Taking Money Back
To save our economy from destruction, wrote Murray Rothbard, and from the eventual holocaust of runaway inflation, we the people must take the money-supply function back from the government. Money is far too important to be left in the hands of bankers and of Establishment economists and financiers. To accomplish this goal, money must be returned to the market economy, with all monetary functions performed within the structure of the rights of private property and of the free-market economy.
Comments (129)
HOLY SH*T!
Sorry, I'm not capable of civil and intelligent right now.
I'm only now just getting it and trying to understand how this fraud has lasted so long.
And why aren't more people mad? Mad? That's not strong enough - outraged, furious. Where's the mob with pitchforks?
My God!
Published: June 14, 2008 10:31 AM
David,
"And why aren't more people mad? Mad? That's not strong enough - outraged, furious. Where's the mob with pitchforks?"
Welcome to the club of an economic knowledgeable minority.
This counterfeiting game has been deliberately obfuscated such that very few of the public can or are able to understand what is happening, therefore no revolt, just great frustration about what is happening and finger pointing in all directions except at the real cause of inflation more rationally known as theft on a grand scale.
Not worry though, thievery can not be extended indefinitely, the Federal Reserve and their cohorts the Congress are on a spending/thieving binge that will end as all binges must end, unfortunately there will be a lot more pain and suffering by the innocents. Someone has to pay for these grand injustices and if the Guilty don't pay then the innocent must. Justice like the law of Gravity can be overcome temporarily, but eventually it is in charge. As I see it we are closer to the end than to the beginning.
Published: June 14, 2008 3:09 PM
Hi
A very interesting article.
I like Rothbard's ideas and I hope they are implemented.
Now, let us visualize that all of Rothbard's recommendations are implemented world wide.
So now we all use gold coins or notes representing 100% warehoused gold.
The total amount of worldwide gold will increase a relatively small percentage each year as more gold is mined.
The total amount of world wide wealth is not static. It grows as a result of human endeavors. A shiny shoe is worth more than a dull one. A 3GHz CPU is worth more than a 200MHz CPU
In other words, worldwide wealth will increase at a much higher percentage each year as human technological advances continue.
From this I conclude that the value of gold will increase over time.
This fact would motivate some people to simply hoard their gold since it increases in value over time. Gold Hoarding would reduce the amount of gold in circulation which in turn would further accelerate gold's increase in value.
I could be wrong, but I think this would be a disincentive towards capital formation for other industries in the long run.
Comments, please.
John Or
Published: June 14, 2008 4:43 PM
David and Matt:
If the Fed operated like a counterfeiter, and if Austrian economics gave a correct view of money, then your outrage would be justified. But the Fed is not a counterfeiter, and Austrians are wrong about money. The paper dollars issued by the fed were issued in exchange for things of value--mostly gold and government bonds. The fed stands ready to use part of those assets (the bonds) to buy back the dollars it has issued. That is not the act of a counterfeiter.
Once you recognize that paper dollars are backed by the fed's assets, the next step is to see that if the fed issued another billion dollars, and received a billion dollars' worth of assets in exchange, then the fed's ratio of assets to money would be unchanged, so the value of the dollar would be unaffected. Thus, the issue of new paper dollars does not reduce the value of existing dollars, and no robbery occurs.
You can click on my name above for further reading.
Published: June 14, 2008 4:45 PM
Mike,
To make more clear my point on counterfeiting.
Just about everyone now working is going to receive in the mail or credited to their bank account $600.
Where is this new money coming from?
If you were to issue money it would be called counterfeiting, when the treasury does it it's called deficit spending if not enough taxes ( labor/goods wealth) are collected.
This new money is not wealth but a future claim on wealth, i.e. real goods or services which are wealth. This new money is more debt on the already Billions of debt.
The savings of millions of people will again be depreciated as a result of this new money (debt) also known as higher prices at the grocery store etc.
Money issued by the FED is not wealth it is a claim on wealth.
Then there is the issue of Fractional Reserve Banking, this is more theft on top of theft.
Banks will not credit to your account Gold or anything of value for the IOU's it issues it will instead give you another IOU, if this is not counterfeiting I don't know what is.
The price of Gold on the free market is another telling sign that the public is catching on to the surreptitious theft in progress since the Roosevelt Administration.
Published: June 14, 2008 8:45 PM
And Libertarians complain when words are given arbitrary definitions on a whim! Counterfeiting means to present a fake object as a real object - a fake dollar note, a fake Mona Lisa, a gold-plate lead coin being presented as a pure gold coin. I've said before and I'll say it again - if the Fed's a 'counterfeiter' then a gold miner's counterfeiting because he's diluting the gold supply (which unlike a diamond miner gold is fungible) and making each gold ounce worth less. Or Rembrant was counterfeiting every time he created another painting. Not to mention big time counterfeiters and destroyers of wealth were Charles Martin Hall and Paul Héroult - they figured out to mass produce aluminium from bauxite causing it to go from a metal more valuable than gold to a common metal certainly making the Capstone of the Washington Monument of laughing joke of an investment.
Published: June 14, 2008 9:38 PM
Matt:
Those stimulus checks might be a bad idea, but they are not counterfeiting--just taking wealth from one pocket and putting it in another. The checks could cause inflation IF they increase government debt enough to reduce the value of govt bonds, but they are not inherently inflationary.
Fractional reserve banking is not inflationary either. When wells fargo issues a checking account dollar, it always gets a dollar's worth of assets in return. So checking account dollars are backed by the assets of the private banks, while paper dollars are backed by the assets of the fed.
It's natural for anyone who has studied economics to lean toward the quantity theory of money, as you do. But the more you study the quantity theory, the more its inconsistencies will slap you in the face. The real bills doctrine, on the other hand, is a remarkably airtight theory of money.
Published: June 14, 2008 11:38 PM
to mike sproul:
if frb is not inflationary, and the fed's backing the currency, how can you possibly explain the loss of 95% of the dollar's value since the creation of the federal reserve?
Published: June 15, 2008 12:02 AM
John Or, what you are describing would only happen over the medium term on going back to a bullion standard (this also works with silver etc.), and even then only if gold or silver was released at prices that turned out to be very far from what the market eventually settled on. As people developed their own bullion holdings, Pigou's real balance effect would start to operate, leading to an equilibrium in holdings and an undistorted market driven flow of capital resources to investment opportunities. In fact, private bullion holdings would provide the very stabilising of the economic cycle that Keynesians claim needs government intervention.
Published: June 15, 2008 2:31 AM
John Or: "This fact would motivate some people to simply hoard their gold since it increases in value over time. Gold Hoarding would reduce the amount of gold in circulation which in turn would further accelerate gold's increase in value."
Not necessarily. You're thinking of a static supply of gold. Gold production increases the supply of gold at roughly the same rate that most economies grow, around 3%. So as Reisman points out in his book "Capitalism" the price of gold would stay relatively the same. And if you look at the history of prices in the 19th century, that's pretty much what happened except for periods of excessive use of paper money and wars. During gold's heyday in the 19th century, huge amounts of gold for investing in new ventures poured into the US.
But even if the supply of gold was static and its value constantly increasing, that increase would be about 3% annually. Entrepreneurs would offer much higher rates of return on other investments, so few people would hoard.
Published: June 15, 2008 8:17 AM
David: "And why aren't more people mad? Mad?"
Good point. My experience is that people don't believe me. They have so much confidence in the goodness of their beloved state that they simply refuse to believe that the state would allow such blatant fraud.
Published: June 15, 2008 8:20 AM
Mike: "Once you recognize that paper dollars are backed by the fed's assets, the next step is to see that if the fed issued another billion dollars, and received a billion dollars' worth of assets in exchange, then the fed's ratio of assets to money would be unchanged, so the value of the dollar would be unaffected."
For those new to this site, you should know that Mike's theory of money violates every principle of value and pricing that economists have learned in the past 150 years, including the subjective theory of value, marginal value, quantity theory of money and how fractional banking works.
Of course, Mike will argue that money is not like other commodities. It exists in a world of its own immune to the laws of economics. But history shows that it isn't. It obeys all of the above laws just like any other commodity. Mike longs to restore the economics of the 15th century.
Published: June 15, 2008 8:28 AM
What I don't quite see is how a single country going back to 100% redeemability would manage to keep its gold...?
In act, if you look at Nixon and the Vietnam war, you could argue: America tried and failed.
Wouldn't gold reserves (and the legal tender) quickly flow out of the borders because of exchange rate issue and rising monetary inflation in other countries? Soon, that money (alias Gold) would indeed have to land in foreign hands because of its security and practicability, while no more could be issued, people would be forced to trade most probably with substitutes (silver notes? Or even "more volatile" underlyings?)
Published: June 15, 2008 10:04 AM
Newson:
"if frb is not inflationary, and the fed's backing the currency, how can you possibly explain the loss of 95% of the dollar's value since the creation of the federal reserve?"
The value of the paper dollars issued by the fed is determined by how much backing the fed holds per dollar. So if there has been inflation, it is because the fed now holds less backing per dollar. This can happen, for example, if the fed lends at below-market interest rates, overpays for bonds, bails out bankrupt homeowners, is forced to hand a portion of its interest earnings over to congress, overspends on printing, buildings, staff, etc.
Fractional reserve banking creates only checking account dollars, and those checking account dollars are a call option on paper dollars, with a strike of zero and no expiration. Just as call options do not reduce the value of the underlying security, checking account dollars do not reduce the value of paper dollars. Naturally, if paper dollars themselves lose value, then checking account dollars, being claims on paper dollars, will lose value as well.
Published: June 15, 2008 10:21 AM
I agree that the inflationary operations of the Federal Reserve in the creation of money by buying big pieces of paper (government bonds) is badly understood. And of course inflation, even if fully anticipated, imposes taxes on the citizenry. The difference between counterfeiters, however, and the Fed is that the Fed does not hide the fact that it creates money. The amount of money it creates is published and known widely. And if the public wishes, the Federal Reserve can be abolished through the democratic process. Counterfeiters on the other hand operate outside the law and hide their operations from the public. They pretend that they are not creating money when in fact they are.
If a bank has $100 of 5-yr fixed term deposit liabilities backed by $100 worth of 5-yr term loans, I would guess that no-one would argue that there is any fraud involved here.
