Do Central Banks Really Inflate? No, Say the Post-Keynesians
The Post-Keynesian school of thought maintains that, as opposed to the popular money multiplier model, central banks do not actively pursue monetary pumping to influence various economic data in the economy. Instead, they claim, the central bank is just aiming at keeping the money market well balanced. The key source of money expansion is commercial banks that, via an expansion in lending, set in motion an expansion in the money supply. FULL ARTICLE
Comments (110)
Mr Shostak's examples are illuminating!
If CB targets interest rates it must necesserily relinquish its control of money supply since it's willing to lend and borrow unlimited amounts at this rate.
RBNZ (Reserve Bank of New Zealand) which is widely thought to be a role model for CB's is using this kind of targeting as a tool to target inflation:
It's willing to borrow and lend unlimited amounts at Official Cash Rate (OCR). OCR determines also other bank's market rates, but web page states that also offshore rates influence NZ rates.
There is also old fallacy about inflation being caused by the "aggregate demand" (demand pull inflation):
"The practical result, over time, is that when market interest rates increase, people are inclined to spend less on goods and services. This is because their savings get a higher rate of interest and there is an incentive to save; and conversely, people with mortgages and other loans may experience higher interest payments.
When people save more or spend less, there is less pressure on prices to rise, and therefore inflation pressures tend to reduce."
If inflation is caused by the increasing demand or supply shocks, then CB has no role in generating inflation... :)
Published: March 1, 2007 9:20 AM
As well as Australia, Canada too, has no required reserve ratios for its banking system, but this doesn't throw the money multiplier out the window, since 'desired' liquidity ratios simply substitute for legal ones.
Also, most central banks target inflation, whether they announce an inflation target or not. Their short term operations in the money market are partly designed for stability but, more importantly, as a path toward price stability (as defined by some low inflation target range). In Canada, the inflation target is 2%, with the short term range 1% to 3%. If inflation is outside this range, drastic short run contractionary or expansionary action is taken, otherwise it is not. Announced inflation targets have been in place in Canada since 1991, and, as far as they go, they have been very successful. People's inflationary expectations therefore are exactly the announced inflation target (2%). Present debate in Canada is whether to reset the inflation target lower, at either 1% or 0%.
Also, banks practised fractional reserve operations long before central banks came onto the scene. I don't believe the liquidity of the system (in the absence of central banks) would depend on the number of banks, but instead on the liquidity of each bank and prudent lending practises.
Published: March 1, 2007 10:26 AM
Here is a question.
Given that the nature of fractional reserve banking and the money pumping of the central banks is well known (that is, this information is in the public domain and not a secret), is it fraudulent?
Sione
Published: March 1, 2007 11:00 AM
Nice article, especially since I could understand it and it dovetails nicely with my thoughts about interest and borrowing. Maybe I'm starting to get the hang of this economics stuff.
Published: March 1, 2007 11:14 AM
Given that the nature of fractional reserve banking and the money pumping of the central banks is well known (that is, this information is in the public domain and not a secret), is it fraudulent?
Yes, it IS fraudulent, because immoral economists and dirty politicians (an oxymoron) advertise the role of central banks and of the pumping of worthless money as "an important task in the regulatory effort of government over the inherent inbalances of the market". It is false advertising in my book.
Published: March 1, 2007 11:45 AM
Sione,
I second Mr. Torres. Fractional reserve banking is fraudulent on its face, for it ultimately depends on a contract between bank and depositor that means two different things to the two parties, as noted in Money, Bank Credit, and Economic Cycles by Jesús Huerta de Soto. The checking-account depositor expects to have unlimited access to his money without penalty. His understanding of the contract is that it's his: he is simply using the bank's services for safekeeping and check-clearing. The bankers see it differently. Once you give them money, it's theirs, and if they want to loan it out to others, well, that's their call. Apart from the inflationary effects of loaning out money that is still owned by someone else, de Soto makes the point that a contract that can be viewed differently by the parties to the contract is essentially void.
I'd like to know more about the last sentence of the article: "...money that is created out of nothing can also disappear just as quickly". By what mechanisms can this happen, in addition to bank failures and central bank deflation (*snort*)?
Published: March 1, 2007 12:23 PM
When a person pays off a credit card account the money supply decreases.
By definition, I don't see how a universally known practice can be called a fraud because every person can compensate for the practice.
Published: March 1, 2007 12:42 PM
Ike - Withdrawls of deposits from the fractional reserve system will do the trick. The mechanism just works in the opposite direction, as funds are pulled out of the bank this restricts their ability to create further deposits/loans.
Published: March 1, 2007 12:45 PM
Sione and billwald,
I would not be willing to stipulate that the nature of fractional reserve banking are widely known. They are certainly well known to anyone who pays attention to and studies economics even a little bit. Thus as Ike points out, the deposit contract can indeed mean two different things to the two parties. Find a friend who is not so well-informed about political economy and talk to them about FRB. They may not even believe you at first. Have you ever watched the "Jaywalking" segment on The Tonight Show"? The level of ignorance in the general public is astounding, and is our greatest challenge.
Published: March 1, 2007 1:01 PM
Sione - For those not deceived, it's not fraud, it's theft. For those deceived, it's both fraud and theft.
Published: March 1, 2007 3:30 PM
I've never thought of fractional reserve banking as theft, so I would like someone to educate me in this regard.
Consider a checking account of $100. The bank's part of the deposit contract is summed up as follows: "If you create a checking account with us, you can write checks on your account up to the balance in your account."
Now, the banks lend out most deposit money, but it is their responsibility to maintain enough liquidity to be able to meet depositors check writing activity. Let me take the most extreme case of fractional banking. Suppose demand deposits are $100, and a bank has demand loans outstanding of $100. If bank borrowers meet their contractual obligations, there would be no liquidity problems for the bank and no deposit or loan contracts would be broken. Where is the theft or fraud involved in such an arrangement?
Just because some people don't understand how fractional reserve banking operates is not enough to claim fraud. If everyone had to understand all institutional aspects of the economy for there not to be fraud, almost all economic transaction would be fraudulent.
Published: March 1, 2007 5:25 PM
I'll second Ken Zahringer in saying that the true nature of the fractional reserve banking is not well-known.
Because if it were, there would be corpses of central bankers swinging in the wind.
Published: March 1, 2007 8:38 PM
FR Banking is fraudulent in a few ways. A good example is to go out and ask people how banks make their money. Most of them will say they make their money on the difference between what they pay on the prime rate and the rate they charge their borrowers. If the prime rate is 5% and the going rate is 8% many people will say and understand that the banks make the 3% difference between the loans.
Many economists have either errantly or fraudulently explained it this way and I have heard many average citizens describe it this way. Many bankers will also agree that this is how the system works but for many of them that is how they have been educated to believe. It is more out of ignorance than actual fraud that they describe the system as working that way.
Another way the system is fraudulent is by putting a false value on money and destroying it's purchasing power and the value of the labor that has earned that money.
Let's assume that a man has gone out and traded his labor for $1,000. He takes his money and then goes and deposits it in his bank. His boss, in order to pay his wages goes out and borrows $900 from the bank to pay wages. This is where it gets bizarre. The laborer goes with his check to the bank and demands it in cash. Not only that but he also demands the $1000 he originally put in the bank for a total of $1,900. How can this be when the bank only has $1,000 on deposit?
The only way this can be solved is by a function in the law. By law the treasury is required to print up the money to satisfy the demand deposits of the bank. When the bank loaned the money it created money out of thin air. Not only that but this perverse example shows that the bank used the laborer's own money to destroy the value of his other dollars. The bank didn't earn those dollars to satisfy the needs of the loan they were created out of thin air. Assume that on that very day the laborer quits his job and his boss doesn't have the money to pay off the loan. The laborer isn't obligated to give the money back. The boss declares bankruptcy and the loan gets written off
Here is another example. Assume another laborer borrows $900 from the bank. He then goes out and buys the tools to compete against the first laborer. The tool manufacturer puts the money in the bank and the bank turns around and lends out $800 to a third laborer to do the same thing.
Now what you have is the bank using the original laborers money to create money out of thin air to compete with the original laborer. Because there is three times the amount of labor the value of their work goes to 1/3. The bank collects interest off two of them and gives a token back to the original laborer while it bankrupts him by creating false competition for him and destroys his ability to earn a competitive wage. Eventually, the other two laborers can't maintain the value of their loans because the original wage conditions under which loan repayment was originally calculated has deteriorated to 1/3 its value. The bank then seizes the goods puts them up for collateral and sells them to meet the original demand deposit(can you say US farm crisis of the '80's)
here is a final example. Joe and his wife want to buy a $300,000 house. The banker says it cannot lend that kind of money without some form of collateral. Joe and his wife take their life savings of $30,000 and beg the nice banker to give them a loan. The banker indicates that they are taking a risk but says they'll let Joe do it this time even though his job situation is shaky.
