How Governments Control Money

This is post #6 in my series on money and Bitcoin. You can jump to the other posts here:

We have learned that money is a tool with five characteristics and it serves three functions. Thiers’ Law states that, under normal market conditions without price controls, good money drives out bad money.¹ Most societies globally do not have completely free markets without price controls.

Interest rates are the most fundamental price control: they determine the price of capital. Every service or commodity is priced in money; fixing the cost of money (interest rates) impacts the price of every other good or service. Governments control the cost of capital. In this, they have incredible power.

Let’s look at why governments grab and seek to maintain this power, how they have exercised it in the past, and what the future could look like.

Why Control the Money?

Positively, governments control the money supply for several well-intentioned reasons:

To stabilize the economy during crises
Fund essential public services and infrastructure
Prevent fraud through counterfeiting
Promote economic development

The methods of control have evolved dramatically over time, from the minting of coins to the sophisticated monetary policies of today. This control has often been a force for good, providing economic stability, facilitating trade, and allowing governments to respond effectively to economic challenges. By managing the money supply, governments can help control inflation, reduce unemployment, and mitigate the effects of economic recessions.

There is a darker side, however. In a fallen world, a world impacted in every dimension by sin, well-intentioned leaders often take actions that have unintended negative consequences. Sometimes, actions are intentionally taken that benefit one group of people over another.

The principle of subsidiarity says that social and political issues are best dealt with at the most local level.² The level of federal governments, where monetary policies are set, is the highest (most removed) level. At the scale of nations that control hundreds of millions or even billions of citizens, decisions affecting monetary policy always have negative consequences. On the best days, negative unintended consequences are unavoidable. On the worst days, policies are knowingly and actively carried out, resulting in harm.

Negatively, governments control the money supply for various self-serving reasons:

To fund wars and expansion
Manipulate the economy for political gain (to “buy” votes and influence)
Centralize power
Expropriate wealth from citizens

This control can cause economic instability, constant erosion of savings through inflation, and significant restrictions on financial freedom. By manipulating the money supply, governments can effectively tax citizens without their consent, fund partisan programs, and bail out favored industries at the expense of others. Understanding how this control has been exercised throughout history is crucial for recognizing the potential dangers of unchecked monetary power.

How have governments exercised this power throughout history?

How Have Governments Controlled the Money?

Coinage

In my last post, I explained coinage as a form of money. Coinage opened the door widely for governments to have more control over the money supply.

The minting and monopolization of coinage is one of the earliest and most direct forms of monetary control. This practice dates back to ancient civilizations, with some of the first known examples coming from Lydia in the 7th century BC. Governments would issue official coins, often stamped with the ruler’s image or state symbols, and declare these legal tender within their territories.

The control extended beyond production. Governments carefully regulated the metal content of coins, often mixing precious metals with base metals to extend supply or to profit from the difference between face value and metal content — a practice known as debasement. This allowed rulers to effectively create money out of thin air, often to fund wars, public works, or popular wishes of their citizens thereby securing votes and/or influence.

To maintain their monopoly, severe penalties were imposed for counterfeiting or using unauthorized currency. In medieval England, for example, counterfeiting was considered high treason and was punishable by death. This monopoly on coinage gave governments significant economic power, allowing them to control trade, collect taxes more efficiently, and finance state activities. The same benefits for governments extend to the present day, but technology allows even deeper levels of control over monetary policy and therefore the people using the money.

Paper Money

The transition from coinage to paper money marked a significant shift in monetary control. Paper currency, first used in China as early as the 7th century AD but not widely adopted in the West until the 17th century, allowed for much greater flexibility in the money supply. Unlike coins, which were limited by the availability of precious metals, paper money could be printed at will.

This new flexibility, however, required new forms of control. Enter central banking. The establishment of central banks, such as the Bank of England in 1694, gave governments powerful tools to manage currency. These institutions received exclusive rights to issue banknotes. In return, they were tasked with maintaining the stability of the currency.

Central banks could now control the money supply through various means. They could print more money and change interest rates, influencing borrowing and lending throughout the economy.

Under the gold standard, banknotes were backed by an equivalent amount of gold. Each banknote could (theoretically) be redeemed for gold. This requirement limited the number of banknotes that could be introduced into circulation.