But, if instead a bank has $100 of demand deposit liabilities backed by $10 of Fed notes and deposits at the Fed, and $90 in 5-yr loans, some people argue that this situation involves fraud. I'm not sure why this is so. At any time, the bank can repay all depositors by borrowing Fed notes from the Federal Reserve. These loans from the Fed are essentially backed by the borrowing bank's 5-yr loan assets. The only possible loss the Fed exposes itself to here is the default loss on the bank's loans. But if the bank is prudent, and has set aside appropriate loan loss provisions, there will be no loss to the Fed (or cost to taxpayers) in these Fed loans. Naturally, imprudent banks should be allowed to fail.
There would clearly be fraud involoved if the bank stated to depositors that for each $1 on deposit the bank keeps $1 in its bank vault. But the banks don't say this, and only very stupid depositors would believe this.
Published: June 15, 2008 11:27 AM
Alex:
"a bank has $100 of demand deposit liabilities backed by $10 of Fed notes and deposits at the Fed, and $90 in 5-yr loans, some people argue that this situation involves fraud. I'm not sure why this is so."
It obviously is not fraud, and the fed is obviously not a counterfeiter. It takes years of Austrian 'education' to make people think otherwise.
Mainstream economists do not help matters when they advocate the quantity theory of money in textbooks. The quantity theory clearly implies that the fed's issue of money, and fractional reserve banking, are inflationary. Mainstreamers won't take the next step and accuse the fed and the banks of fraud, since they don't want to sound crazy. Austrians, however, are quite comfortable being called crazy, and so they do call it fraud.
The quantity theory is the heart of the problem. It is wrong. All money is backed by the assets of its issuer, so the issue of money, by the fed or by private banks, is not inherently inflationary, and therefore not fraudulent. Unfortunately, economists rejected the real bills doctrine in favor of the quantity theory almost 200 years ago, and have been on the wrong track ever since.
Published: June 15, 2008 12:03 PM
Mike:
Surely you agree that the creation of money by a central bank causes general price increases. If not, what do you think has caused, for example, Zimbabwe's current inflation?
Published: June 15, 2008 1:07 PM
Alex: "But, if instead a bank has $100 of demand deposit liabilities backed by $10 of Fed notes and deposits at the Fed, and $90 in 5-yr loans, some people argue that this situation involves fraud. I'm not sure why this is so."
It's fraud because if the state didn't give the bank the authority to create the $90 out of thin air, it would be illegal. If you or I tried to do what the bank does without a license from the state, we would go to jail. Essentially, the state licenses fraud. Proof that it's fraud is that if everyone who claimed to have money in the bank decided to withdraw it all at once, the bank would fail and $10 would have to be split between all of the customers.
Pyramid schemes are illegal, and just like banks, they can operate for years without going broke. If banks are fraudulent, then at best they're pyramid schemes. But no one goes to jail for bank pyramids because the state sells bankers a license to create their pyramids.
The other fraud in fractional banking is the price inflation it creates. The people who receive the first issue of new money can purchase assets before prices rise. The last people to receive the money get it after prices have risen, so fractional banking transfers wealth, without letting people know this is happening, from the late receivers of money to the early receivers of money.
Published: June 15, 2008 3:01 PM
Alex:
"Surely you agree that the creation of money by a central bank causes general price increases. If not, what do you think has caused, for example, Zimbabwe's current inflation?"
No; I don't. I used to, and I even taught it in my money and banking classes from 1981-89. But I was always bothered by questions like how to define money, why fractional reserve banking would be inflationary, what happens when money crosses borders, etc. You can click on my name above for a more complete discusion of the real bills doctrine, and how I arrived at it.
Just for starters, suppose the Fed accepts 100 oz of silver on deposit, and then issues 100 paper receipts (dollars) in exchange. Anyone would agree that the issue of those dollars is not inflationary. And I think most people would also agree that if the bank accepted another 200 oz and issued another $200, that would not be inflationary either.
Now, having issued $300, suppose the bank prints another $300 and lends them to a farmer, and the farmer agrees to repay 330 oz next year (assuming 10% interest) and posts his farm as collateral. That 330 oz IOU is worth 300 oz today. Does that extra $300 cause inflation? I say no, since if the dollar fell to (say) 0.9 oz, then everyone would rush to the bank to redeem for 1 full ounce. Is the bank capable of redeeming all $600 for 600 oz.? Yes; it is. All the banker has to do is sell his 300 oz. IOU for 300 of his own dollars, and then burn them. Then there are $300 left in public hands, which the banker can redeem for the 300 oz. in his vault. So at no time would the dollar fall below 1 oz.
Your next question will probably center on what happens if the currency is inconvertible, like the US dollar. That's a longer story, but I'll start by saying that there are at least two kinds of convertibility: (1) physical convertibility, where the bank agrees to buy back its dollars with silver, and (2) financial convertibility, where the bank agrees to buy back its dollars with bonds. In many cases, if not most, financial convertibility makes physical convertibility irrelevant.
The Zimbabwe currency is losing value because the amount of backing per unit of currency is falling. Either the issue of money is outrunning backing, or the bank is losing backing, or some of both.
Published: June 15, 2008 10:35 PM
mike sproul says:
"Fractional reserve banking creates only checking account dollars, and those checking account dollars are a call option on paper dollars, with a strike of zero and no expiration. Just as call options do not reduce the value of the underlying security, checking account dollars do not reduce the value of paper dollars."
but with an equity call option, the options written cannot exceed the number of shares on issue (and typically call options can only be written against a figure far short of 100%), so no dilution takes place.
the checking account dollars, on the other hand, outweigh the dollars on issue. so if they are exchanged for little green pieces of linen, the numbers of said linen must rise, or some of the contracts will fail to be honoured. so either default or dilution.
as an aside, on safehaven,com there another rbd exponent called antal fekete, are you aware of him?
Published: June 16, 2008 1:45 AM
Artisan, the most likely scenario if one country were on a bullion standard while its trading partners were not is that they would buy its assets with bullion from their reserves and extracted from their people, basically exporting their inflation while they could. That would be self limiting in the long term, since they would run out of bullion. Bullion would flow out if other countries had better terms of trade and allowed their people to hold it and/or if they wanted to put it into their own reserves - but that would effectively mean that they too were bullion oriented. It has happened in the past, but it doesn't match your concerns. Either way - bullion flowing in or bullion flowing out - there can be huge problems over quite a long period, but those are best addressed by looking at the trade side, not the money side.
Published: June 16, 2008 3:45 AM
While being admittedly dumb as a box of rocks and spending most of my time relying on horse sense, it just seems so that I need to be able to trade my little green pieces of linen (as someone said) in for something that has real, inherent value. Government bonds are only good for as long as the government issuing them a) continues to exist and b) is willing to buy the little green pieces of linen back. I'm not interested in trading one piece of paper for another, as it were. I would much rather be able to trade my little pieces of linen in for something of real, inherent value that I can use to sustain myself when this whole thing collapses of what appears to be grandiose overthinking to the point of departure from common sense. I used to think that my grandmother was crazy for keeping her money in 15 separate banks. Grammie was onto something...
Published: June 16, 2008 7:17 AM
Newson:
"but with an equity call option, the options written cannot exceed the number of shares on issue (and typically call options can only be written against a figure far short of 100%), so no dilution takes place."
That might be the way securities laws are written, but except for that, the number of calls can exceed the number of shares on issue. If investors become worried about a possible squeeze when calls exceed shares, then each call can have some fine print that says "redeemable either for 1 share of stock, or the equivalent in cash." Checking account dollars can have a similar feature, specifying that checking account dollars can be redeemed for paper dollars, or an equivalent value of euros.
(BTW There is dilution even when the number of calls is less than the number of shares, since option writers don't have to hold 100% reserves of stock against calls written.)
I've seen Fekete's work. He advocates the issue of money only for productive purposes, while the backing version of the rbd says that money can be safely issued for any purpose, as long as sufficiently valuable collateral is received in exchange.
Published: June 16, 2008 9:36 AM
mike sproul says:
"(BTW There is dilution even when the number of calls is less than the number of shares, since option writers don't have to hold 100% reserves of stock against calls written.)"
this doesn't figure to me. naked call sellers either must deliver stock or must buy back their positions before expiry. there is no dilution of earnings per share by this procedure, merely a change in ownership of underlying.
as regards your cash settlement as alternative to delivery, this would destroy the call market's function. how could i hedge a position on the underlying if i couldn't guarantee that i would receive stock? how could you possibly cash settle if there is a surplus of unsatisfied call holders? you couldn't use the expiry price because that wouldn't incorporate the uncovered deals (ie unsatisfied demand for stock).
Published: June 16, 2008 10:52 AM
mike sproul says:
"Checking account dollars can have a similar feature, specifying that checking account dollars can be redeemed for paper dollars, or an equivalent value of euros."
this is where i have trouble with rbd. when the vastly bigger checking account dollars are presented for swapping to either euros or pieces of green, there will only be enough fed assets to cover the early-birds. so either the fed turns the late-arrivers away, or it prints up a fresh batch of green, and dilutes the cover of existing linen-holders.
i would say the fed has been busy doing the latter for the past 70+ years, and the evidence would be the lack of widespread banking collapses since the depression, when they were a regular, periodic feature of frb prior to central banking. the fed happily accepting toxic sub-prime paper as perfectly good collateral for loans (and who knows that these loans won't be rolled over forever) makes a good case for dilution, i would have thought.
Published: June 16, 2008 11:14 AM
it just seems so that I need to be able to trade my little green pieces of linen (as someone said) in for something that has real, inherent value.
Absolutely, and it works both ways. You 'earn' those pieces of linen/paper by giving someone else something of value (labor, product, etc.), and in return, other people give you something of value when you give them those pieces of paper. But if there is an ever-increasing number of those pieces of paper (inflation), then the value of the decreases. Mr. Sproul likes to tell us that the value of the assets that backs the issuance of those pieces of paper is what gives them value, but what is the value of debt? And it is a striking coincidence, as Newson likes to keep pointing out, that the value of those pieces of paper has decreased so dramatically since the creation of the Federal Reserve back in 1913. Either RBD can explain this, or it can't.
Either way, getting rid of the government monopoly on currency sounds like a good idea to me.
