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WEDNESDAY, SEPTEMBER 1 , 2 01 0
Predicting the Price Level
A key disagreement between the Austrian economists and Keynesian
economists is over the consequences of expanding the money supply.
Keynesians claim that increasing the money supply will cause a
beneficial increase in economic activity, whereas Austrians claim
that increases in the money supply cause all manner of bad
consequences, one of which is the lowering of the purchasing power
of all money currently in circulation. The most visible sign of such
loss of purchasing power is a general rise in the price level. Therefore,
it is important that the Austrians answer the Keynesians who say that
the Austrian monetary theory is wrong, because the governments
pump priming, trillion dollar stimulus spending and the Feds massive
asset purchases have not caused runaway price inflation. In this
essay I will answer this criticism by explaining the fundamental
forces at work to explain the relationship between the money supply
and the price level and the forces of government intervention that
make short term price level predictions impossible.
The Quantity Theory of Money
At the foundation of our understanding of money and prices resides
the quantity theory of money. At this most basic level it is axiomatic
that the price level is the intersection of the quantity of goods for sale
on the market and the amount of money available to purchase these
goods. Prices can rise for only two reasons. One, the quantity of
money rises faster than the quantity of goods for sale. Two, the
quantity of goods for sale drops faster than the quantity of money. Of
course the reverse is true about a falling price level. Prices can fall for
only two reasons. One, the quantity of money falls faster than the
quantity of goods for sale. Two, the quantity of goods rises faster than
the quantity of money.
Lets use a simple example. Assume that there is only one commodity
for sale in the economy. One hundred units of this commodity are
produced. The money supply consists of one thousand units of
currency; well use dollars as our money supply unit. The only price
that will clear the market of all goods offered for sale is ten dollars per
unit. ($1,000 divided by 100 units) Let us suppose that there is a
production improvement that allows the market to produce two
hundred units of the same commodity. Then the market-clearing
price will be five dollars per unit. ($1,000 divided by 200 units)
Likewise, let us assume that the money supply increases to two
thousand dollars while the ability of the market to produce goods
remains the same at one hundred units. Then the market-clearing
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Patrick Barron, an Austrian Economist
An Austrian Economic View of the World
Showing posts with label Monetary Issues. Show all posts
2 009 (5 3 )
About Me
P A TRICKBA RRON @MSN. COM
WEST CHESTER, P A ,
UN ITED STA TES
Pat r ick Ba r r on has been a
consult ant t o t he banking
indust r y since 1 985 . He
t eaches Bank
Management Simulat ion
at t he Gr aduat e School of
Banking, Univ er sit y of
Wisconsin, Madison a nd
Aust r ian Economics at
t he Univ er sit y of Iowa.
He has cont r ibut ed a
weekly essay in t he
Aust r ian v ein t o The
Bullet in, Philadelphia
since 2006. As pr esident
of t he Right Appr oach
Gr oup, which offer s fr ee
mar ket solut ions t o
cur r ent economic
pr oblem, he has spoken a t
economic confer ences at
t he EU Pa r liament offices
in Br ussels, Belgium and
St r asbour g, Fr ance.
View my complet e pr ofile
Syndication
price will be twenty dollars per unit. ($2,000 divided by 100 units)
From this simple example one can clearly see that, if we admit that
the U.S. economy produced more goods today than it did twenty
years ago, then the primary reason that prices have not fallen is that
the money supply increased concomitantly. Likewise, if prices are
higher now than they were twenty years ago and real economic
output is essentially the same, then the culprit must be an increase in
the money supply. But most of us grant that the U.S. economy
produces more stuff than twenty years ago. So if the price level is
higher, the only explanation is an increase in the money supply. Had
the money supply remained stable, the only way that the market
could have cleared the larger supply of goods would have been for
prices to fall.
(Since 1990 M2 has increased by a factor of 2.62 while nominal GNP
has increased by 2.57 , which leads one to the conclusion that the
economy has not really grown at all in terms of real goods and
services in two decades. All of the increase in GNP can be attributed
to higher nominal prices caused by an increase in the money supply.)
The Three Uses of Money
The quantity theory of money is at the foundation of understanding
money and prices, and it does explain long-term trends. But other
factors operating within this foundational theory determine market
prices in the short-term. One of those factors is an explanation of the
purposes to which money can be used.