So what happens? The bank puts the $30,000 on deposit. Because the bank has a 10% reserve requirement they can write a check in the form of $300,000 to the seller of the house(the next day the seller comes in and demands cash, the bank only has $30,000 on deposit so it calls up the treasury who prints up $300,000 to satisfy the demand).
As you can see because Joe put up the deposit the bank's risk is zero. So after two years Joe loses his shaky job and what happens. The bank comes along, seizes his house and sells it.
So what did this cost the people involved.
Joe's original outlay:
$30,000 deposit up front
$15,000 in interest payments for two years(interest only mortgage)
His good credit rating
Total loss to Joe is $60,000 his house, possibly his wife and his credit rating because he is foreclosed on.
What does it cost the bank. Assuming they can auction off the house for the initial purchase price it doesn't cost them anything. Not only that but they keep the original $30,000 deposit plus they collected $30,000 in interest over two years.
Their risk is zero and they didn't even need to meet the demand deposit of the original seller of the house. Not only that but they were able to convince him to eventually put that money on deposit where they were able to create more Fractional Reserve loans to loan out to other suckers. So the bank's original risk is zero and they were the ones who got all the benefit when things fell through. Had Joe survived the bank would have made a mountain of interest of Joe's labor and they still would have taken on little to no risk.
Fraudulent? yes. Unethical? VERY!
Published: March 2, 2007 12:59 AM
I agree with Alex MacMillan that FRB is not necesserily fraudulent since you can easily imagine that bank could explain what they are doing to those who deposit money at this bank.
I agree with Selgin and White that De Soto hasnt proved that deposit can be only a warehousing contract. I dont know if there can be legal objections for customer and bank to make any sort of deals they want.
If FRB banking is not legal then you cannot sell call options if you dont already own those stocks. This is because one who buys this option cannot know if you have stock or not. There is a chance that you cannot honor your obligations if a price of stock in the market skyrockets and you dont already own this stock.
It's not proper for Austrian to try to restrict freedoms of others to make financial arrangements what they are thinking being good for them.
NOTE: I was thinking about free-banking regime with commodity money not this government controlled fiat regime.
Published: March 2, 2007 6:41 AM
Alex - It's theft because money is a claim on goods earned by producing, but there are entities protected by law who have the power to dilute the value you created by selling labor, goods, and services by diluting the existing pool of value created by producers ... then to top it off, that value is loaned back at interest!
The value lost by the twin evils of inflation and taxation is huge. Right now inflation is probably clocking 3.5 - 5% (ignore the gov's numbers). Bank CD's yield 5 - 6. Say you get 6%. You are taxed on the 6%. 6% x 75% = 4.5% (that's your after tax yield) minus inflation = zero. You get nothing for saving in an economy where real savings (i.e. reduced consumption) is in massive short supply! It makes no sense whatsoever.
Example: 3% increase in production would (over time) causes approximately a 3% decrease in prices. The actual rate of inflation today (if calculated using the old methods before they fudged the numbers) is about 6% (unless real estate takes it back down). The value loss is 9% !
Going backward by 6% a year and losing the positive value of 3% a year and you see why so many 'laborers' are struggling (that's not the only reason, but it is a big one). 10 years of that and you're earning 1/2 your wages ... Not only that, the booms and busts whipsaw people so they lose on both ends (buying high and selling low and vice versa). That creates 2x, 3x, 4x (depends on leverage) the effect in losses.
Under gold-as-money, some of the value would go to gold producers (gold supplies tend to rise about 1.5% per year). That's better than going to the banker / government consortium ... and banks would be genuine institutions of finance, rather than participants in the oligopoly of theft.
Another Example: $1000 in an economy. Joe deposits $100 after production. Bank creates $50 off of the new money and lends it. The 'economy' loses 50/$1000 or 5% before prices adjust, and if prices adjusted quickly, they'd lose 50/1050 or 4.7% to the new user of the money (the borrower) - ceteris paribus (all else held equal). The bank only makes a percentage of that money - say net interest margin is 2%. If the bank immediately issues new larger credit after the $50 is paid off, there is a continuous dilution of money which favors borrowers over savers and gives the bank the ability to 'steal value and lend it at interest'.
It used to be periodic deflations would bring lending booms back in line and gold could always be held because it couldn't be created very fast making savers have their day in the sun ... but there's no deflations any more (at least not yet ...) In effect, the titans of finance (who are not to blame, of course unless they happen to be part of the original 1913 committee drafting the Federal Reserve) are now the manipulators of the public's money to their own benefit and to the losses of the public at large.
Published: March 2, 2007 6:52 AM
JIMB, nice examples! Thanks. It looks like you are assuming a statist monopoly over the creation of money. Fair enough, that's the current situation. One could imagine a situation where the government and the Law are not mis-used to defend such monopoly and the creation money, as a tool to facilitate human exchanges, is actually a free business. Customers may choose to do business with a bank practicing fractional reserve, knowing that their money would lose value over time, maybe in exchange of some advantages such as a free safe or lower interest rate on a loan. If the banks hide its practice of fractional reserve, the situation is quite different; it is pure robbery. In the end, I would say that free market common sense would be such that customers would kick out of the markets banks practicing fractional reserve. Good luck to do that with the central banks of the US or Canada.
Published: March 2, 2007 9:03 AM
Thanks DavidB and JIMB for responding to my request to explain the theft undertaken by banks.
As I understand what you have said, the theft is from two sources: 1. inflation and 2. the possibility of not being able to pay back depositors since the banks may invest in illiquid assets.
With regard to inflation, it is the central bank that controls that, not individual banks. The banking system as a whole can only expand deposits and loans at a rate determined by the rate of expansion in bank reserves, which is, in turn, determined essentially by the rate of purchase of government securities by the central bank. The central bank can quite easily determine a zero inflation rate or a negative one. In Canada, as I said earlier, the central bank has for long time had its inflation target at 2%, and that is what inflation has long been. Inflationary expectations are thus 2%, and are held by every borrower and lender, employer and wage earner. The low inflation still involves some hidden taxation by the central bank's purchase of government securities, as it would even if the central bank allowed zero inflation (which is a policy currently being debated).
As for the possible inability of a particular bank to meet current depositor withdrawals, this depends upon the bank's liquidity. The possibility of bankruptcy restrains banks from being so illiquid that they can't meet day-to-day withdrawals. They can sell off securities or borrow from other banks if this situation ever arises. Of course, the existence of deposit insurance guarantees that depositors do not lose their money. Do you consider bank runs to be a problem in the U.S.?
There also seems to be a underlying feeling that banks make too much profit. In some jurisdictions, restrictions on new entrants into the banking industry can produce abnormally high profits. Of course, since banks are private institutions, whose shares trade on the stock market, there is nothing to prevent any of us from owning a piece of the action.
Published: March 2, 2007 9:26 AM
For the record, my current taxing organization is: Canada. I'd love to avoid them, but if I don't support their collectivists policies by giving them money, I am off to jail. Anyway, last year, Canadian government people over there robbed me through their banking system by increasing monetary supply by something between 5 and 10%. At this point the invisible hand stole that amount from me. Of course, they called it virtue because they hide that number (although one can find it on their website somewhere) and explains me that inflation is 2%. To me the real inflation is between 5 and 10%. The difference? Well they also robbed me of the benefits of technological progress and improvements in production that should have decreased prices! On top of that they said that my money was safe at the bank because of some "safe deposit laws"... Obviously those laws did not prevent the above-described robbery. Also, those laws must not capture the real risk of fractional banking. A good insurance should offset the fractional reserve system but then that would defeat the purpose of fractional reserve banking! It is more like I can lose one hundred and I am insured for two and a tiny. Thanks!
Published: March 2, 2007 10:15 AM
To say FRB is fraud or a theft sounds perhaps a bit shocking, and yet…
There’s a so called “pyramid” system that’s quite similarily considered a theft and illegal in Europe (probably in the US as well):
One person is supposed to find ten “friends” that will each give 10$ to his “pilot”, i.e. the first name on a list of ten. By doing this he is allowed to make his own name move one step up from the bottom of the list. After ten rounds, everyone gets 100$!
Sounds good even to an Austrian? Plain contractual system, right?
So why is this a fraud? The point is that everybody knows (just like the current banking system is well known) : apart from the fact that the initiator doesn’t even pay the first 10$, the pyramid is bound to tumble because the payment will necessarily default at some point, except if the whole population of the world would agree to pay over and over again. Thus it is known that the success of one is based on the bankruptcy of ten others…
That’s a form of theft.
Isn’t the analogy striking?
Through exponential FRB, at some point of the levering, some borrowers make a profit based on the bankruptcy of many lenders…
Theft.
