What Capitalism Is
• Economics
• Economics
Introduction
Division of Labor
Competition
Prices
Money
Banking
In
the realm of economics, capitalism applies the
principle of individual rights to the production
and exchange of goods and services. Viewed from the
perspective of economics, capitalism is the system
that completely separates economy and state. Under
this arrangement, individuals are left free to
produce, trade, and consume economic values, both
material and spiritual, according to their own
rational judgment. The government plays only the
role of neutral umpire, providing a system of
objective laws that protects property and contract,
and that punishes the initiation of force and fraud
in economic relationships. The question that
remains is: how does such a system work?
Leaving individuals free to exercise their rights and pursue their economic self-interest is the basic requirement of a capitalist economic order. This principle, however, is not the only important aspect of a capitalist system. To understand capitalism, and to maintain and preserve it, it is not enough merely to state that the economy and state should be separate. It is important, as well, to comprehend how a capitalist economic system works. What are its basic features? Once individuals are left free, how are they likely to interact economically? What types of relationships will they form? By what arrangements will they carry on their interactions?
Economics is the field that answers these questions. It is the science that studies the production and exchange of wealth. By studying the operation of free markets, economics identifies and explains the causal laws that govern these phenomena. For example, an economist might observe how a new product competes with existing products, describing how economic actors in the marketplace respond to the manufacture, pricing, and distribution of the new product. Another example might involve an economist explaining why wage rates in a particular industry have risen relative to other wage rates over the previous decade. Economics also explains the full material consequences of protecting (or failing to protect) individual rights. For example, an economist might illustrate that leaving individual producers free to set their own prices maximizes prosperity and trade whereas government-mandated wages and prices bring dislocations, unemployment, and economic stagnation.
The field of economics also provides unique insights into the role of material production in human life by considering and integrating the long-term consequences of various economic actions. Because the proper standard of ethical conduct is man’s life, lived long-term, economists show how the virtue of productiveness works out over the course of a whole life, the life of a single enterprise, or indeed, the life of a nation. Economists, thus, help to illustrate how a capitalist system of rights protection is both the moral and the practical system for human life.
Leaving individuals free to exercise their rights and pursue their economic self-interest is the basic requirement of a capitalist economic order. This principle, however, is not the only important aspect of a capitalist system. To understand capitalism, and to maintain and preserve it, it is not enough merely to state that the economy and state should be separate. It is important, as well, to comprehend how a capitalist economic system works. What are its basic features? Once individuals are left free, how are they likely to interact economically? What types of relationships will they form? By what arrangements will they carry on their interactions?
Economics is the field that answers these questions. It is the science that studies the production and exchange of wealth. By studying the operation of free markets, economics identifies and explains the causal laws that govern these phenomena. For example, an economist might observe how a new product competes with existing products, describing how economic actors in the marketplace respond to the manufacture, pricing, and distribution of the new product. Another example might involve an economist explaining why wage rates in a particular industry have risen relative to other wage rates over the previous decade. Economics also explains the full material consequences of protecting (or failing to protect) individual rights. For example, an economist might illustrate that leaving individual producers free to set their own prices maximizes prosperity and trade whereas government-mandated wages and prices bring dislocations, unemployment, and economic stagnation.
The field of economics also provides unique insights into the role of material production in human life by considering and integrating the long-term consequences of various economic actions. Because the proper standard of ethical conduct is man’s life, lived long-term, economists show how the virtue of productiveness works out over the course of a whole life, the life of a single enterprise, or indeed, the life of a nation. Economists, thus, help to illustrate how a capitalist system of rights protection is both the moral and the practical system for human life.
The
division of labor describes the process by which
individuals choose to divide among many men the
tasks required to sustain and promote individual
human survival. The result of a division of labor
is an expansion of the productivity of labor
through specialization. As each individual commits
himself to a specialized task such as agriculture,
he acquires a higher level of skill at that task
and can soon outperform in eight hours, for
example, what eight other men could collectively
accomplish in one hour each. By avoiding having to
gather grains for an hour each day, the other men
would likewise raise their productivity in whatever
tasks they chose for their specialized labor.