I'm not sure that fractional reserve banking is fraudulent if depositors agree to it, but of course, what depositors have agreed to it under the current system? The Federal Reserve Notes in my pocket say nothing about fractional banking or convertibility, financial or otherwise. In fact, about all they do say is that they are legal tender for all debts, public and private.
Published: June 16, 2008 11:28 AM
Newson:
"this is where i have trouble with rbd. when the vastly bigger checking account dollars are presented for swapping to either euros or pieces of green, there will only be enough fed assets to cover the early-birds."
The fed does not back checking account dollars. Those are backed by the private banks that issued them. The fed backs only the paper dollars that the fed issued. The fed's balance sheet shows something like $900B in paper dollars in the hands of the public, while the fed holds something like $200B in gold, plus $700B in bonds. If the public stopped wanting to use paper dollars, the fed could first sell off its bonds and retire the $700B in paper dollars received, then it could sell off its gold, and retire the last $200B of paper.
It's the same with private banks. Assuming they have issued $5 Trillion in checking account dollars, backed by $100B in paper plus $4.9 T in bonds, then if people all wanted to redeem their checking account dollars, the private banks could first sell $4.9T in bonds, and retire the checking account dollars received. Then the banks could sell off their last $100B in paper dollars, which would retire the last of the checking acocunt dollars.
Everyone is paid off--not just the earlybirds.
Published: June 16, 2008 11:33 AM
If the public stopped wanting to use paper dollars, the fed could first sell off its bonds and retire the $700B in paper dollars received, then it could sell off its gold, and retire the last $200B of paper.
Assuming that the Fed was willing to redeem the paper currency (a big assumption, I think), why would people want to buy their bonds, which are denominated in U.S. dollars? What value would they have if no one is using those dollars???
Published: June 16, 2008 11:52 AM
Mike_Sproul: Correct me if I'm wrong, but your analysis seems to go something like this:
Austrian: The Fed is causing price-inflation by printing new dollars, which the government then treats as free money.
Mike_Sproul: No, the Fed isn't causing inflation, because it buys and holds assets of equal value when it issues new dollars.
Austrian: That can't be true, because obviously, there has been price inflation.
Mike_Sproul: Right, because the fed doesn't actually back all of its dollars -- it throws off most of the interest as free money for the government, which then causes price inflation.
Austrian: *falls out of chair*
Published: June 16, 2008 11:56 AM
Michael Clem:
The fed redeems paper dollars for bonds every day. It's called an open market sale of bonds. If the day ever comes when the fed has used up all of its bonds buying back paper dollars, then it will start to matter whether the fed redeems the rest of the dollars for gold. If it does, the paper dollar will hold its value. If it doesn't, the paper dollar will lose its value.
The fact that the bonds are denominated in dollars is beside the point. Imagine that we started in a world where the only dollars were silver coins. Then the fed started basing paper dollars on those coins, eventually issuing billions of them in exchange for bonds, denominated in dollars. There is no reason why this can't work in reverse. The dollars that were issued for bonds can be just as easily retired for those bonds.
Person:
If that's what you think the rbd says, then no wonder you are skeptical. Austrians say the fed is no different from a counterfeiter. I say no, because the fed stands ready to use its assets to buy back those dollars. IF the fed loses assets (to the government or to anyone else) then there is less backing per dollar and there will be inflation. If the fed's assets move in step with the issue of dollars, then there will be no inflation.
Austrians hold that inflation is caused by more money chasing the same goods. The RBD holds that inflation is caused by more money laying claim to the same assets. Big difference.
Published: June 16, 2008 1:03 PM
The fed redeems paper dollars for bonds every day...The fact that the bonds are denominated in dollars is beside the point.
It's not beside the point if the point is to STOP using U.S. dollars, as your previous post suggested. It highlights the very flaw of calling a spade a shovel and thinking that they are two different things. Debt is a poor form of asset-backing, since it obviously doesn't prevent inflation.
Published: June 16, 2008 1:14 PM
"The fed redeems paper dollars for bonds every day. It's called an open market sale of bonds."
Mike, you're misrepresenting the Fed. It does not conduct open market sales every day. The Fed almost exclusively conducts open market purchases, not open market sales ie. it buys bonds rather than selling bonds. The ratio of purchases to sales is about 1000:1. It conducts the sales you talk about maybe once or twice a year.
Even if you were a dealer looking to trade your dollars for bonds, you can't just initiate the conversion. You'd have to wait for the Fed to set up a formal auction. Your characterization of convertability as being effortless is a bit weak.
Published: June 16, 2008 1:49 PM
Mike_Sproul: Yet you completely agree (with Austrians) that the existing Fed's practices, taken as a whole, do cause inflation; you only disagree about how much inflation any given issue will cause.
So why the pretense that the Fed is backing all of its dollars when it clearly isn't? (i.e. in the sense that it throws off some of its assets to cover expenses and give freebies to the government)
Published: June 16, 2008 2:46 PM
Mike Sproul:
I'd like to follow through your example regarding the issuance of $300 for which an IOU on a farm was accepted as collateral. I'd like to know your reaction as I continue the example. I'll welcome correction wherever you deem appropriate.
Before continuing the example, some important groundwork is in order. Implicit in your example is that $1 is convertible for 1 oz of silver. Here, I'll place Austrian and rbd theories aside and rely strictly upon principles of voluntary contract. Given the choice, I insist that every paper dollar that I own be backed by something tangible. I would prefer to receive an ounce of silver though I might be persuaded to accept a share in the farm as long as I was confident that I could exchange the share for an ounce of silver in the future.
Those are my terms. There will be no debate on this.
Now to review, the bank issued $600 in paper money. As backing, it claims 300 oz of silver and an IOU on the farm. I'll consider a number of scenarios:
1) The farmer repays his loan by returning $300 in paper money. In this instance, the bank tears up the IOU. Thereafter, it is fully backed by silver. No one should have a problem with this.
2) The farmer repays his loan by returning 300 oz in silver. This time, the bank leaves $600 in paper money circulating. All of it is backed by silver. Again, there should be no problems from anybody.
3) The farmer defaults on his loan. The bank forecloses on his farm and is able to sell it in exchange for at least 300 oz of silver. The bank now has $600 in paper money circulating with 600 oz backing it. Still, no problem.
4) The farmer defaults on his loan. The bank forecloses on his farm but discovers that it is only able to sell it in exchange for 100 oz of silver. The bank made a poor loan and is consequently insolvent. It has $600 of paper money circulating with only 400 oz of silver. It is liquidated and the silver split between the holders of the paper money. Assuming this was the only bank in the economy, each dollar is now 1.5 oz of silver. More likely, this was one of multiple banks. The exchange rate only increases slightly. Inflation has occured since the paper money was insufficiently backed. At least though, the bank responsible for the inflation has suffered the consequences.
5) The loan to the farmer is still outstanding. He is abiding by its terms. Meanwhile, I produce $600 of paper money to the bank that I wish to exchange for 600 oz of silver. What happens?
This one is a little trickier. This is where you may have to wriggle a little to justify your theory. I don't think that you're going to come up with anything that will get me to accept it. The farmer, being a guy like me, expected that each of his dollars would be backed by an ounce of silver. Did he know that rather than borrowing a claim on 300 oz of silver that he was selling his farm short? Whatever the case may be, I won't let the bank force him to buy back his farm to cover the fraudulent short position. The banker is in big trouble in my book.
Another point requires review. In scenario 2, the farmer managed to obtain 300 oz of silver to repay the loan. Yet the paper money that was originally unbacked (don't tell me it was backed by the farm - he had already exchanged 300+ oz to buy it!) remains in circulation. The amount of paper money in circulation has increased with no increase to the real assets backing it. In other words, your bank has caused inflation.
This may be the point at which you try to pull out some kind of financial convertibility on me. I'll tell you now, I'm highly skeptical that it'll work on me. At this point, I'm dead set against your banking system. The only way that I'll live with it is if coercion is employed to force me.
We have a more basic problem there.
Published: June 16, 2008 3:16 PM
Federal Reserve notes aren't counterfeit but they also aren't backed by any promise of anything but more of the same. Money created by commercial banks is inflation unless the bank loans only deposits. If deposits are used as a base upon which to pyramid loans, the money thus created is inflationary regardless of any collateral "backing." As the loan is repaid the inlationary liability is deflated, assuming more loan money is not created to replace it. Adding new capital or new deposits used as reserves, branch banking, new banks etc. increase the opportunity for more inlation.
Using property as collateral for a loan doesn't make the loan more or less likely to be inflationary. But if that collateral (usually not a fungible good) were used to back the money supply, either alone or in conjunction with other goods of any sort, then, there would be no consistent standard of value to bring coherence to the information contained in prices. Recent experience with collaterized debt obligations might suggest as much.
Published: June 16, 2008 4:12 PM
Michael Clem:
The point that matters is that paper dollars that were issued in exchange for bonds can be retired in exchange for bonds. No need to worry about stopping the use of dollars
JP:
Let me rephrase: The fed redeems dollars for bonds on a regular basis. Period. Sometimes it happens as an open market sale of bonds, but more often the bonds held by the fed mature, the fed becomes the owner of so many dollars, and (usually) those maturing bonds are rolled over into new bonds, and the dollars return to the public.
Person:
"So why the pretense that the Fed is backing all of its dollars when it clearly isn't?"
You might as well ask why the pretense that GM backs its stocks, when profits are down and the stock is faling. The point is that the value of money, like the value of stock, DEPENDS on backing. If backing is maintained there will be no inflation. If not, there will be inflation. Austrians say the value of money depends on the fact that the government limits the quantity of those pieces of paper, while their usefulness as money creates a demand for them. Which theory is more believable: the one that says a piece of paper has value because it is a claim to something of value, or the one that says the paper has value even though it is a claim to nothing?
Joe S:
No disagreement on items 1-4, except the dollar is worth 400/600=.67 oz, not 1.5 oz. Also your point about the other banks is unclear.
