. As an addition to the mon ey supply, it is indistinguishable from any other form of money; it becomes, in its effects, a perfect counterfeit.

The creation of bank credit is made possible by the concept of fractional-reserve banking. Quite lawfully, today's commercial bank need not retain all the money placed on deposit by customers ; it is required to safeguard only a small percentage of that money as a reserve. The balance is avail able for the use of the bank in its profit-making operations, primar ily loans and investments. Reserve requirements, estab lished by the Board of Governors of the Federal Reserve System, will vary with the classification of the bank, the type of deposit, and the changing monetary policy of the Fed. For purposes of illus tration of the simplest form of credit creation through the com mercial banking system, assume a 10% reserve requirement for de mand deposits at THE BANK. Mrs. A opens a checking account with THE BANK by depositing $1000 in cash. Since cash in THE BANK's vault is counted as part of its reserves, the ledger entry made by THE BANK would take the following general form: ASSETS LIABILITIES Reserves + $1000 Demand Deposits + $1000 Since reserve requirements are 10% , or $100 of Mrs. A's deposit, THE BANK now has $900 in excess reserves.

Mr. B, a known customer, now wishes to borrow $900. THE BANK accommodateshim by crediting $900 to his checking account.The ledger now shows: ASSETS LIABILITIES (Mrs. A) Reserves + $1000 Demand Deposits + $1000 (Mr. B) Loans + $ 900 Demand Deposits + $ 900 It can be seen that the $1000 deposited by Mrs. A has resulted in checking account balances of $1900. THE BANK has created credit, in the form of a demand· deposit, of $900. Essentially, Mrs. A and Mr. B may now spend the-same "money" at the same time.

726 THE FREEMAN December In this generalized illustration, the supply of "money"was in creased by only 90 %. In .. practice, the supply of money is multiplied many times, since a deposit of $1000 cash would support loans of $10,000, given a reserve require-: mentof 10%. Confusing Debt for Money Whether inflation is accomp lished through the infusion of per fect counterfeit dollars, or by the infusion of dollars created by bank credit, the results are iden tical. Billions upon billions of "dol lars" have been injected into our economic bloodstream through de posits created by bank credit. As a result, money has not only lost most of its value, but has also lost most of its meaning . We have confused debt for· money, and the consequences of our error are upon us. No economic, social, and political structure can withstand the destructive impact of an end less flood of counterfeit money.

Neither can it survive an endless flood .of artificial money in the form of bank credit. The effects, and the results, are the same. While counterfeiting is illegal, and universally condemned, bank credit is not only legal, but vigor ously defended as a benefit to so ciety. For hundreds of years, the creation of credit through the commercial banking system has been accepted as appropriate practice. The validity of the prin ciple of "fractionalregerves~' has received no successful challenge. Certainly, no challenge is to be expected from the banking com munity itself; created credit is the primary source of bank profits. Neither can a challenge be ex pected from the business com munity; bank credit is a primary source of borrowed funds. Re grettably, no challenge can be ex pected to arise from government. The commercial banking system provides the 'means whereby gov ernment debt is converted to a form of "money."

If a challenge to the concept of fractional-reserve banking is to be issued, it must come from a well-informed public: . a public which perceives the true nature, cause, and dangerous effects of in flation. A well-informed public, if it has the courage, will defend it self not only from counterfeit money, but from artificial money as well. Perhaps, in time, a future generation will enjoy the economic blessings of a real money. If that happy condition is ever to become a reality, we can start work by examining the validity of Fractional-Reserve Banking.