Without such a division, it would be difficult if
not impossible for long-range productive action to
take place. No man in a primitive society would
have the time to sew fishing nets, plant seeds, or
build shelter if he had not yet reached a level of
productivity beyond eating the fruit he found on
the trees and the fish he caught each day. The
products of each individuals’ labor would then be
available for trade with other individuals, thereby
allowing each individual to reap all the benefits
of specialization.
Even though human societies have practiced some form of the division of labor since ancient times, capitalism plays a special role in securing and promoting the benefits of such a division. In primitive societies, the division of labor might take the form of some individuals spending their productive energy gathering berries and fruits while others hunted for meat, and still others built and maintained shelters. In a complex, civilized society, it takes the form of some individuals specializing in radiation oncology while others spend their productive efforts making computers, and still others by producing works of philosophy. In both cases, all productive individuals benefit through trading the products of their specialized labor.
As an economy grows and becomes more complex, the division of labor plays a vital role in promoting higher and higher levels of productivity. As individuals join together in business firms, one of the key roles of an effective business manager is dividing, organizing, and coordinating the tasks undertaken by the firm in their production, a job that in earlier stages of economic development would have been performed by each individual producer. Likewise, the task of dividing, organizing, and coordinating how to allocate capital among competing firms in a complex society is not performed by all businessmen, but is left instead to those whose specialized occupation is to be a capitalist—i.e., someone who manages and provides capital in the marketplace. The presence of entrepreneurs as a distinct category of occupation in an economic system also represents a highly specialized economic order.
The unique advantage of the division of labor can only flourish under a system of capitalism, with its protection of individual rights. Because the division of labor depends on individuals choosing to forego current diversified self-sufficient production in the expectation of future trade for divided production, each individual must be certain that he will in fact be able to make that exchange. The system of property and contract rights instituted by capitalism is the means by which this long-range behavior is protected. In the absence of the rule of law and the protection of individual rights, the division of labor economy would collapse. If a man were not certain that his specialized production of computers, for example, would be safe from forced redistribution and that his daily needs for food could be purchased freely in the market instead of doled out by decree, he would never choose to specialize and agree to divide his labor. By protecting rights, capitalism allows the division of labor to flourish to its fullest extent, thereby benefiting all producers with higher standards of living and wealth.
Even though human societies have practiced some form of the division of labor since ancient times, capitalism plays a special role in securing and promoting the benefits of such a division. In primitive societies, the division of labor might take the form of some individuals spending their productive energy gathering berries and fruits while others hunted for meat, and still others built and maintained shelters. In a complex, civilized society, it takes the form of some individuals specializing in radiation oncology while others spend their productive efforts making computers, and still others by producing works of philosophy. In both cases, all productive individuals benefit through trading the products of their specialized labor.
As an economy grows and becomes more complex, the division of labor plays a vital role in promoting higher and higher levels of productivity. As individuals join together in business firms, one of the key roles of an effective business manager is dividing, organizing, and coordinating the tasks undertaken by the firm in their production, a job that in earlier stages of economic development would have been performed by each individual producer. Likewise, the task of dividing, organizing, and coordinating how to allocate capital among competing firms in a complex society is not performed by all businessmen, but is left instead to those whose specialized occupation is to be a capitalist—i.e., someone who manages and provides capital in the marketplace. The presence of entrepreneurs as a distinct category of occupation in an economic system also represents a highly specialized economic order.
The unique advantage of the division of labor can only flourish under a system of capitalism, with its protection of individual rights. Because the division of labor depends on individuals choosing to forego current diversified self-sufficient production in the expectation of future trade for divided production, each individual must be certain that he will in fact be able to make that exchange. The system of property and contract rights instituted by capitalism is the means by which this long-range behavior is protected. In the absence of the rule of law and the protection of individual rights, the division of labor economy would collapse. If a man were not certain that his specialized production of computers, for example, would be safe from forced redistribution and that his daily needs for food could be purchased freely in the market instead of doled out by decree, he would never choose to specialize and agree to divide his labor. By protecting rights, capitalism allows the division of labor to flourish to its fullest extent, thereby benefiting all producers with higher standards of living and wealth.