There are three and only three uses for moneyto hold (hoard),
spend, and invest. Of the three, only the combined size of the spend-
and-invest components determines the price level; i.e., spending and
investing are those components of the money supply that are brought
to market to purchase goods available for sale. As the total quantity
of spending and investing increase in relation to the quantity of goods
and services brought to market, prices will increase. If either or both
of these components decrease, prices will decrease. Importantly, if
the money supply increases and all of the increase goes into
hoarding, the price level will remain the same.
Suppose that the Fed printed enough paper money to give everyone
in America one million dollars. Since there are 300 million
Americans, the money supply would increase by 300 trillion dollars!
Surely that would trigger higher prices! But let us also assume that
every American took the money and placed it under his mattress. He
did not spend one cent. What would happen? Well, the money supply
would increase by 300 trillion dollars, but the price level would
remain the same. All the new money would have gone into hoarding
and would have no impact on prices.
An Ever-Changing Money Supply
So far our discussion of how money affects prices assumes that there
is no intervention by an outside, coercive agent that attempts to
manipulate both the total size of the money supply and the three uses
of money. Unfortunately that is not the case. The government
intervenes regularly and inconsistently in monetary matters, making
it almost impossible to point to one or two factors that will have the
most impact on prices.
Post s
All Comment s
The most important interventionist governmental body is the Federal
Reserve Bank, our central bank, which almost always attempts to
expand the money supply. It adds liquidity, mostly by increasing
bank excess reserves. Right behind the Fed is the Treasury
Department, which spends the money. Both attempt in various ways
to stimulate the economy by ensuring that any increases in money go
into the spending and investing buckets and not into the
holding/hoarding bucket. Currently the Fed and the government
want all of the money to go into the spending bucket exclusively, so
that the GDP numbers will rise. You see, the government measures
the size of our economy by how much we spend, so it tries to
manipulate this number in a variety of ways. The cash for clunkers
program is a case in point. If nothing else causes one to question this
whole paradigm, the governments claim that destroying still useful,
but older vehicles adds to our economic well being should end such
naivet.
It is beyond the scope of this article to explain the many ways that
the Fed increases excess reserves and the effect this increase can
have over time on the size of the money supply. Let us just say that
although the Fed has less than perfect control over the money supply
in the short run (and the short run can be years long), it is the size of
total reserves and the reserve requirements that establish the outside
parameters of the money supply. Typically bank excess reserves are
around only $2 billion or less, not a great deal in an economy the size
of ours. As of July 28, 2010 bank excess reserves stood at $1.012
trillion dollars! Since we have a fractional reserve banking system,
the potential exists for banks to expand our money supply by many
multiples of these excess reserves.
Conflicting Government Interventions
But it gets even more complicated! While one department of the Fed
tries to expand the money supply, there is another whose actions
prevent itthe bank examining force. As the left hand of the Fed
hands out reserves to all comers, the right hand ensures that those
reserves will not be converted into money via lending. In fact the
right hand of the Fed--and other bank regulatory agencies, such as
the FDIC--currently exercise a deflationary impact on the money
supply. These agencies are forcing banks to charge off suspect loans
against capital. When a banks capital ratio falls below that required
by bank regulations, the bank has only two choices. It can attempt to
raise capital, a difficult thing to do these days, or it can reduce the
size of its balance sheet by reducing loans outstanding. Loan
reduction has a deflationary effect on the money supply.
Add to this structural issue the fact that there really arent many good
loans out there, which would create new money as desired by the
Feds left hand, and you can see why all that additional liquidity has
yet to reach its potential as the basis of new money. The key word
here is yet. The potential for a massive increase in the money
supply exists, however.
The Risk of Hyperinflation
Now we get a glimpse of what has been happening. The Fed has been
adding liquidity mostly in the form of excess reserves. As yet these
excess reserves have not been employed by the banking system to
support an increase in the money supply via new lending...the bank
examining force has blocked this route. The money that has found its
way into peoples pockets has stayed in peoples pockets--it has been
hoarded. There is no way to predict the end to hoarding, the end to
bank recapitalization, and the end to bank loan problems. But when
these deflationary factors do end, American prices will rise as the
hoarded money and the increased money created by increased
lending flow into spending and/or investing. At that point we will
enter what Ludwig von Mises called the danger zone. No one will
wish to hold depreciating dollars; they will be spent as rapidly as
possible, creating the real possibility of what Mises called the crack-
up boom. Despite the tough talk by Fed Chairman Bernanke, the Fed
will be powerless to prevent this debacle. Money will become
worthless.
