Chapter III:
Who Gains And Who Loses?

If banks profit from paper money, you may be asking: Who loses? This is an important question because some economists go so far as to contend that no one loses. This is absurd on the face of it. If one segment of the population is receiving values without producing anything in exchange, then it follows that someone else must be producing without getting the product of his labor.

But if one analyzes the situation purely in terms of flows of money, it seems as though these economists are right. The banker, of course, has more money; it is he who has issued it. The businessman to whom he has made the loan benefits; the existence of more loanable funds through this process has meant that he is able to get his loan at a lower rate of interest. In addition, when the businessman starts his project, he employs more workers; so these workers benefit. As the additional money gets spent and flows into the economy of the surrounding area, the people of this area accumulate more money. Everyone gains; no one loses.

This essential theory, in various forms, has continually resurfaced again and again in history. Shortly after our country was established, there was a revolution in the state of Massachusetts called Shays’ Rebellion which advocated general prosperity by paper money. The idea was that government should run a large budget deficit, which would be financed by printing, paper money. To increase the deficit, it was advocated to abolish taxes and to spend money on public works. The fallacy involved in this argument consists of analyzing what happens only in terms of money. Since the essence of the paper money scheme is to create more money, then when measured in terms of money, everyone has more. What must be remembered is that money is not wealth. Money is just a means to facilitate exchange. King Midas had all the money he wanted, but it did him no good because he could not even eat an apple.

The advocates of bank paper praise it because, they say, it gives the businessman more capital, and capital is productive. Capital creates additional wealth. But it is important to distinguish between money capital and real capital. Money capital are pieces of paper in a vault or notations on a ledger. Real capital are steam shovels, which can help dig the foundation for a building; trucks which help carry goods to market; and labor saving machinery, which increases the productivity of workers. Real capital is productive. Real capital increases the quantity of wealth in the world.

But the increased issue of bank paper does not increase real capital. It only increases money capital. When the banks create money to loan to businessmen., these businessmen use the additional money to bid capital away from other members of the community. Let us consider a simple example: There is a small community with ten farmers and one, bank. The bank wants the extra profits from paper money so it persuades one of the farmers, more (enterprising and forward looking than the others, to take a loan to expand his farm. There are ten harvesting machines in this community of which the enterprising farmer has one. He uses his loan to buy an additional harvesting machine.

The banker, of course, has gained. He has the interest payments on the loan. In addition, the enterprising farmer has gained. Because the banker had additional money to loan, he lowered the rate of interest in order to induce borrowing. Before the issue of paper money the productivity of a harvesting machine was 7% of its value, and the cost of a loan was 8% interest. But now the banker has reduced the interest rate to 6%. Thus the enterprising farmer stands to make a gain.

In addition, by buying the additional harvester, the enterprising farmer has bid up the market price of harvesters. Thus all of the other farmers in the community think they are richer because their harvesters are worth more. Even the conservative farmer who sold his harvester is happy. He, after all, has sold his harvester for more than he reasonably could have expected to get for it.

But while everyone is happy, it is clear that not everyone could have gained. In real terms the community has exactly as much capital as it had before. There are still ten harvesters in that community. Since there is now more money in circulation but no additional goods, it will take more money to buy the same quantity of goods. The law of supply and demand has been operating on this community. Since the supply of money has increased, the value of money has gone down. This is expressed in the fact that it now takes more money to buy the same harvesting machine. The value of the currency has depreciated.