In
a capitalist system, economic competition is the
pursuit of economic values, whether dollars or
resources or market share, by business firms or
individuals. The economic use of the term is a more
specific use of the idea of competition, which at
root means the pursuit of values by different
individuals when the achievement of the value
excludes its attainment by others. Under
capitalism, this rivalry for economic values
benefits all productive individuals in a society
because it represents productivity under a system
of freedom and individual rights. Competition,
properly understood, means free competition, which
means unrestrained by government interference in
economic life.
In a capitalist economy, producers face competition from other producers, both existing and potential. Various individuals may compete to sell milk where there is a demand for twenty gallons of milk. If these individuals can each produce twenty gallons of milk, they will compete to sell their product to the purchasers of milk. Another example might be when a new college graduate with specialized skills enters the job market and receives multiple offers from different companies. Each company competes for the services of the graduate and in turn the graduate competes against other graduates. If Joe succeeds in selling twenty gallons of his milk in the market, it necessarily means that Sally cannot sell hers. If Company X hires Betty to be their accountant, it means that Companies Y and Z cannot employ her at that time.
Unlike sporting competition or games, where there is necessarily a winner and a loser, economic competition has features that distinguish it and makes it mutually beneficial for individuals to compete economically. In economic competition, there is always one party that gains the value—the sale of a car to an individual car-buyer and its proceeds—that is therefore unavailable to other parties, but these other parties are not losers in the same sense as the team that loses the championship game. In economic life, there is a harmony of interests between rational economic actors. This is not true in the context of other types of competition. The reason lies in the nature of what it means to compete in each context.
In other competitions, the winner and loser compete to achieve some defined mutually exclusive objective—to score more points, to finish a marathon in less time, to achieve checkmate against an opponent. In these cases, the action or actions that enable one competitor to be declared a winner have meaning only in the context of the contest. Running for 26.2 miles in under two hours and fifteen minutes, while certainly a feat of human athleticism and endurance, is not a value outside the context of running in (or training for) a marathon. The same holds true for other actions taken to compete in sports or games. Moving around small pieces of carved wood on a checkered board is not a value outside of doing so according to the rules of chess against an opponent in the context of a chess match.
In economic competition, the actions that various competitors take to “win” are different. In a capitalist system, individuals compete to be a more successful or more efficient producer of wealth. Whether in the form of earning a wage, inventing a new machine, manufacturing an electronic device, or hiring the best employee, competition in economic life always involves producing and offering values. When different individuals “compete” in the economic realm, they are each achieving a productive value—they each create wealth. Although one producer may exceed the others in success (he may sell more or earn more profits or hire better employees), the producers who have not “won” nevertheless have achieved something of value appropriate to their own productive effort. They may hire some other employee or sell some milk or make some profit. This point has been concretized well by philosopher Harry Binswanger. He notes that “if the New York Yankees could choose between winning by a score of 2 to 1 or losing by a score of 9 to 10, they would unhesitatingly choose winning, even though it means scoring fewer runs.” By contrast, “if a business had to choose between ‘winning’ (being the market-leader in sales) with profits of $2 million or ‘losing’ (being second, third, or lower in earnings) with profits of $9 million, they would unhesitatingly choose ‘losing.’”
Indeed, even when a particular seller of milk, for example, is “out-competed” in the marketplace and is unable to sell any milk, he benefits from the actions of the rival producer. His rival has achieved efficiency and productivity, has made it possible for others to be more productive and efficient, and in turn has created wealth. When the competitor was unable to make a sale, he failed to achieve a new value, but he did not “lose” the sale. It never “belonged” to him in the first place, though he was free to attempt to gain it. That each individual competitor has produced milk does not constitute a right or entitlement to sell it or to deserve customers. Each has entered the competition voluntarily with a full knowledge of the potential gains and risks. When the milk-seller who “loses” has seen his rival devise new ways of reducing the price of milk, he may be motivated to enact such cost-saving measures himself, he may be driven to new levels of productivity, or he may discover that his talents are better suited to another profession (or even to going to work as an employee for his former rival).
