The Plummeting Greenback
No matter how many warnings have been issued, an economic crisis always takes a country by surprise. The most urgent task is to somehow prevent policymakers from doing evil things to "correct" the crisis. Every form of intervention can only make matters worse. The best policy is to adopt a laissez-faire policy through regulatory cuts, sound money, and eliminating legal restrictions on trade. The liquidation must be allowed to happen on its own to provide a suitable foundation for a future recovery.
How can we help this happen? One way is to make sure that the right books are front and center. We might start by reviewing the great event that still inspires today's most fallacious countercyclical policies: the Great Depression. FULL ARTICLE
Comments (43)
David Hillary
It seems like Mr Rockwell has a problem with free trade in credit.
It seems that if party A wants to conduct a current account for B where the balance on the account is the financial position between A and B, and where A will collect payment instruments deposited by B for the credit of B's current account, and where A will pay B's payment orders drawn on B's account, Mr Rockwell will say, "No, that's not allowed under Roman law. You're not allowed to borrow on current account and repay to the customer's order, you have to set this up as some kind of trust or managed fund where there's no borrowing and lending involved."
It seems like if party A wants to issue promissory notes payable to bearer on demand in exchange for money, and to invest the money borrowed on the notes in interest bearing securities Mr Rockwell will say "No, you're not allowed to do that under Roman law, you have to hold the money in coined form, you can't invest or lend your money out for interest."
Under English common law, the bank and the customer do have a debtor-creditor relationship in respect to the customer's current account with the bank, and in fact even if the parties don't specify this, it is an implied term -- it is so obvious at law it goes without saying. The onus is on the parties to vary this by express agreement if they want it otherwise.
Under negotiable instrument law, promissory notes amount to a debt, an engagement to pay, but the liability to pay only arises when the instrument is presented to the maker. The maker has no obligations on the instrument except when it is presented for payment, and, unless the note includes a pledge of property as security, the note is unsecured, and the maker is free to use and invest his money as he pleases.
If you believe in free trade, then it is up to the parties to structure their relationships, and they should be free to use the established and settled law in relation to banking and negotiable instruments regardless of any price changes in any markets that may result.
Published: November 9, 2007 2:19 PM
Kyle Butt
The English common law for banking was established under a period of state intervention into banking. Banks were permitted to reneg on their obligations to note and deposit holders while continuing to demand payment from loan holders. The bank of england was also a central bank that existed to prop up the bankers in the unsound practice of fractional reserve lending.
Published: November 9, 2007 3:26 PM
Allen Holm
It is very simple, fractional reserve banking is the reason the gold standard was lost. Loaning out money that has no value except as a reciept for debt is legalized FRAUD. When I borrow money, I have no qualms with a bank charging interest, but when I find out that most of the value that the money has is my promise to pay it back I am alarmed, confused, and angry. The reason the gold standard is gone is because of fractional reserve banking, plain and simple. The gold standard is hopeless without eliminating fractional reserve banking.
There is at least twenty times more debt owed than money in circulation right now. This is because of fractional reserve banking. If the money supply does not grow, all the money will disappear long before all the debt is payed off. Inflate the money supply by monetizing gold and silver will help, but will not pay off all of the existing debt. If debt based money (fractional reserve money) is not eliminated, the gold standard will dissappear faster than it appears.
Watch carefully as the central bankers push the Amero (google, youtube it) to supplement the dollar. We must not let this happen, as our national sovereignty will completely dissappear.
I thought of a solution that would work to reverse the dollar bubble without a depression.
Create a second central bank called the "Social Security Bank" directly supervised by congress that ONLY loans money to the Fed, money that is backed by Federal Reserve securities and the new Social Security Bank Fund. Interest income would begin paying interest outgo. The money that we put into Social Security would be purchases of long term Federal Reserve Securities. The Federal Reserve will have to sell these Securities to inflate the money supply. This would reverse the debt based devaluation, while covering the money growth needed to pay off debt. Crazy?
Published: November 9, 2007 4:22 PM
David Hillary
Fraud requires both intentional deception and a loss or damage to the party deceived.
What deception is alleged and what damage is alleged by Allen Holm?
Published: November 9, 2007 4:52 PM
Spectator
The deception is that all depositors can get their money back whenever they please. Damage occurs when a bank run ensues, with either taxpayers or depositors with greater than 100K losing money.
Published: November 9, 2007 5:51 PM
David Hillary
There is no deception about the ability of all depositors to get their money back at the same time, because the bank does not represent that it will be able to meet its obligations in all possible circumstances, instead it contractually undertakes to repay on demand. It's like if you paid me $20 now to mow your lawn next Saturday -- I am engaging to and do indeed promise to mow your lawn next Saturday, but if I'm injured by an accident on Friday my promise won't be honoured. This is breach of contract, the remedy for which is return of your money (under total failure of consideration, under other circumstances you'll likely get money damages instead). Breach of contract is not fraud.
Published: November 9, 2007 6:27 PM
David Bratton
"The gold standard is hopeless without eliminating fractional reserve banking."
I disagree. If the government were not backing up the cartel known as the Federal Reserve the free market would discipline banks. There would still be some fractional reserve, but it would be very limited. See A History of Money and Banking in the United Stated starting with page 115.
Published: November 9, 2007 6:37 PM
Anthony
David, just to be clear, are you an advocate of free banking?
Published: November 9, 2007 7:05 PM
David Hillary
Anthony,
Yes, I'm advocating free minting and free banking, both for the issue of banknotes and for accepting demand deposits, and for providing financial services generally.
Published: November 9, 2007 7:23 PM
Anthony
Generally I take no issue with such a position. At least you agree (I hope) that we ought to get our governments out of currency.
Published: November 9, 2007 7:45 PM
David Hillary
Actually getting governments out of currency is not the most important thing, it is more important to get private enterprise into the business of issuing banknotes and to re-institute a gold coin standard as sole unrestricted legal tender, in which both private and government banks of issue must pay their banknotes in (as well as anyone else who owes a debt of money, for that matter).
Obviously it would be better if governments weren't operating or regulating financial institutions, or minting coins for that matter, but freedom primarily consists of being allowed to trade rather than in the government not trading.
