The Official Counterfeiter

In a recent report, “The Ultimate Subprime Borrower: Uncle Sam,” I made this observation:

The easy money policy of Greenspan’s Federal Reserve, beginning in the summer of 2000, lured in the suckers: creditors and borrowers. The FED sent a false signal to the credit markets.

I do not want readers to get the impression that the Federal Reserve under Alan Greenspan was unique in this regard. The primary function of all central banks is to send false signals to borrowers and creditors all the time. Their secondary function is to bail out large commercial banks that suffer bank runs and even face bankruptcy (bank + rupture). Bank runs are the consequence of commercial banks’ implementation of the central bank’s policy of deceiving borrowers and creditors.

This is not taught in money and banking textbooks, with one exception: Murray Rothbard’s 1983 book, The Mystery of Banking. As far as I know, no college or university professor ever assigned this book. It is much too controversial. It explains in detail why central banking rests on the dual assumption that (1) theft through monetary inflation is morally neutral and (2) is often (i.e., all the time) the best monetary policy. Keynesianism, monetarism, and supply-side economics all rest on this dual assumption. They debate only on which rate of theft is wise at any time. You can download the book for free here.


In a free market society, the rate of interest is set by means of a competitive capital market in which each individual decides to lend, borrow, or stay out of the credit markets. His decision depends on his subjective assessment of how valuable future income is to him.

Some people are highly future-oriented. Ludwig von Mises called this outlook low time-preference. Other people are highly present-oriented. Mises called this outlook high time-preference. Most people are somewhere in between.

When a person has low time preference, and if he seeks future income, he is willing to lend his capital (money) at a low interest rate. The borrower does not have to offer him a high rate of return to persuade him to forfeit the use of his wealth for a specified period of time.

In contrast is the high time-preference individual. He wants the use of his money now, so that he can buy consumer goods and services. He wants gratification — maybe not instantly, but soon, very soon. To persuade him to forfeit the use of his money, a borrower must offer him a very high interest rate.

The free market allows high time-preference people, mid-time-preference people, and low time-preference people to come together and make offers and counter-offers to borrow or lend. In other words, they make bids. The capital markets are gigantic auctions for capital. Through these objective bids, the subjective time preferences of acting individuals produce specific rates of interest in specific capital markets.

A rate of interest is, at bottom, the price of obtaining capital for a specific period of time in a specific risk market. It is governed by the subjective time preferences of capital owners and borrowers.

Borrowers possess a crucial capital asset: their likelihood of repayment. This is determined objectively by such factors as their net income, net worth, existing debts, and record of past payments. Modern credit markets have profit-seeking credit-rating services that trace individuals’ past payment performance. They assign an objective number to each individual. Lending institutions use this number to assess individual credit risk.

This is another way of saying that borrowers can capitalize their moral commitment to repay. An objectively good credit rating reflects a morally good commitment to repay. The psalmist wrote 3,000 years ago: “The wicked borroweth, and payeth not again” (Psalm 37:21a).

Banks have long functioned as brokers in the loan markets. Lenders hire bankers to screen candidates for loans. Borrowers go to bankers to obtain money deposited by lenders. This is a legitimate economic function of banks. They capitalize on their specialized information of the credit markets, including borrowers’ likelihood of non-payment.

A rate of interest is ultimately a product of subjective assessments of the relevant discount for time and objective assessments of credit risk.


Any tampering with any rate of interest by a government agency or a government-licensed, private, profit-seeking agency constitutes a deliberate attempt to use legalized coercion to deceive lenders and borrowers about the prevailing subjective discounts for time and the objective credit risk of borrowers.

Central banks have been licensed by governments and given monopoly control over domestic banking. Politicians assume that central bankers will deceive the public in government-approved ways. This assumption is usually correct. Occasionally, this assumption is incorrect. These occasional departures are called, respectively, mass inflation and recession/depression.

First, a central bank begins its process of deception by hiring economists to decide which economic theory to apply to statistical information. This theory shapes which information is collected.

Second, a central bank hires specialists to collect statistical information on the overall economy. Sometimes, the government supplies this information. Often, this information must be supplied to the government by private individuals or businesses on threat of negative sanctions for refusing to supply it.

Third, other central bank economists interpret the significance for the overall economy of the collected information. They pick and choose in terms of the prevailing economic theory, which includes a theory of the boom-bust cycle.

Fourth, a different group of economists decides whether to buy, sell or hold government debt certificates in order to change the prevailing interest rates or keep them the same. A central bank can buy long-term government debt to lower the capital markets’ long-term rate of interest: bonds and mortgages. Rates will then fall. Or it can buy short-term debt to influence the overnight rate of interest that commercial banks lend to each other. Rates will then fall. It can also sell debt certificates in order to produce the reverse effects. Central banks rarely do this for more than a few weeks.

The underlying presuppositions of central bank deception are these:

The free market is not a reliable agency to allocate capital.Central bankers have both a legal right and a moral obligation to alter the rate of interest.An economic boom (expansion of the division of labor) is preferable to whatever conditions the free market would otherwise impose.An economic bust (contraction of the division of labor) is to be avoided because (a) it may produce bank runs, and (b) incumbent politicians, who officially have the authority to set central bank policy or even revoke its grant of monopoly, fear the political results of an economic bust.It is preferable to be a central banker, whose career is protected by the government, than to be a commercial banker or an economist who competes in an unhampered market.