On #5, I assume you mean that you collected all 600 paper dollars that were in circulation, and presented them to the bank, demanding silver. The bank has 300 oz, plus the farmer's IOU that, by assumption, is worth 300 oz. So the bank first pays out its 300 oz, then sells the IOU for 300 oz and then redeems the remaining 300 paper dollars. You can come up with some scenario where the banker is unable to sell the IOU for 300 oz., and in that case, the banker would have had to put some fine print on his paper dollars, specifying that they are redeemable for 1 oz, or for the farmer's IOU. The farmer is only obligated to pay back his IOU on the original terms, and the banker simply pays out an IOU worth 300 oz, rather than 300 oz itself. (I have just pulled out some kind of financial convertibility.)
And about your point on scenario #2: The bank, according to your story, is in possession of 600 oz, and there are 600 paper dollars in circulation. No problem.
Joe B:
Show me the bank that issues money without taking assets of at least equal value, and I'll send them more business than they can handle. Every dollar that is issued on these terms is matched by an equal increase in bank assets, so the dollars hold their value
Published: June 16, 2008 6:22 PM
Newson:
"this doesn't figure to me. naked call sellers either must deliver stock or must buy back their positions before expiry. there is no dilution of earnings per share by this procedure, merely a change in ownership of underlying."
I meant that if there are 100 shares of the underlier in existence, and 60 calls are issued, then it will appear to investors that there are now 160 shares available to buy. Now, this is not really dilution, since the 100 shares are claims against the corporation that issued them, and the 60 calls are claims against the call writers. The calls and the underlier are different things. Note that the issue of calls will not reduce the value of the underlier. Austrians make a mistake when they say that the issue of checking account dollars (calls on paper dollars) reduces the value of the underlying paper dollars. That's why I brought up calls and underliers--to point out this error.
"as regards your cash settlement as alternative to delivery, this would destroy the call market's function. how could i hedge a position on the underlying if i couldn't guarantee that i would receive stock?"
I believe most calls end with a cash settlement. Apparently, it's not a big deal, since most investors are content with cash instead of stock.On the other hand, this problem might set some kind of limit on the issue of call options. If 1% of call holders actually do want stock instead of cash, the issue of calls couldn't exceed 100 times the number of underlying shares. I don't know of any actual examples of this.
"how could you possibly cash settle if there is a surplus of unsatisfied call holders? you couldn't use the expiry price because that wouldn't incorporate the uncovered deals (ie unsatisfied demand for stock)."
I think you're right that the price would be corrupted. I also think, as above, that it's a rare enough case that it hasn't caused major problems.
Published: June 16, 2008 7:15 PM
Mike Sproul:
Suppose that there are no commercial banks and that Federal Reserve notes are the only legal form of money, as declared by the government.
Suppose the Fed on its balance sheet has $700 billion of government bonds as assets "backing" (to use your term) $700 billion of Fed notes circulating as money.
The first thing to note is that the almost all the interest on the government bonds is remitted back to the Treasury, and, that to the extent the Fed's government bond portfolio grows over time, the $700 billion held by the Fed are rolled over but never paid off. This fact means that the $700 billion of government bonds held on the Fed's balance sheet represent interest-free perpetual public debt, or, in other words, a cumulative amount of taxes that the government has extracted via the Fed.
Now, suppose the Fed decides to suddenly purchase another $1 trillion of government bonds presently in the public's hands (on the open market). This action will, naturally, reduce interest rates and increase the amount of money in the public's hands by $1 trillion. The question is what will the public do with the extra $1 trillion of fed notes that they have bought with the bonds they sold to the Fed. The view that you (Mike) dispute is that this is would be a disequilibrium situation concerning the demand for goods and services, financial assets, real assets and money, and that at least some of this "excess" money would find its way to increase the demand for goods and services thereby driving up their prices. If you think not, what's your story in the re-establishment of equilibrium between money and goods and services?
Published: June 16, 2008 7:20 PM
Alex:
If you hadn't specified that there are no commercial banks, I would have had two answers about the effects of the extra $1 trillion: 1) $1 trillion of checking account dollars would have refluxed to the commercial banks, or (2) the extra $1 trillion would sit idle in people's drawers.
I would also point out that the public now holds an extra $1 trillion of green paper, where they used to hold $1 trillion of bonds, so the public's spending power is not much affected.
Of course the basic problem is your assumption that the fed forces money into circulation with no attention paid to its economic effects.
Published: June 16, 2008 7:49 PM
Michael A. Clem, a spade and a shovel are two different things. A spade has a digging action, so it needs a long lever arm and a narrow blade with no raised sides with their resistance. A shovel has a scooping and lifting action, so it needs a short lever arm that keeps the weight close to the effort and a wide blade with raised sides to reduce spillage.
Published: June 16, 2008 11:06 PM
to mike sproul:
i think only difference between the rbd and the austrians is that the latter insist on a money whose stock is as close to constant as possible. that way the function of money as a yardstick is stable over time.
with rbd, the backing of the money is a moving target, with loans to particular sectors having a positive feedback on valuation of the backing assets.
so in the sub-prime case, banks loaned on property valuations which were pumped up by the vast amounts of credits already destined towards the sector. dog chases tail.
Published: June 17, 2008 12:59 AM
Mike:
Yes. You're right. I flipped my ratio. My point about other banks would only apply in the presence of a central bank that required all branch banks to use the same notes. If the bank used its own notes, then the exchange rate on its notes would be 0.67 oz per dollar. If it used notes common to other banks, then there would be a less significant dilution to the value of the dollars. I think that this is tangential to the primary discussion though I'll certainly carefully consider a response if you think it's worth pursuing.
On #5, it is possible for the bank to contract with its note holders to accept either silver or a share of the IOU. If the farm is worth far less than 300 oz of silver, then it seems that the scenario is reduced to something like #4. The real value of the assets backing the notes is not what the bank initially claimed it to be. It seems to follow that inflation is the result. Since you didn't object to #4, can I infer that you agree that inflation can occur in this manner?
The financial convertibility of the IOU is troubling to me. It seems like you could quickly lose track of the collateral. The bank could sell its IOU not for silver but for notes from another bank. The bank receiving the IOU might then conceivably issue another $300 with the IOU backing it. A determined observer might discover the practice and call it out, but it seems likely to me that banks might get away with trading these financial assets and issuing money with multiple claims on the same assets. It has kind of the same feel as the sub-prime mess. Debt has been repackaged and sold so many times that it is difficult to sort out who is holding the empty bag.
When it comes down to it, here is where I am starting to land on your real bills doctrine. It is not necessarily at odds with my economic philosophy (most strongly influenced as it is, by the Austrian school). While it may be true that most Austrians are gold-bugs (or at least advocates of commodity money), I don't read anything in basic Austrian principles that requires money to based upon precious metals. Rather, a central tenant of the school is that exchange is subjective. People do not intrinsically quantify their desires. They can only order their desires in a cardinal manner. It is only the introduction of money that makes economic calculation possible.
There is no economic law prohibiting competing currencies. Neither is there law prohibiting issuing money that may have multiple convertibility - silver, gold, an IOU or other financial asset. If people voluntarily agree to an exchange, then it can not be found in conflict with Austrian economic principles.
Now all that being said, I deeply distrust the notion of backing money with other financial assets. As I explained in connection with my original scenarios, I believe that such backing will quickly become obscured and that the money supply will inflate beyond control. I remain an advocate of defining money as a commodity that is stable in quantity. Such a money is much less prone to manipulation than any other that I could conceive.
In any case, surely you must agree that the U.S. dollar has been subject to significant inflation. Would you be willing opine on how that has happened? Do you have no problem with that inflation? And do you not agree that there have been wealth transfers as its result?
Published: June 17, 2008 8:42 AM
Newson:
On RBD principles, keeping the money stock constant would not assure that the amount of backing per unit of currency is constant, so it would not prevent price inflation. What it would do is leave the public with too little money during booms, and too much money during busts. The RBD allows elasticity of the money supply, where the money supply can grow and shrink according to the needs of business. Sometimes there will be speculative bubbles, but you'll have those under any system. We'll have bubbles until we get better crystal balls.
Published: June 17, 2008 8:48 AM
Thanks for the correction, P.M., but I still wonder what Mr. Sproul is shoveling.
The point is that the value of money, like the value of stock, DEPENDS on backing. If backing is maintained there will be no inflation. If not, there will be inflation. Austrians say the value of money depends on the fact that the government limits the quantity of those pieces of paper, while their usefulness as money creates a demand for them. Which theory is more believable: the one that says a piece of paper has value because it is a claim to something of value, or the one that says the paper has value even though it is a claim to nothing?
A piece of paper has value because other people are willing to accept it in exchange for something of value, that's the claim currency has. Why they are willing to accept it is more complicated, perhaps even psychological. A dollar used to be a certificate representing a quantity of gold, and now it represents a 'financial asset' like a Treasury bond. The psychological difference should be obvious: gold is a very real, physical substance with weight and mass. A bond is a debt--a promise that the seller will come up with money in the future and pay it back. You tell me which is more secure.
Nonetheless, people DO take U.S. dollars, in spite of the lack of commodity backing. Supply and demand still apply to dollars, just like any other commodity. All other things being equal, the supply of dollars DOES make a difference to the value of the dollar. The real question is, are all other things equal? I don't think debt-backed dollars have the same weight as gold-backed dollars, but either way, backing only affects the value of dollars to the extent that people trust the backing, and are thus willing to accept dollars.
Published: June 17, 2008 9:05 AM
Mike Sproule:
The debate is whether or not increases in money cause increases in the general level of prices of goods and services. Let me give a second example, which probably should have been my first, then deal with your above comments.
President Mugabe has a $1 trillion Zimbabwean (face value) government bond printed up (big piece of paper) and has it carted over to the Zimbabwean central bank. The Zimbabwean central bank in return for this bond, sends back to Mugabe 1 trillion Zimbabwean dollars currency. Mugabe then spends this money on Zimbabwean goods and services. Do you argue that these actions have no effect on the Zimbabwean price level?
Though not so dramatically, the above is exactly what happens between the Treasury and the Fed. The Treasury has big pieces of paper (T-bonds) printed up and lots of them are purchased by the Fed. If, say, $1 billion worth is purchased directly from the Treasury by the Fed, the Fed simply creates a $1 billion Treasury deposit at the Fed, which the federal government then spends on goods and services. Though $1 billion is not as large as $1 trillion, qualitatively the government-Fed transaction would have the same effects on U.S. spending and the price level as would Mugabe's diddling.