A final aspect of economic competition is worth highlighting. Consider again the rival producers of milk. Each of these producers is in competition not only with other producers of milk, but also with producers of substitute goods as well as any other goods. Some purchasers of milk may prefer instead to spend their money on soy milk, or on soda, or orange juice, or any other beverage. Beyond this, if their purchase of milk is done as an additional, luxury good, they may choose instead to spend their money on car wax or hot dogs, or they may even choose to invest the money at interest. In this wider context, milk producers compete not only with other milk producers, but also with other producers in the marketplace who might offer a more attractive substitute at a similar price. For this, it is clear that even a marketplace with only one producer of milk is still competitive because potential purchasers of milk can either choose not to do so or to spend their money on rival goods. Even when there is only a single producer or a handful, it is usually because they are the low-cost producers; they gain, not by “price gouging,” but by efficiencies and cost savings that yield higher rates of profit. Thus, even these single producers will themselves have to compete for capital and resources against other producers in other fields.
In a capitalist economy, producers face competition from other producers, both existing and potential. Various individuals may compete to sell milk where there is a demand for twenty gallons of milk. If these individuals can each produce twenty gallons of milk, they will compete to sell their product to the purchasers of milk. Another example might be when a new college graduate with specialized skills enters the job market and receives multiple offers from different companies. Each company competes for the services of the graduate and in turn the graduate competes against other graduates. If Joe succeeds in selling twenty gallons of his milk in the market, it necessarily means that Sally cannot sell hers. If Company X hires Betty to be their accountant, it means that Companies Y and Z cannot employ her at that time.
Unlike sporting competition or games, where there is necessarily a winner and a loser, economic competition has features that distinguish it and makes it mutually beneficial for individuals to compete economically. In economic competition, there is always one party that gains the value—the sale of a car to an individual car-buyer and its proceeds—that is therefore unavailable to other parties, but these other parties are not losers in the same sense as the team that loses the championship game. In economic life, there is a harmony of interests between rational economic actors. This is not true in the context of other types of competition. The reason lies in the nature of what it means to compete in each context.
In other competitions, the winner and loser compete to achieve some defined mutually exclusive objective—to score more points, to finish a marathon in less time, to achieve checkmate against an opponent. In these cases, the action or actions that enable one competitor to be declared a winner have meaning only in the context of the contest. Running for 26.2 miles in under two hours and fifteen minutes, while certainly a feat of human athleticism and endurance, is not a value outside the context of running in (or training for) a marathon. The same holds true for other actions taken to compete in sports or games. Moving around small pieces of carved wood on a checkered board is not a value outside of doing so according to the rules of chess against an opponent in the context of a chess match.
In economic competition, the actions that various competitors take to “win” are different. In a capitalist system, individuals compete to be a more successful or more efficient producer of wealth. Whether in the form of earning a wage, inventing a new machine, manufacturing an electronic device, or hiring the best employee, competition in economic life always involves producing and offering values. When different individuals “compete” in the economic realm, they are each achieving a productive value—they each create wealth. Although one producer may exceed the others in success (he may sell more or earn more profits or hire better employees), the producers who have not “won” nevertheless have achieved something of value appropriate to their own productive effort. They may hire some other employee or sell some milk or make some profit. This point has been concretized well by philosopher Harry Binswanger. He notes that “if the New York Yankees could choose between winning by a score of 2 to 1 or losing by a score of 9 to 10, they would unhesitatingly choose winning, even though it means scoring fewer runs.” By contrast, “if a business had to choose between ‘winning’ (being the market-leader in sales) with profits of $2 million or ‘losing’ (being second, third, or lower in earnings) with profits of $9 million, they would unhesitatingly choose ‘losing.’”