Posted by PatrickBarron@msn.com at 7:51 AM No comments:
Labels: Monetary Issues
WEDNESDAY, AUGUST 4 , 2 01 0
Understanding the Relationship between Money and
the Price Level
One of the conundrums of current economic life is why the increase in
the money supply had not caused runaway price inflation.
Furthermore, the federal government has run a one-trillion-dollar
deficit this year, with promises of more for several more years, while
at the same time interest rates have fallen to unprecedented low
levels. Both of these phenomena seem to violate economic law.
Shouldnt more money drive up prices? And shouldnt governments
massive borrowings cause interest rates to rise? Yet prices for most
goods have remained stable and the interest rate is at historic lows.
Has all economic law been shown to be fallacious?
In this essay I will explain the fundamental forces at work to explain
the relationship between the money supply and the price level, which
will, coincidentally, help to explain the low rate of interest. There is
no violation of economic law. The seeming anomalies stem from the
fundamental error of placing economics within the realm of the
physical sciences and not in the realm of the social sciences. The view
of economics as a physical science leads one to the conclusion that
economics is mechanical and can be explained by formulas; whereas
understanding economics as a social science leads one to understand
that human volition cannot be predicted or reduced to mathematical
formula with substantive and temporal exactness.
The Quantity Theory of Money
At the foundation of our understanding of money and prices resides
the quantity theory of money. At this most basic level it is axiomatic
that the price level is the intersection of the quantity of goods for sale
on the market and the amount of money available to purchase these
goods. Prices can rise for only two reasons. One, the quantity of
money rises faster than the quantity of goods for sale. Two, the
quantity of goods for sale drops faster than the quantity of money. Of
course the reverse is true about a falling price level. Prices can fall for
only two reasons. One, the quantity of money falls faster than the
quantity of goods for sale. Two, the quantity of goods rises faster than
the quantity of money.
Lets use a simple example. Assume that there is only one commodity
for sale in the economy. One hundred units of this commodity are
produced. The money supply consists of one thousand units of
currency; well use dollars as our money supply unit. The only price
that will clear the market of all goods offered for sale is ten dollars per
unit. ($1,000 divided by 100 units) Let us suppose that there is a
production improvement that allows the market to produce two
hundred units of the same commodity. Then the market-clearing
price will be five dollars per unit. ($1,000 divided by 200 units)
Likewise, let us assume that the money supply increases to two
thousand dollars while the ability of the market to produce goods
remains the same at one hundred units. Then the market-clearing
price will be twenty dollars per unit. ($2,000 divided by 100 units)
From this simple example one can clearly see that, if we admit that
the U.S. economy produced more goods today than it did twenty
years ago, then the primary reason that prices have not fallen is that
the money supply increased concomitantly. If the money supply had
remained stable, the only way that the market could have cleared the
supply of goods for sale would have been for prices to fall. Since most
price statistics show that prices have not fallen and in fact have risen
somewhat, then the only explanation is that the money supply
increased.
(Although the quantity theory of money knows no definitive author
and has been known for centuries, Professor George Reisman has
written extensively on the subject. I recommend pages 505 and 506
of his magnum opus Capitalism for a brief explanation. Then the
reader can continue elsewhere in this magnificent book for further
and more detailed discussion of money, prices, and production.)
There Are Only Three Uses of Money
Yet my illustration above and recent experience seem to make a
mockery of economic science. I had said that economics was not a
physical science, and yet I used mathematics to illustrate my point.
Is not mathematics a physical science? Furthermore, my illustration
would predict that prices must rise when the money supply increases,
and yet in recent months the money supply HAS increased and prices
have not followed. Should we discard the quantity theory of money?
No. The theory is at the foundation of understanding money and
prices and it does explain long-term trends. (Since 1990 M2 has
increased by a factor of 2.62 while nominal GNP has increased by
2.57 , which leads one to the conclusion that the economy has not
really grown at all in terms of real goods and services in two decades.
All of the increase GNP can be attributed to higher nominal prices
caused by an increase in the money supply.) But other factors
operating within this foundational theory determine market prices in
the short-term.
There are three and only three uses for moneyto hold (hoard),
spend, and invest. Of the three, only the size of the spend-and-invest
components determine the price level; i.e., spending and investing
are those components of the money supply that are brought to
market to purchase goods available for sale. As the total quantity of
spending and investing increase in relation to the quantity of goods
and services brought to market, prices will increase. If either or both
of these components decrease, prices will decrease. Furthermore, if
the money supply increasesthat is, the total of all three uses
increasesand all of the increase goes into hoarding, the price level
will remain the same.