So the conservative farmer is not as smart as he thinks. He has sold his harvester for more money, but it is money of depreciated value. The eight other farmers think their harvesters are worth more; but they are only worth more in terms of depreciated money. As the extra money circulates through the community into all the channels of trade, it gradually raises the average price of goods. When the conservative farmer and the other farmers go to spend their money, they will find that they can buy less. Although in money terms they are richer, their money has depreciated; in real terms they are poorer. And the amount of their loss is (approximately) equal7 to the gain of the banker and the enterprising farmer. As Jefferson said: capital may be produced by industry, and accumulated by economy; but jugglers only will propose to create it by legerdemain tricks with paper.8

In actuality, the mistake made by the conservative farmer is the same in kind as the mistake made by those who sold estates to Andrew Dexter, Jr. in our previous example. They sold real wealth for depreciated paper, and although the amount of money they got was higher, the value they got was lower. This example serves to illustrate a number of points:

  1. The basic thing which is going on as a result of an issue of paper money is a transfer of wealth from the community as a whole to the banker and the borrower.
  2. In this transfer, a large number of people lose a small amount, and a few gain a large amount.
  3. If we look at the transactions only in money terms, it appears as though everyone has gained.
  4. However, what has really happened is that the value of the money has depreciated. Thus in terms of money the average price of goods is higher. When people go to spend their money, they will cry: Inflation.

In the 18th century there was a vehement debate over whether, in these circumstances, it was the value of money which was going down or the value of goods which was going up. The banking interests tried to contend that their issues of additional paper money did not cause a depreciation in the value of money. Faced with the fact that it took more money to buy the same goods they responded that it was the value of goods which had risen, with the implication that this rise in goods was spontaneous and accidental and in no way related to the extra issues of paper money.

This theory appears plausible in our present society — where honest money has been outlawed by the government and prices are only stated in terms of depreciated currency. But the War of 1812 provides a clear example of paper money and gold/silver money circulating side by side. During this war, the Southern and Western banks overexpanded their note issues to lend money to the Government, and when the war went badly, there were runs on these banks; like William Paterson in 1696, they suspended their payments of gold and silver. The New England banks, however, did not overexpand and were able to continue redeeming their notes in gold and silver. The result was that the price of goods in terms of New York or Baltimore bank notes was 10% to 25% higher than their price in terms of Boston bank notes. Clearly it was the New York and Baltimore money which had depreciated in value. As Daniel Webster noted at the time:

The depreciation of bank-notes was the necessary consequence of a neglect or refusal to pay them, on the part of those who issue them. It took place immediately, and has continued, with occasional fluctuations in the depression, to the present moment. What still further increases the evil is, that this bank paper, being the issue of very many institutions, situated in different parts of the country, and possessing different degrees of credit, the depreciation has not been, and is not now, uniform throughout the United States. It is not the same at Baltimore as at Philadelphia, nor the same at Philadelphia as at New York. In New England, the banks have not stopped payment in specie, and of course their paper has not been depressed at all … This difference in relation to the paper of the District where we now are, is twenty five percent.9

The propaganda of the banking forces was ultimately successful and the theory of a mysterious and accidental rise in goods unrelated to the increase in the money supply took hold. It is this theory which is implied in the word inflation. Inflation means a going up. To use that word in connection with higher prices implies that goods have gone up. But when we look at the economic universe at a time of large issues of paper money we find that that is not the case. We find that values of goods bear the same relationship to each other. We find that values of goods bear the same relationship to hard money, which has not been increased in supply. We find that in the whole economic universe only one item has significantly changed its value: That is the paper money which has been issued to excess. And the value of this item in relation to all other items is down.

For this reason, the correct word to use in this circumstance is depreciation, which means a going down. When average prices rise as a result of an issue of paper money, what is occurring is a depreciation of the currency.

The relationship between paper money and currency depreciation is vividly illustrated in the accompanying chart (see Illustration 1, page 24). Pro-bank economists are still trying to argue that paper money does not depreciate the currency. They do this by only focusing on the short range picture, where economic causes have not had time to show their effects or where the inadequacies of their own indicators distort their picture of reality. Study this chart carefully to see the long term relationship between paper money and the value of the dollar.

There were three periods of inflation or currency depreciation during this time; each of them was associated with a war and extra issues of paper money, and each of them saw some abrogation of the gold standard. But in each case, after the emergency, the money supply was contracted and prices declined to their previous levels. Thus, over a period of 145 years, the U.S. currency retained its value. Prices in 1933 were approximately the same as they had been 145 years earlier when the Constitution first established a gold standard.