Indeed, even when a particular seller of milk, for example, is “out-competed” in the marketplace and is unable to sell any milk, he benefits from the actions of the rival producer. His rival has achieved efficiency and productivity, has made it possible for others to be more productive and efficient, and in turn has created wealth. When the competitor was unable to make a sale, he failed to achieve a new value, but he did not “lose” the sale. It never “belonged” to him in the first place, though he was free to attempt to gain it. That each individual competitor has produced milk does not constitute a right or entitlement to sell it or to deserve customers. Each has entered the competition voluntarily with a full knowledge of the potential gains and risks. When the milk-seller who “loses” has seen his rival devise new ways of reducing the price of milk, he may be motivated to enact such cost-saving measures himself, he may be driven to new levels of productivity, or he may discover that his talents are better suited to another profession (or even to going to work as an employee for his former rival).
A final aspect of economic competition is worth highlighting. Consider again the rival producers of milk. Each of these producers is in competition not only with other producers of milk, but also with producers of substitute goods as well as any other goods. Some purchasers of milk may prefer instead to spend their money on soy milk, or on soda, or orange juice, or any other beverage. Beyond this, if their purchase of milk is done as an additional, luxury good, they may choose instead to spend their money on car wax or hot dogs, or they may even choose to invest the money at interest. In this wider context, milk producers compete not only with other milk producers, but also with other producers in the marketplace who might offer a more attractive substitute at a similar price. For this, it is clear that even a marketplace with only one producer of milk is still competitive because potential purchasers of milk can either choose not to do so or to spend their money on rival goods. Even when there is only a single producer or a handful, it is usually because they are the low-cost producers; they gain, not by “price gouging,” but by efficiencies and cost savings that yield higher rates of profit. Thus, even these single producers will themselves have to compete for capital and resources against other producers in other fields.
In
a capitalist system, a price is an exchange ratio
that individuals freely place on any transaction.
When any two men trade in an advanced economy, they
set the terms of trade as the price of exchange.
Prices exist in every economy, but only under
capitalism, where individuals are free to set
prices (both at which they will sell and buy
economic values), does the price system achieve its
fullest function.
Under capitalism, prices are crucial integrators and conveyors of information. In a fully free market system, prices act to allocate resources by indicating where they will be most effectively and efficiently used. Prices perform this function by bringing together information about the value of goods and services being produced and the exchange ratios that these goods and services have relative to each other. By amassing literally millions of points of information, a price is the distillation of this information into a convenient and graspable form.
Prices reflect the balance between the supply and demand for resources (including raw materials, labor, information, and any other economic value). The law of supply and demand states, simply, that the producers of any good or service will increase their production if the price rises and that the demand for any good or service will increase as the price falls, with the inverse holding as well. What this means for an economy is that prices convey signals to producers about the quantity of goods that they should produce. The production of goods represents an implicit demand for goods and services. In an advanced economy, when primitive production for immediate use has largely disappeared, production of one product constitutes a demand for other products by exchange.
The pricing system acts to integrate the activities of all the individuals in the marketplace, signaling the producers of goods about where the most efficient use of resources is. In our example, the new production of wheat by our dairy farmer creates a larger supply to the market. For the price of wheat before his entry into the marketplace, buyers of wheat had demanded a certain quantity. Now that the quantity of wheat has increased, some suppliers will be left with surpluses at the current price level. To get rid of these surpluses, the sellers respond by lowering their price on current stocks of wheat until it is sold. The new price signals that wheat is not as valuable relative to other production as it had been before. Now, producers of wheat may choose to dedicate some portion of their output to corn, which, relative to the same resources it would require in production as those used to produce wheat, is being sold for a higher price. As a dynamic market moves forward, these price signals act to bring equilibrium to the marketplace by allocating resources where individuals can use them most efficiently and effectively.