Published: November 9, 2007 7:57 PM
Anthony
Agreed.
Published: November 9, 2007 8:10 PM
Kyle Butt
"Breach of contract is not fraud. "
Only If the breach is not intentional. If I intentionally breach a contract, then I have committed fraud. e.g. If you jumped in front of a car to avoid mowing my lawn, then you have committed fraud. You entered a contract which you had no intentions of fulfilling.
Now for banking. A banker enters a contract with ALL of his depositors to repay on demand. By circumstances HE controls, he makes the deposits of some depositors unavailable. The bank run only REVEALS this fact.
A more accurate analogy with your leg-breaking example would be a bank robbery (assuming he had made reasonable provision against it.) Then the banker would be irresponsible.
But to enter into a contract (To have money ready on demand), and then intentionally not fulfill it is fraud.
Published: November 9, 2007 8:29 PM
Allen Holm
David Hillary, it seems that you are trying to rationalize what common sense calls fraud. Just because the fine print says: "the bank does not represent that it will be able to meet its obligations in all possible circumstances" does not mean a common farmer like me does not expect his money to stay his even when he puts it in a bank.
David Bratton, while I agree that it is possible to have limited fractional reserve banking (I own that book) It has been proven throughout history that every single bank failure has been caused by fractional reserve banking. I think it is dishonest at the very least. Most common folk don't even believe me when I tell them that most of our money is as valuable as hot air (promissory credit).
To me, Central Banking is not even threat to our standard of living twithout fractional reserve banking. Very few people care to abolish the Federal Reserve and go to the gold standard as long as their standard of living is relatively unaffected. Most people expect the government to regulate banking like they regulate every other industry. My research tells me that banking actually regulates my government.
Because I don't just think that fractional reserve banking is dirty; I also think the bond market is dirty. Just to think that private banks can buy my future tax money by devaluing my savings (through fractional reserve) and buying treasury bonds with it. Anyone who advocates these things can never be a patriotic American in my mind. Suits and ties and college degrees shouldn't make common sense less common.
Right now valueless money is CREATED by the Federal Reserve AND every bank underneath it, THEN they "regulate" it by raising interest rates. Inflated at the top, and deflated at the bottom. The Fed could improve the strength of the dollar tomorrow without raising the discount rate one bit. Merely raise the reserve requirement.
Published: November 9, 2007 8:34 PM
David Hillary
Actually, perhaps the United States of America is already half way to opening this up to commercial banks:
1. Commercial banks are able to issue their own banknotes according to this source: http://www.google.com/url?sa=t&ct=res&cd=1&url=http%3A%2F%2Fwww.cato.org%2Fpubs%2Fjournal%2Fcj20n3%2Fcj20n3-8.pdf&ei=GxU1R86VGKe2pgSnjK3EDA&usg=AFQjCNFnlvmPlPYS7Pfxu6DBsXpJk1Cqaw&sig2=eswpJN3Lqk6fj6kuu8JUdw
2. The US mint still mints full bodied gold coins that are legal tender in the, under a 'dual currency' system according to this source: http://www.liberty-watch.com/volume03/issue08/coverstory.php
3. Under the constitution of the United States of America, it appears that a) the federal government has no power to regulate private mints, and b) the states can regulate matters of legal tender, provided they only make gold and silver a legal tender. The federal government can mint coins and fix their value, and that of foreign coin, but it can't make them a legal tender, and obviously it can't make banknotes legal tender, constitutionally. Thus any state in the union could move to establish its own monetary standard, either in parallel to the FRNs or displacing it.
Published: November 9, 2007 8:41 PM
David Hillary
Kyle Butt:
Even intentional breach of contract is not necessarily fraud. For example, if the reason I didn't show up and mow your lawn is because my mother died on Friday, I would be intentionally deciding not to honour my promise to mow your lawn because I want to comfort my family instead. You may or may not sympathise with my loss, but the situation, legally, is simply breach of contract, and not fraud. It is only if I did not intend to honour my contract at the time I'm making it that I'm defrauding you, in other cases I'm just an unreliable tradesman.
Your analysis of banking puts banks on a higher standard than other commercial parties. For example if a company that carries on the business of manufacturing concrete pipes borrows money from a bank on overdraft, and goes on to invest the borrowed money in plant and equipment, leasehold improvements and work in progress that is not readily able to be liquidated, the company is said to be running a normal commercial risk, and if the bank calls in the overdraft, which it has a right to do at any time, then the company knows it will default on the obligation and risks liquidation or being put into receivership, but it's decided that is an acceptable commercial risk, because it doesn't think its bank will take this action unless the business is failing, and because, perhaps, other sources of finance are less attractive.
If you put banks onto the same standard as commercial borrowers, banks are actually far more conservative and prudent, generally; but the commercial and corporate laws facilitate even risky ventures.
Allen Holm:
Money lent is no longer the property of the creditor, but of the debtor, and the creditor only has a claim on the debtor, and not the debtor's property, except any property that is securing the debt. When you deposit money into a current account with a bank, or on a term deposit, you are lending that money to the bank, and you have only an unsecured claim on the bank. If you want your money to stay your own you can rent a safe deposit box and put it in there.
Published: November 9, 2007 9:08 PM
Allen Holm
David Hillary:
Money lent increases the money supply. It shouldn't. Plain and simple. Our entire economy is a bubble because of this. The money lent has value based on what? 90% the IOU. If the loan is defaulted on, the money ballon created by the loan pops. The hot air escapes and everyone elses money becomes worth less.
Why can't I put my money in the bank and have them store it for me as common sense says? They charge me for it. And why is it unknown they are using it to back TEN TIMES the amount in loans? Why does it take an education just to realize what is happening? Poe folks like me are getting robbed, and my government is getting robbed, and taxing me to pay the crooks.
Published: November 9, 2007 10:02 PM
David Hillary
Allen Holm,
Credit transactions may or may not increase the stock of money, it depends on whether the claim on the borrower is usable as money. Claims on banks that are repayable on demand generally can be used as money, especially in the form of banknotes or current account balances subject to cheque.