But here comes the State servants saying “no, that’s perfectly all right… “. They find a way not to suppress the banckruptcy risk, but to dilute it tremendously over the whole population as to not being directly noticeable, and moreover, as the article explains, they create an artificial inflation that even levers their great profits again, being as the major borrowers in the nation.
Published: March 2, 2007 10:28 AM
With regard to inflation, it is the central bank that controls that, not individual banks. The banking system as a whole can only expand deposits and loans at a rate determined by the rate of expansion in bank reserves, which is, in turn, determined essentially by the rate of purchase of government securities by the central bank.
The bank can also borrow directly from either the central bank or other banks in the system at their preferred rate. There is theoretically no limit to the amount of money an individual bank can create. The only limit is the fact that the cartel and the head of the cartel would start raising eyebrows if one of their members went renegade and started drawing attention to itself.
Their very existence depends on the public not noticing their operations and thus getting aroused against them to action
The central bank can quite easily determine a zero inflation rate or a negative one.
It can but what a coincidence that in the 70 years of the fed's existence it has contracted the money supply only a few times. The average over the last 70 years is something like 5% a year. That is a 5% tax rate that people have had their currency diluted by
As for the possible inability of a particular bank to meet current depositor withdrawals, this depends upon the bank's liquidity. The possibility of bankruptcy restrains banks from being so illiquid that they can't meet day-to-day withdrawals. They can sell off securities or borrow from other banks if this situation ever arises.
They can also borrow from the central bank. The system is so well geared for the benefit of the cartel that they would have to be flippin' morons to crash their banks. And why would they? Why would you slay the goose that lays the golden eggs? They have a strongly vested interest in only making people debt slaves and keeping the system going as long as possible. That is where they make their income from and it keeps them ahead of most in society. When you are a king you don't shoot the peasants and you don't do anything to get them looking into what you do
Of course, the existence of deposit insurance guarantees that depositors do not lose their money.
only to a limit
Do you consider bank runs to be a problem in the U.S.?
Once again why should they with a system that is greased so efficiently in the favor of the banking system
There also seems to be a underlying feeling that banks make too much profit.
I don't begrudge them their profit. It is their monopoly cartel that is the problem. Since you can only compete with them if the government lets you(a government sanctioned cartel) their is not enough competition to keep the system efficient enough to ensure the excesses are wrung out of the banking system. The last housing boom is proof of that as it was the result of Greenspan panicking to save the nasdaq after the bust
In some jurisdictions, restrictions on new entrants into the banking industry can produce abnormally high profits. Of course, since banks are private institutions, whose shares trade on the stock market, there is nothing to prevent any of us from owning a piece of the action.
Are you saying a shareholder who can collect a 5% dividend every year gets to participate in the profits the same way a company officer does who gets a million in stock options every year? That is like saying the depositor who collects 5% interest on his $1000 participates in the profits that his $1000 makes when it is turned into $10,000 by the money multiplier and loaned out to produce $500 in interest payments.
There is a bit of an unbalanced benefit there. Especially when it is the depositor AND the shareholder who are taking all the risk
Published: March 2, 2007 11:16 AM
Adi and Alex are right that fractional reserve banking is not fraudulent. If I put $100 in a bank, knowing full well that the bank will hold $10 in cash and the other $90 in other assets, and if both the banker and I agree to it, there is no fraud.
Published: March 2, 2007 11:45 AM
JCR and DavidB, it's not the banks that are creating inflation robbery, it's the central bank (i.e., the federal government). The central bank determines whatever inflation rate it wishes. Money and credit expand via the commoercial banks, but that is simply institutional mechanics as far as inflation is concerned. The banks do not play a role in determining inflation.
The Fed. may be only weakly controlled by Congress, and it may cause an inflation rate that we don't like. I certainly agree with this point.
JCR, if inflation is not measured properly, that too is a separate issue from whether banks steal and commit fraud.
Artisan, in a pyramid scheme there are no assets backing 10 people's $10 contributions. In banking every $100 of deposits is represented by $100 of assets. That's a very significant difference.
DavidB, if the present value of a company's expected future profits (whether we are talking about a bank or not) =$1000 and if 100 shares are outstanding, each share will have a market value of $10. The value of each share thus captures all future expected profits whether dividends are issued or not.
The fact that some executives of corporations may not be worth the compensation they receive is not peculiar to banking, but arises in any industry. Also, on average, unless individual and institutional shareholders are stupid, exectutives receive compensation commensurate with their contribution to the market value of the firm, in the same way that, for example, other highly paid people (basketball players, movie stars, rap artists) receive compensation related to the market value of what they produce.
DavidB, suppose there is, of course, a limit as to how much a given bank can borrow from other banks or the central bank, and hence there is a limit as to the expansion of a given bank's loans and deposits. If a bank borrows $100 from another bank, the first bank gains reserves, but the lending bank loses reserves.
Some banks, by competiting for deposits and loan business, can expand faster or more slowly than other banks, but the banking system as a whole (the consolidated banking system) can only expand as fast as the central bank allows reserves to expand.
Published: March 2, 2007 2:09 PM
Sorry, I have just spied an extraneous "suppose" as the second word of my second to last sentence. It should not be there.
Published: March 2, 2007 2:12 PM
Frank Shostak,
Since I thought everyone (regardless of their label) knew it was central banks (i.e., governments) that determine inflation, I would be interested in reading the L. Randall Wray paper. I went to the Levy Economics Institute but was not able to find it listed.
Published: March 2, 2007 2:25 PM
Mike, JCR, Alex - Capital gains and legal tender laws complete the theft - you cannot avoid, without a large transaction cost (the capital gains taxes on temporary investments which rise in price opposite to the depreciating dollar), the losses from inflation. The interplay is something most people do not realize.
The additional problem is that "insurance" (Fed bailout by price fixing the interest rate and deposit insurance) encourages risk-taking: so instead of small corrections, the pressure will build up to large crashes.
Example: having government insurance (mispriced) to build in a flood plain means a lot more people will rebuild / move onto the flood plain than otherwise. The next flood (whenever it happens) will be more catastrophic.
The presense of deposit insurance also causes the necessary expansion of laws by government officials to "protect the public" from aggressive banks. Seeing how a bank can be started with no owned capital (i.e. the capital is simply created by another creating money as an 'investment' like any other loan) and that accounting standards have been eroded to help the S&L crisis (the government and industry changed accounting laws to allow insolvent banks to appear solvent and to book loans at historic cost even when the risk changes their worth substantially and they are far underwater mark-to-market), I'd say after a big real estate boom we run a decent risk of bank closures. In fact, you should prepare for them (keep one month's worth of expenses in physical cash in case your bank gets hit).
It's fraud if the risks of the process are not well understood ahead of time, it's theft because of the unavoidability of many of the losses. For most people (me and you - unless you are very wealthy), it is near impossible to hedge against.
Published: March 3, 2007 6:53 AM
JIMB,
I agree with you that federal deposit insurance encourages risk taking by some banks that is inappropriate relative to their deposit insurance premiums. The solution would be to make the FDIC vary premiums according to the risk of the institution's loan portfolio, or, better still, turn deposit insurance over to the private sector.
Again, as far as inflation is concerned, as I explained earlier, fractional reserve banking is not responsible for that; inflation is caused by the government via the central bank.
Published: March 3, 2007 12:06 PM
Great back and forth.This is what makes the blog
worth reading.Mises felt that FRB could exist in a limited way absent government intervention, resulting in very mild business cycles.Rothbard points to 120 yrs of free banking in Scotland,~1720-1840, as an example of how the market alone can punish naughty bankers.Both agree
that an increasing supply of money is not a requirment for an increasing standard of living.
Published: March 3, 2007 12:15 PM
JIMB and ALex:
Here's an analogy: GM issues stock, and Merrill Lynch isues call options on that stock. Everyone agrees that when GM issues new stock in exchange for equal-valued assets, the price of GM will not change. Everyone also agrees that when M-L issues calls on GM, the price of GM is unaffected.
A checking account dollar is nothing but a call option on green paper dollars; therefore the issue of checking account dollars does not affect the value of green dollars. Green dollars are like GM stock: if the Fed issues more green dollars in exchange for equal-valued assets, the value of the dollar will not change. Inflation only happens when the Fed loses assets relative to the amount of money issued. In the same way, GM stock only loses value if GM loses assets.
Published: March 3, 2007 1:18 PM
Yes there is a lot of confusion about this subject.
First.. The Federal Reserve is (are) Private banks
but have the power to create IOU's, paper money. It's nice to be a legal counterfeiter.
Second.. This bank was authorized by the Government.
Third.. They work together in milking the public.
How convenient for both. The banks are guaranteed to make profits. The Government is guaranteed to be able to spend beyond its income...Wonderful.