The reason for this is simple. During this period the dollar was defined as a quantity of gold. The dollar maintained its value because goldmaintained its value. And gold maintained its value because it could not simply be printed up and issued to excess like a piece of paper. In fact gold was chosen as money by people because, of all the economic goods circulating in human commerce, it has the best record for maintaining its value.

But since the enactment of a legal tender law in 1933, there has been a continual depreciation of the currency. Since that time the dollar has been defined, not as a quantity of gold, but as a piece of paper declared to have value by the fiat of the state.

In addition to the direct benefit to the banker, who issues the paper money, and the benefit to the debtor, who receives the loan, the depreciation associated with the paper money also sets up additional imbalances in the regular path of commerce:

(1) The real value of your wages declines in a period of currency depreciation. In a free economy, prices are always fluctuating in response to supply and demand. But some prices are more responsive than others. The prices of vegetables in your local supermarket and stocks in the stock market are extremely responsive and change within a few minutes or a few days. On the other hand, the price of a piece of real estate may not change for years. It happens that wages are more like real estate in this regard. History shows they are slower to change in response to changes in the value of the currency than prices. In a period of currency depreciation, prices will move up before wages, and in a period of currency appreciation, prices will move down before wages. The following statistics illustrate this fact.10 (See tables below.)

Civil War currency depreciation — change from 1861
Year Wholesale price index Wages
+ 17%
+ 49%

The sharp rise in prices early in the Civil War was not matched by the rise in wages.

Civil War currency appreciation — change from 1864
Year Wholesale price index Wages

But wages kept going up after the war and caught up.

World War I currency depreciation — change from 1915
Year Wholesale price index Wages

And the same thing happened in WWI. But wages began to catch up in 1919 and 1920.

World War I currency appreciation — change from 192O
Year Wholesale price index Wages
1921 -37% -8%

And they really caught up in 1921 by only slipping a little in the face of a major price decline.

Great Depression — change from 1929
Year Wholesale price index Wages

In the Great Depression, prices fell more rapidly than wages.

Silver demonetization currency appreciation — change from 1882
Year Wholesale price index Wages

And in a price decline in the 1880s, wages didn’t fall at all but merely rose less rapidly.

Thus, in the early stages of a currency depreciation, the prices you pay will rise faster than your wages. The businessman then benefits from a period in which the prices he charges for his goods go up while the wages he pays Ms workers either remain the same or go up much more slowly. This is a truth which seems to have been forgotten today as people are blaming labor for the present inflation. But it was widely recognized in previous times. As President Cleveland said: At times like the present, when the evils of unsound finance threaten us, the speculator may anticipate a harvest gathered from the misfortune of others, the capitalist may protect himself by hoarding or may even find profit in the fluctuation of values; but the wage earner — the first to be injured by a depreciated currency and the last to receive the benefit of its correction — is practically defenseless.11 Even Keynes recognized this when he said: When money-wages are rising, this is to say, it will be found that real wages are falling; and when money-wages are falling, real wages are rising.12 So, as the currency depreciates, the employer benefits at the expense of the employee.

(2) Debtors gain at the expense of creditors. We have already seen how debtors are enabled to borrow money at lower rates of interest due to the surplus lending power of the banks (as in the case of the enterprising farmer). But an additional benefit to debtors from paper money lies in the fact that they are enabled to pay their debts in depreciated currency.

A debtor who borrows $1,000 may pay back the same nominal sum. But if the currency has depreciated 20% in the interval, then he is only paying back $800 in real terms. A debtor who borrowed $1,000 in 1861, when the dollar was 25.8 grains of gold, was borrowing 25,800 grains of gold. If he paid his debt in legal tender greenbacks (issued to help fight the Civil War) in 1864, at a time when the dollar had depreciated 50% in terms of gold, then he paid back 12,900 grains of gold. This meant that he had a profit of $500.