"shouldn't" -- why not? what makes your preferences determine what other people are allowed to do with their savings and financial affairs? If people want to lend money to banks in forms they can use as money, I can't see any reason to stop them doing so.
IOUs are not used in finance, loan and note documentation is normally structured as an affirmative promise to pay, for example a mortgage note, which is a form of promissory note used in property lending.
Fractional reserve banking means that the RESERVES are a fraction of the DEMAND DEPOSITS. The loans have nothing to do with it.
I don't know about America, but here in New Zealand there are plenty of no fee or low fee bank accounts that pay high interest from the first dollar. For example you can get 8.2% p.a. on New Zealand dollars with a Rabobank online savings account, and Rabobank is rated AAA by S&P. (shhh ... don't tell anyone but you can get this tax free if you're a non-resident and you own tax authority won't be told about it...). Most NZ banks offer reasonable interest on foreign currencies too.
Published: November 9, 2007 10:36 PM
Allen Holm
David,
I appreciate the jargon education, but I still think IOU's are IOU's by whatever legal name you choose. The problem is the dollar not the IOU. When a bank loans dollars that only exists because of credit, and the loan (by whatever name) defaults. The dollar spent by the debtor has zero backing, including credit, and never deflates. Does this not devalue all the rest of the dollars? I say shouldn't because when this happens my dollar becomes worth less when I am not even involved.
Fractional reserve banking, I know, is fraction of demand deposits. I am not an economist, but I still believe that in our closed loop system, fractional reserve is a fraction of backing for loans also. Else how is there so much more debt than dollars in existence? And why did the gold backing dissappear? THIS video was what got me looking into this.
Simpleton as I am, and not inclined to do much more than keep a savings account, I think it is immoral for my money to lose its value just because bankers wanted to make money on credit backed by nothing but the IOU. I am punished if I do not seek out ways to earn interest to combat inflation.
Published: November 10, 2007 12:47 AM
David Hillary
Allen Holm,
Whooh there! I sure can't follow what you're saying there, and I wonder if you even understand what you've written?
I have a theory that if I can't explain something clearly then I don't understand it well enough to defend any opinion on it.
The difference between and IOU and a promissory note is primarily a legal difference, and the latter has a much more clear and defined right to be paid compared to the former, which is why people in business tend to use them -- they want legal certainty (which is of course not the absence of financial risk, but clarity about the legal position and rights.)
Whether banking activities can impact on the value of the unit of currency is a different question to the one about whether the transactions themselves are or ought to be legal. Most legal transactions do have the impact of supply or demand of or for some good or asset, and I suppose banking is no different, but if there is such an effect this is not normally a basis for saying it isn't or shouldn't be legal. That said, when the legal standard of payment is gold coin, then I can't see how banking transactions can affect the purchasing power of gold coin, and I don't accept the quantity theory of the purchasing power of money.
Whether bank assets perform or not primarily impacts on the bank's profits or losses, and whether the bank fails. If the non-performing assets are not exceptionally large, the bank will normally make some losses but not fail, since most banks are capitalised sufficiently to withstand adverse conditions, and have a probability of failure of between about 0.02% to 0.2% over a 1 year horizon.
The amount of debt far exceeds the amount of bank issued money for the obvious reason that bank issued money is a subset of all debts. Investors have part of their wealth in the form of money, and part in the form of land, buildings, shares and bonds and other forms of assets. The banking system responds to demand: if people pull their funds out of banks, the funds don't disappear but go into other assets. Banks contract their balance sheets by selling assets, while investors expand their non-money holding by buying the assets sold by banks. Banks can also borrow money by means other than issuing bank account balances and banknotes -- they can issue bonds directly to investors. Perhaps an example can make this more clear:
Suppose there is a simple, closed economy with 1 bank and 10 000 people, and suppose each person has $100 000 to invest, and that the amount of coined money was fixed at $10 million, and the bank has a capital of $30 million. Suppose, to make things simple, there are 100 non-bank business companies, each with a 1 to 1 debt to equity ratio and a share market and a bond market, and that all the savings of the community went into coin, shares, bonds and bank deposits, and all the non-bank companies obtained all their borrowings from bonds.
So the total assets of the community are:
$10 million in coin
$30 million in bank shares
$480 million in corporate bonds
$480 million in non-bank shares
If the people want to invest an average of $30 000 each in the form of bank deposits and $69 500 each in shares and bonds and $500 in coin. So the bank accepts $300 million in deposits and invests $325 million in bonds and maintains reserves of $5 million.
Now suppose that investors then decided that they didn't want to invest as much in the bank deposits, suppose the new average they wanted to invest was $20 000. So the bank sells $100 million in bonds, and the investors buy $100m in bonds. Since everyone is a customer of the bank in this example, the reserves aren't even used, the investors effect their desire for less bank deposits by buying bonds using their balance with the bank as payment, so the bank simply hands them the bonds (assuming they're in bearer form) and deducts the price from their balance with the bank. It should be clear that the quantity of bank deposits has no relationship with the value of the dollar: no asset prices needed to change in this example even though the quantity of bank deposits fell by 33%.
Finally, about the supposed immorality of your money losing its value. Gold loses value too. I saw an article in the paper from 99 years ago, a story of a four bedroom house burning down, and the article stated that the house was insured for 150 pounds. A 1 pound coin at the time has a gold content of about 8 grams, which today is worth USD214, so the house was insured for USD32100. To build a four bedroom house on a vacant site today would cost about five times as much, so I think this shows that even gold at its current high price is still worth only perhaps 20% of what it was worth 99 years ago.
You don't need to hold a significant amount of money or dollar denominated assets in your portfolio, you can move your portfolio to inflation indexed government bonds or shares or property if you want to have assets and incomes that are inflation hedges.
Published: November 10, 2007 2:59 AM
Kyle Butt
David Hillary:
A few points.
A: You didn't get your mother sick. Banks KNOW runs could occur, they create the conditions for them. If you knew your mother would get sick the
day you would mow my lawn, then you would be committing fraud. Banks have the obligation to each (therefore all) of their clients to have their money available on demand. Banks may not have an obligation to redeem in all circumstances, but they don't get a pass for any circumstances they control.
The case law is in my favor with every other fungible good besides money.
The long history of banking is one of government privilege. Banks who default on notes and deposits are NOT taken into receivership and closed down. They get to suspend redeemability, while people who owe them money do.
About mismatched maturities, (Which basically what the whole construction argument is):
Mismatched maturities aren't fraudulent if the money was originally intended as a loan. But the moment you can't pay, you are liable to have your assets liquidated.
History would be quite different if every bank that couldn't redeem had been liquidated.
Published: November 10, 2007 8:51 AM
DickF
Kyle Butt,
You make a basic mistake. You assume that the agreement between the fractional bank and the depositor is that the fractional bank does not disclose its practices and risks. A person should have the right to deposit anywhere he wants and if he determines that deposits with a fractional bank are more beneficial then he should have the right to depost with them. Otherwise you are using the force of the government to force your morality on another.
Published: November 10, 2007 9:27 AM
Allen Holm
David Hillary:
I can tell that you do not understand what I am talking about. Please watch this film and tell me where it is incorrect.
I have nothing against land based money, or commodity based money, or gold and silver based money, or even oil and coal based money. The difference between those and credit based money are stark and obvious. It gives the power to reduce the buying power of every other monetary unit to human beings. Not all human beings, but only some, called bankers. When money is based upon a creditory document (IOU) and has no value without that document, then if the document liquidates, that monitary unit already given to the debtor inflates the money supply and deflates the value of the monetary unit. No?
If I get a credit card, and buy $1000 worth of junk, and then default on the "loan", that $1000 that was given to the store is still money, only now it has no backing and will never deflate the money supply. As a consumer, not an investor, I unwittingly cause inflation. No? Grandad's retirement money loses some of it's value every time this happens.
Every dollar in society today is owed to a bank, this is not because the banks have a bunch of preexisting money to give, it is because banks have the power to "create" money.
“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in iniquity and born in sin. Bankers own the earth, take it away from them but leave them the power to create money, and with the flick of the pen they will create enough money to buy it back again. Take it away from them and all great fortunes like mine will disappear, and they aught to disappear, for then this world would be a better and happier world to live in. But if you want to continue to be slaves of the banks and pay the cost of your own slavery, then let bankers continue to create money and control credit.” -Sir Josiah Stamp, former director of the Bank of England 1928-1941
Published: November 10, 2007 10:04 AM
Allen Holm
One last thing. When a bank considers promisory notes as "assets", they might as well call slavery a commodity. This video is long, but shows my historical view better than even Rothbard does.
Published: November 10, 2007 11:55 AM
Kyle Butt
With 2 parties:
If I give you 100 dollars and you promise to keep them available for me on demand, and then you lend out a portion, you commit fraud, because you didn't intend to keep my money available for me.
Nothing changes when there are N parties, except that the probability of discovery decreases.
However if people voluntarily cede the availability of their money, then no fraud is committed. The very word deposit hides this from the public at large. Ask anyone off the street how much they've lent to the bank, and most likely they won't include their checking account. They'll count it as their money, and not the banks.
Money cannot be in 2 places. It cannot be both lent and available. If I lend you money for 3 months, then it's not available to me for 3 months. It's not a quantum particle, so it can't be in 2 states at once until you observe it.
The banks are offering something that seems too good to be true: a return (in services or interest) on your money, and it's always available. If this promise turns out to be false, it is the fault of those who promised it.
That said, I have no problem with fractional cash-reserves provided that it is made clear that it is not a deposit. It can either be equity shares at the bank, or a bond from the bank, or something else that is clearly a loan. As long as it is made clear that your money is invested, and that there is a chance you won't get it back on demand. It can't be a deposit like every other irregular deposit of a fungible good.
Side note on bank notes:
If a bank-note only has "To the bearer: 1 oz silver", it CAN'T be a loan to the bank, because it implies immediate and certain redemption.
A note that said "Fractional reserve note: 10:1, 1 oz silver" would be valid. (This way if you give it to someone else, it's clear their accepting an IOU and not a demand certificate)
You could call it honesty in advertising.
Published: November 10, 2007 1:47 PM
Don Duncan
We lost the gold standard(honest money) because people were ignorant; thanks to the public schools(indoctrination). We need to stop trusting government with our young minds. If we do this, widespread freethinking will not tolerate slavery or the scams of immoral men. Attack the root, not the leaves on the tree of evil.
Published: November 10, 2007 5:46 PM
David Hillary
Kyle Butt:
Even if I decided to break my contract because a friend invited me to his birthday party, it is still not fraud, it is breach of contract. In fact even if I just changed my mind about mowing your lawn and decided to go fishing, again it is breach of contract, not fraud. If the contract is validly made by offer and acceptance, with consideration and agreement on the terms and contractual capacity on each side and lawful means and ends etc. then it is not fraud if either party fails to meet his end of the bargain, even if he intends to default or has no justification for it.
Banks do not represent or undertake to have money available to meet demands, instead they undertake merely to repay on demand. If banks undertook to have, keep and maintain the full amount of the money they may be called upon to repay to banknote holders and demand depositors, then they would have to set out these terms in their contract with the noteholders and demand depositors, and/or enter into a financial covenant to do so, and/or pledge coins as security for their obligations. The law does not imply such terms, and banks and depositors generally don't enumerate such terms or make such arrangement either, so these terms simply don't apply to the bank-customer contract or to the banknote maker-holder contract either.
The relationship between bank-customer and banknote maker-holder is a debtor-creditor relationship at law, and therefore a form of loan.