The public at large are sheared little by little,
never too much for that would create a panic.
Gentlemen, whatever we have it is not honest money.One could say we had honest money before the Federal Reserve was created.Alas no more.
Published: March 3, 2007 2:12 PM
Mike - I don't mean to be harsh, but the following is so disastrously false (if I read it right) that you should read 'Fiat Money Inflation in France' here http://www.mises.org/books/inflationinfrance.pdf
re: If the Fed issues more green dollars in exchange for equal-valued assets, the value of the dollar will not change.
Remember, you would be saying that "printing" 40T in cash and buying up all the real estate in the U.S. would not affect inflation ... You should know cash in circulation is estimated at 806B which you can find here http://www.federalreserve.gov/releases/h41/Current/ (look at the middle of section 1)
You are right that private issuance of currency could be collateralized by new production which would grow and shrink with the changes in the volume of trade.
You are almost right about the checking account dollars - it is a credit transaction until a purchase is made where it creates a demand for liquidity for settlement.
However, if we were to (fictional situation) increase all checking account balances by say 10%, 'demand for liquidity' would likely soar (current psychology), and would have to be offset by much higher interest rates to prevent the extra purchasing power from bidding up the prices of goods.
In effect, the 'gift' of 10% higher checking account balances would have to be offset by the bankruptcy of a number of spenders by higher interest rates ... that is the effect of an increase in money supply.
Published: March 3, 2007 3:12 PM
Mike,
Bank reserves increase for the most part by open market purchases of U.S. Treasury bonds (bills). The asset side of the Fed balance sheet increases (T-bills); the liability side increases by an equal dollar amount of various bank deposits at the Fed. These bank deposits at the Fed are of course the reserves that allow the supply of money and credit to expand, and inflation to result. It wouldn't matter what assets the Fed purchased, bank reserves would increase by such action as would the money supply. So expansions, not reductions, in Fed assets lead to monetary expansion and inflation.
The Fed is owned privately, through member banks, but it operates, of course, with the good wishes of Congress. So, I think it is fair to place the rate of monetary expansion and inflation squarely on the shoulders of the federal government.
Almost all profits of the Fed are transferred to the federal Treasury. Though these profits are fictional. E.g., Say the Fed earns $2 billion in profits in a given year. Perhaps $1.80 billion would return to the Treasury as so called "profits". This $1.8 billion in profits is purely fictional, as you can see. The Treasury simply writes a check to the Fed to pay the interest on these bonds and the Fed turns around and hands almost all of it back to the Treasury.
Suppose, out of the remaining $200 million, that operating costs are $180 million and $20 million is paid out in dividends. This means that the cost to the American taxpayer of operating the Fed is $200 million.
The Fed, therefore, doesn't earn profits (unless you want to count the small amount that accrues to the shareholders of the Fed); it incurs operating and financial costs, and these costs are paid for by the American taxpayer.
These costs must be added to the increased holdings of Treaury bonds on the Fed's balance sheet. If, in a given year the Fed's net acquisition of Treasury securities is, say, $15 billion, then the inflation tax cost to taxpayers of the Fed is $15 billion.
Published: March 3, 2007 6:57 PM
JIMB and ALEX:
You're assuming what you're trying to prove--that an increase in the money supply, accompanied by an increase in the issuer's assets, will cause inflation. That is not true of stocks, bonds, options, warrants, or any other financial security, and yet you insist it must be true of money. You get nowhere by assuming exaggerated scenarios like $40 trillion being issued. In real life, the Fed issues one new dollar in exchange for one dollar's worth of bonds. Surely you see the difference between that and a bank that issues a new dollar and gets no new assets. No inflation in the first case, and inflation in the second.
Published: March 3, 2007 9:18 PM
Mike - Inflation isn't only about assets, it's also about a term mismatch ... i.e. too few ** consumer ** goods in comparison to other assets.
Example: If the Fed issues one trillion dollars to match one trillion dollars worth in new shuttle parts for a fleet of personal space shuttles due in 2050, I guarantee massive inflation will result. Why? Because money is used to bid for consumer goods NOW.
I think you need to think the examples through carefully because the exaggerated scenarios make the point especially well. Buying assets with new money DOES depreciate money's value even if the assets are priced exactly at the value they command on the market at present.
In my view, your example of Stocks, bonds, options, warrants, are also very much in error because none of those things ** are money **. GM stocks are not accepted (and so they are not demanded) for settlement for trade. You will not find a wide market for GM stocks versus goods (i.e. you cannot directly buy beer with your GM stock certificate).
In contrast, it is the demand for transactions that makes (almost all) the demand for money. Issuing 40T for real estate would flood the market with more than 40x the money it needs for ** transactions ** regardless of the value of the assets. That is inflationary because of money's special role.
And in practice, the Fed does not issue $1 for $1 worth of bonds, they issue $1.10 for $1 worth of government bonds (holding interest rates artificially low by bidding up the price) and that is why the money supply expands faster than does the production of consumption goods which results (after a lag) in consumer price inflation.
Published: March 3, 2007 11:10 PM
Mike,
For simplicity, let's disregard captial (housing, machinery, office buildings, etc.) for the moment. Let's suppose total production in the economy is 100 widgets. The money supply is $10 and the price of each widget is, say $1.
The federal government scribbles on a piece of paper "$100 Treasury bill". The Fed purchases this piece of paper and puts it in their safe (on the Fed balance sheet, assets increase by $100). The Fed pays the government for this piece of paper by creating a government deposit of $100 (Fed liabilities increase by $100). The government now has $100 of spending power they didn't have before, and this spending power was created purely out of a piece of paper, ink, and accounting debits and credits. Now, even neglecting the further increase in money supply that would occur via the banking system, what do you think would happen to the price of widgets?
Published: March 4, 2007 9:44 AM
Alex:
When the government issues a $100 bond, the government's liabilities rise by $100, so the government does not have any more purchasing power than it used to. It could have just as well bought goods with that $100 bond as with $100 in green paper. Meanwhile, the Fed's assets and liabilities both rise by $100. If the newly created $100 sits idle somewhere, and if the Fed follows its usual policy of conducting open-market sales when money is sitting idle, then the $100 will simply find its way back to the Fed, by way of the Law of the Reflux. At no point is there any upward pressure on prices.
Published: March 4, 2007 1:38 PM
JIMB:
You are also neglecting the Law of the Reflux--that unwanted money will simply return to the issuer. I have no quarrel with the idea that issuing money in exchange for inadequate assets (like space shuttles) will cause inflation. But it is clear that if a bank has issued 100 paper dollars in exchange for 100 ounces of silver, then each dollar will be worth 1 ounce. If that bank issues another $100 for another 100 ounces, the dollar will still be worth one ounce. If the bank then issues another $100 for an amount of wheat worth 100 ounces, the dollar will still be worth one ounce, and the same is true if dollars are issued for bonds or anything else.
Published: March 4, 2007 1:45 PM
My view is that fractional reserve banking should be considered fraudulent because of the reason that bankers cannot fulfil their obligations against all their depositors. This is a logical proof by itself.
It does not matter if bank depositors are well educated in fraudulent banking procedures or not. Reality and logic sets the limit and real laws should be in accordance with reality. Otherwise they are destructive and wrong. No contracts can invalidate reality and logics.
A true monetary loan is an exchange of present goods for future goods, whereby “the future” is defined as an agreed upon time between the parties when the loan expires.
If a “depositor” really wants to lend out his money, he should also comply with what a true loan is and “not try to eat his cake and still try to keep it.”
An Austrian economist has all the reason in the world to be against fractional reserve banking as he wants the economy to correspond to a true voluntarily saving ratio and not to a vague (and therefore fraudulent) one. Because of the fact that fractional reserve banking is relied upon this vagueness and therefore swindle, he also knows that this very vagueness and swindle are the really causes of horrible and anti social depressions and business cycles, which he therefore wants to end once and for all.
Apart from mentioned logical proof of why fractional reserve banking is fraudulent, another logical proof should also be mentioned and that is that the Austrian business cycle theory by itself proves that “savings” through fractional reserve banking does not harmonize with true voluntarily saving ratios of individuals as business cycles are still existent in a fractional reserve economy and are, also, the very cause of them. The Austrian business cycle theory teaches “that recessions and depressions are caused by initially lowering of the rate of interest which do not correspond to true saving ratios, but by increases of the money supply. When the economy adjusts to true saving ratios, malinvestments are liquidated.”
We could say that slave contracts should not, in a libertarian society, be allowed for the same reason i.e. they are contradictory and not in accordance with reality and logics as;
“A man cannot renounce his right to self-ownership, since a man in his very nature controls his own mind and body (natural disposition), that is, he is a natural self-owner of his own will and person (having a free will) and he will still be so even if he has “tried” o renounce his natural self-ownership to another person. He cannot renounce something which is a biological and physical fact of his very own life and which will never, as long as he lives, leave him.”