(As is the case with the quantity theory of money, the concept that
there are only three uses of money was not discovered by any single
economist, but I refer the reader to chapter seven of Hans-Hermann
Hoppes The Economics and Ethics of Private Property for an
excellent discussion of the subject.)
Here is an example that I use in my Austrian economics class at the
University of Iowa: Suppose that the Fed printed enough paper
money to give everyone in America one million dollars. Since there
are 300 million Americans, the money supply would increase by 300
trillion dollars! Surely that would trigger higher prices! But let us also
assume that every American took the money and placed it under his
mattress. He did not spend one cent. What would happen? Well, the
money supply would increase by 300 trillion dollars, but the price
level would remain the same. All the new money would have gone
into hoarding and would have no impact on prices.
Now we get a glimpse of what has been happening for several years.
Central banks around the world have been printing money, but most
of this money has been hoarded. When governments spend money
without first borrowing it from the existing monetary stock or taxing
it from the citizenry, the new spending eventually goes into bank
reserves. Since the banks have not increased lending, the money
supply has not increased. As of July 28, 2010 bank excess reserves
stood at $1.012 trillion dollars. This is a form of money hoarding.
Another form of money hoarding is the buying of sovereign debt. For
example, the U.S. government has sold hundreds of billions of dollars
of debt to our trading partners. This happens when foreigners
foolishly believe that running large trade surpluses is somehow a
national advantage. But Frederic Bastiat exploded this fallacy over a
century and a half ago in his essay Government. By holding its
currency cheap in order to export goods, a country impoverishes
itself by shipping useful goods in exchange for depreciating paper
money. Since these foreign governments have no use, so far, for
American products, they buy U.S. Treasury debt in order to park
the money until some future date. This, too, is a form of hoarding,
because the money does not finance spending and/or investing.
The End to Hoarding
There is no way to predict the end to hoarding, but when it comes
American prices will rise: the hoarded money will flow into spending
and/or investing. At some point the hoarded money will burn a hole
in peoples pockets. The first holders of large amounts of American
money will be able to exchange their dollars for goods, services, and
assets at todays prices. But as this hoarded money flows into
spending and investing, prices will start to rise. Other holders of
hoarded U.S. dollars will realize that nothing can stop the
depreciation of the dollar, as illustrated by relentless price increases.
Now we will enter what Ludwig von Mises called the danger zone.
Even if the central banks try to stop the flow of hoarded funds into
spending and investing, they will be unsuccessful because market
psychology has changed. No one will wish to hold depreciating
dollars; they will be spent as rapidly as possible, creating the real
possibility of what Mises called the crack-up boom. Money
becomes worthless.
Just as the psychology of todays market mitigates holding dollars,
once the floodgates have been opened the psychology of the market
will reverse. In The Mystery of Banking Murray N. Rothbard
explained that market psychology can change very slowly, as in
America for the first two decades after World War II, or very rapidly,
as in Germany after World War I, where in 1923 the world witnessed
the worst crack-up boom ever to appear in a modern, industrial
nation. Germany recovered only when it exchanged the old mark for
the new Rentenmark at one trillion old marks for each new
Rentenmark and the Reichsbank pledged to hold the supply of
Rentenmarks stable. When the Reichsbank kept its word gradually the
people regained confidence in their currency. But the damage had
been done. The resources of the middle class had been wiped out,
and, more importantly, the German peoples confidence in social
institutions had been shattered, opening the door to the
demagoguery of National Socialism.
It Cant Happen Here
Americans are no less ruled by the iron laws of economics than are
other, less fortunate peoples. Never in the history of the world has so
dominant a world power engaged in such massive money
debasement. The trillions of dollars held around the world represent
claims upon the productive sector of the U.S. economy that simply
cannot be met--at least not at todays prices. The German
hyperinflation of 1923 wiped out the German governments war
reparation debt, but at the stupendous price of ushering in the
fascists. Likewise, the U.S. could technically pay its national debt by
so devaluing the dollar that it effectively robs dollar holders of their
good faith claims upon American resources. I would remind
xenophobic Americans, who may believe that robbing foreigners is of
no concern, that Americans hold dollar claims, too, and would suffer
just as much, if not more.