The law of insolvency is not simple, and there is a difference between defaulting on a financial obligation and being insolvent and there are a number of different options for dealing with defaults and insolvencies. I can't really explain this fully because of lack of time, space and my limited knowledge of this complex area of law. Nevertheless it should be noted that under insolvency law the debtor company's affairs can be restructured so that, notwithstanding the its default and inability to pay debts in full, it is possible for creditor compromises to save the company as a going concern. Companies can be put into receivership and management by secured creditors, and then come out of receivership. Company creditors can compromise and such compromises approved by 75% of the creditors by value can be binding on all creditors. So it is not reasonable to expect that the moment a debtor company defaults on a debt that by some automatic procedure, a pre-determined method of liquidation will or should occur. The reality is that it depends on whether the debt is secured or unsecured, and what actions the creditors, and any relevant security holding trustees, do to enforce their security, and what the debtor company does to seek restructuring, and whether the required supermajority of creditors can agree to a plan, and so many other complex variables that take time to play out. It should also be noted that liquidation of the borrowing company is NOT necessarily in the best interests of creditors, even receivership isn't necessarily in the best interests of secured creditors: just last week creditors of Geneva Finance Limited approved a restructuring plan that avoided receivership and extended the maturity of all deposits by 6 months (the plan was supported by the Bank of Scotland which had provided a large line of credit).
Allen Holm
Yes I already admitted that I don't understand what you're talking about.
You comment that: 'The difference between those and credit based money are stark and obvious. It gives the power to reduce the buying power of every other monetary unit to human beings.'
I can understand this comment but I can't agree with it. I don't accept or agree with the quantity theory of the purchasing power of money. There is no mechanical relationship between the quantity of money and its purchasing power.
You comment that: 'When money is based upon a creditory document (IOU) and has no value without that document, then if the document liquidates, that monitary unit already given to the debtor inflates the money supply and deflates the value of the monetary unit. No?'
I can't figure out what you mean here. Your terminology is strange: there is no such word as 'creditory' or 'creditory document' and as I have explained several times, financial instruments are not mere IOUs. I have no idea what you mean by giving 'monitary unit' to debtors or what liquidation would mean in this incomprehensible context.
You comment: 'If I get a credit card, and buy $1000 worth of junk, and then default on the "loan", that $1000 that was given to the store is still money, only now it has no backing and will never deflate the money supply. As a consumer, not an investor, I unwittingly cause inflation. No? Grandad's retirement money loses some of it's value every time this happens.'
If you borrow money on a credit card and don't pay it back, the loss is with the lender, and unless your grandad is investing in the credit card lender, he has nothing to lose unless he is the guarantor of your credit card debt. Your gain of buying things on credit and not paying it back is obviously offset by the lender's loss, and I can't see how this would affect inflation.
You comment: 'Every dollar in society today is owed to a bank, this is not because the banks have a bunch of preexisting money to give, it is because banks have the power to "create" money.'
Some coinage in the United States today is full bodied gold coin, and the owners of it own a metallic object and not a financial claim on a bank or to a bank. Every Federal Reserve Note is owed BY, not TO a bank: the Federal Reserve Bank. The Federal Reserve Bank is a net creditor: it is owed more than it owes, but the same can be said of all banks that are solvent (ignoring direct bank ownership of land, buildings, plant and equipment, metallic reserves and shares in companies that could in cases be more than the bank's capital). A bank, like any company, has a balance sheet with assets and liabilities and capital (or equity). The bank's capital comes from original investments of capital by share subscribers, plus retained earnings. When a bank creates money, its balance sheet expands on both sides: it gains assets and liabilities in equal measure. Creating money does not create profit on the bank's income account: income is accrued over time through transactions with fees and through interest margins.
Banks consider promissory notes assets when they are the holder thereof, and liabilities when they are the maker thereof, and not the holder thereof. This is the same as any other commercial party.
Regarding the supposed representation or undertaking to keep money available, see my response to Kyle Butt above, second paragraph.
The semantics of money and deposit are not important to the law, the law looks at the nature and structure of the relationship rather than the words: "...it is inimical to the effective administration of justice in commercial disputes that a court should use a finely tuned linguistic fork." (Rogers J in Banque Brussels Lambert S A v Australian National Industries Ltd).
People use the term money to mean money's worth or wealth, and in this respect is is not wrong to say my money's in the bank in the same way they'd say my money's in my share portfolio. The term 'deposit' is likewise quite wide and flexible. For example you may put a deposit of money with a shop when buying goods on layby, and the deposits are treated at law installments on the goods that have the effect only of changing the financial position between the parties, and with no obligation to hold or keep the money paid as a trustee or bailee (for example in the Layby Sales Act 1971 (NZ), section 9 (3) the part payment for the goods is called a deposit). A person granted bail 'may be required to deposit a sum of money' and such monies deposited are not treated as a bailment or trust but as the liability of the state to repay that amount to the person or as satisfaction of his liabilities in the case he is charged with. Deposit can have a physical meaning too, especially for deposit of documents, but also sometimes for paying money : for example in the Boxing and Wrestling Act 1981 (NZ) -- 'Contest means a boxing contest or a wrestling contest, as the case may require, being any boxing or wrestling match, competition, or exhibition to which a charge is made for admission or at which a collection is taken up, or at which those present are invited or permitted to contribute money or to throw money into the ring or to otherwise deposit it in the building where the contest is held or elsewhere, or on the result of which any stake, payment, or prize depends:'
Deposit is also both a verb and a noun: to put something somewhere or to make a payment; or the goods or rights that result from it. Thus the term is very wide and flexible and the law looks at the nature and structure of the relationship more than the words used.
The argument that money can't be both saved and available to the saver isn't a good one. If I invest my savings in a marketable security, then the issuer of the security has my funds, but owes them back to me (whether on demand or at a future date is not important), while I have the marketable security that I can sell or offer to someone else for goods. The seller of the goods or buyer of the security becomes the new saver and net investor in the issuer of the security, while I have effectively spent the money I saved, someone else has saved the money I spent.
On banknotes: the wording of banknotes traditionally runs: "The Hongkong and Shanghai Banking Corporation Limited promises to pay 100 Hong Kong dollars on demand to the bearer at our offices here." Obviously changing the bank name and the amount, and the place of payment may be omitted. This wording is used by all three note issuing banks in Hong Kong, and by all three note issuing banks in Scotland and all four note issuing banks in Northern Ireland, and by the Bank of England to this day. Another example is tokens issued for small change in the 1700s: on the front: PAYABLE AT THE INDIA TEA WAREHOUSE
1793
On the back:
ONE HALFPENNY HAWKINS BIRD
WINE STREET No2 BRISTOL
Thus there is no promise to have or hold available any thing, just a promise to pay on presentation for payment.