Björn Lundahl
Göteborg, Sweden
Published: March 4, 2007 1:46 PM
Shock Report: 'Rothbardian' Errors Exposed
http://www.lewrockwell.com/corrigan/corrigan77.html
Björn Lundahl
Göteborg, Sweden
Published: March 4, 2007 2:13 PM
Mike,
Bjorn Lundahl said, "fractional reserve banking should be considered fraudulent because of the reason that bankers cannot fulfill their obligations against all their depositors. This is a logical proof by itself."
Consider a company that has liabilities of $100. On the asset side of its balance sheet it has, say, $8 cash and various other assets. Would you say the company is fraudulent? No. Would you say this balance sheet shows the company cannot fulfill all their debt obligations? No. Then why would you say this if the company in question is a bank?
Just because a bank does not hold $100 in cash against every $100 of deposit liabilities does mean at all that the bank cannot meet all its deposit liabilities, in the same way that a company that has liabilities of $100 but only cash of $8 doesn't mean this either.
JIMB,
If the federal government had bought goods with its $100 bond, rather than selling it to the central bank, then people outside the central bank have saved $100 to offset the government's spending. As a result, there is no increase in net spending.
If, however, the Fed. purchases that same $100 bond (either directly or via an open market purchase), the non-government public is not reducing their spending to offset the government's $100 increase in spending.
Published: March 4, 2007 2:56 PM
Heck, I meant "Bjorn", not "Mike" for the first part of my last post, and I meant "Mike", not JIMB for the second part. Apart from that....
Published: March 4, 2007 2:59 PM
I think I have provided the answers already in my above comment but I will emphasise this:
A demand deposit is for the purpose of securely and quickly providing frequent access to funds "on demand". That is the bank’s obligation. This should not be confused with an ordinary company’s balance sheet and obligations.
Björn Lundahl
Published: March 4, 2007 4:11 PM
100 percent gold reserve money standard
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://www.mises.org/rothbard/agd/chapter1.asp#preventing_depressions
Money must develop out of a commodity with a previously existing purchasing power, such as gold and silver had.
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 exchange. 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 commodity 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://www.mises.org/rothbard/mes/chap4b.asp#5B._Money_Regression
As demand deposits functions as monies, they should also be what monies logically therefore are supposed to be, and those are only compositions of certain amounts of weights in gold, silver or other monies developed out of commodities through the market process.
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.
• 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.
Björn Lundahl
Göteborg, Sweden
Published: March 4, 2007 4:31 PM
Bjorn - Several issues: 1 - deposits are a credit transaction (trading current goods: cash, for a future good: access to cash, check writing, transfers, etc).
2 - Fractional reserve banking is not fraud unless there is misrepresentation. If a fractional reserve bank can refuse immediate redemption or promises only to redeem with a mark-to-market price, it is not fraud. So it ** can ** be non-fraudulen. In fact, I think it likely that government intervention would be required to make a 100% reserve banking system and gov intervention is a big no no.
3 - You cannot go from an "IS" to an "OUGHT" ... the fact that I (my brain) controls my body does not mean that I have the constellation of rights that libertarians refer to as "self-ownership". I could as easily observe that "the strong kill the weak" and then reason that "the strongest should survive at the cost of the weak". It is not self-ownership that is the starting point of morality, but our sense of justice. There are a lot of "IS's" out there implying very different "OUGHTs" ...
Published: March 4, 2007 8:34 PM
Mike - Where does excess money reflux in today's economy?
Published: March 4, 2007 8:34 PM
Alex:
So if the govt hands its $100 bond to a farmer for $100 of wheat there is no net increase in spending, but if the govt hands that bond to the Fed in exchange for 100 green pieces of paper, and then hands those pieces of paper to the farmer instead of the bond, then you say there is an increase in spending.
Or think of it my way: The govt hands its $100 bond to the Fed in exchange for $100 in paper dollars. The government is no wealthier for this, so there is no change in overall purchasing power, and the Fed's assets rise in step with its liabilities, hence no change in the value of the dollar.
Published: March 4, 2007 8:41 PM
Consider a company that has liabilities of $100. On the asset side of its balance sheet it has, say, $8 cash and various other assets. Would you say the company is fraudulent? No. Would you say this balance sheet shows the company cannot fulfill all their debt obligations? No. Then why would you say this if the company in question is a bank?
Based only on the information given, I wouldn't. But the information given is irrelevant: money in demand deposits is not an asset of the bank, and shouldn't show up on its balance sheet (it's the customer's money, not the bank's!)
Published: March 4, 2007 11:02 PM
Several issues: 1 - deposits are a credit transaction (trading current goods: cash, for a future good: access to cash, check writing, transfers, etc).
No.
2 - Fractional reserve banking is not fraud unless there is misrepresentation. If a fractional reserve bank can refuse immediate redemption or promises only to redeem with a mark-to-market price, it is not fraud.
It's also not money!
You cannot go from an "IS" to an "OUGHT" ... the fact that I (my brain) controls my body does not mean that I have the constellation of rights that libertarians refer to as "self-ownership".
No.
Published: March 4, 2007 11:07 PM
Gentlemen
Thanks for your most illuminating contributions and answers to the question I asked.
I was curious about this subject as a result of what a friend of mine said to me not so long ago. He felt that there was no fraud because the nature of fiat money and the nature of FR banking was in the public domain- hence known and therefore not fraud. One of my objections was along the lines that Bjorn and others have presented above (apart from which there is the theft aspect - taking value from the money people have earned and saved).
Still, I am interested in the perspective other people have about this matter. It's an amazing feat to be able to loot from people so openly and get away with it. What is it that makes people so tolerant of the situation?
Sione
Published: March 5, 2007 12:01 AM
Life and self-ownership
Mark Humphrey
Mark Humphrey “I don't want to precipitate trench warfare with devoted Rothbardians, but I strongly suspect that Rothbard owed his insight about "life as the standard of moral value" to Ayn Rand. I can't prove this, of course. Sadly, in "The Ethics of Liberty", (published in the early Eighties) Rothbard chose to, in a sense, blacklist Rand by claiming that NO ONE, other than himself, in the libertarian movement was working to develope a system of rationally defensible ethics. (Maybe Rothbard meant "at the moment I am writing this statement".)”
Björn That life is an axiomatic value and functions “as the standard of moral value” in an ethical system, Rothbard could, alternatively for example, have gotten this insight from Mises himself through analyzing his statement in his book, “Human Action”, page 11:
“We may say that action is the manifestation of a man's will.”
http://www.mises.org/humanaction/chap1sec1.asp
I am not saying that Rothbard did get his insight from Mises; I am only saying that it was possible. Surely, many other possibilities exist which we do not know anything about.
Mark Humphrey “It has been awhile since I've read Hoppe, and Rothbard; but I suspect Hoppe's reasoning goes: either we all own ourselves, or everyone owns everyone else. Since the first proposition is clearly more defensible than the latter absurd proposition, one can affirm self ownership as valid. But if this is the argument, it fails. For that argument assumes that which it sets out to prove, namely that an ethical concept, "ownership", exists. But on this basis, ownership remains unproven, so that one could just as well assert: "no one owns anything, and anything goes."”
Björn Self-ownership is a natural fact, since a man in his very nature controls his own mind and body (natural disposition), that is, he is a natural self-owner of his own will and person (having a free will) and if this was not true, neither could he effectively control any property and, therefore, not own it. In other words; “nothing could control and own something”.
Naturally, praxeology the science of human action, by itself logically confirms the natural fact of self-ownership, since praxeology is based upon “the acting man consciously intending to improve his own satisfaction” and I quote from answers.com:
“From praxeology Mises derived the idea that every conscious action is intended to improve a person's satisfaction. He was careful to stress that praxeology is not concerned with the individual's definition of end satisfaction, just the way he sought that satisfaction. The way in which a person will increase his satisfaction is by removing a source of dissatisfaction. As the future is uncertain so every action is speculative.
An acting man is defined as one capable of logical thought — to be otherwise would be to make one a mere creature who simply reacts to stimuli by instinct. Similarly an acting man must have a source of dissatisfaction which he believes capable of removing, otherwise he cannot act.
Another conclusion that Mises reached was that decisions are made on an ordinal basis. That is, it is impossible to carry out more than one action at once, the conscious mind being only capable of one decision at a time — even if those decisions can be made in rapid order. Thus man will act to remove the most pressing source of dissatisfaction first and then move to the next most pressing source of dissatisfaction.
As a person satisfies his first most important goal and after that his second most important goal then his second most important goal is always less important than his first most important goal. Thus, for every further goal reached, his satisfaction, or utility, is lessened from the preceding goal. This is the rule of diminishing marginal utility.