At the present time there is no better market alternative to holding
American dollars. All currencies are fiat currencies, managed by the
whim of politicians buying votes with more entitlements. But forces
are building to end American hegemony in monetary affairs. The
Chinese, the Indians, the Arabs, and the Russians are floating rumors
of issuing a gold-backed currency, and the market always rewards a
better product. It would be the greatest tragedy to befall this nation,
if our foolish government destroyed our currency at the height of our
productive capacity, making indirect, peaceful, cooperative
exchange an impossibility. It can happen here!
Posted by PatrickBarron@msn.com at 11:15 AM 2 comments:
Labels: Monetary Issues
THURSDAY, JUNE 1 0, 2 01 0
My Letter to the NY Times re: Blog Prophet of Euro
Zone Doom
From: patrickbarron@msn.com
To: letters@nytimes.com
Subject: Letter-to-the-Editor
Date: Thu, 10 Jun 2010 14:04:01 -0400
re: Blog Prophet of Euro Zone Doom
Dear Sirs:
Mr. Edward Hugh may be correct that the Euro will fail, but it will not
fail as a direct result of cultural differences among its members. It will
fail because the European Central Bank (ECB) succumbed to political
pressure to abandon its primary responsibilities to keep the currency
stable and chose instead to destroy the Euro's purchasing power.
Profligate nations can coexist in the same currency zone as
financially responsible nations, but eventually the profligate nations
will be forced to mend their ways or they will run out of money. This
is good--one of the benefits of a sound money is its use as a unit of
account, revealing when one is accumulating capital and when one is
destroying it.
The Greek financial crisis revealed that nation's path to destruction
much earlier than otherwise because it was on the Euro and could not
hide its problems by debasing the drachma. This was a Greek financial
crisis that is merely denominated in Euros; it was not a Euro crisis. It
became a Euro crisis only when the ECB bought Greek bonds and
forced the European Union (EU) nations to guarantee them against
the will of their citizenry. At that point it became obvious that the
more responsible nations might be forced to leave the Euro Zone by
the overwhelming demands of their citizenry to do so.
It is not true that debasing one's currency is a means to restoring
financial solvency. Debasing the Euro may spur EU exports
temporarily, but it is no long term solution. By making imports
expensive a debased Euro will raise the cost of living for the common
man in Europe and even raise the cost of those imports that are used
as factors of production in export industries.
The world's politicians should abandon their search for a quick
financial fix that does not exist. If some claimed that they have found
one, you can bet that the costs either are hidden or will be borne by
politically unpopular minorities. The EU had a golden opportunity to
allow the free financial market to impose discipline upon the Greek
government. The Greek people should demand that their leaders keep
them in the Euro Zone, because that is the surest and quickest path to
forcing their government to abandon its destructive fiscal policies.
More debt or currency debasement will only hide the problem, make
it bigger, and result in a worse situation in the future.
Patrick Barron
Posted by PatrickBarron@msn.com at 11:16 AM No comments:
Labels: Monetary Issues
TUESDAY, MARCH 2 3 , 2 01 0
My Letter to the NY Times re: China's Currency
Manipulation
Re: China Uses Rules on Global Trade to Its Advantage, by Keith
Bradsher--March 15, 2010
http://www.nytimes.com/2010/03/15/business/global/15yuan.ht
ml?
scp=1&sq=China%20Uses%20Rules%20on%20Global%20Trade&st=c
se
Dear Sirs:
Mr. Bradsher gets the consequences of state currency manipulation
exactly backwards. No country can inflict damage upon another by
manipulating its own currency; all harm accrues to the citizens of that
country alone. By holding its currency weak, China subsidizes
exports at the expense of its own citizens. The citizens of China's
trading partners enjoy cheaper and/or better quality goods, while the
Chinese experience higher prices due to trading more renmindi for
foreign currencies than the unhampered market would allow. In
economic terms this is called "importing inflation". Mr. Bradsher
makes another crucial error when he makes the claim that "unlike
extra government spending in the United States and other countries,
currency intervention does not expand global demand, but shifts it
from other countries to China." No, the process is the same, whether
within one country or among several countries; that is, that
governments cannot increase total demand. Mr. Bradsher describes
perfectly the "fallacy of composition", whereby it is assumed that,
since a government can shower benefits on one economic entity, it
can shower benefits on all economic entities. On the contrary,
government spending rewards some at the expense of others. Neither
currency manipulation nor government spending will increase
resources, but, instead, will transfer them--at a cost, of course--from
some segments of the economy to others. The so-called stimulus
spending in the United States does not increase total demand within
our country any more than China's currency manipulation increases
worldwide total demand.