Published: November 10, 2007 8:35 PM
Boss
I'm not sure if it has been mentioned, but
if the legal tender laws were repealed, then
the fiat money, private notes, and real money
would compete openly.
Published: November 10, 2007 8:53 PM
Mike Sproul
David Hillary:
That was a great link you posted about the repeal of the ban on private bank notes. Monay and banking texts have taught for years that private bank notes have been legally suppressed since the National Banking Acts during the Civil War.
My hat is off to your efforts to explain that fractional reserve banking is not fraudulent. I once asked Murray Rothbard if fractional reserve banking was fraudulent even when the bank and the customer both agree to it, and his answer was "They don't know what they are agreeing to." If the master was that obtuse, there's no reason to expect the disciples on this blog to be any better.
Nowadays, with Ron Paul preaching against fractional reserve banking to a wide audience, there is a real danger that some of that nonsense might actually get written into law. Anyone who can successfully defend fractional reserve banking is doing a real public service.
Published: November 10, 2007 9:24 PM
scineram
Yes, public service is what the world needs.
Published: November 11, 2007 9:16 AM
Anthony
Yep, and the Fed. What a wonderful institution. Note, even if one is for free banking it still isn't sufficient to justify the Fed.
Published: November 11, 2007 9:43 AM
mikey
"My hat is off to your efforts to explain that fractional reserve banking is not fraudulent. I once asked Murray Rothbard if fractional reserve banking was fraudulent even when the bank and the customer both agree to it, and his answer was "They don't know what they are agreeing to." If the master was that obtuse, there's no reason to expect the disciples on this blog to be any better. "
Yes.Under free banking, people can and will take their chances with fractional banks, attracted by the (initially) higher rates for deposits.
Over a period of time, however, the solvent banks will put the FR banks out of business as people see that they are not affected by periodic runs.
A study of free banking in Scotland supports this.
While Rothbard may have been right about depositors not understanding what they were getting into, they would soon learn....and so would the banks.No government intervention is neccessary, the market itself would deal with FRB.
As always, it is worth repeating that the world raises its standard of living by capital accumulation, not by increasing the number of paper claims circulating.
Published: November 11, 2007 12:49 PM
Mike Sproul
"Over a period of time, however, the solvent banks will put the FR banks out of business as people see that they are not affected by periodic runs.
A study of free banking in Scotland supports this."
By "solvent banks" you mean 100% reserve banks? Those banks won't earn interest, while FR banks will. Both types of banks have existed for as long as there have been banks, and a casual look around at the banks of the world (and Scotland) makes me think it was the 100% reserve banks that were driven out of business, not the other way around.
"the world raises its standard of living by capital accumulation, not by increasing the number of paper claims circulating."
Who ever said otherwise? I know that quantity theorists have sometimes wrongly attributed that view to advocates of the real bills doctrine (e.g., John Law), but that was just a reflection of quantity theorists' misunderstanding of the RBD. Also, there have been times where an economy was so starved for cash (e.g., colonial America) that the introduction of paper money made trade vastly easier, and people could have been forgiven for thinking that printing paper money was as good as finding so much gold. But the intelligent writers of the period (e.g. Ben Franklin) understood that paper money had stimulated business just by removing the inefficiencies of barter.
Published: November 11, 2007 2:43 PM
Mike
so what happens during a bank run?
Published: November 11, 2007 9:34 PM
Allen Holm
David Hillary:
I too appreciate learning from you, (I had an ah-ha moment) but I still do not agree with the ability for banks to create money. It is not a legal argument, it is a moral argument.
From what I now understand, you are saying that a bank creates money and loans it without using any of its reserves, but keeps its reserves as collateral or insurance against the possibility that the loan may default. That, to me, is wrong. It is a tool used to create wealth without honesty.
If a credit card company loans me the money, the money is created as I spend it, but none leaves their capital investment unless the loan is defaulted on, as my debt is an asset and a liability.
If a poor man like me has no insurance capital, but wants to loan money at a risk of .0002% to the government, why can't I just write a check? The check is offset by the security, and as the loan is paid off to me I decrease the check amount and all that is left is the interest money which I can pocket. Is that just and illegal, or unjust and legal? Depending on who does it?
I do not agree with the quantity theory of the purchasing power of money either, but I do believe that the purchasing power of money is reduced now because money merely represents debt, and only does so because over time the gold behind the money has been reduced to nothing by legalized fraudulent lending practices. This is the reason credit cards have replaced savings accounts.
I do not have anything against fractional reserve demand deposit banking either, IF it is CLEARLY understood up front. I would bet that not one in a hundred people realize that it is even happening with their money.
All money enters society as debt, and because all debt must be repaid with interest, the creditor owns not only all of the money, but interest besides.
I believe that money, if fiat should enter society as King Henry the first, Ben Franklin, and Lincoln did it; and that is by spending it. The gold standard was able to come back after Lincoln only because there was no debt tied to the greenbacks, but now it would almost be impossible.
Published: November 11, 2007 9:48 PM
Mike Sproul
Mike
Bank runs happen when a bank that has issued $100 finds itself with only 99 oz. worth of assets, but still tries to maintain convertibility at 1 oz/$. Customers, who finds they can only get .99 oz/$ in the open market, will rush to the bank to get 1 oz/$ while they can. The bank loses .01 oz. on every transaction, and the resulting loss of assets leads to inflation and a collapse of the bank. Three ways to avoid a run are:
1) Don't lose the 1 oz. of assets in the first place
2) devalue the dollar to .99 oz.
3) Suspend convertibility, and market forces will reduce the value of the dollar to .99 oz.
Published: November 11, 2007 11:19 PM
Kyle Butt
David Hillary: If you enter the contract never intending to mow my lawn then it IS fraud. You can't get around that. It is a crime, not just a breach of contract. Banks take your money not intending to keep it all available. They never CHANGE their mind. They intended from the beginning to appropriate your money.
Why is something that is fraud between 2 people not fraud with N people? The law of large numbers doesn't change the nature of crimes.
If they were called loans and not deposits, banks would get fewer "deposits".
You still haven't explained why the law governing every other fungible good doesn't apply to irregular deposits of money.
And you still never explained how money can be both lent and unlent. It's a simple question. Either the bank has your money, or it doesn't. Either it intended to have your money whenever you asked for it, or it didn't.
I said above that I don't disagree with disclosed holding of fractional reserves provided it is clear that it is a loan to the bank. (Not some hidden loan covered up in 1800's english jurisprudence). The phrase, "To the bearer on demand" is incompatible with fractional reserves. "To the bearer on demand, at our convenience." is not. (I wouldn't ever take the second in commerce, but you're free to.)
Mike Sproul:
Money is not "BACKED". Historically money WAS gold. Titles to gold held somewhere else are simply transfers of gold.
My problems with your real bills doctrine:
You have this WEIRD Idea about 'WORTH'. An iou is worth 1 oz/silver. Read Menger. Nothing is WORTH anything else, they only have subjective valuations in the minds of people. The only thing objectively worth 1 oz silver is exactly 1 oz silver. Anything else is only 'worth' 1 oz silver in someone's mind. So by your other premises, if you can only take things that are objectively worth 1 oz silver, then you are at 100% reserves.
As an isolated transaction:
It is fraud to take a car as an asset and then print out tickets to silver. You're misrepresenting what you have. Now if you sold the car, and got silver, and then gave the car-depositor tickets to the acquired silver, no problem. But this would then require selling loans to someone who actually has real silver, and none of this creating money out of thin air (loaning it into existence).
That said: In a credit crunch those IOU's that you've held as "BACKING" become worthless. No one wants to loan money (which is what purchasing an IOU is) And now your bank is insolvent.
EVERY Fractional reserve bank without a central bank behind it has gone bankrupt.
No: bank runs occur when you have more claims to silver than silver on hand, and people decide they don't want that IOU that's the only thing left in the vault. When this happens in a large enough group of people, you can no longer sell that iou.
Published: November 12, 2007 10:02 AM
Kyle Butt
Mike Sproul:
I meant transfers of titles to gold held elsewhere are simply transfers of gold.
Published: November 12, 2007 10:07 AM
David Hillary
Allen Holm,
It seems you are missing the distinction between reserves and capital.
Reserves means assets that can be used to meet obligations directly, i.e. legal tender. Sometimes the word is used to mean liquid assets but in banking theory debate it means actual legal tender that can discharge the bank's obligations directly, without the need to sell it. Banks maintain reserves to provide liquidity.
Capital means excess of assets over liabilities. This is used to bear risks, primarily the risk of default on the loans made by the bank, but also the risks of losses from selling assets for less than their book values or revaluing assets that have fallen in value, or from adverse operational events such as embezzlement, robbery or damage to the bank's office buildings.
It is capital, therefore, that absorbs your failure to repay your credit card debt, and not reserves.
A bank can cease payment on its obligations for two reasons:
1. the bank writes down the value of its assets to the point that its capital is exhausted, and the bank declares itself insolvent and ceases payment of its obligations even while it still has not run out of reserves.
2. the bank's creditors doubt the bank's ability and enough of them demand repayment at the same time (or not enough new funding is supplied to the bank) and the bank runs out of reserves and ceases payment because it has no more payment media.
However the two failure modes are confounded because:
a) 1. is avoided by the bank because it doesn't want to admit to its problems (even if it has a legal obligation to do so) and/or information about the bank's problems leak out and cause a mode 2. failure;
b) a bank facing a threat of a mode 2. failure will do everything within its power to liquidate assets rather than default on obligations, and in doing so will sell assets for less than their book value, causing losses that eventually exhaust its capital as well as its reserves. The bank will do this because any default on its obligations will cause very serious damage to its reputation and because it is difficult for the bank to convince creditors that it defaulted on its obligations for liquidity problems only: creditors will suspect and fear that the bank's capital is exhausted even if this is not true.
I can't really follow what you're saying about writing a 'check' to the government. Government obligations have a probability of default well in excess of 0.0002% p.a. it could be about 0.02% p.a. if you believe the government should get a credit rating of AAA or AA, or up to perhaps 1% p.a. or even higher if you count that the US federal government has defaulted about once or twice per 100 years in the past.
The reason that the FRN is worth less in terms of gold than before is because the US federal government defaulted on its gold redemption obligation under the Bretton Woods agreement in the early 1970s. By definition, if the obligations were honoured and payment in gold maintained, then the value of FRNs would not have changed in terms of gold. Securities issued and redeemable at par are valued at par so long as the issuer continues to honour its redemption obligation.