The nature of the price system exists across the entire range of goods and services in a capitalist economy. The free functioning of the price system enables a capitalist system to allocate resources not only most efficiently but also consistent with individual freedom and justice. Individually, all members of society make decisions about the competing uses of their time, energy, and resources based on the prices of the marketplace. The price system does not, of course, protect individual producers against making incorrect decisions. They may produce a good or service that is not as valued on the marketplace as they thought (for literally hundreds of reasons, from a shifting supply to the introduction of better substitute goods to the mere changing taste of buyers). Nevertheless, even when individual producers must sell below cost, this information relays a crucial piece of information not only to that producer (stop using resources in this way), but also to every other producer in the marketplace (resources will be better used elsewhere). Even a single individual’s consumption of caviar sends important signals through the price system. At the current price, he is willing to buy caviar in a certain quantity but not if the price is any higher. That information indicates to producers and potential producers of caviar how to use their time and resources in productive activity. Overall, the information that is captured by prices facilitates the interaction of specialized producers in a division of labor economy and makes productivity possible. Further, it is only under a system of capitalism, where individuals’ rights to property and contract are protected and enforced, that prices reflect each individual’s free choices. In other system of prices (whether they are set by a central price office or are artificially set at maximum or minimum levels), the individual is forced to use his life, time, and resources in a manner inconsistent with his judgment.
Under capitalism, prices are crucial integrators and conveyors of information. In a fully free market system, prices act to allocate resources by indicating where they will be most effectively and efficiently used. Prices perform this function by bringing together information about the value of goods and services being produced and the exchange ratios that these goods and services have relative to each other. By amassing literally millions of points of information, a price is the distillation of this information into a convenient and graspable form.
Prices reflect the balance between the supply and demand for resources (including raw materials, labor, information, and any other economic value). The law of supply and demand states, simply, that the producers of any good or service will increase their production if the price rises and that the demand for any good or service will increase as the price falls, with the inverse holding as well. What this means for an economy is that prices convey signals to producers about the quantity of goods that they should produce. The production of goods represents an implicit demand for goods and services. In an advanced economy, when primitive production for immediate use has largely disappeared, production of one product constitutes a demand for other products by exchange.
The pricing system acts to integrate the activities of all the individuals in the marketplace, signaling the producers of goods about where the most efficient use of resources is. In our example, the new production of wheat by our dairy farmer creates a larger supply to the market. For the price of wheat before his entry into the marketplace, buyers of wheat had demanded a certain quantity. Now that the quantity of wheat has increased, some suppliers will be left with surpluses at the current price level. To get rid of these surpluses, the sellers respond by lowering their price on current stocks of wheat until it is sold. The new price signals that wheat is not as valuable relative to other production as it had been before. Now, producers of wheat may choose to dedicate some portion of their output to corn, which, relative to the same resources it would require in production as those used to produce wheat, is being sold for a higher price. As a dynamic market moves forward, these price signals act to bring equilibrium to the marketplace by allocating resources where individuals can use them most efficiently and effectively.
The nature of the price system exists across the entire range of goods and services in a capitalist economy. The free functioning of the price system enables a capitalist system to allocate resources not only most efficiently but also consistent with individual freedom and justice. Individually, all members of society make decisions about the competing uses of their time, energy, and resources based on the prices of the marketplace. The price system does not, of course, protect individual producers against making incorrect decisions. They may produce a good or service that is not as valued on the marketplace as they thought (for literally hundreds of reasons, from a shifting supply to the introduction of better substitute goods to the mere changing taste of buyers). Nevertheless, even when individual producers must sell below cost, this information relays a crucial piece of information not only to that producer (stop using resources in this way), but also to every other producer in the marketplace (resources will be better used elsewhere). Even a single individual’s consumption of caviar sends important signals through the price system. At the current price, he is willing to buy caviar in a certain quantity but not if the price is any higher. That information indicates to producers and potential producers of caviar how to use their time and resources in productive activity. Overall, the information that is captured by prices facilitates the interaction of specialized producers in a division of labor economy and makes productivity possible. Further, it is only under a system of capitalism, where individuals’ rights to property and contract are protected and enforced, that prices reflect each individual’s free choices. In other system of prices (whether they are set by a central price office or are artificially set at maximum or minimum levels), the individual is forced to use his life, time, and resources in a manner inconsistent with his judgment.
Money
in a capitalist economy is a commodity chosen by
individuals to serve as a medium of exchange and a
store of value. Money arises as a means of
facilitating calculation and trade. In a society
without money, individual producers who wish to
trade must exchange the commodities or goods that
they produce directly for other goods. Although
money has existed since ancient times, it can only
perform all of its functions fully under a system
of capitalism and its protection of individual
rights.