The United States abandoned the gold standard in 1971, and so began a “fiat standard.”³ No longer constrained by gold reserves, governments and central banks had unprecedented control over the money supply. They could respond to economic crises with monetary policy, financing deficit spending through money creation.

This power came with risks. Hyperinflation in countries like Weimar Germany and Zimbabwe, and devastating inflation in Argentina and Venezuela have demonstrated the potential for disaster when this control is mismanaged.

Given the principle of subsidiarity and the inherent difficulty of managing monetary policy on the scale of an entire country, central banks have a difficult task.

Banking System Regulation

As economies grew more complex, governments extended their control beyond currency to the regulation of the broader banking system. This regulation took various forms aimed at stabilizing the financial system and, by extension, the money supply.

One tool is reserve requirements. Banks must hold a certain percentage of their deposits as reserves, limiting their ability to create money through lending. By adjusting these requirements, governments can expand or contract the money supply.

Governments enforce lending restrictions, controlling who banks can lend to and under what terms. This allows them to direct credit to preferred sectors of the economy or restrict lending during periods of overheating.

Another tool is deposit insurance. By guaranteeing bank deposits, governments aimed to prevent bank runs and maintain confidence in the banking system. Stability is crucial for maintaining control over the money supply, as panics lead to rapid contractions in available credit.

Capital requirements, stress tests, and restrictions on certain types of financial activities are also used by governments. While aimed at protecting consumers and ensuring financial stability, these regulations help control the flow of money through the economy.

Modern Tools

Governments develop increasingly sophisticated tools for controlling the money supply. One of the most important is open market operations – the buying and selling of government securities to inject or remove money from the economy.

During the 2008 financial crisis and the COVID-19 pandemic, many central banks employed a more extreme version of this tactic called quantitative easing. This involves large-scale purchases of assets, dramatically expanding the money supply to stimulate the economy.

These modern tools provide governments with more responsive control over the money supply than ever before. However, they also raise concerns about privacy, financial freedom, and the potential for abuse.

The Future of Monetary Policy

One thing is certain: the future of monetary policy will be influenced by technology.

Governments tend to expand, not shrink. If new tools enable a government to expand its power, they will eventually be used. A Central Bank Digital Currency (CBDC) is the logical next step in the progression of monetary policy technology.

Some governments are exploring CBDCs, which would give them unprecedented control over the money supply. CBDCs could potentially give governments unprecedented control over people’s financial lives.

With CBDCs, authorities could theoretically track every transaction in real time, giving them insight into individuals’ spending habits, income sources, and financial behaviors. This level of surveillance could be used to enforce tax compliance, detect illegal activities, or even influence behavior through targeted financial incentives or penalties.

Governments could program the CBDC, allowing them to set expiration dates on stimulus funds or restrict purchases to certain categories of goods. CBDCs could be a key part of social credit systems, where access to financial services is tied to government-approved behaviors. Authorities could potentially freeze assets or block transactions instantly, without the current limitations of the traditional banking system. During economic stress or civil unrest, governments could use CBDCs to limit cash withdrawals or restrict the flow of money between certain regions.

While these capabilities could be used for legitimate purposes like combating financial crime, they raise significant concerns about privacy, autonomy, and the abuse of power. Governments throughout history have a terrible record when it comes to abuse of power.

Summary

Governments have wielded significant control over money throughout history, from minting coins to implementing complex monetary policies. While this control can stabilize economies and fund public services, it brings the risk of manipulation and abuse. The evolution of monetary tools has given governments unprecedented power over the money supply, with future technologies like CBDCs potentially extending this control even further.

As we look ahead, it is crucial to balance the benefits of monetary policy with concerns about privacy, financial freedom, and the potential for overreach. Understanding history is essential for navigating the future of money and governance.

Future posts will look more closely at the Bitcoin network and the implications of a Bitcoin standard for churches and ministries.

¹ https://en.wikipedia.org/wiki/Gresham%27s_law

² https://www.perplexity.ai/search/Explain-the-principle-afjs8TFFSRyhze9l85OFoQ

³ https://www.perplexity.ai/search/What-is-the-LXKIL8ZGTDaOVtze.vPspA

This is post #6 in my series on money and Bitcoin. You can jump to the other posts here: