Is Debt Alone a Threat?
In his writings, Fisher argued that the size of the debt determines the severity of an economic Here I argue that it is not the size of the debt as such that determines the severity of a recession, but rather monetary policies of the central bank. Debt alone does not lead to the misallocation of capital. Rather, misallocations are causes by the Fed's loose monetary policies that permitted the debt to increase beyond what it might be in a market setting. Blaming debt as the cause of economic recession absolves the Fed from any responsibility in actually setting the whole process in motion. FULL ARTICLE
Comments (90)
Mark Brabson
Central banking and fiat money ultimately make this debt possible. In a commodity money system with 100% reserve banking there would be finite limits on the available amount of credit in the economy. To spend, government would have to tax, borrowing would, as it once was, tend to be restricted to wartime situations. Central banking bears much of the blame for this situation. The Federal Reserves open spigot of easy credit makes this mountain of debt possible. Of course, politicians taking advantage by borrow and spend policies are guilty in themselves, but the Federal Reserve is at least fifty percent to blame.
Published: November 2, 2006 9:21 AM
John Taylor
Bill Bernanke was specifically employed to handle the consequences of the Greenspin monetary bulge. His academic background is the great depression and that is why he mentioned that the way to retain liquidity was to drop dollars from helicopters. Obviously that is not what he will physically do but he will likely start pumping money into areas that will maintain consumption. One method will be possibly to start buying the stock market with fed printed money (plunge protection) which simultaneously drops money on the groups which has closest ties to government, maintains consuption , and increases the US control of the american economy. However is that The ultimate problem for the fed is that it is no longer in control of the economy but dependent on overseas money flows to maintain the markets and the dollar.
Rgds
John Taylor
Rgds
John Taylor
Published: November 2, 2006 9:26 AM
David C
Bernanke is going to be in for a rude supprise. If he pumps money into the system (which he is), that will drive up prices but not pay. With information technology making business processes more efficient, and overseas labor offsetting domestic costs. That will make sure the pay that people need to relieve the debt is the last of all prices to go up.
Hold on for your life. Being the "genius" that he is, he will probably decide to fix the "problem" by pumping in so much God forsaken money that the whole economic system will explode in a glorious flameout. God help us.
Published: November 2, 2006 9:51 AM
Mike Sproul
Money is not created out of thin air. No sane banker will lend me 400,000 newly-created checking account dollars unless I give him a lien on my $500,000 house. The money is backed by the house. The Fed will not issue 1 million new paper dollars unless someone gives them a $1 million US bond in return. This money is backed by the bond, which in turn is backed by the tax-collecting ability of the US.
Published: November 2, 2006 10:06 AM
Eric
Mike:
Mike:
But the bond you say is backed by the tax collecting capability of the government is like saying the bank lent me money, NOT backed by my house, but by my ability to steal money from other people. Perhaps this is a safe bet for the bank, if I am a successful thief. But what happens if I run out of victims. In addition, the money the bank lends me is deposited into some other bank, which then has new reserves and lends the same money out to someone else.
I agree that we shouldn't call this money out of thin air, as it continues to confuse the public, who just don't get it. We should call it what it really is, counterfeiting - ok, legal counterfeiting, but nonetheless, it has the same affect and the public does understand the harm that that does.
Published: November 2, 2006 11:06 AM
David White
Mike Sproul:
Along with a nearly $10 trillion dollar national debt, and counting, we've got another $65 trillion, and counting, in unfunded liabilities. As there's no way these obligations can be met through direct taxation, inflation -- taxation through depreciation -- is the only alternative.
As for banks, their reserve requirements of 10% means that they can lend an additional nine dollars for every dollar on desosit, charging interest on this out-of-nowhere money.
How long can this massive, 24/7/365 fraud continue?
Only until foreign bond holders decide that the dollar's too depreciated to hold any longer, which could be virtually any time.
Published: November 2, 2006 11:37 AM
Mark Brabson
You can refer to what the fed does one of two ways. Counterfeiting. Or, more politely, emitting bills of credit. Either way, it is not, nor will it ever be creating money. Money can only arise on the market as a commodity that people are voluntarily willing to use as a medium of exchange.
Bills of credit have no inherent value, just the vague promise of their attendent federal securities someday being redeemed. They are nothing more than fraud.
Published: November 2, 2006 11:57 AM
Daniel M. Ryan
When it comes down to it, we don't know how far the credit bubble can go, nor the inevitable meltdown. Dr. Shostak does make a good point about real savings, one that implies that any meltdown will end long before what would be indicated by a simple calculation of the amount of fiduciary media over money proper.
Published: November 2, 2006 12:33 PM
Bill, deflation fan
First the argument is that hell will befall us with deflation is complete crap.
We will never need to get out the helicopter and drop the money. What is so bad about deflation? Things like computers and electronics deflate (are supplied at lower prices) all the time. I like those things. It is the things that inflate that I get mad at like government or schools.
To prove my point: When a Kohls, Target or a supposedly evil Walmart opens near a mall you can bet that prices in the mall will fall causing deflation. But I am better off.
Also, as prices drop, people like me( Known as Bargin Hunters, Bottom Fishers, etc.) bring out credit cards or some excess cash and buy stuff. The same thing happens with corporations who also react to the fake money created by Uncle FED. They are buying back stock like crazy because they can not generate cash as fast as the Fed can throw it out of helicopters.
Published: November 2, 2006 2:15 PM
Eric
"Money can only arise on the market as a commodity that people are voluntarily willing to use as a medium of exchange"
True, but this should read the "free market" as force can easily create money, as did the Chinese once by declaring that anyone not accepting the government's paper as money would be killed immediately. Legal tender law is the same thing, except you get to keep you head a little bit longer (so long as you do obey and don't resist).
Published: November 2, 2006 2:24 PM
mikey
Re Mike's comment- don't gov'ts usually redeem maturing debt instruments with newly created debt instruments, and not retire them with cash from tax revenues?
Published: November 2, 2006 3:08 PM
Joe
The footnote links in yesterday's and today's Daily Articles are wrong. Instead of being something like https://mises.org/daily2345/#_ftn1 they are https://mises.org/manager/#_ftn1.
Published: November 2, 2006 3:11 PM
Björn Lundahl
Recessions and The Great Depression were caused by Government Interventions!
In a purely free market (without Government intervention), the rate of interest is determined by people’s “willingness to save and invest” (which is called people’s time preferences) for future use, as compared to how much they are “willingly to consume now”. If people change their “willingness to save” (time preferences) and want to save more, the additional savings will cause the rate of interest to fall (increased supply of savings), and businesses will borrow and invest these additional savings. When the Central Bank (for example The Federal Reserve) increases the money supply and expands bank credit (which Central Banks does everywhere and all the time and always “out of thin air”), it initially lowers the rate of interest and thereby misleads businessmen to act in a manner as if true savings have increased, which in turn leads businessmen to invests those supposed savings in capital goods. New projects that were not profitable before, will now suddenly with this lower interest rate, be profitable. While this process is working, the economy is in an inflationary boom phase (expansion). Capital goods such as stocks, real estate etc, will be more demanded and invested in, and prices of those will rise faster and more intensely in relation to consumption goods. As these supposed savings have worked their way through the economy, prices of goods, services and wages have generally increased to a height which prices for them would have not reached without these supposed savings.
As mentioned, people’s “willingness to save and invest” have not changed (people’s time preferences have not changed) for it was only the Central Bank that increased, out of thin air, additional “savings”. When supposed savings have worked their way through the economy and are received, finally, in increased wages, people still spend their real wages in the same manner as before. They save/ consume in real terms and in same proportion to each other, as before mentioned increase in supposed savings. Because of this, a lack of savings will occur and the rate of interest will rise. Projects that businessmen have invested in and that seemed to be profitable when the rate of interest was lowered are now revealed to be unprofitable. All those investments are revealed to be malinvestments. Businessmen will stop investing in those projects and lay off workers. Prices of capital goods, real estate, stocks etc, will fall sharply and relatively to the fall in prices of consumer goods. The economy is in a depression phase. When those investments are liquidated, the economy is adjusted to people’s “willingness to save and invest” and to consume. The economic structure corresponds to the ratio which people want to save and consume. The economy is now healthy again.
Now then, in the 1920s the Federal Reserve, in the US, increased the money supply and bank credit, which in the 30s resulted in The Great Depression. The same story goes with Japan during the 1980s, which during the 90s, resulted in a depression, go to; http://en.wikipedia.org/wiki/Japanese_asset_price_bubble
In Sweden we had banks lending out heavily during the late 80s, which also, led to a depression in the 90s.
All business cycles are caused by the same phenomenon. Economic crisis can occur because of other factors such as wars, boycotts, oil prices etc, but pure business cycles have in common the same cause.
I have tried, in a very few words and in a easy manner, to explain Ludwig von Mises business cycle theory, which is also called the Austrian theory of the business cycle. All faults are mine. Friedrich August von Hayek elaborated this theory and received in 1974 the Nobel Prize* for this. Go to;
http://nobelprize.org/nobel_prizes/economics/laureates/1974/
If you want to know more about this theory, go to;
http://mises.org/rothbard/agd/contents.asp
And to;
http://mises.org/money.asp
Björn Lundahl
Göteborg Sweden
* Information about the Nobel Prize in Economics, go to;
http://cepa.newschool.edu/het/schools/nobel.htm
Published: November 2, 2006 3:39 PM
Björn Lundahl
What Has Government Done to Our Money? By Murray Rothbard.
Some information about 100 percent gold reserve money.
I quote from the above mentioned book:
Money Warehouses
“It should be clear that, economically, there is no difference whatever between a bank note and a bank deposit. Both are claims to ownership of stored gold; both are transferred similarly as money substitutes, and both have the identical three limits on their extent of use. The client can choose, according to this convenience, whether he wishes to keep his title in note, or deposit, form. [14]
Now, what has happened to their money supply as a result of all these operations? If paper notes or bank deposits are used as "money substitutes," does this mean that the effective money supply in the economy has increased even though the stock of gold has remained the same? Certainly not. For the money substitutes are simply warehouse receipts for actually-deposited gold. If Jones deposits 100 ounces of gold in his warehouse and gets a receipt for it, the receipt can be used on the market as money, but only as a convenient stand-in for the gold, not as an increment. The gold in the vault is then no longer a part of the effective money supply, but is held as a reserve for its receipt, to be claimed whenever desired by its owner. An increase or decrease in the use of substitutes, then, exerts no change on the money supply. Only the form of the supply is changed, not the total. Thus the money supply of a community may begin as ten million gold ounces. Then, six million may be deposited in banks, in return for gold notes, whereupon the effective supply will now be: four million ounces of gold, six million ounces of gold claims in paper notes. The total money supply has remained the same”.
http://mises.org/money/2s12.asp
Björn Lundahl, Göteborg, Sweden
Published: November 2, 2006 4:27 PM
banker
The Federal Reserve's balance sheet is broken because it prints its money. Every single other entity that exists does not have that problem because either they use external financing or internal savings.
Private Bank Balance Sheet:
Asset- Loan Portfolio (money loaned out, right to future cashflows of repayment)
Liabilities- Customer Deposits (zero maturity loan, vocab not withstanding), Bank debt (commercial paper market)
Equity- Hopefully a lot more than zero. Assets-Liabilities
"No sane banker will lend me 400,000 newly-created checking account dollars unless I give him a lien on my $500,000 house."-quote
The assets on the balance sheet ONLY consist of rights to future cash flows. Hence, the present value of these cash flows (what appears on the balance sheet) is heavily affected by what interest rate the central bank chooses (real estate bubble, etc).
A house, like any other object on the face of the Earth, is only worth what you can sell it for. A house is a house not cash. Since people do not save too much, the prevailing factor in the value house is the current interest rate. IMO, people make their judgement based on their monthly payments over 30 years versus the bank which is only looking at the cash flow that comes from selling the house. People use loans (and very little cash) to buy homes these days (unfortunate). Hence, the present value changes according to interest rates, which affects how this collateral is valued by the bank. No bank would be stupid enough to think that a house is equivalent to holding X amount of dollars. If interest rates skyrocket that $500k house is looking more like $400k or less.
The house NEVER goes onto the balance sheet because the bank never owns or has a right to it. Only the mortgage (the right to future cash flows) is valued to reflect the chance that the borrower defaults and at what price the house can be sold for (recovery value is the technical term I believe).
Published: November 2, 2006 4:36 PM
M E Hoffer
Bjorn,
"Economic crisis can occur because of other factors such as wars, boycotts, oil prices etc..."
These occur?
Yet, any Economy with a, putative, Comparative Advantage in "Services" would, without question, be best served by Exporting its Manufacturing Sector, wholesale, and Import, or try to, its necessary Goods, retail?
That's Fantasy, in the same league of: We need the FedRes to 'manage' price stability and the 'business cycle'. Isn't it?
Published: November 2, 2006 4:49 PM
Mike Sproul
Eric:
Whether taxes=theft or not, taxes back US bonds, which back US dollars. When banks create new dollars based on those reserves, those new dollars will be backed by new liens on new property. The Fed is not a counterfeiter. No counterfeiter puts his name on his money, or recognizes it as a liability on his balance sheet, or buys his money back with his bonds.
Published: November 2, 2006 9:45 PM
Mike Sproul
David White:
Whatever the US debt is, the market will put a price on US bonds, and the Fed will issue a dollar for a dollar's worth of those bonds. Thus each dollar is issued for equal-valued assets, not out of thin air.
Private banks also issue new money only in exchange for equal-valued assets--not out of nowhere.
Published: November 2, 2006 9:50 PM
Björn Lundahl
Mike Sproul
“Whatever the US debt is, the market will put a price on US bonds, and the Fed will issue a dollar for a dollar's worth of those bonds. Thus each dollar is issued for equal-valued assets, not out of thin air.
Private banks also issue new money only in exchange for equal-valued assets--not out of nowhere”.
If you print US dollars (and people accept them) and you then lend them out, it does not matter if the whole world backs them up with their property.
It is still money created out of thin air. Every “economist” (including the board of governors at the Federal Reserve) knows this. Really, you should go to the nearest bookstore
and read and study it in any economics book.
Björn Lundahl
Göteborg, Sweden
Published: November 3, 2006 1:28 AM
Björn Lundahl
Eric
” True, but this should read the "free market" as force can easily create money, as did the Chinese once by declaring that anyone not accepting the government's paper as money would be killed immediately. Legal tender law is the same thing, except you get to keep you head a little bit longer (so long as you do obey and don't resist)”.
The origin of money “can only arise on the market as a commodity that people are voluntarily willing to use as a medium of exchange”.
Björn Lundahl
Published: November 3, 2006 1:39 AM
Björn Lundahl
Eric
I quote from Man, Economy and State, by Murray Rothbard:
” One of the important achievements of the regression theory is its establishment of the fact that money must arise in the manner described in chapter 3, i.e., it must develop out of a commodity already in demand for direct use, the commodity then being used as a more and more general medium of ex¬change. Demand for a good as a medium of exchange must be predicated on a previously existing array of prices in terms of other goods. A medium of exchange can therefore originate only according to our previous description and the foregoing diagram; it can arise only out of a commodity previously used directly in a barter situation, and therefore having had an array of prices in terms of other goods. Money must develop out of a com¬modity with a previously existing purchasing power, such as gold and silver had. It cannot be created out of thin air by any sudden “social compact” or edict of government”.
http://mises.org/rothbard/mes/chap4b.asp
Björn Lundahl
Published: November 3, 2006 1:55 AM
Björn Lundahl
M E Hoffer
”"Economic crisis can occur because of other factors such as wars, boycotts, oil prices etc..."
These occur?”
Not often, I think.
Björn Lundahl
Published: November 3, 2006 2:09 AM
Paul Edwards
Nice article.
Published: November 3, 2006 2:12 AM
M E Hoffer
Bjorn,
Then, in that case, no worries, right? :-)
You might care to check out the idea of "Fat Tails" from Mandelbrot and Grantham.
Published: November 3, 2006 5:09 AM
Björn Lundahl
M E Hoffer
I want also to mention that those crises (and not business cycles) that might rarely occur despite a 100 percent gold reserve money standard are usually caused by governments. Governments cause wars, boycotts, oil prices (that are suddenly increased through OPEC) etc. Societies based on liberty will be without those destructive actions caused by governments.
“Yet, any Economy with a, putative, Comparative Advantage in "Services" would, without question, be best served by Exporting its Manufacturing Sector, wholesale, and Import, or try to, its necessary Goods, retail?”
If an economy that is based on a free market has a comparative advantage in producing services, the market will produce those services because it will be profitable, and the people on the average will be more prosperous than they otherwise would be without this production.
Björn Lundahl
Göteborg, Sweden
Published: November 3, 2006 6:16 AM
M E Hoffer
Bjorn,
Your grasp of the fundamental aspects of Free Market Economics, is Fine, and is, certainly, fine by me.
There is, though, today, or as always, a Grand Gulf between "What Is" and "What Should Be".
The Division of Labor, taken to too far, stops propagating wealthy Individuals resplendent with ever greater variety of Choice. Too far, the fissioning foments, no longer Wealth and Liberty, but Intractable Dependence and the Poverty of Few Options.
Published: November 3, 2006 7:04 AM
Dan Coleman
M E Hoffer,
If there is such a limit on how the free market works, are you suggesting that we've hit its limit as of recent times, or that we will soon?
Would you have said the same thing 50 years ago, when Mises wrote against critics who were arguing that the division of labor had already gone "too far"?
Even if you wouldn't have made this criticism 50 years ago, but do today, doesn't it strike you as odd that you predict an even horrizon for economic activity from which a free market may not recover? Is there really a state in which individuals free to act so enslave themselves through voluntary contract that they cannot rectify the situation? As I see it, enslavement is the function of aggressive force, not free association.
If the division of labor is specialized enough that it ceases to be profitable, then the market will clear and resources will be shuttled back to their most urgent uses. The fact that this happens incrementally over time (through human action spurred on by marginal preference) shows that "the Division of Labor, taken to too far," will not be a reality that will simply wake up to one day.
As I argued in another thread that seems to have been abandoned, if anything we must fear the government for distorting price signals rather than the division of labor that naturally occurs in free markets. A liberated people will not enslave themselves voluntarily, but government policy threatens to do just that.
Published: November 3, 2006 8:52 AM
Mike Sproul
Björn Lundahl:
I wrote a few of those economics books.
Show me a bank that issues money without taking adequate security in exchange for it, and I'll send them more customers than they can handle.
Money's value is determined by its backing, and as long as backing moves in step with the quantity of money, the value of money will be unaffected by the quantity of money--just like any other financial security.
Published: November 3, 2006 10:02 AM
M E Hoffer
DC,
You state: "If anything, we must fear the government for distorting price signals rather than the division of labor that naturally occurs in free markets. A liberated people will not enslave themselves voluntarily, but government policy threatens to do just that."
I concur, I think that's accurate.
What I was trying to point, above, is: we are living in just such a schema. One rife with faulty Financial Price signals fueled by faulty Fiat, both Fiduciary and Legislative.
Further, I was hoping to serve, as a reminder, by pointing to the existence of the Asymptote that exists, in my view, in that theory of "Division of Labor", past which lies the "voluntary enslavement" you give rise to.
You ask, above, if I am suggesting that we've "gone too far". No. I hold no such level of Conceit. I certainly was suggesting that we Search for the bright line, that Asymptote, and, through Reflection, use it as a Mirror so that we may better view our current State.
Published: November 3, 2006 10:09 AM
David White
Mike Sproul:
"Money's value is determined by its backing, and as long as backing moves in step with the quantity of money, the value of money will be unaffected by the quantity of money--just like any other financial security."
What backing, "the full faith and credit" of the largest debtor nation in human history?
What complete and utter nonsense. (Remind me to keep your "economics" books away from my kids.)
Actually, money's value is ultimately determined by people's faith in it and nothing else. Since the American people are completely ignorant about money -- as Henry Ford said, "It is well enough that the people do not understand our banking and monetary system, for if they did I believe there would be a revolution by tomorrow morning" -- they are oblivious of the fact that they are no more than debt slaves and that once our financial house of cards collapses, they'll be left holding the bag. And that bag will contain nothing but IOUs, the gold and silver that was once in it having been stolen by the banksters and their henchmen.
Published: November 3, 2006 10:32 AM
Dennis Sperduto
There continues to be confusion amongst some regarding the fundamental nature of money, and this confusion leads to erroneous analysis and conclusions.
Money is the generally accepted medium of exchange, or viewed another way, the final means of payment for a good or service. As others have previously pointed out many times on this Blog, money is not debt, nor is money “backed” by debt or some real asset. Money has value not because of what “backs” it, but because individuals desire to hold cash, i.e. money, balances. Even fiat paper money, which is not backed by or convertible into any real asset, has value because individuals still desire to hold it in their cash balances.
The final stage of a hyper-inflation, when money literally becomes worthless, begins when individuals no longer desire to hold cash balances and spend money almost as fast as they receive it. At this point the demand for money has fallen to zero.
Such eminent economists as Mises and Rothbard have stressed these facts for many years.
Published: November 3, 2006 11:32 AM
mikey
To me, the point of this article was that debt alone is not a threat, and Shostak does a good job explaining why.Not all government bond sales are to savers.The government sells some of its bonds to the central bank,which in turn sets up a fictitious chequing account which is used to meet current expenditure.The effect is the same as if the government had printed the money.
Published: November 3, 2006 11:59 AM
David White
Dennis:
As Rothbard writes in "What Has the Government Done to Our Money?":
"If one good is more marketable than another—if everyone is confident that it will be more readily sold—then it will come into greater demand because it will be used as a medium of exchange. It will be the medium through which one specialist can exchange his product for the goods of other specialists. Now just as in nature there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability. It is clear that in every society, the most marketable goods will be gradually selected as the media for exchange. As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium which causes more marketability, etc. Eventually one or two commodities are used as general media—in almost all exchanges—and these are called money."
Thus is Rothbard quite clear in stating that money is a GOOD that is a generally accepted medium of exchange. Therefore, while paper money substitutes that are backed by such a good are perfectly (i.e., morally) acceptable, banknotes that are unbacked by such a good are not. On the contrary, they are counterfeit -- i.e., fraudulent -- money and thus are no more genuine than a counterfeit Picasso is.
Bottom line: Paper currency that is unbacked by (redeemable in) a good that used as a medium of exchange is not money, no matter that the vitcims of the fraud have been led to believe it is.
Published: November 3, 2006 12:21 PM
Dennis Sperduto
David, I sympathize with your position, and I certainly believe that a 100% commodity (gold) monetary framework would be a much more stable and ethical system.
However, fiat paper money and even electronic bookkeeping entries, despite their significant economic and ethical shortcomings, undeniably currently serve as the generally accepted medium of exchange (money). The existence of our current monetary framework does not contradict or nullify the teachings of Mises and Rothbard, since this system has devolved, over at least the past 90 or 100 years, from a framework that was substantially anchored in gold.
Published: November 3, 2006 1:47 PM
M E Hoffer
Dennis,
I think that David would call that, what you're describing: "Currency", a mere vehicle of conveyance, a "Service", if you will.
Rather than "Money", which, in its full, is Both a Currency and a Good.
And, if David wouldn't, I will. :-)
Published: November 3, 2006 1:57 PM
David White
M E Hoffer:
Yes, I would say that, adding that the only way for money to be moral is for it to be sound and that the only way for money to be sound is for it to be a good that accordingly exists in a finite (if changeable) quantity.
And I reiterate that just because the masses are duped into using an irredeemable paper currency (as well as required by "law" to do so) doesn't mean that they/we aren't being swindled every minute of every day and that the paper therefore is real money.
Published: November 3, 2006 2:42 PM
greg
Mike S> Show me a bank that issues money without taking adequate security in exchange for it, and I'll send them more customers than they can handle.
And that is decidedly not what is being discussed.
Mike S> Money's value is determined by its backing,...
Federal Reserve Notes are "backed" by Federal Reserve Notes. That means if you take your old torn-worn sawbuck down to the Feds, they'll give you a nice new one and a kiss, but nothing else.
The US fiat currency is only "backed" by what someone other than the issuer (the US) will give you for it. But that is not what is meant by "backed."
Mike S> ... and as long as backing moves in step with the quantity of money, the value of money will be unaffected by the quantity of money--just like any other financial security.
Sorry, but that is incorrect. Even if the notes were specie backed, and there was a huge gold strike, and gold coins were stamped out en-masse. "The value" of money would go down then, even with the specie backing. The "value" of money is what it will do, not the number stamped upon it. MV=PQ, and simply more available cash does not create productive capacity. You are left with P to balance.
Mike S> I wrote a few of those economics books.
Good grief.
Published: November 3, 2006 3:36 PM
Dennis Sperduto
Still, the defining, the praxeological differentiating characteristic of money is that it is the generally accepted medium of exchange. Whether or not we agree with the morality of paper money and fractional reserve banking, anything, including paper, that is utilized as the generally accepted medium of exchange is money.
Moral considerations, while important, should not impact economic analysis, and they have no effect on economic and praxeological law. The laws of supply and demand and all economic law are independent of ethical considerations.
I think we may have gone somewhat astray from the purpose of my initial comment, which was to criticize the real bills doctrine.
Published: November 3, 2006 3:43 PM
David White
Dennis:
Every fiat currency that has ever existed has been destroyed through inflation, and given that the dollar has lost over 95% of its value since 1913 (when the constitutional dollar was unconstitutionally destroyed), it is doomed to this same fate, the only question being when.
It is a fraud, in other words, and all I'm saying that unwitting participation in it by its victims (as well as by those who know it's a fraud but are coerced into participating in it) doesn't turn the fraud's vehicle of conveyance into money.
Published: November 3, 2006 4:03 PM
Mike Sproul
Greg:
"Even if the notes were specie backed, and there was a huge gold strike, and gold coins were stamped out en-masse. "The value" of money would go down then, even with the specie backing. The "value" of money is what it will do, not the number stamped upon it. MV=PQ, and simply more available cash does not create productive capacity. You are left with P to balance."
You missed the point about backing. If a banker gets 100 oz. of silver on deposit, and issues 100 paper receipts called dollars in exchange, then each of those dollars will be worth one ounce, even on nights and weekends, when the dollars are temporarily inconvertible. If they get another 100 oz deposit and issue another $100, each dollar will still be worth one ounce, because backing has moved in step with the issue of dollars. If someone comes in with an amount of gold that is worth 100 oz. of silver, then the bank can issue another $100 for it without causing inflation. The same remains true if people bring in 100 oz. worth of wheat, land, bonds, etc.
As for MV=PQ, that just says the amount of money spent equals the amount received--about as meaningless as saying that the amount of rain falling from the sky equals the amount hitting the earth.
Everyone recognizes that if GM stock is worth $60 per share, and if GM prints a new share and sells it for $60, then GM's assets will rise in step with the number of shares issued, and the stock price will be unaffected. It should be obvious that the same thing is true of money. It should also be obvious that the equation of exchange is just as applicable to the value of GM stock as it is to money (hint: M=number of shares of GM). No stock market analyst would be fool enough to use MV=PQ as an aid to stock valuation, and yet economists are fool enough to think that MV=PQ determines the value of money.
Published: November 3, 2006 7:48 PM
banker
"If someone comes in with an amount of gold that is worth 100 oz. of silver, then the bank can issue another $100 for it without causing inflation."--quote
Gold!=Silver or anything else. The bank will have to procure 100oz of silver in order to redeem the silver note. The fact that gold != silver means that the price is not fixed in concrete; it changes (a lot sometimes). Hence, the bank has just taken a relative bet on the value of gold versus silver. The bank hopes later that it can exchange gold for silver at a rate higher than it got the gold. (50oz gold = 100oz silver at time 1; 50oz gold = 500oz Silver time 2).
The first transaction: the bank sold silver and bought gold.
Second transaction: the bank sold gold and bought silver (covered short position in silver).
This is just a highly leveraged transaction betting on relative prices. This is true for any two assets the bank trades in, including houses for dollars.
"Everyone recognizes that if GM stock is worth $60 per share, and if GM prints a new share and sells it for $60, then GM's assets will rise in step with the number of shares issued, and the stock price will be unaffected."--quote
Accounting wise this is true, but accounting numbers are based on historical prices and do not change over time. If investors don't perceive GM creating AT LEAST $60 present value of NEW cash flow from investing $60 from new share issuance, then the stock price will go down.
You are confusing accounting numbers with Real Word, Real Time prices and this is a HUGE mistake. Accounting = historical, fixed; Current Prices = Current prices, always changing.
Published: November 3, 2006 8:16 PM
billwald
If I give my neighbor an IOU for $20 have I not increased the money supply? If I sign a credit card slip have I not increased the money supply?
Would you gold afectionados also ban credit cards?
Published: November 3, 2006 9:17 PM
Mike Sproul
Banker:
" the bank has just taken a relative bet on the value of gold versus silver."
For that matter, every depositor of silver has taken a bet that the bank won't be robbed. So what if the bank takes in gold instead of silver? As long as the bank and its customers understand the risk?
"If investors don't perceive GM creating AT LEAST $60 present value of NEW cash flow from investing $60 from new share issuance, then the stock price will go down."
Perfectly true. GM might get more or less than $60 of new cash flow. And a bank that issues a new dollar might get assets worth more or less than $1. If less, there will be inflation, if more, deflation.
Billwald:
Correct on both counts, and in both cases the new money is backed by whatever assets you put behind the money you issued.
Published: November 3, 2006 10:28 PM
averros
If I give my neighbor an IOU for $20 have I not increased the money supply?
You didn't - for he cannot spend it. IOU is not money, it is a promise to transfer money at some future date.
f I sign a credit card slip have I not increased the money supply?
Not at all. If the bank is not engaged in fraud, they decrease their cash accounts by exactly the same sum they loaned you.
Before the CC slip is processed you merely created IOU to the merchant - which he cannot spend (and which in some cases can be rejected by the bank), and when he gets cash from the bank in exchange for IOU, the bank loses that cash.
Would you gold afectionados also ban credit cards?
Not at all. Only fraudulent manipulations with unbacked loans. The basic CC operation is quite sound.
You'd be well-advised to read Rothbard's "What has the government done to our money" - it contains the very clear explanation of what the money is and what it isn't.
Published: November 3, 2006 10:28 PM
banker
"If someone comes in with an amount of gold that is worth 100 oz. of silver, then the bank can issue another $100 for it without causing inflation."--quote1
"For that matter, every depositor of silver has taken a bet that the bank won't be robbed. So what if the bank takes in gold instead of silver? As long as the bank and its customers understand the risk?"--quote2
You're not talking about a deposit bank then. You're talking about a hedge fund or a trading firm. What would the point be for a bank to issue a silver receipt if the person has deposited gold? I would think the bank would issue a gold receipt for gold deposits, which is completely different from you wrote.
A receipt for a deposit means retaining ownership over what you deposited. That can be used as a currency in place of physical gold or silver. The bank just keeps custody over your gold.
Loaning the bank money (what a deposit is today) is not the same. The bank IOU for your deposit will not be accepted as currency because the bank has ownership of the "deposit" (meaning they can invest it and lose it) and the person with whom you exchange that IOU for something will still not have ownership over the gold or silver the bank owes.
IOU, like any form of debt, trades at a discount to the cash that is being promised by the borrower. This is where the interest rate (time preference) and default risk (risk preference) come into play.
Dollars are not IOU's, despite what the letters on it say. It is the base currency, like gold or silver. The problem with the dollar is that the Federal Reserve can print dollars, which destroys the value of using it as a currency. If the dollar is an IOU, what is it redeemable for? Redeeming a dollar now for dollars later does not make it a receipt. The Federal Reserve's balance sheet is total crap because they finance themselves with the printing press, while everyone else has to use either internal or external savings. How can the currency be a liability and IOUs for dollars be an asset?
Published: November 3, 2006 11:00 PM
Björn Lundahl
Banker
” Dollars are not IOU's, despite what the letters on it say. It is the base currency, like gold or silver. The problem with the dollar is that the Federal Reserve can print dollars, which destroys the value of using it as a currency. If the dollar is an IOU, what is it redeemable for? Redeeming a dollar now for dollars later does not make it a receipt. The Federal Reserve's balance sheet is total crap because they finance themselves with the printing press, while everyone else has to use either internal or external savings. How can the currency be a liability and IOUs for dollars be an asset?”
Well said. I completely agree.
Björn Lundahl
Published: November 4, 2006 3:14 AM
Björn Lundahl
Age of inflation
Economics teaches us that if the supply of marketable commodities increases, the price of each unit will fall.
As this is true, it is also true that if the supply of money-commodities increases, the price of each unit will fall.
No more theories are needed about this subject! Go home and study something else (joke)!
With the exception of the Austrian School of Economics, other schools are completely messed up.
Björn Lundahl
Göteborg, Sweden
Published: November 4, 2006 3:20 AM
Björn Lundahl
Another example.
I quote from the book For a New Liberty, by Murray Rothbard:
9 Inflation and the Business Cycle: The Collapse of the Keynesian Paradigm
”By far the most important route for the Fed's determining of total reserves is little known or understood by the public: the method of "open market purchases." What this simply means is that the Federal Reserve Bank goes out into the open market and buys an asset. Strictly, it doesn't matter what kind of an asset the Fed buys. It could, for example, be a pocket calculator for twenty dollars. Suppose that the Fed buys a pocket calculator from XYZ Electronics for twenty dollars. The Fed acquires a calculator; but the important point for our purposes is that XYZ Electronics acquires a check for twenty dollars from the Federal Reserve Bank. Now, the Fed is not open to checking accounts from private citizens, only from banks and the federal government itself. XYZ Electronics, therefore, can only do one thing with its twenty-dollar check: deposit it at its own bank, say the Acme Bank. At this point, another transaction takes place: XYZ gets an increase of twenty dollars in its checking account, in its "demand deposits." In return, Acme Bank gets a check, made over to itself, from the Federal Reserve Bank.
Now, the first thing that has happened is that XYZ's money stock has gone up by twenty dollars—its newly increased account at the Acme Bank—and nobody else's money stock has changed at all. So, at the end of this initial phase—phase I—the money supply has increased by twenty dollars, the same amount as the Fed's purchase of an asset.
"If one asks, where did the Fed get the twenty dollars to buy the calculator, then the answer is:
it created the twenty dollars out of thin air by simply writing out a check upon itself. No one, neither the Fed nor anyone else, had the twenty dollars before it was created in the process of the Fed's expenditure".
But this is not all. For now the Acme Bank, to its delight, finds it has a check on the Federal Reserve. It rushes to the Fed, deposits it, and acquires an increase of $20 in its reserves, that is, in its "demand deposits with the Fed." Now that the banking system has an increase in $20, it can and does expand credit, that is, create more demand deposits in the form of loans to business (or to consumers or government), until the total increase in checkbook money is $120. At the end of phase II, then, we have an increase of $20 in bank reserves generated by Fed purchase of a calculator for that amount, an increase in $120 in bank demand deposits, and an increase of $100 in bank loans to business or others. The total money supply has increased by $120, of which $100 was created by the banks in the course of lending out checkbook money to business, and $20 was created by the Fed in the course of buying the calculator.
In practice, of course, the Fed does not spend much of its time buying haphazard assets. Its purchases of assets are so huge in order to inflate the economy that it must settle on a regular, highly liquid asset. In practice, this means purchases of U.S. government bonds and other U.S. government securities. The U.S. government bond market is huge and highly liquid, and the Fed does not have to get into the political conflicts that would be involved in figuring out which private stocks or bonds to purchase. For the government, this process also has the happy consequence of helping to prop up the government security mar¬ket, and keep up the price of government bonds”.
http://mises.org/rothbard/newliberty9.asp
Björn Lundahl
Göteborg, Sweden
Published: November 4, 2006 4:37 AM
Björn Lundahl
In above quote from the book For a New Liberty, the reserve requirement set by the Federal Reserve on banks is exemplified by the ratio 6:1 (the required maximum multiple of de¬posit to reserves).
Björn Lundahl
Published: November 4, 2006 5:11 AM
Jim
Mark Brabson call it fraud & banker says its crap, but just what is the "credit" problem?
As i see it there's the basic fraud, which, as I'll show below, can be easily demonstrated; and there's the wider problem - the refusal to admit that basic fraud is both so simple and independendent of the "state" [except that the fraud requires the state to be in the hands of fools]. The following demonstration was 1st written 3 years ago and has been repeated to various 'Misesians'.
Can we agree that to "give credit" is not the same as to "lend money"? To see how the two are confused, let's examine a specific example - I'll try to defraud you of money by giving credit!
If I give you credit, I am trusting you to fulfil a commitment within a specified time. If I lend you money (or anything else), I may trust you to fulfil a commitment to REPAY me (perhaps with interest). I may trust you only because I have (or you give me) "security". So! Would you give me a commitment to pay me some money in future, if all I did was trust you to pay me (& keep a record of your commitment to pay me some money as a "debt" owed - with interest!)?
If you would give me a commitment to pay me some money on such terms, then I accept! How much money (assuming USD is money) can you commit to pay me in future (and with how much interest)?
If you give me a written commitment to pay me (or someone authorised by me) say USD 100,000 in 2 years, I am sure I could find a buyer to exchange say USD 80,000 now, for your written commitment to pay me later. The buyer would be "giving credit" - trusting you to fulfil your commitment to me - and I would immediately be 80,000 USD richer!
The obvious question is why would you give me a commitment to pay me - or anyone - some money in future?? Did you believe I did, or would, "lend money" to you? Why? Did I say so? Or did I trick you into giving me a written commitment to pay me, by misleading you (with terms like interest & repayments) to believe I was lending "money" to you? Bankers know the difference between when they "give credit" and "lend money", but do they ever tell customers (even US presidents) which type 'transaction' they have entered in their accounts, & we have 'agreed' to?
Are you clear or confused? What next? Who will tell the people of the confusion?
Published: November 4, 2006 5:35 AM
M E Hoffer
As far as the FedRes' RRR is concerned, for today, last updated 18 Oct 2006: "Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors has sole authority over changes in reserve requirements. Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks."..."The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution. The Garn-St Germain Act of 1982 exempted the first $2 million of reservable liabilities from reserve requirements. This "exemption amount" is adjusted each year according to a formula specified by the act. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent was set under the Monetary Control Act of 1980 at $25 million. This "low-reserve tranche" is also adjusted each year (see table of low-reserve tranche amounts and exemption amounts since 1982). Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent."
For transaction amounts sub-~U$D 46 MM, the RRR is effectively 0.
links: http://www.federalreserve.gov/monetarypolicy/reservereq.htm#table1
and the figures, especially, at the end of this paper are rather interesting:
http://arxiv.org/PS_cache/physics/pdf/0507/0507160.pdf
Published: November 4, 2006 8:07 AM
Mike Sproul
To all you quibblers over what is money and what is not:
Around 1700, people denied that the new-fangled paper pounds were money, since each paper pound had ultimately to be paid in coin. Around 1840, people denied that the new fangled checking account pounds were money, since they were ultimately paid in notes or coin. Since about 1950, people have denied that credit card dollars are money, since they are ultimately paid with checks, notes, or coins. Seems it takes 100-150 years for people to recognize money when they see it. So in the year 2100, people will finally recognize that credit card dollars are actually money (except for Austrians, of course). As for recognizing that money's value depends on its backing, that will probably take about as long as the heliocentric theory of planetary orbits did--2-3 thousand years or so.
Published: November 4, 2006 2:35 PM
Scott D
Mike Sproul,
I'll admit to lacking a deep and thorough understanding of economics, but the Real Bills Doctrine just doesn't seem like anywhere near a coherent and complete model. I can see some overlap with the Misean concept of money, but it's just not coming together for me.
For example, if the value of money depends on its backing, how does marginal utility factor in? If a great abundance of the goods being used to back units of money is produced, does the value of the money those goods are backing shrink proportionately, so that price remains stable in spite of an increase in supply? If so, this seems to contradict observation. Don't increases in supply of a good generally lead to a corresponding drop in price?
Published: November 4, 2006 5:40 PM
Björn Lundahl
We can all be rich! Hurray! I am a genius! Hurray!
All people should be allowed to print dollars under the condition that we all commit ourselves to offer them as loans, which would be a very good thing. We would not need to work anymore! As long as the loans we make are backed with property, everything is just fine. We could even make more backing and provide more security through not lending out more “money” than the value of the properties which we already own (our houses, cars etc). If we all also call ourselves “The Federal Reserve”, it will be even better! I wonder if I will receive the “Nobel Prize” for this? I am a Swedish guy and I live in Sweden, so the Nobel Prize committee should really recognize me with such a genial idea. But the Nobel Prize committee is in Stockholm and I live in Göteborg (only the second largest city in Sweden)? I know it! They will discriminate me for being a “Göteborgare” (an inhabitant from Göteborg). That is why I will not receive the “Nobel Prize” for this genial idea. That is the only reason. They might change their minds if I also suggest that all people should be allowed to print kronor (Swedish currency). Naturally, the printing of kronor must be done under the same specifications that I have suggested for being allowed to print dollars. Those specifications are of the greatest importance for making this a very good thing.
Björn Lundahl,
Göteborg, Sweden
Published: November 4, 2006 6:04 PM
Mike Sproul
Scott D.
"If a great abundance of the goods being used to back units of money is produced, does the value of the money those goods are backing shrink proportionately, so that price remains stable in spite of an increase in supply?"
I don't understand what you're trying to say here. Here's one way of expressing the real bills doctrine: If a bank has issued 100 paper dollars, and backed them with (say) 100 oz. of silver, then each dollar will be worth one ounce. If new silver discoveries reduce the value of silver, then dollars lose value too, and when you go to the grocery store, you'll have to pay more dollars (or more silver) to buy groceries.
In general, if assets move in step with the amount of dollars issued, the value of the dollar will stay the same. If the amount of dollars outruns assets, there will be inflation, and if assets outrun the amount of dollars issued, there will be deflation.
Check out: www.geocities.com/sproulmike/nofiatmoney.doc
or just google "fiat money sproul"
Published: November 4, 2006 10:11 PM
Björn Lundahl
A 100 percent fiat money reserve standard.
If we lived under a system which banks are required to maintain 100 percent reserves of fiat money against all demand deposits and the Central Bank did not print more money (including minting) than those that are worn- out, that would, also, bring an end of the business cycle and inflation. Banks would no longer be able to create money out of thin air.
Some implications:
A/ The government still has the power to change the reserve requirements.
B/ Fiat money would still be counterfeited money (as money can arise only out of a commodity previously used directly in a barter situation).
C/ People would still not be allowed to choose which goods they want to use as a medium of exchange (money).
D/ The government still influence the market and the system, therefore, deviates from pure liberty and a pure free market.
Björn Lundahl
Göteborg, Sweden
Published: November 5, 2006 3:46 AM
Björn Lundahl
Mike Sproul.
In my above quote from the book For a New Liberty, Rothbard illustrates how the monetary system works and that in this example the system has increased the money supply by 120 dollars. In this case it does not matter at all if the money is backed or not. What matters is that the Federal Reserve has just printed the “money” (20 dollars) with no productive effort and bought a pocket calculator. The banks have created checkbook money (100 dollars), also, with no productive effort and they too could have bought pocket calculators (apart from not being allowed to do so).
With a 100 percent gold reserve money standard it is not possible for the Federal Reserve just to print money. If the Federal Reserve would be allowed to exist under that standard (for what purpose?), it has to have acquired the gold first before it could issue gold notes of that certain amount of gold*. Those gold notes would be receipts (gold claims) and the Federal Reserve has to store the gold until the owners of those gold notes claims the gold. The total money supply has not increased as the gold stored at the Federal Reserve is not an effective part of it and is therefore not counted as money. The total money supply has not either decreased, as mentioned gold notes, which are used as money, have replaced the gold as an effective part of the money supply.
Björn Lundahl
Göteborg, Sweden
• In other words, the Federal Reserve has to be productive through enterprise or work to acquire the gold. How that would be possible, I really do not know. Another possibility for the Federal Reserve to acquire the gold is that someone donated the gold to the Federal Reserve.
Published: November 5, 2006 6:21 AM
Mike Sproul
Bjorn:
No money-issuing bank, public or private, is a counterfeiter. Banks only issue money in exchange for assets whose value is equal to or greater than the money issued. Banks also stand ready to use some of those assets to buy back the money they have issued. No counterfeiter does this. For example:
...ASSETS.......................LIABILITIES
1) 100 oz. silver deposited.....100 paper dollars
2) IOU worth $200...............200 paper dollars
In line 1, the bank receives 100 oz. of silver on deposit and issues 100 paper receipts called dollars in exchange. In line 2, a customer borrows 200 newly-printed dollars, while promising to repay (say) $220 next year. At a 10% interest rate, this IOU is worth $200 today. The value of each dollar must remain at 1 oz, even though the supply of dollars has tripled, because if it fell below 1 oz, customers would return their dollars, demanding one oz. each. The bank could respond by selling its $200 IOU for 200 of its own paper dollars and then burning the dollars. Then the bank could pay out the remaining 100 oz. for the remaining $100. At no point does the value of the dollar fall below 1 oz.
This does not create a free lunch for the banker or anyone else.
Published: November 5, 2006 10:26 AM
Björn Lundahl
Mike Sproul
“No money-issuing bank, public or private, is a counterfeiter. Banks only issue money in exchange for assets whose value is equal to or greater than the money issued. Banks also stand ready to use some of those assets to buy back the money they have issued. No counterfeiter does this. For example:
...ASSETS.......................LIABILITIES
1) 100 oz. silver deposited.....100 paper dollars
In line 1, the bank receives 100 oz. of silver on deposit and issues 100 paper receipts called dollars in exchange”.
As long as the bank keep 100oz silver deposited in their vault, everything is fine. The bank is not allowed to make loans with 100oz silver deposited; it must be stored in the vault to meet the bank’s obligation whenever the owner claims it.
If the bank makes loans with 100oz silver deposited and has therefore less stored in their vault (less than what is deposited), the bank is counterfeiting and the process of increasing the money supply has started.
I quote from America’s Great Depression, by Murray Rothbard:
Preventing Depressions
“Private banks, it is true, can themselves inflate the money supply by issuing more claims to standard money (whether gold or government paper) than they could possibly redeem. A bank deposit is equivalent to a warehouse receipt for cash, a receipt which the bank pledges to redeem at any time the customer wishes to take his money out of the bank's vaults. The whole system of "fractional-reserve banking" involves the issuance of receipts which cannot possibly be redeemed”.
And:
But a 100 percent gold reserve requirement would not be just another administrative control by government; it would be part and parcel of the general libertarian legal prohibition against fraud. Everyone except absolute pacifists concedes that violence against person and property should be outlawed, and that agencies, operating under this general law, should defend person and property against attack. Libertarians, advocates of laissez-faire, believe that "governments" should confine themselves to being defense agencies only. Fraud is equivalent to theft, for fraud is committed when one part of an exchange contract is deliberately not fulfilled after the other's property has been taken. Banks that issue receipts to non-existent gold are really committing fraud, because it is then impossible for all property owners (of claims to gold) to claim their rightful property. Therefore, prohibition of such practices would not be an act of government intervention in the free market; it would be part of the general legal defense of property against attack which a free market requires.[28], [29] “.
http://mises.org/rothbard/agd/chapter1.asp#preventing_depressions
Björn Lundahl, Göteborg, Sweden
Published: November 5, 2006 12:09 PM
Mike Sproul
Bjorn:
I had this same discussion with Rothbard around 1993 or so, when he gave a seminar at Cal. State Northridge. I said "What if the bank sold 50 oz. of silver for an equal value of gold. Is that fraud?"
He answered that it was, then became angry, saying things like "Why can't you understand this?" When I spoke to the four other econ professors who had been at the seminar, and asked if they believed that stuff about fraud, one answered "Not a word." and the others agreed. It's simple: If the banker sells or lends the silver, and the customers agree to it, it is not fraud. (Rothbard's reply to that one was "They don't know what they're agreeing to.", and that pretty well cemented his reputation as a kook.)
Published: November 5, 2006 1:23 PM
Björn Lundahl
Mike Sproul.
” If the banker sells or lends the silver, and the customers agree to it, it is not fraud”.
You have got it all wrong.
If the bank makes loans with the deposited money, fraud has been done against the depositor and not against the borrower.
If for example, I ask you to store 100 oz. silver for me and you promise to redeem the 100 oz silver at any time when I demand it, you have an obligation to do just that. Now then, if I come back to you a month later to claim the 100 oz silver and you answer me “sorry I have lent the 100 oz silver to Mr X and I wont get it back for another two months”, you have committed a fraud against me. Can’t you see that?
It makes no difference if you store 10 000 oz silver for one hundred people. If you make loans with some of the 10 000 oz silver, it is impossible for all the property owners to claim their property. You must meet your obligations, all the time, for all property owners.
In other words, if it is a “bank run” the bank must meet its obligations for all property owners (depositors). That is why the deposits are called “demand deposits”.
I think this is very obvious.
Björn Lundahl
Göteborg, Sweden
Published: November 5, 2006 6:20 PM
greg
Mike S> You missed the point about backing.
No point was missed. You don't know the difference between a private bank and the government.
If a banker gets 100 oz. of silver on deposit, and issues 100 paper receipts called [defined as] dollars in exchange, then each of those dollars will be worth one ounce, even on nights and weekends, when the dollars are temporarily inconvertible. If they get another 100 oz deposit and issue another $100, each dollar will still be worth one ounce, because backing has moved in step with the issue of dollars.
No problem with that. Who said otherwise?
Mike S> If someone comes in with an amount of gold that is worth 100 oz. of silver, then the bank can issue another $100 for it without causing inflation.
Um, no they can't, because "today's" market parity of X weight of gold to Y weight of gold is not "dollars." It is just "today's" exchange rate between silver and gold in terms of dollars. And dollars were solely specified (defined) in silver. A depositor may willingly choose to accept the particular weight of gold as a substitute, but that is another matter. You are not justified in simply assumming a pegging of exchange between commodities, any of which may be used as money.
Mike S> The same remains true if people bring in 100 oz. worth of wheat, land, bonds, etc.
Mike, that is just pure nonsense. You have some bizarre notion of constant exchange value of commodities. One can't issue silver backed notes because they got a z grams of crack as a deposit. They could, however, issue crack backed notes. If someone issues a note for 100 oz. of silver it doesn't mean z grams of crack. It means what it says on the note -- the note is basically a contract of redemption.
Mike S> Perfectly true. GM might get more or less than $60 of new cash flow.
No, GM would have gotten exactly $60 of new cash flow, and don't start confusing that with inflation or deflation, which has to do with changes in the total money stock, and more. What the GM stock was valued at before and after the stock sale is another matter entirely.
Mike S>
...ASSETS.......................LIABILITIES
1) 100 oz. silver deposited.....100 paper dollars
2) IOU worth $200...............200 paper dollars
In line 1, the bank receives 100 oz. of silver on deposit and issues 100 paper receipts called dollars in exchange. In line 2, a customer borrows 200 newly-printed dollars, while promising to repay (say) $220 next year. At a 10% interest rate, this IOU is worth $200 today. The value of each dollar must remain at 1 oz, even though the supply of dollars has tripled, because if it fell below 1 oz, customers would return their dollars, demanding one oz. each. The bank could respond by selling its $200 IOU for 200 of its own paper dollars and then burning the dollars. Then the bank could pay out the remaining 100 oz. for the remaining $100. At no point does the value of the dollar fall below 1 oz.
You should at the outset say you are defining a dollar as 1 oz of silver. Are you saying that? If so, the comment "if it fell below 1 oz" is a nonsensical condition -- the matter is purely definitional. And what sucker, pray tell, would buy the empty IOU, which calls out 200 non-existant oz. of silver (220 oz futures)? Say the inital borrower was building a house and bought some lumber with the silver backed dollar notes. You're saying the IOU for $220 future dollars worth of presently non-existant silver is valuable to the lumbar company (or someone else in the chain)? You're saying the lumbar yard says "sure, fine, I feel good about the next unknown Comstock strike -- I'll gamble it -- the IOU is fine"? Does the intial author of the IOU know they are on the hook for mining some silver? Tell me more.
Mike S> I had this same discussion with Rothbard around 1993 or so, when he gave a seminar at Cal. State Northridge. I said "What if the bank sold 50 oz. of silver for an equal value of gold. Is that fraud?"
He answered that it was, then became angry, saying things like "Why can't you understand this?"
His question looks to be a good one. If I deposit 50 oz of silver, and get a note of deposit for it, then that is what I expect to get back, not gold. I am not an expert on Rothbard, but I think he viewed the bank in an old-fashioned sense, where it would be more like a safety deposit box rather than the modern view. Of course, someone would have to pay for the safe keeping, and I think I remember him writing so. I think from the private contractarian perspective, depositors and banks could make any arrangements they wish. This means they wouldn't necessarily demand the exact same oz of silver back that they deposited and may even accept certain exchange ratios to other materials as gold. As long as the contract spells it out (the notes reflect this in an obvious way) I don't think there is a problem. In fact, even fractional reserve (to me) is conceptually acceptable on the private market if the parties know what they are agreeing to. (The notes *say* they are fractional -- the taker willingly accepts the risk of a bank run when they accept the notes in a transaction.)
Mike S> When I spoke to the four other econ professors who had been at the seminar, and asked if they believed that stuff about fraud, one answered "Not a word." and the others agreed.
I doubt they even understood what they weren't agreeing to. So are you saying this is like a democratic theory? We vote to decide which is the right perspective?
Mike S> It's simple: If the banker sells or lends the silver, and the customers agree to it, it is not fraud.
I like how you now add "if they agree to it." I have my doubts about the details of your conversation with Rothbard.
Mike S> Rothbard's reply to that one was "They don't know what they're agreeing to.", and that pretty well cemented his reputation as a kook.
When it comes to economists, that is pretty much a non-statement. It's like the imates X & Y of an asylum calling inmate Z a nutjob.
PS: Regarding credit cards, send your's to me and I will check them to see if they are money.
Published: November 5, 2006 6:24 PM
greg
In my above post, the following paragraph was Mike Sproul's, not mine, and thus should have been italicized:
Mike S> In line 1, the bank receives 100 oz. of silver on deposit and issues 100 paper receipts called dollars in exchange. In line 2, a customer borrows 200 newly-printed dollars, while promising to repay (say) $220 next year. At a 10% interest rate, this IOU is worth $200 today. The value of each dollar must remain at 1 oz, even though the supply of dollars has tripled, because if it fell below 1 oz, customers would return their dollars, demanding one oz. each. The bank could respond by selling its $200 IOU for 200 of its own paper dollars and then burning the dollars. Then the bank could pay out the remaining 100 oz. for the remaining $100. At no point does the value of the dollar fall below 1 oz.
Published: November 5, 2006 6:28 PM
Peter
Björn: Mike Sproul is a crank. Just ignore him. "Don't feed the trolls"
Published: November 5, 2006 6:30 PM
Mike Sproul
Bjorn:
A key point was that the customers agree to it. That is, they agree that the bank will actually keep just 50 oz. of silver on hand, while the rest is lent at interest, part of which will be paid to the depositor in order to compensate him for the small chance that there will be times when the bank will not be able to pay silver on demand. Two rational parties with their eyes open: no fraud.
Published: November 5, 2006 7:07 PM
Mike Sproul
Greg:
"I think from the private contractarian perspective, depositors and banks could make any arrangements they wish. This means they wouldn't necessarily demand the exact same oz of silver back that they deposited and may even accept certain exchange ratios to other materials as gold. As long as the contract spells it out (the notes reflect this in an obvious way) I don't think there is a problem. In fact, even fractional reserve (to me) is conceptually acceptable on the private market if the parties know what they are agreeing to. (The notes *say* they are fractional -- the taker willingly accepts the risk of a bank run when they accept the notes in a transaction.)"
My point exactly. And as long as money-issuing banks only issues new money in exchange for assets--not necessarily silver--of adequate value, then every new issue of money is matched by an equal increase in bank assets, and there is no fraud and no inflation.
Published: November 5, 2006 7:18 PM
Mark Brabson
Mike Sproul:
If a bank is gonna run fractional reserve, then in addition to making that fact known on the note, I would also add the caveat that they disclose the minimum fraction on reserve.
Published: November 5, 2006 7:33 PM
Peter
Breaking with my own advice to ignore the clown:
A key point was that the customers agree to it. That is, they agree that the bank will actually keep just 50 oz. of silver on hand, while the rest is lent at interest, part of which will be paid to the depositor in order to compensate him for the small chance that there will be times when the bank will not be able to pay silver on demand. Two rational parties with their eyes open: no fraud.
This is perhaps the first sensible thing you've ever written...but that's not a demand deposit! If customers want to lend their money to the bank for its own use, in return for interest, nobody has any problem with that.
Regarding this:
[in the event of a bank run] The bank could respond by selling its $200 IOU for 200 of its own paper dollars and then burning the dollars. Then the bank could pay out the remaining 100 oz. for the remaining $100.
Just who are they supposed to sell these IOUs to? When a bunch of customers turn up demanding their ounces of silver, they want silver, not IOUs! You'll have bankers - and RDB cranks, hopefully - hanging from the nearest telephone pole.
Published: November 5, 2006 7:48 PM
banker
"And as long as money-issuing banks only issues new money in exchange for assets--not necessarily silver--of adequate value, then every new issue of money is matched by an equal increase in bank assets, and there is no fraud and no inflation."--quote
My question is who would be stupid enough to voluntarily use a currency like that? If the bank's money is suppose to be a receipt for some tangible metal ONLY, then why would someone accept a receipt for gold from a bank that issues receipt for things other than gold?
Hapless Person- "Huh, I get US bank check and I am going to turn it in for 100oz of gold like the check says I can."
US bank teller- "I am sorry, but we don't have any gold to give you because we issue receipts for things other than gold. Would you like a house instead last valued 10 years ago at an heavily inflated price (ie worthless)?"
Hapless Person- "I am a fool for accepting this worthless money/receipt from the bank"
The point of using receipts for money is that one cannot spend both the gold and the receipt for gold at the sametime. Hence, the supply of receipts cannot increase faster than the supply of gold. This is why only receipts from banks who only issue receipts for gold can be used safely as money.
Receipt versus IOU
One is an investment and the other is a currency. Do not confuse the two.
Published: November 5, 2006 7:57 PM
Mike Sproul
Banker:
Once or twice in my life, I've tried to withdraw a few thousand in cash from my bank and been told they didn't have enough cash on hand. I was miffed, but kept my money in the bank for the sake of convenience and the interest they paid. Like most depositors, I recognize that this will happen sometimes, but I still prefer fractional reserve banks to 100% reserve banks, partly because of the interest they pay, and partly because they are less vulnerable to robbery. The only 100% reserve bank I know of was the Bank of Amsterdam, established 1609, and I believe it crashed around 1800. Apparently natural selection has favored fractional reserves.
Published: November 5, 2006 11:11 PM
Mike Sproul
Mark Brabson:
I hope you're not going to tell us you're a libertarian!
Published: November 5, 2006 11:14 PM
banker
I was not talking about the merits between a private fractional reserve bank versus 100% reserve bank. I am correcting the mistaken belief that "receipts" issued by a fractional bank is considered a true currency. You CANNOT use IOUs from a fractional reserve bank as currency. You can deposit Real currency into a fractional reserve bank and get an IOU, but you cannot use this IOU as a substitute for currency unless the bank is 100% reserve bank.
Basically, it can be summed by:
Custodian vs Investment vehicle
PS Do you use a treasury bond to buy groceries?
Published: November 5, 2006 11:21 PM
Björn Lundahl
Mike Sproul.
“A key point was that the customers agree to it. That is, they agree that the bank will actually keep just 50 oz. of silver on hand, while the rest is lent at interest, part of which will be paid to the depositor in order to compensate him for the small chance that there will be times when the bank will not be able to pay silver on demand. Two rational parties with their eyes open: no fraud”.
Such a contract is not allowed since it is a contradiction in terms. As Peter has pointed out, you can not have a demand deposit and at the same time contract that you might not have money deposited if the depositor claims them. I myself thought of this several years ago.
“Rothbard's reply to that one was "They don't know what they're agreeing to”” is a correct reply to your question.
As Walter Block puts it:
“At present, money placed in a bank is called a "demand" deposit, logically implying that it would be available, in full, whenever demanded, with a probability of certainty. If the "fractional reserve parking lot" were to be an accurate analogy to monetary practice, instead of being called a "demand" deposit, it should be called "purchasing a lottery ticket for money," or some such. Further, in every other way-publicity, explicit contracts, etc.-banking procedures would have to be brought into line with parking lot practice. Then, and only then, could the charge of fraud be dropped. Under such conditions, there would still be the empirical question of whether or not anyone would purchase a "lottery ticket money deposit."
http://mises.org/journals/rae/pdf/rae9_1_3.pdf
Peter, I was going to follow your advice, but now this morning I saw your comment.
Björn Lundahl
Göteborg, Sweden
Published: November 6, 2006 2:39 AM
mike sproul
Banker:
"You CANNOT use IOUs from a fractional reserve bank as currency."
A checking account dollar is my bank's IOU, which promises to deliver one paper dollar on demand. I use checking account dollars to buy stuff all the time. I also use credit card dollars, which are the credit card company's promise to deliver a checking account dollar to the merchant. I even use gift certificate dollars, which are the merchant's promise to deliver a dollar's worth of stuff on demand.
Published: November 6, 2006 9:44 AM
mike sproul
Bjorn:
Then I suppose you would not object if a bank lent out its silver overnight, while promising that its dollars (either paper dollars or checking account dollars) would be payable only in the daytime. Merchants would no doubt still accept the bank's dollars during the night, even though they are inconvertible overnight, and the customer who borrowed the silver could use it to buy stuff, while the depositor of the silver can spend it just as easily as before, in the form of a check. The economists you quoted are just as wrong today as they were back then.