Now, in a more roundabout way. Suppose the public has $1 billion of money and purchases $1 billion of newly issued government bonds. Then the Fed engages in a $1 billion open market purchase of these bonds to get them onto its balance sheet. The net effect is exactly the same as if the Treasury had sold the bonds directly to the Fed.
Now, if when the Treasury sells its bonds to the fed (either directly or in two steps), the government doesn't spend the money it has raised from the bond sale, then there will be no increase in the general price level. (If you like, the demand for money holdings (by the government) has increased by exactly the same as the increase in money supply.) But, of course, if the newly created money is spent by the government on goods and services, this will drive up prices.
Now to your comments:
Not sure what "refluxed to the commercial banks" means. Anyway, there were no commercial banks in my example.
"or (2) the extra $1 trillion would sit idle in people's drawers. I would also point out that the public now holds an extra $1 trillion of green paper, where they used to hold $1 trillion of bonds, so the public's spending power is not much affected."
These statements assume unrealistically that people are completely indifferent to the amount of money and other assets that they hold. For example, they don't care whether they hold $1 trillion of interest bearing government bonds or $1 trillion of cash earning no interest.
"Of course the basic problem is your assumption that the fed forces money into circulation with no attention paid to its economic effects."
My example was extreme to demonstrate a point. I believe there would be large price level effects from such a Fed action, but I thought you said there would not be any economic effects for the Fed to worry about by such an action.
Published: June 17, 2008 9:40 AM
mike sproul says:
"What it would do is leave the public with too little money during booms, and too much money during busts."
but the primary purpose of money is as a measuring stick of value. just as distance, to be measured accurately must be denominated in widely understood and accepted units, so to must money stock remain constant in order to accurately price different goods over different times.
if i choose to measure a cricket in inches, i still can use the same unit to measure a football field. people don't ever need more money, only the stuff it represents. inches don't grow to measure football fields.
Published: June 17, 2008 10:42 AM
I've never understood what people meant by statements such as Mike's:
What it would do is leave the public with too little money during booms, and too much money during busts.
I've always figured that it was because the statements don't make sense. newson's post seems reasonable and only reinforces my figuring. But I'd like to ask Mike (who seems more thoughtful than the typical arm-chair economist) to back up the statement. Focusing on the boom side of your statement, if "too little money" is a bad thing, can you explain just what would be the consequences of having "too little money"?
I can see having too little or too much money from the standpoint of the function of money (for instance, using water as money in an area dotted by lakes). But that is an entirely different matter.
Published: June 17, 2008 11:12 AM
Mike: “…keeping the money stock constant would not assure that the amount of backing per unit of currency is constant, so it would not prevent price inflation. What it would do is leave the public with too little money during booms, and too much money during busts.”
Exactly! Booms should be based on savings, so there should be a break on booms. RBD completely ignores the capital structure that is the foundation of Austrian econ. Booms go bust when too much money chases too few capital goods. Because capital goods are scarce and take time to produce, the plans of many businessmen must fail. But when growth is financed by savings, the limited amount of savings causes balanced, sustainable growth that prevents too much money chasing scarce capital goods.
Austrian econ would produce counter-cyclical movements in the money supply. The Fed follows a version of the RBD which cause a pro-cyclical money supply, and its history proves. In other words, the money supply feeds booms and starves busts. Mike’s statement demonstrates that his RBD doctrine not only violates established theories of value and the Austrian theory of money, but the Austrian Business Cycle Theory as well.
Mike’s RBD says that money is neutral, or in econo-speak, “endogenous.” In other words, money does not cause changes to the real economy, it responds to them, the view of mainstream econ, too. If that’s true, then what causes the business cycle? In technical terms, random shocks. In plain English, acts of God. In other words, neither mainstream econ nor Mike’s RBD have a theory.
Austrian econ predicts that RBD will cause the money supply to grow first, and the boom will follow. Then, when businesses start going broke from malinvestments, they will be unable to pay back loans and the money supply will shrink. In some cases it will shrink so fast due to failing business confidence that the Fed can’t catch it even using RBD. Austrian econ predicts that under the Fed’s RBD the money supply will be too high during booms and too low during busts, as history shows.
Published: June 17, 2008 11:16 AM
Mike Sproul:
I find the RBD helpful in explaining how money maintains its value. I don't think that the QT adequately explains why money supply growth is often associated with a RISING currency value - e.g. the Yuan or Aus Dollar in recent years.
But I disagree with many of your conclusions. In particular, I think that the Austrian version of the QT is actually consistent with the RBD theory of monetary backing.
1. I don't find periodic bond sales a reassuring form of convertibility. Bonds are claims to future dollars, and dollars are backed by bonds, so they rise and fall in value together. Maintaining backing in terms of Treasuries is therefore no check on inflation.
It would be more reassuring if the Fed had conducted periodic gold trades to keep gold at $40/oz. That's the only kind of financial convertibility that's worth a crumpet.
2. You say that a call option does not affect the value of the underlying stock, and that is broadly true. But money is no ordinary stock. Money is the medium of exchange, ergo the means of payment. If a claim to money is itself generally accepted as payment then it too is money in its own right, by definition. It is as if a call option to a share of stock itself automatically becomes a share of the stock. This doesn't prove that the QT is true, or that the RBD is false, but that the effect of issuing a "call option" on money might not be neutral.
3. Suppose the currency is redeemable in gold, and then the bank fills half of its vaults with silver by value. If the gold-price of silver falls too much, then your bank will be in trouble. Likewise if it buys too many bonds: if interest rates rise, it will be in trouble. Little wonder that you prefer a currency which is not physically convertible, since I doubt that a bank could hedge against this. Even FDIC depends on taxpayer largesse.
4. The MECHANISM by which an inconvertible currency maintains its value seems unstable to me. An RBD bank is like a fixed-income mutual fund, with capital-guaranteed shares which are used as money. According to you, the market-value of each share may be expected to trade at its net asset value (NAV). But what mechanism will ensure this? Mutual fund shares often trade way above or below their NAV for extended periods. The Austrian business-cycle can be seen as an instance of the market-value of money being pushed below its NAV (inflation) during booms, only to spring part-way back explosively (deflation) during busts.
5. How might this come about? If banks are free to create fiduciary media with no reserve-limit or Basel-limit, then one would expect interest-rates to be lower than if the banks draw exclusively on time-deposits to make loans. The proof of that does not rely on the QT, but may be explained by a reduced demand for time-deposits. This gives rise to the mismatch between savings and investment at the heart of the ABCT.
6. Alternatively, if we accept a mild form of the QT, the extra money being issued hits a "hot" sector first, and raises its price. Dependent sectors then experience price-inflation in turn. Retail prices are usually the last to be affected, but it is only then that there is belated recognition that money is trading below its NAV, as measured by the CPI.
Under the discipline of a gold standard, this would provoke a rash of redemptions, and bank asset-sales to meet them. The firesale of bank-assets pushes up interest rates and thereby exposes the loan-component of existing monetary backing as inadeqate, since they were established at depressed interest-rates. Banks embark on capital raising, and many close down.
Under the current monetary system, interest rates are raised in response to rising CPI, and the effects are similar, except that fewer banks need to close down because the Fed will bail many of them out. The Fed also degrades its own backing to ease the pain on the banks, by lending (via repos) at sub-market interest-rates, and recently by accepting illiquid assets at unrealistic valuations.
Published: June 17, 2008 11:55 AM
Michael Clem:
"A piece of paper has value because other people are willing to accept it in exchange for something of value,"
You seem pretty well aware of the circularity and general absurdity of this view of money. I think you'd also agree that if money were backed by gold, then there would be nothing 'complicated' that required explanation. The only thing complicated about the RBD is the idea that money can be backed without being physically convertible. If the quantity theory were correct, and backing didn't matter, you should be able to find at least a few central banks that hold no assets against their money, but there are no such banks. Before 1933, the dollar was physically convertible, so nobody thought it was fiat money. Of course, the fed suspended physical convertibility every night and every weekend, but the dollar held its value because everyone knew that the fed's assets were still there in its vaults. So what happened in 1933? Physical convertibility was suspended for an indefinite time, but financial convertibility was maintained, and the fed's assets were still there, still backing the paper dollars issued by the fed. That's why I say that the dollar is backed by the fed's assets, and the idea of fiat money is an illusion.
Alex: When money is issued for assets of inadequate value (like Mugabe's IOU) then the money will lose value. It might help to ask yourself what would happen if the fed issued money passively, rather than on its own initiative. Some citizen wants cash, and has a $100,000 T-bill. He takes the T-bill to the fed, which pays him $100,000 cash for it. (If the economy were already flush with cash, he would have gotten the cash on the open market, rather than going to the fed.) That way, money is only issued when the economy has a need for it. Since the fed does, in fact, try to issue the 'right' amount of money, this voluntary issue is a better way to understand money than those 'forced' scenarios you describe.
The Law of the Reflux describes the process whereby a bank that issues more money than the economy can use will have the excess money returned (refluxed) to it by its own customers.
Newson:
"but the primary purpose of money is as a measuring stick of value. just as distance, to be measured accurately must be denominated in widely understood and accepted units, so to must money stock remain constant in order to accurately price different goods over different times."
You are assuming the correctness of the quantity theory, which is the very point in dispute. To take a simple example, suppose that dollars are backed and physically convertible into 1 oz. of silver. In that case you would not have said that the money stock had to remain constant for the price level to stay the same. The price level MUST be the same no matter what the money supply is, since a dollar must be worth 1 oz. During busy times (christmas, harvest time) people would need a lot of dollars, so the bank would issue more than usual. After the boom was over, dollars would reflux to the bank as loans are repaid, bonds mature, etc. Through all that, the dollar is still worth 1 oz. If that seems reasonable enough, now take the next step, which is to recognize that physical convertibility can be replaced with financial convertibility. Then maybe it won't sound so strange when I talk about the supply of money rising and falling according to the needs of business.
Joe S.
"can you explain just what would be the consequences of having "too little money"?
When the christmas season hits, people need more cash to conduct the extra business. If that cash is not issued, people will be forced to use some less efficient method of trading--think of people being reduced to barter because of the lack of cash.