The existence of money is what makes a division of labor economy possible. Without money, the only means of trade would be direct exchange, for example, a wheat farmer trading his wheat for pigs or tools. The men who raise hogs and make tools would face a similar situation. This barter system inhibits the division of labor because it makes calculation difficult—how many bushels of wheat count for one hog? How do you divide a living hog into fractions when wheat or tools are only needed in that amount? How do you price the exchange of pigs, which vary in quality even when they weigh the same, and hammers, where each additional hammer is indistinguishable? How long would the wheat stock have to remain on hand spoiling before the farmer could attain enough value to exchange for a tool or a pig? Individuals can solve this problem by executing their exchanges in terms of a third commodity, money.
Money is a means of solving the problems of complex exchange and trade. It acts as a medium of exchange, a unit of account, and as a store of value. Money serves as a tool of exchange, a commodity that producers agree to use as a medium of exchange for other commodities. It can be used to pay for goods or services. When all producers in an economy recognize the value of the exchange commodity, it can be used to store productive value. In other words, the wheat farmer can buy his ham from the hog farmer with money, which he has received for his previous production of wheat.
Over time, individuals have used various commodities for money (including everything from shells to tulip bulbs to cigarettes and precious stones), but gradually settled on the use of precious metals, especially gold, as the best for use as money. The use of gold reflects the objective requirements for such a tool of exchange and saving. Money must be a material commodity that is rare, durable, homogenous, and relatively stable in its inherent value. This commodity acts like a yardstick of the unit of account—it is fixed in value.
In a capitalist economy, where the control of money is entirely free from governmental interference, money is a symbol of productivity. To the extent that men are productive and act long-range, their money will serve as a means of increasing their future productivity and their standard of living. To the extent that the government protects individual rights, especially the right to property in every commodity including money, an economy can benefit from the increased productivity and wealth that a stable medium of exchange can provide.
The existence of money is what makes a division of labor economy possible. Without money, the only means of trade would be direct exchange, for example, a wheat farmer trading his wheat for pigs or tools. The men who raise hogs and make tools would face a similar situation. This barter system inhibits the division of labor because it makes calculation difficult—how many bushels of wheat count for one hog? How do you divide a living hog into fractions when wheat or tools are only needed in that amount? How do you price the exchange of pigs, which vary in quality even when they weigh the same, and hammers, where each additional hammer is indistinguishable? How long would the wheat stock have to remain on hand spoiling before the farmer could attain enough value to exchange for a tool or a pig? Individuals can solve this problem by executing their exchanges in terms of a third commodity, money.
Money is a means of solving the problems of complex exchange and trade. It acts as a medium of exchange, a unit of account, and as a store of value. Money serves as a tool of exchange, a commodity that producers agree to use as a medium of exchange for other commodities. It can be used to pay for goods or services. When all producers in an economy recognize the value of the exchange commodity, it can be used to store productive value. In other words, the wheat farmer can buy his ham from the hog farmer with money, which he has received for his previous production of wheat.
Over time, individuals have used various commodities for money (including everything from shells to tulip bulbs to cigarettes and precious stones), but gradually settled on the use of precious metals, especially gold, as the best for use as money. The use of gold reflects the objective requirements for such a tool of exchange and saving. Money must be a material commodity that is rare, durable, homogenous, and relatively stable in its inherent value. This commodity acts like a yardstick of the unit of account—it is fixed in value.
In a capitalist economy, where the control of money is entirely free from governmental interference, money is a symbol of productivity. To the extent that men are productive and act long-range, their money will serve as a means of increasing their future productivity and their standard of living. To the extent that the government protects individual rights, especially the right to property in every commodity including money, an economy can benefit from the increased productivity and wealth that a stable medium of exchange can provide.
In
a capitalist economy, banks facilitate and foster
economic activity. Like money, banks existed before
capitalism, but only perform their vital functions
fully and best under a system of individual rights
and capitalism.