Patrick Barron
Adjunct Instructor in Austrian Economics
University of Iowa
Iowa City, Iowa
Posted by PatrickBarron@msn.com at 9:03 AM No comments:
Labels: Monetary Issues
FRIDAY, MARCH 1 9 , 2 01 0
Fed Chief Wants to Eliminate Bank Reserves
The link below is a transcript of Federal Reserve Chairman Ben
Bernanke's Feb 10, 2010 testimony to Congress. The last line of the
final note at the end of the letter has the pertinent statement that the
Fed may eliminate reserves completely.
http://www.federalreserve.gov/newsevents/testimony/bernanke20
100210a.htm
Here is my analysis:
With over a trillion dollars in excess reserves right now, the banking
system is not limited by reserves. Since its founding in 1913 the Fed
has steadily destroyed the public's understanding of real money.
Therefore, eliminating reserves fits into the scheme of things as just
another move away from any semblance of sound money.
Without reserve requirements, the banking system would have no
limits to its manufacture of money; therefore, I see this as a step
toward government allocation of credit--the government's ultimate
goal. Because the banks would be in a position to expand credit
without limit, the government could claim that only it has the
foresight and the power to prevent another crisis. This is the banking
system as it was practiced during the communist reign in Eastern
Europe. I taught many East European bankers at the University of
Wisconsin in the late '90's. They related that the role of bankers
during the communist era was simply to implement orders from the
government; that is, allocate so much credit to the steel industry, so
much to agriculture, etc.
If sound money is eliminated and the banks are not required to hold
any reserves, there hardly is any other way to conduct banking.
Posted by PatrickBarron@msn.com at 11:35 AM No comments:
Labels: Monetary Issues , Regulation
MONDAY, MARCH 1 , 2 01 0
THE VELOCITY OF MONEY AND THE BUSINESS
CYCLE
The velocity of money is the one of the factors that determines GDP.
The well-known formula is GDP = M x V; that is, Gross Domestic
Product equals the quantity of Money times its Velocity. Velocity
refers to how many times a given quantity of money is spent during
the period under consideration, usually one year. Less understood is
how changes to moneys velocity come about. The formula makes
clear that a decrease in velocity can adversely affect GDP and vice
versa. But, that just begs the question, what causes changes in
monetary velocity?
The primary determinant of how often a given quantity of money is
spent is the desire of the public to hold money; that is, the publics
demand for money. When demand for money is high, meaning that
the public wishes to hold more money in the form of cash balances,
the velocity of money decreases. Likewise, when the publics demand
for money is low, velocity accelerates. Therefore, we have entered
the realm of perception, which is not an exact science in the sense
that one can establish a formula of the magnitude and time frame for
changes in perception. Nevertheless, it is possible to establish the
factors that eventually will change perception and, therefore, will
cause the demand for money to increase or decrease.
The demand for money is influenced primarily by the quantity of
money. This simple statement reveals something very important
that if the quantity of money changes very little, then the demand for
money will change very little and the economy will experience stable
conditions. Commodity moneythat is, gold and silverexperiences
very small changes in its quantity; therefore, one would expect that
commodity money velocity would change very little. But even in the
days of the gold standard, the demand for money varied. The reason
was that the money supply was not backed one hundred percent by
gold but, rather, only a fraction of the money supply was backed by
gold. The rest of the money supply was anchored in bank loans
instead. As banks increased lending during temporary boom times,
the quantity of the fiduciary media, as Ludwig von Mises called this
money not backed by gold, increased, which caused the demand for
money to decrease and moneys velocity to rise. This is the very
definition of a boom. However, eventually this increase in the money
supply causes prices to rise, among other evils, revealing that the
boom is unsustainable. There does not exist any new, real capital to
fund it.
When bank loans become uncollectable, the quantity of fiduciary
media decreases. Now the demand for money increases dramatically,
as the public scrambles to convert their fiduciary mediabank
checking accounts now of questionable valueinto currency. This
increase in the demand for money causes a decrease in moneys
velocity, exacerbating the bust. The only way out of this predicament
is for prices to fall, so that the remaining, smaller supply of money
will be sufficient to allow the market of goods and services to clear.