Money shortages were actually a major problem in the 1800's, which is why the fed's charter listed 'providing an elastic currency' as the fed's primary duty. Then, as now, quantity theorists did not know what to make of the claim of 'too little money'. They figured that if the money supply were doubled, the value of each dollar would be halved, so they resisted calls for more money. They did not see that if the money supply wer doubled, and the assets backing it were also doubled, there would be no change in the value of the dollar, but the extra cash would make it easier to do business.
Fundamentalist: A bank that follows the RBD will accommodate booms and busts--not cause them. Think of a hot dog vendor. Should that vendor accommodate his customers by cooking hot dogs when they want them, and not when they don't? Or should he follow the Austrian 'countercyclical' policy of cooking hot dogs when nobody wants them, and then refusing to cook enough to accommodate the lunchtime rush? That's what a bank would be doing if it tightened its issue of money during booms, and eased during busts.
Fusgerm:
"Bonds are claims to future dollars, and dollars are backed by bonds, so they rise and fall in value together."
True. This is what I've called 'inflationary feedback', in my paper "There's No Such Thing as Fiat Money"
"It would be more reassuring if the Fed had conducted periodic gold trades to keep gold at $40/oz. That's the only kind of financial convertibility that's worth a crumpet."
That's physical convertibility, not financial. Believe it or not, nobody has ever said "worth a crumpet" to me before.
"According to you, the market-value of each share may be expected to trade at its net asset value (NAV). But what mechanism will ensure this? "
Ordinary open-market operations are one way to ensure this. My "No Fiat Money" paper actually makes a concession to the quantity theory on this point. There's a graph in the paper that shows a falling demand curve for money, and in certain cases the overissue of money can cause it to fall below its backing value.
Published: June 17, 2008 2:03 PM
Mike_Sproul: If GM kept issuing new shares, and used the proceeds to buy frivolities, like gold statues of the executives, I would say, "Hey, GM is devaluing its shares." And I'd be right (though the effect could be blurred if somehow other forces propped up GM's profitability).
Similarly, if the Fed kept issuing new dollars, and blowing the proceeds on giveaways (like it does), I would say, "Hey, the Fed is devaluing the US Dollar." And I'd be right (though the effect would get blurred).
And the Austrians here would say the same thing. And they would be right. So again, why keep arguing about all the conditions under which the Fed "could" print money while not devaluing the dollar, conditions which don't actually apply today?
Published: June 17, 2008 2:19 PM
Mike, you either ignored or missed my post dated June 17, 2008 8:42 AM (understandable while you're engaging at least half a dozen people at once). I'm still interested in a return comment if you're willing - especially regarding my questions at its end.
Published: June 17, 2008 2:54 PM
Mike, I have to challenge your first statement:
When the christmas season hits, people need more cash to conduct the extra business.
I can conceive of situations when notes would become so scarce as to hinder transactions from a practical standpoint. To illustrate, suppose for example that we have an economy with a minimum denomination of one dollar. Suppose further that the economy has grown to the point at which the typical household only has a handful of dollars but makes scores of transactions a month. Clearly, there are not enough dollars in circulation.
Fortunately, suitable candidates for money are divisible (even the farm IOU is divisible to a point though the division would be messy and highly subjective). You could break the dollars down to pennies or even smaller units. There would be practical limits to which the division could occur, and an adjustment to the monetary system would be required (such as changing the commodity backing, introducing another one or some other innovation). However, these limits would be entirely independent of any boom/bust seasonal factors.
Even though your first statement kind of loses me on the rest, I will further challenge your closing statement:
(Quantity theorists) did not see that if the money supply were doubled, and the assets backing it were also doubled, there would be no change in the value of the dollar, but the extra cash would make it easier to do business.
I went along with you fine when you put a farm up as backing for money. It's a real, tangible asset. I can go along with financial assets as long as they are eventually backed by real assets. But you've lost me again there. How exactly do you double assets without making money appear out of thin air? And if money is a claim to real assets but is not backed by real assets, then won't the first receivers of this new money have just received a windfall at the expense of later receivers?
Published: June 17, 2008 3:20 PM
Mike: “Think of a hot dog vendor.”
Ah, but the hot dog vendor must supply his customers out of his savings or borrow the savings of others. In order to have the hot dogs that customers will want when they want them, the vendor must save some of his sales revenue, or borrow the savings of someone else, and purchase the hot dogs to sell. If hot dog vendors could create weiners and bread out of thin air, I’m sure they would love it.
If banks were limited to lending only the savings of depositors, that is, required to keep 100% reserves, then they would be like the hot dog vendor. Banks could make available for loan only the money that others had deposited, but could not create money out of thin air. In that case they would be free to make loans available when customers want them, but no more than what other customers had deposited from real savings.
Banks differ from other types of businesses only in the fact that banks can create their product, money, ex nihilo. Everyone else on the planet has to save, or borrow other people’s savings, and buy the needed inputs. Banks don’t under RBD, which is a fancy name for fractional reserve banking.
Mike: “Or should he follow the Austrian 'countercyclical' policy of cooking hot dogs when nobody wants them, and then refusing to cook enough to accommodate the lunchtime rush?”
So you acknowledge that the money supply under RBD/mainstream econ makes booms and busts worse by being pro-cyclical, that is, giving a loan to everyone who wants one during the boom while making sure that no one who wants a loan during the bust can get one.
Mike: “That's what a bank would be doing if it tightened its issue of money during booms, and eased during busts.”
That’s not what Austrians advocate. They advocate letting the market determine interest rates. In the ABCT, a boom (as opposed to steady growth) would happen only if savings increased rapidly. If some event caused an increase in demand for loans, the interest rate would rise naturally. If savings increased relative to demand for loans, interest rates would naturally fall; banks wouldn’t manipulate the interest rate.
The whole point of the ABCT is that capital goods are scarce and take time to make. If banks finance growth through loans from savings, then no mismatch between demand for and supply of capital goods will take place. But if you try to boost growth artificially by creating money out of thin air, as under the RBD, you destroy the balance between supply/demand of capital goods by creating excessive demand and the short-lived booms busts.
Published: June 17, 2008 4:17 PM
Joe: "I can conceive of situations when notes would become so scarce as to hinder transactions from a practical standpoint."
Actually, that's not very likely. If money becomes scarce, prices don't stay the same. Scarce money means money is more valuable. More valuable money becomes evident through falling prices. Within a short time prices would fall to a level that matches the new, higher value of money so that the money available will be totally sufficient to allow all of the transactions that people want.
Published: June 17, 2008 4:21 PM
Mike Sproul:
Mike, you say: "Alex: When money is issued for assets of inadequate value (like Mugabe's IOU) then the money will lose value. It might help to ask yourself what would happen if the fed issued money passively, rather than on its own initiative. Some citizen wants cash, and has a $100,000 T-bill. He takes the T-bill to the fed, which pays him $100,000 cash for it. (If the economy were already flush with cash, he would have gotten the cash on the open market, rather than going to the fed.) That way, money is only issued when the economy has a need for it. Since the fed does, in fact, try to issue the 'right' amount of money, this voluntary issue is a better way to understand money than those 'forced' scenarios you describe."
Mike, in the "passive" case that you mention. If the public's demand for money increases by $100 and the Fed increases the money supply by $100, there would be no spending increase resulting from the Fed's actions, nor would the Fed's actions cause an observed increase in the price level for goods and services. (Though spending and the price level will still be higher than they would have been had the Fed not increased the money supply to meet the $100 in increased money demand.)
My "forced" examples simply make it easier to see that when the Fed causes the supply of money to increase faster than the demand for money, there will be increased spending on assets and goods and services, and a general increase in goods and services' prices.
Again I ask you to explain what you think happens to prevent spending and price level increases when a central bank increases the supply of money at a faster rate than the demand for money is increasing. Surely you believe this happens all the time, in other words, that over and over again central banks expand the money supply in a (to use your terminology) non-passive manner.
Published: June 17, 2008 5:46 PM
Person:
"if the Fed kept issuing new dollars, and blowing the proceeds on giveaways (like it does), I would say, "Hey, the Fed is devaluing the US Dollar." And I'd be right (though the effect would get blurred).
And the Austrians here would say the same thing. "
Austrians are very explicit in denying the relevance of backing to physically inconvertible currencies like the dollar. Mises and Rothbard specifically say that the value of the dollar is determined by supply and demand, not by backing.
Joe S.:
Inflation happens when the fed's ratio of assets to money falls, as happens when the fed lends at below-market rates, overpays for bonds, (or if the bonds lose value), hands its interest earnings over to the treasury, wastes money on staff and buildings, etc. Certainly, borrowers gain from unexpected inflation and lenders lose, but if the inflation is anticipated there doesn't have to be a wealth trasfer.
Yes; Austrians are gold bugs, especially mises and rothbard. It's not consistent with libertarianism, since they advocate some very unlibertarian restrictions on banking when they denounce fractional reserve banking.
The RBD says you can back money with anything of value--from gold to wheat to land to bonds to lottery tickets. It's value that matters--and bonds can certainly have value just like precious metals can. Bonds might be less stable, but it should be up to the bank and its customers to decide how stable they want the backing to be.
"How exactly do you double assets without making money appear out of thin air? And if money is a claim to real assets but is not backed by real assets, then won't the first receivers of this new money have just received a windfall at the expense of later receivers?"
In my earlier example, the bank issued 300 paper dollars in exchange for 300 oz. deposited. You wouldn't say those dollars were created out of thin air. The next 300 paper dollars were issued for the farmer's IOU, which was worth 300 oz. That is not a case of money coming out of thin air. That IOU has value, just like the 300 oz of silver. Further, the IOU is backed by a lien on the farm, and once that 300 oz. lien is placed on the farm, the farmer is unable to borrow any more money against that farm, unless the farm is worth more than 300 oz. That is not 'thin air'. Counterfeiters create money out of thin air. Banks only issue money to people who allow that bank to place liens on their assets.
Since the new money is matched by new assets, there is no inflation, and no windfall to the first receivers.
Fundamentalist:
"If banks were limited to lending only the savings of depositors, that is, required to keep 100% reserves, then they would be like the hot dog vendor. Banks could make available for loan only the money that others had deposited, but could not create money out of thin air."