In human society many actions will be trading activities where one person regards a possession of another person as more desirable than one of his own possessions, and the other person has a similar higher regard for his colleague's possession than he does for his own. This subject of praxeology is known as catallactics, and is the more commonly accepted realm of economics.”
http://www.answers.com/Praxeology?gwp=11&ver=2.0.1.458&method=3
Further:
The Ethics of Liberty, page 45:
Footnote:
“[1]Professor George Mavrodes, of the department of philosophy of the University of Michigan, objects that there is another logical alternative: namely, “that no one owns anybody, either himself or anyone else, nor any share of anybody.” However, since ownership signifies range of control, this would mean that no one would be able to do anything, and the human race would quickly vanish.”
http://www.mises.org/rothbard/ethics/eight.asp
Or in my own words from the essay “Normative principles”:
“Why must anybody own anything?
In accordance with our objective test to find out if something is a condition for something else, we grasp a state of things where the following principle is none existent anywhere and at all:
“Everybody owns themselves and their Justly owned property rights”.
Nobody would be able to do anything, since nobody has the right to control anything. Not even themselves (see below about property rights in your own person).
This question is not only a contradiction it is also silly. You ask a question which means that you control yourselves (natural disposition), that is owning yourself (see below the excellent writing of Hans-Hermann Hoppe). The other contradiction is that if nobody would own anything, nobody would be able to hinder anyone to own anything either since they would otherwise have an invalid control (having the disposition to) of everyone else, that is having an invalid ownership to everybody else (see below about valid property rights in your own person).
Ownership itself is, therefore, an objective condition for the preservation of human life.”
http://normativeprinciples.blogspot.com/2006/12/normative-principles-pure-free-market_10.html
An Animated Introduction to the Philosophy of Liberty:
http://www.isil.org/resources/introduction.html
The animation in full-sized window:
http://www.isil.org/resources/introduction.swf
Björn Lundahl
Göteborg, Sweden
Published: March 5, 2007 1:26 AM
Sione
“What is it that makes people so tolerant of the situation?”
Hi, I would say that one factor is ignorance.
Regards
Björn Lundahl
Published: March 5, 2007 1:36 AM
Mike Sproul do not remember that Fed and Govt are same; it's artificial to separate central bank and govt which control Fed through legislation. Legal aspects are not same as economic reality and this wont change just by using some weird terminology (like that money is backed by some other assets than money itself).
Of course Govt is wealthier if it's given 100 new dollars which it may spend as it wish. Assets and liabilities view to central banks is false; no other corporation can write check on itself. Fed could increase its holding of Govt bonds to infinity and Govt could pay all interest payments because it will get them back from central bank.
Hyperinflations around the world are examples what happens if central banks try to monetize governments debts.
RBD theory of money is false in its all forms...
Published: March 5, 2007 5:51 AM
Mike Sproul, in your view nominal income should Granger-cause nominal money since you seem to be saying that money backed by assets should not increase price level. If nominal income is increasing then people should demand more money since they have now extra assets to back money.
But what if it's found out that lagged money supply also Granger-causes nominal income?
Early statisticians did find out something like that even in 1920's (they didnt have vector auto-regressive models or didnt know about the concept of Wiener-Granger causality).
I must apologize for my empirical questions, but they are usefull in certain sense.
I dont think that Austrian position is harmed if it's noticed that stable relations between money, incomes and interest rates are not found. This just proves that economists have made errors when making theories which depend on these issues.
Published: March 5, 2007 6:33 AM
Mike - Where does excess money reflux in today's economy?
When the central bank believes there is excess money, it will sell bonds and retire the dollars received. Thus the dollar refluxes back to the central bank that issued it.
Published: March 5, 2007 11:09 AM
adi:
So pretend the govt and the Fed are the same. The govt can write up a $100 bond and buy wheat with it, or it can print 100 green paper dollars and buy wheat with that. Any person or firm can do the same thing. If the issuer has enough assets to back the paper issued, the paper will hold its value. If not, the paper will lose value.
Published: March 5, 2007 11:12 AM
For Mike Sproul- do you believe capital equipment
is the kind of asset that can be used to back the issuance of money?
Published: March 5, 2007 12:34 PM
Mike,
Yes, the gov selling a bond to a farmer for his produce is much different than the government selling newly created paper currency to the farmer for his produce. In the former case, interest is paid to the farmer on the bond, making the bond worth the present value of this interest ($100). In the second case of printing a new $100 bill and selling it to the farmer for his produce, there is no interest to be paid on this currency to anyone, and hence its present value is $0. The only reason the farmer will accept the $100 bill is because the government says the bill is worth $100 (This is the fraud. The game of musical chairs if you will.). The farmer accepts the $100 bill because he believes he can pass it on to others for goods and services. These other sellers of goods and services will in turn use it to buy other goods and services, etc.
Published: March 5, 2007 5:06 PM
Peter,
The $100 deposit received from a depositor is recorded as a liability on a bank's balance sheet. Assuming the bank lends all the depositor's funds out immediately upon their receipt, then "loans" is the asset that would increase by $100 on the bank's balance sheet. Bank loans are the primary assets that back deposits. Whether the bank has difficulty in meeting withdrawals in not an asset insufficiency problem but a liquidity (or cash flow problem). Once more, fractional reserve banking does not involve fraud.
Published: March 5, 2007 5:12 PM
Bjorn,
You say Rothbard said that money cannot be created by a social compact or an edict of government. But that's exactly how our fiat money is created. So, money can be created by an edict of government.
There is no question that fiat money involves a hidden tax imposed by the government, when the central bank issues paper currency or purchases government bonds. But fractional banking involves no tax (or "fraud" if you will) beyond that.
Published: March 5, 2007 5:32 PM
The $100 deposit received from a depositor is recorded as a liability on a bank's balance sheet. Assuming the bank lends all the depositor's funds out immediately upon their receipt, then "loans" is the asset that would increase by $100 on the bank's balance sheet.
I know. And that's precisely the problem! When people deposit money in demand accounts, they're not making a loan! It shouldn't show up on the balance sheet - the fact that it does is just an indication of criminality.
Published: March 5, 2007 6:16 PM
Alex MacMillan
“You say Rothbard said that money cannot be created by a social compact or an edict of government. But that's exactly how our fiat money is created. So, money can be created by an edict of government.
The regression theory proves that money must “originally” be developed out of a commodity with a previously existing purchasing power, such as gold and silver had, this during the period between a state of barter and a money economy.”
“There is no question that fiat money involves a hidden tax imposed by the government, when the central bank issues paper currency or purchases government bonds. But fractional banking involves no tax (or "fraud" if you will) beyond that.”
As banks by themselves increase the money supply, they too impose hidden “taxes” on the public and are fraudulent institutions as they cannot fulfil their obligations against all their depositors.
Björn Lundahl
Göteborg, Sweden
Published: March 5, 2007 6:27 PM
In other words, if there would be bank runs (which, naturally, would be extremely unlikely under 100% gold reserve money standard), the banks could meet any claims of the depositors.
Some consequences of not having a 100% gold reserve money standard:
• Panic of 1819 http://www.answers.com/topic/panic-of-1819
• Panic of 1837 http://www.answers.com/topic/panic-of-1837
• Panic of 1857 http://www.answers.com/topic/panic-of-1857
• Panic of 1873 http://www.answers.com/topic/panic-of-1873
• Panic of 1884 http://www.answers.com/topic/panic-of-1884
• Panic of 1890 http://www.answers.com/topic/panic-of-1890
• Panic of 1893 http://www.answers.com/topic/panic-of-1893
• Panic of 1896 http://www.answers.com/topic/panic-of-1896
• Panic of 1901 http://www.answers.com/topic/panic-of-1901
• Panic of 1907 http://www.answers.com/topic/panic-of-1907
Why should we have central banks and fractional reserve banks that mess things up in the first place? Why should we have business cycles and malinvestments just for the sake to please some perversive lust for power and fraudulent money? Do we really want to have malinvestments? Is unemployment that good? What is the justification?
Björn Lundahl
Göteborg, Sweden
Published: March 5, 2007 6:34 PM
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://www.mises.org/rothbard/agd/contents.asp
And to;
http://www.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: March 5, 2007 6:39 PM
Peter - read the post again: banknotes are not money, they are ** credit ** i.e. a right to redeem money. You don't get banknotes today, you get a 'statement' where the electronic balance is redeemable in money ... that's credit. That's why #2 is also correct.
Published: March 5, 2007 6:42 PM
banknotes are not money, they are ** credit ** i.e. a right to redeem money.
They're money substitutes - substituting for the actual money, which is presumed to be stored someone on your behalf. This is not a credit transaction (in which the bank becomes owner of the money in return for a promise to pay it back later).