All this can take quite some time. In todays fiat money, central bank
monetary system the bust phase can be papered over for quite some
time with increases in fiduciary media. But the demand for money
detects subtle changes, thusly precipitating changes in moneys
velocity. For instance, rising prices are a signal to money holders to
reduce their demand for money. A reduction in money demand
causes its velocity to increase, putting further upward pressure on
prices. If there exist other assets in which the public can easily invest,
then one would expect to see upward price movements. Stock market
and commodity price increases are symptoms of such movements
out of money, reflecting reduced demand for money, furthering an
increase in moneys velocity.
It is typical of such boom periods that credit is readily available.
Businesses, then, are more prone to reduce cash holdings in the
certainty that bank loans can be used as a substitute for ready cash to
meet business needs. This drop in business demand for holding
money is a further spur to an increase in moneys velocity.
Furthermore, since central bank manipulation of the interest rate in a
downward direction was the precipitous cause of the temporary
boom, business has even less incentive to moderate its borrowing in
lieu of holding cash. Better to invest in inventories that may rise in
value than hold cash, especially when loans not only are easy to
obtain but are cheap, too.
Therefore, what economists see as an increase in moneys velocity is
actually a rational decision by market participants to reduce their
demand for money following central bank intervention to lower the
interest rate and ignite a temporary boom. But, when the boom turns
to bust, the reverse happens. Now the market demands more cash at
a time when fiduciary media is being wiped out by bank loan losses.
Prices fall, making it wise to hold cash in the expectation of even
further price reductions. Businesses begin to hoard cash when bank
lending dries up in the face of falling bank capital ratios due to loan
losses. And they stop investing in inventories that become less
valuable each day. Finally, the public bails out of a falling stock and
commodity market in favor of the comfort of cash holdings. Money
velocity drops even more.
In a free market, capitalist economy marked by little government
intervention and the existence of soundthat is, commodity
money, the demand for money and its inverse, the velocity of money,
are of little interest to economists let alone the public. The demand
for money reflects real choices based upon market forces rather than
opportunistic or defensive choices based upon wild, temporary
swings in economic fortunes based upon government and central
bank intervention. Prices change very slowly. Banks are institutions
of probity and practice good asset-liability management; that is, they
match loan maturities to deposit maturities. This may sound dull to
some, but it beats the wild boom/bust cycles that create millionaires
one day and paupers the next.
Posted by PatrickBarron@msn.com at 6:22 AM 1 comment:
Labels: Monetary Issues
MONDAY, FEBRUARY 8, 2 01 0
Deadly Duo: Fiat Money and Fractional Reserve
Banking
The government propaganda machine is in full swing. It denounces
bankers for making bad loans. It proposes more numerous and more
onerous regulations in addition to increasing the bureaucracy to
implement them. The message is that the free enterprise banking
system itself is to blame, that without government regulation there is
nothing to prevent bankers from looting their depositors money in
order to line their own pockets. Bankers make loans that they KNOW
will not be repaid and cannot be repaid, all the while paying
themselves enormous salaries and bonuses. When the house of cards
comes crashing down, the bankers give the bill to the government
and the taxpayers.
All the above is a lie.
The fact is that this current crisis, as with all previous crises in the
past one hundred years, was caused by government interference in
the financial markets. Specifically it is governments creation of fiat
money-- money backed by no commodity; that is, nothing of intrinsic
valuethat is primarily responsible for our economic problems. This
money has two sourcesthe Feds printing press and bank credit
expansion. This deadly duo touches off the boom/bust business
cycle. This business cycle is not something inherent in capitalism. A
commodity based money and a legal prohibition against bank credit
expansion will end these vicious, wealth destroying and, ultimately,
liberty destroying economic crises.
Money is as much a moral as an economic good. Real money is part
and parcel of the market economy. It originates as a widely accepted
commodity that comes to be used, through the market process, as
indirect exchange. As such, its value increases beyond demand for its
intrinsic use to include a new demand as something to be exchanged
later for some other good. Thusly, real money facilitates the
exchange of something for something. This is its moral component.
But fiat moneythat is, money manufactured by the government and
backed by nothingalways enters the monetary system as a
counterfeit something for nothing. There are two corrupt sources of
this counterfeit evil.
The first evil source is Federal Reserve monetization of the
governments debt, meaning that the Fed buys government bonds
with money that it creates out of thin air. Government itself benefits
directly, when, for example, it pays bureaucratic salaries, buys goods
and services, and when it rewards its constituents, such as political
contributors and voters, through earmarked targeted spending. The
first recipients of this new money can purchase goods at the current
lower price. Subsequent recipients pay higher prices, because the
supply of money increased and pushed up the price level.