See my 'thin air' comments above. The people with silver got their $300 because they deposited silver. The farmer got his $300 because he 'deposited' his farm. You say that deposits must be in the form of gold, silver, etc. I say they can be in any form that the banker and the customers agree to.
"If money becomes scarce, prices don't stay the same. Scarce money means money is more valuable. More valuable money becomes evident through falling prices. Within a short time prices would fall to a level that matches the new, higher value of money so that the money available will be totally sufficient to allow all of the transactions that people want."
Exactly the argument that quantity theorists made in the 1800's, while real bills'ers would have said that issuing new money for assets of adequate value would not cause inflation.
Alex:
"Again I ask you to explain what you think happens to prevent spending and price level increases when a central bank increases the supply of money at a faster rate than the demand for money is increasing. Surely you believe this happens all the time, in other words, that over and over again central banks expand the money supply in a (to use your terminology) non-passive manner."
If the fed wants to force another $100 into circulation, and if the public is already well-stocked with cash, then the fed will start by bidding $100 for a bond worth $100. But by assumption, the public has no particular desire to trade the $100 bond for the $100 cash, so the fed has to offer $101 in paper for the $100 bond in order for the cash to be accepted by the public. Now the fed's assets have risen by $1 less than its liabilities, so there will be inflation. I say the inflation was caused by a loss of backing, while you say it was because there is now another $101 chasing the same amount of goods. If I added something about how the $101 of paper simply displaced $101 of checking account dollars (which would reflux to their issuers) then under reasonable conditions, your model would say there would be no inflation. Mine would say there is still inflation, because of the $1 loss of backing.
I haven't really explained my more-or less complete dismissal of the concepts of supply and demand as regards money. For now I'll say that supply and demand works fine for commodities, but not for financial securities. Financial securities can be nothing but computer blips, which can be created and destroyed in an instant. Ordinary ideas of supply and demand simply don't apply.
Published: June 17, 2008 8:08 PM
fusgerm says:
"I find the RBD helpful in explaining how money maintains its value. I don't think that the QT adequately explains why money supply growth is often associated with a RISING currency value - e.g. the Yuan or Aus Dollar in recent years."
isn't it that the chinese currency is buoyed by tightening monetary conditions (raised banking reserves etc.), trade surplus vis-a-vis rest of world, and rising domestic interest rates? and that the aussie dollar is really only strong against the usd, and that the high interest rates and commodity story is the ostensible short-term reason?
paper currencies can fail to reflect country fundamentals short/medium term, but not long term. i cannot see why this should negate the quantity theory. this seems to me to be the very beauty of the austrian approach - that increasing the amount of money will impact prices, but way various prices are impacted and time-frame are unknowable.
the argentine peso remained overvalued for an incredibly long period before the peso/usd link was broken. money had flowed into the country for years, in spite of vast growth in money supply. why can't bubbles (mispricing) also affect currencies?
Published: June 17, 2008 9:26 PM
Mike: "In my earlier example, the bank issued 300 paper dollars in exchange for 300 oz. deposited. You wouldn't say those dollars were created out of thin air."
I can't see how you can describe it as anything else. Say the reserve requirement is 10% undeer the RBD. That means that a bank can loan out about 9 times its cash reserves. How does it create those loans? It simply writes the numbers in the accounting system under the account of the borrowers. The bank doesn't even have to print paper money, a simple accounting entry does the trick. If that's not creating money out of thin air, I don't know what you call it. In exchange for a simple accounting entry, the bank takes as collateral real wealth, such as a farm, so that if the borrower fails, the bank gets real wealth in exchange for its accounting entry.
Published: June 17, 2008 10:28 PM
PS: The bank uses the money it created out of thin air to pay workers, dividends, and buy the land it sits on and its building. In that way, the bank exchanges money from thin air for real wealth.
Published: June 17, 2008 10:32 PM
fusgerm: "I don't think that the QT adequately explains why money supply growth is often associated with a RISING currency value..."
In addition to what newson wrote, keep in mind that money supply growth is relative. China may be inflating its money supply, but if the US inflates at a faster rate, Chinese currency will increase in value relative to the dollar, even though both are losing value against commodities such as gold.
Published: June 17, 2008 10:35 PM
Newson says:
the aussie dollar is really only strong against the usd, and the high interest rates and commodity story is the ostensible short-term reason? ...i cannot see why this should negate the quantity theory. this seems to me to be the very beauty of the austrian approach
I was referring to the classic statement of the QT, e.g. by Fisher, which asserts an almost linear inverse relationship between the quantity of money and its value. That is certainly false, and Mises was one of its staunchest critics.
The Austrian version of the QT indeed fits the facts of the recent boom very well. Looking at Australia, for example, the monetary base doubled in three years from $AU 52 B from Y/E Jun 30 2004 to $ 106 B in Y/E Jun 30 2007, yet no one claims that retail prices doubled in that time.
In the same period, AUD rose by approx 10% against EUR, GBP and USD, by 20% against JPY, by 15% against CHF, remained stable against NZD, and fell against only one major currency - 10% against CAD. (visual estimates.) AUD has in fact risen against most currencies (except EUR, which also started from a low point in 2002), not just against USD.
Clearly, the results are not what the classic QT would predict.
Where has all the new AUD money gone? Into the local stock market, into the mining sector, and into the property prices of states most affected by the mining boom. This contradicts the RBD, which holds that the new money should be neutral in its effect on prices, so far as it is adequately backed.
Why, then, do I say that the RBD is helpful in understanding AUD? Because the intrinsic value of the Australian dollar, as determined by the backing theory, holds AUD on a leash. When the commodity cycle turns, the bubble sectors will deflate to restore money closer to its intrinsic value. In Austrian terms, the boom can only end in a bust. Or else, of course, in the apocalyptic alternative of the crack-up boom and hyperinflation.
Published: June 18, 2008 8:10 AM
Fundamentalist says:
keep in mind that money supply growth is relative. China may be inflating its money supply, but if the US inflates at a faster rate, Chinese currency will increase in value relative to the dollar, even though both are losing value against commodities such as gold.
I do not have the figures to hand for CNY, but this is contradicted by AUD, at least over the past 5 years. See my reply to Newson above.
Moreover, it is impossible to define precisely the "purchasing power" of a currency, still less to predict it. And the reason is that monetary inflation never makes its presence felt in a uniform fashion. If by "purchasing power" you mean retail prices, then this is a lagging indicator and generally the last to be affected by money which is loaned into existence.
Mises commented in TMC:
we make use in our discussion of only one fundamental idea contained in the Quantity Theory, the idea that a connexion exists between variations in the value of money on the one hand and variations in the relations between the demand for money and the supply of it on the other hand...
Beyond this proposition, the Quantity Theory can provide us with nothing.
Published: June 18, 2008 8:16 AM
Mike, you need to clarify something. In your examples to me, you've made it seem like you claim that RBD is backed by 100% reserves. What is different is that you say that assets other than precious metals can enter into the financial system as backing to the currency.
This is at odds with what I understand to be the case for our fractual reserve system. To return to your farm-as-collateral example, it seems that posting the farm as collateral worth $300 would allow the bank to lend $3000. Do you claim that somehow the Fed holds assets of real value to back the extra lending?
I see glaring contradictions between how you've characterized RBD and the fractional reserve system. The contradictions exist whether I rely upon my recent Austrian studies or if I rely upon my college macro-econ classes.
Published: June 18, 2008 8:25 AM
Fundamentalist:
" "In my earlier example, the bank issued 300 paper dollars in exchange for 300 oz. deposited. You wouldn't say those dollars were created out of thin air."
I can't see how you can describe it as anything else."
A bank can issue a checking account dollar because someone (1) deposited one ounce of silver or (2) deposited a $1 IOU backed by a $1 lien on a farm. I've never heard anyone but you claim that case (1) creates money out of thin air. Austrians generally claim (wrongly) that case (2) creates money out of thin air, but the only case that I'd say qualifies for 'thin air' status is a counterfeiter who doesn't put his name on the dollar, and won't buy it back. I'm actually wondering if I heard you right. Did you really mean to apply the 'thin air' designation to case (1)?
Joe S.:
"This is at odds with what I understand to be the case for our fractual reserve system. To return to your farm-as-collateral example, it seems that posting the farm as collateral worth $300 would allow the bank to lend $3000."
That's a plain old textbook error in your understanding of fractional reserves. If the bank has issued $300 to people who deposited 300 oz of silver, and another $300 to a farmer who 'deposited' a $300 lien on his farm, then the only way for the banker to issue another $2400 is for a borrower to 'deposit' something worth $2400--like an IOU backed by a lien on his house. Your concept of fractional reserves violates the first rule of banking: Never lend $1 to someone unless they give you collateral worth at least $1.
ASSETS.............................LIABILITIES
300 oz of silver deposited.....300 chk acct dollars
IOU worth $300....................300 more chk acct $
another IOU worth $2400......2400 more chk acct $
If you can suffer through a T-account, you'll see that the left side of the balance sheet must equal the right side. The $3000 in checking account dollars are backed by $3000 worth of assets. Mind you, there is only 300 oz of RESERVES, and the bank has 'multiplied' that out to $3000, but only by getting an additional $2400 worth of assets.
Published: June 18, 2008 9:22 AM
Mike_Sproul -- college edition!
"Mike, you can't just run up credit card and student loan debt to fund parties, pizza, and beer!!! Think about what this is going to do to your future!"
"Whoa whoa whoa, timeout, Dad. Under the Human Capital Theory, going into debt *cannot* hurt your net wage, so long as you spend the funds on human capital enchancements that grow faster than the interest rate."
"But you're ... NOT ... spending your money on that stuff, you're spending it on worthless frivolities, devaluing your own human capital."
"Yeah, but some of you guys are all acting like going into debt MUST hurt your net wage, when that needn't be true."
Published: June 18, 2008 9:47 AM
Mike: "A bank can issue a checking account dollar because someone (1) deposited one ounce of silver or (2) deposited a $1 IOU backed by a $1 lien on a farm."
In case (1) the customer either sells the silver to the bank, and receives dollars, or the customer used the silver as collateral for a loan. Either way, where does the bank get the checking account dollars to issue? In RBD it creates them ex nihilo because the bank keeps its cash as reserves and creates 9 more dollars for every dollar in reserve by making new bookkeeping entries. If the customer places the silver in a safe deposit box, he gets no dollars, just receipt. Case (2) is no different. The collateral doesn’t matter. What matters is where the bank gets the dollars to give to the customer.