If you go out to a restaurant, someone might take your car to park it for you and give you a ticket to get it back later, right? Does the parking attendant own your car while you're eating? If he was asked for a list of his assets and liabilities, would it make sense for your car and the claim ticket to be on the list? No, of course not. Same thing.
Published: March 5, 2007 7:49 PM
mikey:
Capital equipment, or anything else of value can and has been used to back money. Note that if backing loses value, then the money will lose value too.
Published: March 5, 2007 10:06 PM
Alex:
Bank notes can bear interest. The issuer just states that it can be redeemed for 1 ounce today, 1.10 oz. next year, etc. This was actually common in 19th century Britain. The difference you claim between money and bonds would then disappear. Also, you give government a power it doesn't have: to give paper value just because it says so. Do you value Rwandan currency because Rwanda says so? No; you'd only value it if Rwanda could back that currency.
Published: March 5, 2007 10:18 PM
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 market, and keep up the price of government bonds”.
“So here we have, at long last, the key to the mystery of the modern inflationary process. It is a process of continually expanding the money supply through continuing Fed purchases of government securities on the open market. Let the Fed wish to increase the money supply by $6 billion, and it will purchase government securities on the open market to a total of $1 billion (if the money multiplier of demand deposits/reserves is 6:1) and the goal will be speedily accomplished. In fact, week after week, even as these lines are being read, the Fed goes into the open market in New York and purchases whatever amount of govern¬ment bonds it has decided upon, and thereby helps decide upon the amount of monetary inflation.”
* The reserve requirement set by the Federal Reserve on banks is exemplified by the ratio 6:1 (the required maximum multiple of deposit to reserves).
http://www.mises.org/rothbard/newliberty9.asp
Björn Lundahl
Göteborg, Sweden
Published: March 6, 2007 1:33 AM
It seems that Mike Sproul is again spreading his herecies..
There should a Ministry of Truth (MiniTruth) which will dictate what kind of ideas are acceptable. Mike's monetary theory dont belong to that group..
:)
Published: March 6, 2007 6:11 AM
Mike, I had problems with my wireless connection or I would have answered earlier.
The federal government purchases $100 of goods and services and sells $100 of new bonds to a domestic person or firm. The government sector has negative savings of $100 from this transaction, while the private sector has positive saving of $100. There is therefore no net saving (or therefore, no net spending) effect from this transaction and no inflationary effect.
When the federal government prints $100 of new currency and spends it on goods and services, there again is $100 negative government savings (positive spending) of $100 from this transaction, but, unlike the previous case, no added saving takes place in the private sector as a result of this transaction. As a result, total spending has increased.
Published: March 6, 2007 5:25 PM
Bjorn,
Yes, that's how the modern fiat money supply expands. I don't think there's any dispute about that.
I'm currently doing some thinking about a situation of 100% gold reserve backed money. Obviously all prices would be relative to gold as the effective numeraire. We would still have loan companies, who acquire funds (deposit-like liabilities) from the public and re-lend these funds out at a higher interest rate than the rate on deposits.
I don't see a problem with fractional reserve banking (any fraud elements, etc. as I've argued here), but for some reason, some people don't like it because the public doesn't understand it. At least, that's the argument against it that I think I'm reading. Especially since fractional reserve banking has no effect on the actual money supply, in the sense that the existing central bank (with fiat money) has no difficulty determining any money supply it wishes regardless whether there is fractional reserve banking or not.
I understand that 100% gold-backed money would take money supply control out of the hands of the central bank (we wouldn't need a central bank), but instead the money supply would then be determined by the supply of gold. I'm not sure whether the amount of money determined this way would be efficient. But, I'm going to do some reading on it, unless someone here has a simple explanation as to why the quantity of money determined by the supply of gold would be a good idea.
Published: March 6, 2007 5:40 PM
Alex MacMillan
I can not understand the reason for having a difficulty in understanding why fractional reserve banking is based on fraud. It is quite obvious. As banks must redeem, on demand, any cash claims of the depositors, they can not do that because they have, to a great extent, lent them to other people and businesses. It does not matter at all how large assets the banks have as they can not still, on demand, meet all the depositors’ rightful claims. That is also why it is called “fractional” reserve banking.
Haven’t you heard of bank runs? History is full of them. Why bank runs if banks can meet all the depositors’ rightful claims? Or do you not understand that when you make a deposit and the bank makes a loan with the same money, you and the borrower have claims on the same money? So what is the problem?
A true monetary loan is an exchange of present goods for future goods, whereby “the future” is defined as an agreed upon time between the parties when the loan expires. That is, also, the kind of loans the banks should instead focus on.
If, for example, a company (or a bank) issues a bond (IOU) and you purchase it, you and the issuer do not at the same time have claims, on
demand, of the same money.
“I understand that 100% gold-backed money would take money supply control out of the hands of the central bank (we wouldn't need a central bank), but instead the money supply would then be determined by the supply of gold. I'm not sure whether the amount of money determined this way would be efficient.”
You can not print gold. So the supply is severely limited. You would not have any business cycle, malinvestments and no inflation. That is quite efficient.
Björn Lundahl
Göteborg, Sweden
Published: March 6, 2007 7:09 PM
The purchasing power of money, the gold standard and fiat money
If the gold supply will, on the average, increase as much as total output in a 100% gold reserve money standard or not, is not a praxeological fact but a speculation. It might be a relatively good speculation, but it still is a speculation. Technological advancements that favour increased gold supplies have, of course, been going on since the beginning of the industrial revolution.
Historically, prices have on the average fallen when economies were on a gold standard and those economies were not even based on a 100% gold reserve money standard.
Deflation defined as increases of the purchasing power of money is not, at all, harmful for the society and the economy.
Rothbard saw falling prices as a natural condition of a market economy, For a New Liberty:
“Thus, falling prices are apparently the normal functioning of a growing market economy.”
“And, indeed, if we look at the world past and present, we find that the money supply has been going up at a rapid pace. It rose in the nineteenth century, too, but at a much slower pace, far slower than the increase of goods and services; but, since World War II, the increase in the money supply—both here and abroad—has been much faster than in the supply of goods. Hence, inflation.”
http://www.mises.org/rothbard/newliberty9.asp
Now when another masterpiece has been added to the great family of superb books in Austrian economics with the title “Money, Bank Credit, and Economic Cycles” written by Jesús Huerta De Soto, I am pleased to quote the author’s comment about the purchasing power of money under 100% gold reserve money standard page 776:
“Consequently one aspect we can foresee is that in the proposed model, nominal interest rates would reach historically low level. Indeed, if on average we can predict an increase in productivity of around 3 percent and growth in the world’s gold reserve of 1 percent each year, there would be slight annual “deflation” of approximately 2 percent.”
And on page 777:
“The model of slight, gradual, and continues “deflation” which would appear in a system that rests on a pure gold standard and a 100-percent reserve requirement would not only not prevent sustained, harmonious economic development, but would actively foster it.”
I quote from the book “Democracy The God That Failed”, by Hans-Hermann Hoppe, page 58:
“During the monarchical age with commodity money largely outside of government control, the “level” of prices had generally fallen and the purchasing power of money increased, except during times of war or new gold discoveries. Various prices indices for Britain, for instance, indicate that prices were substantially lower in 1760 than they had been hundred years earlier, and in 1860 they were lower than they had been in 1760. Connected by an international gold standard, the development in other countries was similar. In sharp contrast, during the democratic-republican age, with the world financial center shifted from Britain to the U.S. and the latter in the role of international monetary trend setter, a very different pattern emerged. Before World War I, the U.S. index of wholesale commodity prices had fallen from 125 shortly after the end of the War between the States, in 1868, to below 80 in 1914. It was then lower than it had been in 1800. In contrast, shortly after World War I, in 1921, the U.S. wholesale commodity price index stood at 113. After World War II, in 1948, it had risen to 185. In 1971 it was 255, by 1981 it reached 658 and in 1991 it was near 1,000. During only two decades of irredeemable fiat money, the consumer price index in the U.S. rose from 40 in 1971 to 136 in 1991, in the United Kingdom it climbed from 24 to 157, in France from 30 to 137, and in Germany from 56 to 116.
Similarly, during more than seventy years, from 1845 until the end of World War I in 1918, the British money supply had increased about six-fold. In distinct contrast, during the seventy-three years from 1918 until 1991, the U.S. money supply increased more than sixty-four-fold.”
Björn Lundahl
Göteborg, Sweden
Published: March 6, 2007 7:19 PM
Increase of gold supplies does not either cause business cycles in a 100% gold reserve money standard.
America’s Great Depression:
“The potential range of such cyclical effects in practice, of course, is severely limited: the gold supply is limited by the fortunes of gold mining, and only a fraction of new gold enters the loan market before influencing prices and wage rates.”