Published: November 6, 2006 9:55 AM
George Gaskell
The only 100% reserve bank I know of was the Bank of Amsterdam, established 1609, and I believe it crashed around 1800. Apparently natural selection has favored fractional reserves.
There is nothing "natural" about the economic policies of one of the most aggressively mercantilistic governments at the height of its mercantilistic period.
That's the trouble with historical data -- you can't isolate an economic actor from the environment in which exists. I assume this bank was in competition with other banks. To what extent did government policy favor competitors?
In other words, to be useful as an example, you will have to account for how all of the banks of this period were affected by the legal environment in which they all operated.
Published: November 6, 2006 10:03 AM
billwald
Why do the gold traders who advertize only on "talk radio" want my valueless govt money more than they want their metallic gold?
Published: November 6, 2006 1:10 PM
Mark Brabson
Mike Sproul:
Well, actually, I am a Libertarian. I did not think that a small request that the minimum fractional reserve be placed on a bank note disqualified me. If a bank is not operating on 100% reserves, consumers have a right to this information. For example, suppose I am running a small store. There are four banks in town, Bank A at 100% reserve, Bank B at 90% reserve, Bank C at 60% reserve and Bank D at 40% reserve. In good economic times, I would probably do business with all four bank's banknotes. However, if things turn sour, I may start restricting the amount of banknotes from Bank's C and D and if I think there is trouble, I may stop accepting them altogether. Even when I do accept them, I will hurriedly redeem them either for gold coin or exchange to banknotes from Bank's A or B.
Bottom line, it is a matter of the customer of the bank being fully informed, which point I think you conceded earlier in the thread.
Published: November 6, 2006 2:33 PM
Björn Lundahl
Mike Sproul.
”Then I suppose you would not object if a bank lent out its silver overnight, while promising that its dollars (either paper dollars or checking account dollars) would be payable only in the daytime. Merchants would no doubt still accept the bank's dollars during the night, even though they are inconvertible overnight, and the customer who borrowed the silver could use it to buy stuff, while the depositor of the silver can spend it just as easily as before, in the form of a check. The economists you quoted are just as wrong today as they were back then”.
This would not change anything. A bank makes a contract with a depositor that the 100 oz silver is only redeemable during daytime and rushes to make a 100 oz silver loan in the evening and adds 100 oz silver to the “daytime demand deposit” of the borrower. In day two, during daytime, the bank must meet its obligations for both of them, but how?
Björn Lundahl
Published: November 6, 2006 2:46 PM
Mike Sproul
Bjorn:
"A bank makes a contract with a depositor that the 100 oz silver is only redeemable during daytime and rushes to make a 100 oz silver loan in the evening and adds 100 oz silver to the “daytime demand deposit” of the borrower. In day two, during daytime, the bank must meet its obligations for both of them, but how?"
The silver is lent out at sundown, and repaid at daybreak. Overnight there is no obligation the bank has to meet. The next day, the bank has its 100 oz. of silver back, so it can meet its $100 obligation. Meanwhile, overnight the borrowed silver can be spent, and so can the 100 dollars.
Published: November 6, 2006 9:15 PM
Peter
Sproul-troll: if the 100oz borrowed overnight is spent, how does the bank get it back the next morning???
Published: November 6, 2006 10:54 PM
Björn Lundahl
Mike Sproul
“The silver is lent out at sundown, and repaid at daybreak. Overnight there is no obligation the bank has to meet. The next day, the bank has its 100 oz. of silver back, so it can meet its $100 obligation. Meanwhile, overnight the borrowed silver can be spent, and so can the 100 dollars”.
Peter
”If the 100oz borrowed overnight is spent, how does the bank get it back the next morning???”
I wonder too. If the borrower does some sort of short term speculation and can not pay back at daybreak, the bank is in trouble, because it is a criminal act if the 100 oz silver is not there. The bank itself could do the speculation, but it would not dare. In reality this would be a very serious matter and not just an intellectual abstraction for mental play.
Björn Lundahl
Published: November 7, 2006 1:25 AM
Björn Lundahl
Mark Brabson
I am against fractional reserve banking and I do believe that 100% gold reserve banking is in accordance with true libertarian principles.
Never mind, I also believe that to avoid lawsuits, there would be a lot of warnings and information on products, and in connection with services, which are sold. When buyers know the risks that are involved in using a certain product or service, this knowledge is an essential part of a contract.
Björn Lundahl
Published: November 7, 2006 6:35 AM
Björn Lundahl
Mark Brabson
I am against fractional reserve banking and I do believe that 100% gold reserve banking is in accordance with true libertarian principles.
Never mind, I also believe that to avoid lawsuits in a libertarian society, there would be a lot of warnings and information on products, and in connection with services, which are sold. When buyers know the risks that are involved in using a certain product or service, this knowledge is an essential part of a contract.
Björn Lundahl
Published: November 7, 2006 6:43 AM
Mike Sproul
Bjorn:
"If the borrower does some sort of short term speculation and can not pay back at daybreak, the bank is in trouble, because it is a criminal act if the 100 oz silver is not there."
It's not a criminal act if the borrowers agreed to it in the first place. Banks lend money overnight all the time, where it is spent on short-term projects, bonds, etc. It is usually repaid, and if it's not the depositors knew the risk. Depositors would correctly figure that the 100% reserve bank might be robbed overnight anyway, so why not let the money be lent overnight for a profit, as long as the money's at risk anyway.
Published: November 7, 2006 9:18 AM
Björn Lundahl
Mike Sproul.
“It's not a criminal act if the borrowers agreed to it in the first place. Banks lend money overnight all the time, where it is spent on short-term projects, bonds, etc. It is usually repaid, and if it's not the depositors knew the risk. Depositors would correctly figure that the 100% reserve bank might be robbed overnight anyway, so why not let the money be lent overnight for a profit, as long as the money's at risk anyway”.
If the money is not there for the depositor during daytime the bank is in trouble. During daytime the deposit is a demand deposit. That is the contract and nothing less.
Anyway, as the bank notes are not payable on demand during night time, they also cease to be bank notes and a part of the money supply during the same period. If merchants accept inconvertible “bank notes” during nights have nothing to do with it. They might accept “bank notes” that are convertible even further away in time.
This discussion is all about technical issues and has nothing to do with neither fractional reserve banking nor 100% gold reserve money.
Björn Lundahl
Göteborg, Sweden
Published: November 7, 2006 4:36 PM
Björn Lundahl
Sorry!
To avoid misunderstanding I want to, in my last sentence and in above comment, add the word “justification”:
“This discussion is all about technical issues and has nothing to do with the justification of neither fractional reserve banking nor 100% gold reserve money”.
Björn Lundahl
Published: November 7, 2006 5:46 PM
Björn Lundahl
Billwald
” Why do the gold traders who advertize only on "talk radio" want my valueless govt money more than they want their metallic gold?”
I do think it, partly, has something to do with legal tender laws.
I quote from answers.com:
“Legally valid currency that may be offered in payment of a debt and that a creditor must accept.”
And:
“Money recognized by law as acceptable payment for debts owed to creditors. In the United States, legal tender (also called lawful money) is all forms of circulating paper money, mostly Federal Reserve Notes, and coins. The term means that money offered as payment has the backing of the government and must be accepted by a creditor, unless a contract calls for another method of payment”.
http://www.answers.com/topic/legal-tender
For more causality, please also, go and read this:
http://mises.org/money/3s3.asp
Björn Lundahl
Göteborg, Sweden
Published: November 7, 2006 6:02 PM
Björn Lundahl
100% gold reserve money standard versus 100% silver reserve money standard.
As governments especially after World War II have had such love affairs with the money printing press, I think the adoption of a 100% silver reserve money standard would be much easier than an adoption of a 100% gold reserve money standard.
I know that gold has a special attractiveness for you Americans, but I do think that silver can do the trick as well when it comes to hinder any increases of the money supply.
Silver money is also just as market oriented and libertarian as gold money.
As Murray Rothbard puts it in his book For a New Liberty:
“Markets have universally found gold or silver to be the best standards whenever they are available, the natural course of these economies is to be on the gold or silver standard”.
http://mises.org/rothbard/newliberty9.asp
Some information about the increase of the money supply since 1959:
http://www.federalreserve.gov/releases/h6/hist/h6hist1.txt
Björn Lundahl
Göteborg, Sweden
Published: November 8, 2006 2:25 AM
F.D.
In response to Mike Sproul's November 2nd post - The "money" you borrow isn't backed by the house, it's backed by your future labor. The Fed bets on you toiling for the next 30 years. They print up the debt money without contributing anything to society. You go to work, contribute to society and the Fed profits on "money" they didn't have to begin with. Under this counterfeiting system, the people get the privilege of trading in their lives in order to make their interest and tax payments.
Published: December 1, 2006 12:15 PM