The Mystery of Banking

Foreword
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consumers, or wage-earners. Even in the exceptional instances,
such as the Great Depression, when inept Fed policy is blamed for
making matters worse, the Fed’s errors are ascribed to not yet
having learned how to properly wield the “tools of monetary pol-
icy,” the euphemism used to describe the various techniques the
Fed uses in exercising its legal monopoly of counterfeiting money.
Each new crisis, however, stimulates the public-spirited policy-
makers at the Fed by a trial-and-error process to eventually con-
verge on the optimal monetary policy, which was supposedly hit
upon in the heyday of the Greenspan Fed during 1990s. 
Rothbard rejects such a superficial and naïve account of the
Fed’s origins and bolstering of the banking system development.
Instead, he deftly uses sound monetary theory to beam a penetrat-
ing light through the thick fog of carefully cultivated myths that
surround the operation of the Fed. Rather than recounting the
Fed’s response to isolated crises, he blends economic theory with
historical insight to reveal the pecuniary and ideological motives
of the specific individuals who played key roles in establishing,
molding, and operating the Fed. Needless to say, Rothbard does
not blithely accept the almost universal view that the Fed is the
outcome of a public-spirited response to shocks and failures
caused by unruly market forces. Rather he asks, and then answers,
the incisive, and always disturbing, question, “
Cui bono
?” (“To
whose benefit?”). In other words, which particular individuals
and groups stood to benefit from the Fed’s creation and its spe-
cific policies? In answering this question, Rothbard fearlessly
names names and delves into the covert motives and goals of
those named. 
This constitutes yet another, and possibly the most important,
reason why Rothbard’s book had been ignored: for it is forbidden
to even pose the question of “who benefits” with respect to the
Fed and its legal monopoly of the money supply, lest one be
smeared and marginalized as a “conspiracy theorist.” Strangely,
when a similar question is asked regarding the imposition of tar-
iffs or government regulations of one sort or another, no one
seems to bat an eye, and free-market economists even delight in
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and win plaudits for uncovering such “rent-seekers” in their pop-
ular and academic publications. Thus economists of the Chicago
and Public Choice Schools have explained the origins and policies
of Federal regulatory agencies such as the ICC, CAB, FDA, FTC,
FCC, etc., as powerfully shaped by the interests of the industries
that they regulated. Yet these same economists squirm in discom-
fort and seek a quick escape when confronted with the question
of why this analysis does not apply to the Fed. Indeed, Rothbard
does no more than portray the Fed as a cartelizing device that lim-
its entry into and regulates competition within the lucrative frac-
tional-reserve banking industry and stands ready to bail it out,
thus guaranteeing its profits and socializing its losses. Rothbard
further demonstrates, that not only bankers, but also incumbent
politicians and their favored constituencies and special interest
groups benefit from the Fed’s power to create money at will. This
power is routinely used in the service of vote-seeking politicians
to surreptitiously tax money holders to promote the interests of
groups that gain from artificially cheap interest rates and direct
government subsidies. These beneficiaries include, among others,
Wall Street financial institutions, manufacturing firms that pro-
duce capital goods, the military-industrial complex, the construc-
tion and auto industries, and labor unions. 
With the U.S. housing crisis metamorphosing into a full-
blown financial crisis in the U.S. and Europe and the specter of a
global stagflation looming larger every day, the Fed’s credibility
and reputation is evaporating with the value of the U.S. dollar.
The time is finally ripe to publish this new edition of the book
that asked the forbidden question about the Fed and fractional-
reserve banking when it was first published twenty-five years ago. 
J
OSEPH
T. S
ALERNO
P
ACE
U
NIVERSITY
J
ULY
2008
Foreword
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I.
M
ONEY
: I
TS
I
MPORTANCE
AND
O
RIGINS
1. T
HE
I
MPORTANCE OF
M
ONEY
T
oday, money supply figures pervade the financial press.
Every Friday, investors breathlessly watch for the latest
money figures, and Wall Street often reacts at the opening
on the following Monday. If the money supply has gone up
sharply, interest rates may or may not move upward. The press is
filled with ominous forecasts of Federal Reserve actions, or of
regulations of banks and other financial institutions. 
This close attention to the money supply is rather new. Until
the 1970s, over the many decades of the Keynesian Era, talk of
money and bank credit had dropped out of the financial pages.
Rather, they emphasized the GNP and government’s fiscal policy,
expenditures, revenues, and deficits. Banks and the money supply
were generally ignored. Yet after decades of chronic and acceler-
ating inflation—which the Keynesians could not begin to cure—
and after many bouts of “inflationary recession,” it became obvious
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to all—even to Keynesians—that something was awry. The money
supply therefore became a major object of concern. 
But the average person may be confused by so many defini-
tions of the money supply. What are all the Ms about, from M1-
A and M1-B up to M-8? Which is the 
true
money supply figure,
if any single one can be? And perhaps most important of all, why
are bank deposits included in all the various Ms as a crucial and
dominant part of the money supply? Everyone knows that paper
dollars, issued nowadays exclusively by the Federal Reserve Banks
and imprinted with the words “this note is legal tender for all
debts, public and private” constitute money. But why are check-
ing accounts money, and where do they come from? Don’t they
have to be redeemed in cash on demand? So why are checking
deposits considered money, and not just the paper dollars backing
them?
One confusing implication of including checking deposits as a