Read the rest “Gold Changes and the Cycle”:
http://www.mises.org/rothbard/agd/chapter1.asp#problems_in_the_austrian_theory
Björn Lundahl
Göteborg, Sweden
Published: March 6, 2007 7:25 PM
What Has Government Done to Our Money? By Murray Rothbard:
“Defenders of banks reply as follows: the banks are simply functioning like other businesses—they take risks. Admittedly, if all the depositors presented their claims, the banks would be bankrupt, since outstanding receipts exceed gold in the vaults. But, banks simply take the chance—usually justified—that not everyone will ask for his gold*. The great difference, however, between the "fractional reserve" bank and all other business is this: other businessmen use their own or borrowed capital in ventures, and if they borrow credit, they promise to pay at a future date, taking care to have enough money at hand on that date to meet their obligation. If Smith borrows 100 gold ounces for a year, he will arrange to have 100 gold ounces available on that future date. But the bank isn't borrowing from its depositors; it doesn't pledge to pay back gold at a certain date in the future. Instead, it pledges to pay the receipt in gold at any time, on demand. In short, the bank note or deposit is not an IOU, or debt; it is a warehouse receipt for other people's property. Further, when a businessman borrows or lends money, he does not add to the money supply. The loaned funds are saved funds, part of the existing money supply being transferred from saver to borrower. Bank issues, on the other hand, artificially increase the money supply since pseudo-receipts are injected into the market.
A bank, then, is not taking the usual business risk. It does not, like all businessmen, arrange the time pattern of its assets proportionately to the time pattern of liabilities, i.e., see to it that it will have enough money, on due dates, to pay its bills. Instead, most of its liabilities are instantaneous, but its assets are not.
The bank creates new money out of thin air, and does not, like everyone else, have to acquire money by producing and selling its services. In short, the bank is already and at all times bankrupt; but its bankruptcy is only revealed when customers get suspicious and precipitate "bank runs." No other business experiences a phenomenon like a "run." No other business can be plunged into bankruptcy overnight simply because its customers decide to repossess their own property. No other business creates fictitious new money, which will evaporate when truly gauged.
The dire economic effects of fractional bank money will be explored in the next chapter. Here we conclude that, morally, such banking would have no more right to exist in a truly free market than any other form of implicit theft. It is true that the note or deposit does not actually say on its face that the warehouse guarantees to keep a full backing of gold on hand at all times. But the bank does promise to redeem on demand, and so when it issues any fake receipts, it is already committing fraud, since it immediately becomes impossible for the bank to keep its pledge and redeem all of its notes and deposits. [15] Fraud, therefore, is immediately being committed when the act of issuing pseudo-receipts takes place. Which particular receipts are fraudulent can only be discovered after a run on the bank has occurred (since all the receipts look alike), and the late coming claimants are left high and dry. [16]”
http://www.mises.org/money/2s12.asp
Björn Lundahl
Göteborg, Sweden
Published: March 7, 2007 2:16 AM
*Above reasoning done by Murray Rothbard refers to a fractional reserve system working under a gold standard. Implicitly it refers to any fractional reserve system such as a “fiat money standard”.
Björn Lundahl
Published: March 7, 2007 2:33 AM
Alex:
It's not clear who you say is saving or dis-saving or why, but I assume you mean that when the govt buys wheat with a $100 bond, then the govt has dis-saved $100 because it issued the bond, while the farmer has saved $100 because he bought the bond (with his wheat). There is no difference between this and a case where the govt prints $100 and hands them to the farmer. The govt dis-saves $100 because of the dollars, while the farmer, assuming he holds the $100 just like he held the bond, is saving $100. (You never addressed my point that paper money can bear interest, just like bonds, so paper money can be "saved" just like bonds.) Even if the dollars bore no interest, and the farmer spent them, that just transfers his saving to someone else, which is exactly what would have happened if the farmer has transferred the bond to someone else.
You've also never addressed my claim that the amount of spending is irrelevant. It's backing that matters. As long as every new dollar is adequately backed, the dollar will hold its value as new dollars are issued. That's clearly true of every financial security, but you deny that it's true of a certain financial security that happens to have the label "money" pinned on it.
Published: March 7, 2007 11:11 AM
Mike Sproul is right that it's the backing of money substitutes which matters: if bank do not have 100% commodity reserves against money substitutes it has issued, it's notes are valued below par.
Bank cannot sell some IOU's for commodity money and destroy these paper notes when customer comes asking for the real thing because there will a deflationary spiral. These IOU's wont be worth as much as the number printed on them.
We remember from historical episodes that there will be a flight to quality papers when some economic disaster occurs.
And Mike Sproul should remember that RBD regime is very unstable since only one discount rate brings stability. Otherwise there will be a Wicksellian "cumulative process".
Published: March 7, 2007 1:19 PM
Some Austro-Swedish idea's about inflation:
Wicksell's
cumulative process
Published: March 7, 2007 1:42 PM
adi:
Wicksell's cumulative process assumes banks lend at, for example, below-market rates. That assumes foolish behavior on the part of the bank. Realistically, a bank would only lend at the market rate, and as long as it does, new money lent will always be matched by new IOU's acquired. Besides, if the central bank only buys and sells bonds at auction, it can't help but acquire equal-valued assets every time it issues a new dollar.
Published: March 7, 2007 10:20 PM
Bjorn,
Yes, I've heard of bank failures, just as I've heard of other business failures. But I wouldn't outlaw business just because some fail.
Let's suppose I start a loan business. I raise funds for the most part by issuing interest paying debentures. Some debentures are redeemable on specific maturity dates, and some are redeemable on demand for gold. The ones that are redeemable on demand, of course, pay less interest. Also, the debentures that are redeemable on demand are transferrable. Can you see any fraud in this business activity?
Published: March 8, 2007 8:58 AM
Mike,
Mike, when the farmer trades his wheat for government bonds, the farmer is saving (not spending). When the farmer accepts money for the wheat, the farmer spends the money (and it doesn't matter if the money is interest bearing). If the farmer decides to not spend the money, then you are assuming an increase in the demand for money occurs that is exactly equal to the increase in money supply ($100 in this case). But the assumption that when the government issues more money it is always accompanied by an equal increase in money demand is totally unrealistic. The argument is that inflation occurs when the money supply is increased relative to money demand. So to illustrate by example why this occurs one must assume that an increase in the money supply ($100 in my example) takes place in the face of an unchanged demand for money, otherwise you are refusing to deal with the issue: How an increase in money (relative to demand) causes inflation.
Published: March 8, 2007 9:11 AM
Bjorn,
I am going to read that Rothbard money article you referred me to. Thanks.
Published: March 8, 2007 10:32 AM
Alex MacMillan
Hi,
My pleasure!
Best regards
Björn
Published: March 8, 2007 1:46 PM
Alex:
You are assuming that the $100 was issued when there was no demand for it. As long as the central bank only issues a dollar to people who offer a dollar's worth of stuff for it, dollars will only be issued when they are wanted. You are saying that if the government issues a white piece of paper called a bond, and buys goods with it, then there will be no inflation, but if it issues green pieces of paper, there will be inflation.
Part of the problem is that you use supply and demand to analyze money. Supply and demand is a model for consumable goods--not for financial securities that can be created and destroyed at the flip of a computer chip. If I want to explain why the value of GM stock is $60 per share, I explain it by way of GM's assets and liabilities--not by the supply and demand for GM stock. Money is valued in the same way.
Published: March 8, 2007 5:07 PM
Alex MacMillan
“Let's suppose I start a loan business. I raise funds for the most part by issuing interest paying debentures. Some debentures are redeemable on specific maturity dates, and some are redeemable on demand for gold. The ones that are redeemable on demand, of course, pay less interest. Also, the debentures that are redeemable on demand are transferrable. Can you see any fraud in this business activity?”
The “debentures” that are redeemable on demand are not loans as they are redeemable on demand and lack maturity dates. They also pay interest. Logically they are totally a contradiction in terms and should therefore be legally invalid.
Björn Lundahl
Göteborg, Sweden
Published: March 8, 2007 5:23 PM
Bjorn,
If I borrow money from you and pay you interest (or not) and agree that I shall repay you on demand, why should that be illegal? Do you believe all demand loans should be illegal? If so, why?
I have read the first part of that article of Rothbard, enjoying it so far. Shall try and finish it tonight.
Published: March 8, 2007 6:48 PM
Mike,
I can't follow your logic. First of all, supply and demand analysis is valid for assets as it is for goods and services. Your theory that demand and supply should only be used in the context of consumable goods is a new one on me.
The whole point of money and inflation is that additional money is put into the economy when there is no demand for it. Hence people spend it rather than save it. If the government buys $100 of sgoods from us, almost always, we don't want the cash; we want the goods and services that we can acquire by soon spending that cash.