If you haven’t heard anyone call fractional reserve banking the act of “creating money out of thin air” you should read de Soto’s book. Opponents of RBD/fractional banking have been calling it that for at least four centuries.
Published: June 18, 2008 10:51 AM
You seem pretty well aware of the circularity and general absurdity of this view of money. I think you'd also agree that if money were backed by gold, then there would be nothing 'complicated' that required explanation.
Here's the point you keep missing. Even a gold-backed dollar can have monetary inflation--the bank(s) simply issue more money by buying more gold--but the fact that it is gold, and that they have to buy gold, is the limiting factor on how much they can inflate. Commodity backing doesn't make inflation impossible, just harder. Currently, there's no firm limit on how much debt the Fed can buy in issuing currency.
Published: June 18, 2008 11:02 AM
Mike Sproul:
"If the fed wants to force another $100 into circulation, and if the public is already well-stocked with cash, then the fed will start by bidding $100 for a bond worth $100. But by assumption, the public has no particular desire to trade the $100 bond for the $100 cash, so the fed has to offer $101 in paper for the $100 bond in order for the cash to be accepted by the public. Now the fed's assets have risen by $1 less than its liabilities, so there will be inflation. I say the inflation was caused by a loss of backing, while you say it was because there is now another $101 chasing the same amount of goods. If I added something about how the $101 of paper simply displaced $101 of checking account dollars (which would reflux to their issuers) then under reasonable conditions, your model would say there would be no inflation. Mine would say there is still inflation, because of the $1 loss of backing.
I haven't really explained my more-or less complete dismissal of the concepts of supply and demand as regards money. For now I'll say that supply and demand works fine for commodities, but not for financial securities. Financial securities can be nothing but computer blips, which can be created and destroyed in an instant. Ordinary ideas of supply and demand simply don't apply."
Okay, so you do agree that when the supply of money is increased relative to its demand, that causes increases in spending and the relative price level. I thought you disputed that point. Semantics appear to be different, however. When the Fed buys a bond for $101, it has acquired an asset not worth $100, but $101, so in your terminology the "backing" for the $101 of new money is $101. In my terms when the Fed issues $101 of new money, there is never any "backing." The big pieces of meaningless paper (government bonds held on the Fed's balance sheet that don't pay the Fed any interest and will never be paid back) is no backing in my books. If the Fed simply burned those pieces of paper, what difference would it make, apart from the fact that it would hinder the occasional open market bond sale the Fed might want to make? (So, let's say the Fed burns almost all of their government bonds that they hold. Big meaningless deal!)
I would love an example of how the laws of supply and demand are violated when credit transactions are carried out via securities created by computers.
Published: June 18, 2008 11:42 AM
IOU worth $300
An asset is only worth what someone is willing and able to pay for it. If the farmer's IOU is truly worth $300, then he could exchange it for 300 of the existing paper dollars belonging to a real saver. If he can't do this, then his IOU isn't worth that much. Of course, the IOU might come to be worth $300 to someone after the RBD bank has printed up 300 more paper dollars and injected them into the economy, but doesn't that prove that the injection was inflationary?
Published: June 18, 2008 11:56 AM
So we should be able to look at the entire money supply and identify the reserves and collateral that backs it. I'm skeptical that you can do it, but I'd like to see actual data reconciling the Fed's balance sheet with the total money supply (realizing that much of it is now unpublished). I welcome anyone other than Mike as well who might have a handy data source.
Supposing for the moment that there are assets backing every dollar in circulation, the backing must consist primarily of government bonds - IOUs by the federal government to pay in the future. Whatever your economic views, you must admit that an IOU by a government to pay out of future tax receipts differs markedly from an IOU voluntarily contracted on personal property.
The federal government can issue bonds and sell them to the Federal Reserve in exchange for newly created cash. (Alternatively, it sells to the public or banks - ultimately some of them end up as reserves at the Fed.) By RBD, you may claim that the bonds have real value because they are claims on future tax receipts. (Am I right?) The government then spends the newly created money (enriching the connected contractors in the process). The new money enters the economy and begins circulating. Taxes are levied against this rising monetary base thus providing the income necessary to pay interest on the bonds.
Have I followed the process through correctly? [Comments from others than Mike are welcome] Wouldn't this monetizing of government debt (really a promise to steal in the future) cause inflation? Is this really a system that you defend?
Published: June 18, 2008 12:08 PM
Mike or Alex (I'm not sure who wrote it): "I haven't really explained my more-or less complete dismissal of the concepts of supply and demand as regards money. For now I'll say that supply and demand works fine for commodities, but not for financial securities. Financial securities can be nothing but computer blips, which can be created and destroyed in an instant."
So it wouldn't bother you at all if someone hacked into your bank's computer and deleted the "computer blips" stored in your account?
Published: June 18, 2008 12:26 PM
Joe:
You said:
"Supposing for the moment that there are assets backing every dollar in circulation, the backing must consist primarily of government bonds - IOUs by the federal government to pay in the future. Whatever your economic views, you must admit that an IOU by a government to pay out of future tax receipts differs markedly from an IOU voluntarily contracted on personal property.
The federal government can issue bonds and sell them to the Federal Reserve in exchange for newly created cash. (Alternatively, it sells to the public or banks - ultimately some of them end up as reserves at the Fed.) By RBD, you may claim that the bonds have real value because they are claims on future tax receipts. (Am I right?) The government then spends the newly created money (enriching the connected contractors in the process). The new money enters the economy and begins circulating. Taxes are levied against this rising monetary base thus providing the income necessary to pay interest on the bonds."
You are exactly right, except for the last sentence. No taxes are levied against the rising monetary base. No taxes are needed to pay interest on Federal Reserve held government bonds, since almost all the interest on these bonds is remitted back to the government. And since the government bonds on the asset side of the Fed grow with the monetary base over time, effectively there are no taxes needed to pay off any of these bonds.
Taxation occurs at the moment a government spends a given $1. The only question is the manner of the taxation. The government may decide to raise explicit taxes by $1 to finance the spending. The government may decide to borrow $1 to finance the spending, in which case the present value of the future taxes needed to repay the debt is exactly $1. When a central bank purchases government debt for $1, $1 of taxes are effected at that time through the monetary system.
Published: June 18, 2008 2:52 PM
Fundamentalist:
"In case (1) the customer either sells the silver to the bank, and receives dollars, or the customer used the silver as collateral for a loan. Either way, where does the bank get the checking account dollars to issue? In RBD it creates them ex nihilo because the bank keeps its cash as reserves and creates 9 more dollars for every dollar in reserve by making new bookkeeping entries. If the customer places the silver in a safe deposit box, he gets no dollars, just receipt. Case (2) is no different. The collateral doesn’t matter. What matters is where the bank gets the dollars to give to the customer."
Case 1 is 100% reserve banking, not fractional reserve banking, and nobody but you puts the 'thin air' label on 100% reserve banking.
The 9 more dollars are only issued if a customer gives the bank collateral worth at least nine dollars. No bank would issue the $9 otherwise. No thin air here either. That's why I want to hold on to my computer blips.
Michael Clem:
"Even a gold-backed dollar can have monetary inflation--the bank(s) simply issue more money by buying more gold--but the fact that it is gold, and that they have to buy gold, is the limiting factor on how much they can inflate. Commodity backing doesn't make inflation impossible, just harder. Currently, there's no firm limit on how much debt the Fed can buy in issuing currency."
I suppose by 'monetary inflation' you mean an increase in the money supply, as opposed to price inflation. And of course the only limit on how much money can be created is how many goods the borrowers are able to present to the bank as collateral. But what we care about is PRICE inflation, and as long as every new dollar is adequately backed by the bank's assets, price inflation won't happen.
Alex:
"Okay, so you do agree that when the supply of money is increased relative to its demand, that causes increases in spending and the relative price level. I thought you disputed that point. Semantics appear to be different, however. When the Fed buys a bond for $101, it has acquired an asset not worth $100, but $101,"
No; my assertion is that when money increases relative to the assets of the bank that issued it, there will be inflation. Supply and demand is not an appropriate model for financial securities--just for commodities. And when I said the fed paid $101 for a bond worth $100, I really meant the bond was worth $100--not $101.
Joe S.
"So we should be able to look at the entire money supply and identify the reserves and collateral that backs it. "
You have to remember that paper dollars are issued only by the fed, so they are backed by the fed's assets, which are published every month. The fed's assets do not back wells fargo's checking account dollars. Those are backed by wells fargo's assets.
" Wouldn't this monetizing of government debt (really a promise to steal in the future) cause inflation?"
If the government loses the ability to steal, then the dollars have less backing and there will be inflation. If the government keeps the ability to steal, then the dollars are backed by that ability, and will hold their value..
Published: June 18, 2008 7:21 PM
Mike_Sproul: Didn't you think my post was kinda clever?
Published: June 18, 2008 9:24 PM
Person:
So clever that I didn't even understand it.
Published: June 18, 2008 11:27 PM
to mike sproul:
leaving aside fiduciary media, would you acknowledge that if gold were used exclusively as money, and that its quantity were to increase markedly, then it's likely gold's purchasing power would be eroded to some extent?
Published: June 19, 2008 1:03 AM
Mike: "Case 1 is 100% reserve banking, not fractional reserve banking, and nobody but you puts the 'thin air' label on 100% reserve banking.
The 9 more dollars are only issued if a customer gives the bank collateral worth at least nine dollars. No bank would issue the $9 otherwise. No thin air here either. That's why I want to hold on to my computer blips."
Case 1 may or may not be 100% reserve banking. It all depends on where the bank gets the money to loan on the collateral, whether silver or land. If the money comes from reserves or from the savings of another customer, then it is 100% reserve banking. On the other hand, if the bank just enters the value in the borrower's account, it is fractional banking.
No, everyone may not use the exact words "thin air" but every Austrian and most economists since John Law have used similar terminology for the same process of credit expansion.
You're using "backing" for a loan as a red herring, attempting to distract the reader from the main event, the creation of money ex nihilo by the bank.
Published: June 19, 2008 6:40 AM