A bank is simply a business that provides financial services for its clients. The earliest banks began as warehouses for gold deposits, which could be relied upon to store and protect an individual’s assets. These warehouses issued receipts to depositors for their gold. Over time, these deposit receipts circulated as a stand-in for actual currency. Since the receipts—which in legal form were a contract for storage and disbursement of the gold—could be taken to the warehouse and exchanged for gold, they served as a convenient circulating currency.
As banking became more sophisticated, the gold warehouses undertook to make loans at interest from their gold deposits. In return for the risk incurred by the depositor as well as the inconvenience of not having immediate access to his gold on demand, the gold on deposit would earn interest. Banking thus served a specialized role in a division of labor economy. Productive individuals with large capital reserves might wish to lend some of their money at interest, and entrepreneurial individuals with new ideas might require borrowing capital to start their businesses. The interaction of these parties might take place on an individual basis in a free economy to the extent that strangers might be able to gauge the risk of new ventures and to the extent that strangers can persuade others to offer them capital for untried ideas. The banking business serves as a specialized actor in this regard, taking on the burden of making all the decisions about risk and cost, thereby leaving entrepreneurs and capitalists to remain specialized at their own occupations.
By balancing the rates of interest and taking into account the other costs of operating a bank, the managers of a bank earn a return—a profit—by successfully operating their enterprise. In a capitalist economy, banks compete for customers just as any other business does, by offering the best products (credit products, stable and dependable currency, etc.).
Under a capitalist system, just as the supply and use of money would be determined by the market, so too would the size, complexity, and operations of the banking industry. In such a system, a central bank that directs interest rates and currency policy by legislative authority would be as strange to us as a central automotive agency that directed the production of automobiles by legally controlling how many auto makers could exist, what types of cars they made, what color they would be, and the prices they could charge. In a free banking system, which largely existed in the United States in the years prior to the Civil War, banks operated in the same manner as other businesses. To the extent that they offer economic value to those to whom they offer their products, they succeed. To the extent that they mismanage depositors’ assets or overextend their loan portfolio, they fail.
A bank is simply a business that provides financial services for its clients. The earliest banks began as warehouses for gold deposits, which could be relied upon to store and protect an individual’s assets. These warehouses issued receipts to depositors for their gold. Over time, these deposit receipts circulated as a stand-in for actual currency. Since the receipts—which in legal form were a contract for storage and disbursement of the gold—could be taken to the warehouse and exchanged for gold, they served as a convenient circulating currency.
As banking became more sophisticated, the gold warehouses undertook to make loans at interest from their gold deposits. In return for the risk incurred by the depositor as well as the inconvenience of not having immediate access to his gold on demand, the gold on deposit would earn interest. Banking thus served a specialized role in a division of labor economy. Productive individuals with large capital reserves might wish to lend some of their money at interest, and entrepreneurial individuals with new ideas might require borrowing capital to start their businesses. The interaction of these parties might take place on an individual basis in a free economy to the extent that strangers might be able to gauge the risk of new ventures and to the extent that strangers can persuade others to offer them capital for untried ideas. The banking business serves as a specialized actor in this regard, taking on the burden of making all the decisions about risk and cost, thereby leaving entrepreneurs and capitalists to remain specialized at their own occupations.
By balancing the rates of interest and taking into account the other costs of operating a bank, the managers of a bank earn a return—a profit—by successfully operating their enterprise. In a capitalist economy, banks compete for customers just as any other business does, by offering the best products (credit products, stable and dependable currency, etc.).
Under a capitalist system, just as the supply and use of money would be determined by the market, so too would the size, complexity, and operations of the banking industry. In such a system, a central bank that directs interest rates and currency policy by legislative authority would be as strange to us as a central automotive agency that directed the production of automobiles by legally controlling how many auto makers could exist, what types of cars they made, what color they would be, and the prices they could charge. In a free banking system, which largely existed in the United States in the years prior to the Civil War, banks operated in the same manner as other businesses. To the extent that they offer economic value to those to whom they offer their products, they succeed. To the extent that they mismanage depositors’ assets or overextend their loan portfolio, they fail.
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