Over time, #5 replaces #1, which replaces #2, etc. How much time? This is an empirical question. My guess is about three weeks.


When central banks buy any asset, they create money to buy it. The seller of the debt certificate then spends the newly created money.

The seller of the debt certificate is like an auctioneer. He likes lots of people to show up at his auction. The seller of a promise to pay future money wants to pay a low rate of interest. The more lenders who show up at the auction, each bidding against the other, the better it is for the borrower. Sellers keep saying, “I’ll accept a lower rate.” The borrower thinks, “How much lower?”

When no lenders in the debt market have counterfeited money to buy the debt, there will be no long-term price inflation. Under such conditions, rates do not fall as a result of counterfeit money being used to buy the debt certificates. Every lender forfeits the use of his money during the period of the debt. The borrower spends this money, but the lender would also have spent it. No new purchasing power comes into the market.

A central bank is the government’s officially licensed counterfeiter. So, when a central bank creates new money to buy debt, there is no offsetting reduction of spending, as would otherwise be the case with a non-counterfeiting lender.

Counterfeiting is illegal because governments, central banks, and commercial banks want no competition. What they are really protecting is their government-protected trademark. If anyone could create money, this would destroy the purchasing power of money.

I once saw a cartoon of a counterfeiter who had a graph on the wall. The line sloping downward and to the right was “value of money.” The line sloping upward and to the right “price of paper.” The upward line had just intersected the downward line. The counterfeiter yells: “Stop the presses!”

In a purely government-run counterfeiting operation, the insulated bureaucrats may not stop the presses this early. Hence, we had the great mass inflations in history, such as Germany, 1919—23, and Hungary, 1945—48.

When central banks issue counterfeited new money, governments spend this money. The new money multiplies through the fractionally reserved commercial banking system. In this sense, the central bank’s holdings of government debt serve as the legal monetary base of the commercial banking system. When the central banks increases the monetary base, commercial banks increase their loans. When the central bank sells assets, commercial banks must decrease their loans.

In the early stages of the boom, the central bank’s purchases of government debt lower the rate of interest, meaning short-term rates, unless the central bank buys bonds. Lower rates send a signal to borrowers: “There is more capital available.” But there isn’t. There is merely more money. At a lower price, a greater quantity is demanded. The level of debt rises. More business projects get started. If the borrowers are consumers, more consumer purchases take place. “Happy days are here again!”

But then prices begin to rise, or else they don’t fall as they otherwise would have. Why? Because the newly counterfeited funds that were lent to borrowers and immediately spent into circulation added to the money supply. On a free market, funds lent could not be spent by the lenders to buy anything.

As prices rise, the boom accelerates. Buyers think, “I had better buy now, before prices rise further.” Sellers think, “I had better hold onto my property; prices are rising.” So, prices continue to rise. But, at some point, they rise so high that new buyers cannot afford to buy any more. Then, like an ocean liner that has hit an iceberg, the economy begins to slow; then it sinks. Capital that had been invested in booming sectors of the economy is revealed to have been invested in items that consumers are no longer willing to buy.

A financial bubble is always fiat-money created. It is created by interest rates that are set below what would have prevailed on a free market. When it pops, and investors lose money, they rarely blame the official counterfeiters: the central bank and the commercial banks.


Florida was a bubble real estate market for five years. It began reversing in 2006. Here is a recent report, published in Florida Today (March 15). In Brevard County, it’s a buyer’s and renter’s market.

Just ask Sharon Montano, 44, an assembler at DRS. The Palm Bay resident lived with her three teenaged sons in a three-bedroom, $745-a-month unit at Country Garden Apartments until six weeks ago, when she decided to rent a four-bedroom home for $945 a month.

“The boys needed a backyard. They couldn’t play on the grass there. The kitchen (in the apartment) was really small and I hated cooking,” she said. “There are so many restrictions in an apartment, and so much comfort in a house.”

Although he wishes he didn’t, Ken Myers owns 15 rental homes along the central coast of Florida, including five in Brevard County.

Like many home flippers — people who build or buy homes, improve them if need be and then sell them for a profit — Myers made money for three or four years until the new home market softened about a year ago.

“I was trapped into renting,” he said.

To compete in this market, Myers has to keep rents low, negotiate for less than his monthly costs and even offer the first month free.

“I’ve got mortgages for $2,700 a month, and I’m renting a 3,000-square-foot (house) for $1,200. I’m upside down,” Myers said.

He plans to stick it out until the housing market reverses.

He think that will be soon.

Florida owners thought so in 1926, too.

This situation has taken place because of Federal Reserve policy, as well as central bank policy in Japan and China, which also have bought U.S. government debt. They created fiat money, bought dollars, and bought T-bills. Rates fell from mid-2000 to mid-2003. Now they have risen. Those who got sucked in are finding that the bubble mentality has begun to fade.


There are no free lunches. There is no free money. At some point, a rational counterfeiter shouts, “Stop the presses!”

Bernanke’s FED dramatically slowed the presses, beginning in February, 2006. The monetary base from March 15, 2006 to March 14, 2007 was up by 1.8%.

There are winners in the boom phase who become losers in the bust phase. The bust phase is beginning. The losers will soon feel a great deal of pain.

March21, 2007

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 19-volume series, An Economic Commentary on the Bible.

Copyright © 2007

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