(3) The unscrupulous gain at the expense of the gullible. You have already seen how an infusion of paper money into a community makes everyone at first think they are richer. As a result, many people purchase luxury items, which they can not properly afford, and a favorite luxury item is a fling in the stock or commodity markets. Every period of paper money expansion has seen some type of bubble whereby large numbers of naive newcomers enter the speculative markets hoping to make a lot of money. To accommodate these people, there arise fast buck operators who are always handy with schemes for instant riches. Starting with the Mississippi bubble and the South Sea bubble to the recent new breed (who rose to make profits from the paper money associated with the Vietnam War), every period of paper money expansion has seen some type of emotional mania on the markets. When the dust has lifted from these manias and the overinflated stocks have collapsed down to their true values, it can be seen that there has been a large transfer of wealth from the gullible newcomers to the fast buck operators who promoted the schemes which took them in.

We are now at a point where we can understand what happens when paper money is issued. Some people do gain something for nothing, but this is counterbalanced by a loss to the great majority of people, a loss which shows up in a depreciation of the currency,, which the average person calls inflation. This loss can not be seen by examining money. In terms of money, everyone gains. It can only be seen by examining real wealth.

To summarize, there are those who lose and those who gain from paper money. Bankers gain from paper money, of course, because it is they who issue it. This main is made at the expense of the rest of the community, which suffers from the depreciation of the currency.

Business, especially big business, gains from paper money in three ways. First, since wages are slower to rise than prices in response to the depreciation, the real wages of labor go down. Business benefits because in real terms it is paying, lower wages.Second, it is not widely known, but the major debtors in our society (or any society) are the big businesses. An individual or a small business is not as good a credit risk as a large corporation and cannot go as deeply into debt. In its capacity as a borrower, business benefits because the creation of paper loanable funds reduces the rate of interest below what it otherwise would have been. When the rate of interest is artificially lowered, all debtors benefit at the expense of those who save (primarily the middle class). Lastly, business also benefits in its capacity as a borrower because, in a period of currency depreciation, it is enabled to pay off its debts in money of lower value.

Promoters and fast buck operators, the hanger-ons of any paper money scheme, take advantage of the gullible to create an emotional turbulence on the markets.

As against these, the vast majority of people in the society lose. In particular, the elderly in a society suffer from the depreciation of the currency. It is they who have put away money for their old age. As this money depreciates in value, they are reduced to poverty. For example, in 1960 it was not unreasonable for a 50-year-old man to plan retirement on a $3,000 annual income. But now, as retirement approaches, how much will $3,000 buy? $3,000 is now below the poverty line. And if the inflation continues until 1985, how much will $3,000 buy then?

The middle class also lose. Like the elderly, they lose from the depreciation of their savings. However, they also lose from the artificial lowering of the rate of interest. Since it is they who are the most thrifty and do the real saving (saving of real capital), it is they who lose most from a depressed interest rate.

And of course, the worker loses as his wages do not keep pace with the depreciation of the currency.


  1. It is actually greater because the process involves waste. This will be discussed below.
  2. Thomas Jefferson, letter to John W. Eppes, Nov. 6, 1813, Writings, XIII, p. 413.
  3. Daniel Webster, The Legal Currency, speech delivered in the House of Representatives, April 26, 1816, The Debates and Proceedings in the Congress of the United States, Fourteenth Congress — First Session (Washington, D.C., 1854), pp. 1441-42.
  4. Historical Statistics of the United States, Colonial Times to 1957 (Washington, 1960) Wholesale Price Index — series E1-24; wages prior to 1890 — series D 573; wages WWI — series D590, average hourly earnings in manufacturing; wages depression — series D 654, average hourly earnings in 25 manufacturing industries.
  5. Grover Cleveland, Annual Message to Congress — 1888, as quoted in The Great Quotations, compiled by George Seldes (New York, 1960), p. 163.
  6. John Maynard Keynes, General Theory of Employment, Interest and Money (London, 1936), [rights controlled by Harcourt Brace Jovanovich, Inc.] p. 10.