To Kyle Butt as well:
The issue of clarity is significant. I called up the four major banks in New Zealand that have 90% of the banking market here: ANZ, Bank of New Zealand, Westpac, and ASB, and asked them about what is a bank account etc. and the answers varied widely. The ANZ representative told me in no uncertian terms that I retained title to the money, that the bank doesn't use the money for its own purposes, and that the bank keeps the depositors money separate, and funds their lending through managed funds (i.e. unit trusts, like 'mutual funds' in the USA). I didn't ask to speak to a supervisor, which I did when I called the other banks if I got this answer. The Westpac representative told me basically the same thing, as did her team leader, and then I got put through to the local branch and left a voicemail for the branch manager. The Bank of New Zealand representative told me the same thing again, her supervisor wasn't available so I got put through to a banking generalist who was qualified to talk to me about a broader range of products. He was a Malaysian and he said that the deposited money was the bank's, that the bank invested the money in loans, and that the bank owed the deposited money back to the customer. The ASB representative was a Filipino who told me that money deposited was recorded in the customer's account, and that the bank used the deposited money, along with all the other money it received, for lending, and this is how the bank was able to pay interest to depositors, and she agreed that the bank owed the money to the customer in the same way that the bank's loan customers owned the money they had borrowed to the bank. Since the answers varied so much I thought I should call some more banks to see how frequent each answer was. Kiwibank's representative said that the title to money deposited passes to the bank, and that the customer gets an electronic book entry in the books of the bank that is able to be used anywhere in New Zealand, and that it was not exactly the same as a loan but similar, and more like (or 'pretty much like') a debtor-creditor relationship than a trust relationship. He also said that the bank invests deposits repayable on demand in, or largely in, liquid assets rather than loans, whereas deposits repayable at maturity were invested in regular loans. TSB's representative said that cash deposited becomes part of the bank's cash reserves, and that the bank uses money from depositors for investments in local government bonds, balances with the central bank and making loans to borrowers. She said that the bank owes money to the customer and that the customer is the creditor of the bank. I decided to call the ANZ again to see how far up the bank I would have to go to get the correct answer. I called and spoke to a representative who gave me a very different answer from the earlier one: the money goes into the bank's safe, the bank can use the money to pay withdrawals to other customers and to invest in loans or other investments, the title to the money deposited passes to the bank, he said. The bank owes the balance of the account to the customer and the customer has that amount of credit with the bank. I called the National Bank, the other brand of ANZ, and the representative told me that the title to the money passes to the bank, and that the customer gets a right to withdraw that amount again, and that the bank invests the money how it pleases, such as making loans, and that the bank owes the balance to the customer and that there is a debtor-creditor relationship between the bank and the customer. I called Westpac again: The representative I spoke with told me that the money deposited becomes the bank's and that the customer gets a 'credit' in their account since the bank now has their money, but she had some difficulty explaining what the bank did with the money deposited, she did agree that the bank used it, and money from term deposits, for making loans and other things. When I asked her what she meant by a credit, she said that is how much money the bank owes to the customer, and agreed that the bank was borrowing money from customers. So, the overall score is:
First time correct -- 5 (ASB, Kiwibank, TSB, ANZ (second call), Westpac (second call))
Supervisor/second person on call correct -- 1 (BNZ)
Third time correct -- 0 or 1 (Westpac first call - waiting for call back)
First time incorrect -- 1 (ANZ (first call))
Third time incorrect -- 0 or 1 (Westpac first call - waiting for call back).
So, overall, more than 50% of the calls resulted in the legally correct answers (given the present law recognised by the courts) being given by the bank's frontline contact staff.
Published: November 13, 2007 7:54 PM
David Hillary
The local Westpac branch manager called back and said that when I deposited $100 to my bank account the bank became my debtor to that amount, and the bank records a liability in its books accordingly, and that the bank had to pay me on demand. He said the title to the cash passes to the bank and that the bank uses the money for paying its other liabilities and/or making new loans. He agreed that there was a debtor-creditor relationship between bank and customer. Being the branch manager he was able to explain the bank's accounting records in some detail and said that deposit liabilities were also shown on the bank's annual financial accounts.
I bet if I called 10 chartered accountants I'd get the same answer 10 times. If I called 10 branch managers I probably would too. If 10 investment advisers I still think I'd get 10 out of 10. If I visited 10 bank tellers, I'd expect some variation but still a majority would be able to answer it correctly. If I asked 10 bank customers who were regular employees in non-financial firms perhaps I'd be lucky to get 50% with the right answers.
The other thing is to examine the bank's written terms and conditions for the accounts, I'm sure you'd find the relationship correctly explained where it is explaimed, but for reasons below this is not common.
Under the securities laws of New Zealand, securities offered for subscription by the public in New Zealand require the prospective subscriber to be invited to subscribe for the securities in an investment statement that sets out the terms of the security in terms that a prudent but non-expert investor can understand, and also to register a prospectus that discloses the terms of the security and the financial situation of the issuer in greater detail, suitable for an expert investor or financial adviser. But call debt securities are exempt from the requirement for an investment statement, and so these securities can be offered and subscribed for without any disclosure whatsoever, although a prospectus must still be registered. Debt securities issued by a registered bank under the Reserve Bank of New Zealand Act are exempt from the requirement to register a prospectus, and also from the investment statement requirement for call debt securities, so bank accounts are totally exempt and can be offered without any written terms and conditions, and/or with written terms and conditions that perhaps cover only some aspects of the banking relationship. Most banks don't seem to have the terms and conditions in writing, other than in relation to:
1. fees and charges
2. banking channels
3. dispute resolution
4. website.
Published: November 13, 2007 11:06 PM
TLWP Sam
Perhaps the difference of paper money vs gold & silver is one of trust versus mistrust?
Two scenarios:
Bill the orange farmer and Bob the apple farmer regularly swap a crate of orange for a crate of apples - the barter system. However, a crate of apples and a crate don't become ready at the same time such the barter system doesn't always work - hence money creation.
1. Bill and Bob trust one another. Bill doesn't have the oranges but takes the crate and signs an I.O.U. owing Bob a crate of oranges when it's ready. Bill could theoretically deny the note was real and claim to others he already gave a crate of oranges to Bob and Bob is trying to steal a crate of oranges from him. Or Bob and Bill could start writing I.O.U.s without the other consent and claim that one owes the other. Either way without the trust the system breaks down and goes back to bartering. Cue a credit system, fiat currency, Real Bills Doctrine?
2. Bill and Bob don't trust each other as far as they could throw the other. When Bob finds out that Bill doesn't have a crate of oranges ready he decides that if Bill wants the apples he has make a deposit with something valuable as collateral. Too little collateral and Bill would just steal the crate. Too much collateral and Bob could keep it for himself. So Bill sacrifices a gold ring of 1/2 oz weight and will get it back when he brings a crate of oranges within 3 months if not then Bob get to keep the ring. Cue the gold standard, silver standard, any 'commodity with a value other than being currency' standard?
Hence aren't goldbugs itching for gold because they know if they were left holding gold and silver coins should the U.S. monetary system goes belly up, their coins are still valuable in almost every other country?
Published: November 14, 2007 12:10 AM
David Hillary
I was just visiting someone who happened to be a Chartered Accountant, and she was able to correctly explain how a bank works and how the bank is the debtor of the customer.
Published: November 14, 2007 2:17 AM
M E Hoffer
TLWP Sam,
"Hence aren't goldbugs itching for gold because they know if they were left holding gold and silver coins should the U.S. monetary system goes belly up, their coins are still valuable in almost every other country?"
At the minimum, Of Course!~
One of the most basic 'pro-' arguments, for commodity-based currencies, is that: "they are no one else's Liability.."
Published: November 14, 2007 6:53 AM