Furthermore, this money creates even more money via the
fractional reserve banking system. Recipients of government
spending deposit the checks into their bank accounts; then their
banks deposit the checks with the Fed. Bank reserves increase, and
banks are allowed to pyramid around ten times the amount of the new
and excessive reserves into new loans. These new loans are matched,
dollar for dollar, with an increase in the money supply, because banks
lend money by crediting the borrowers checking account. The
borrowers spend the money, of coursethat is why they borrowed it
in the first place. Thusly, bank credit expansion creates new money
based upon DEBT. We shall see shortly how fragile this system can be.
Thus far, bank credit expansion has triggered a boom. New projects
are started, because the increased quantity of money lowers the
interest rate, making long term projectsthose for which the cost of
funds is most importantnow appear to be feasible. Factories
expand, mines open, etc., all of which may take years before bearing
any real fruit. The problem is that the consumer has not changed his
spending habits. He has NOT decided to save more. He purchases
immediate, consumer-type goods in the same relationship to his
savings as before. In fact the boom may prompt him actually to
increase his consumption-to-savings ratio. Therefore, there is no new
capital for the successful and profitable completion of these longer-
term projects, so these malinvestments must be abandoned. Since
the projects are abandoned, they never generate revenue for paying
off their bank loans. As loans default, the money supply drops,
because a large component of the malinvestment was funded by loan
generation--when the loans fail, the money disappears.
Now the banks are in trouble. Their capital is reduced dollar for dollar
by the loan defaults. It is foolish to ask them to resume lending,
because their capital-to-asset ratio is so low. They must build capital
before they can begin lending again. But this is not the worst
consequence of building the money supply out of debt. The reduction
of the money supply reduces overall spending in the economy. This
impacts even businesses that did not expand and that previously
were healthy and profitable. Their revenue decreases too, driving
them to unprofitability. The total amount of goods and services in the
economy cannot be sold with this lower volume of spending UNLESS
PRICES DROP. Therefore, it is crucial that government do nothing to
prevent prices, including the price of labor, from falling. Only a lower
price level can bring the economys supply of goods and services into
equilibrium with less money. As Professor George Reisman of
Pepperdine University has explained, falling prices are the antidote
to deflation (where deflation is defined as a fall in the supply of
money).
Perversely, the government recently raised the minimum wage and
gave Fannie Mae and Freddie Mac its UNLIMITED guarantee!
Governments current attempts to prop up prices are doomed to
failure. Supply can clear only at lower prices. The malinvestment,
especially in housing, must be allowed to liquidate on as good terms
as current owners, mostly developers, can get. There is an excessive
supply of housing in the economy in relation to other necessary
goods. Reports of government efforts to revive housing are
indications that government is thwarting the necessary correction
via its many bailout programs. A more encouraging report would be
that the price of housing is falling precipitously. This would be
welcome news to all seeking housingdont we all love a sale?
We are doomed to repeat these boom and bust cycles, probably with
even greater intensity due to governments foolish interventions, as
long as government can print money out of thin air and banks can
create even more money out of debt. No regulations can prevent this
cycle. In fact some government agencies, such as Fannie Mae and
Freddie Mac, are trying to rekindle the boom while other government
agencies, such as bank regulators, claim that they can so regulate
bank lending to prevent any future malinvestment. This is impossible.
The problem lies in the very nature of the monetary system, which
sends false signals to bankers and bank regulators alike, inducing
them to fuel another unsustainable boom. Money is lent on the cheap
to precipitate projects for which no real new capital exists. This
money built on debt will vanish as it has in the past, wiping out the
hopes and dreams of tens of millions. The lower quantity of money
means that total spending will be inadequate to clear the production
side of the economy at current, boom-induced high prices. Yet, even
though lower prices are the only cure, government and organized
labor fight this cure tooth and nail.
The answer lies in driving a stake through the heart of this deadly
duo. First of all, return to commodity money, most likely gold. Gold
money can be neither created nor destroyed. Once brought into
circulation, gold money remains in circulation. Total spending
remains the same; only prices changeusually downward, based
upon productivity gainsvery gradually over time. Next, prohibit
banks from engaging in fractional reserve banking. All money must be
backed one hundred percent by gold. Loans must be based upon the
transfer of gold from saver to borrower via a professional banking
system, which exacts a small profit for its intermediation services.
There is no role for government in this system beyond insuring that
banks do not engage in fraud by lending out more money than they
have gold on deposit. Government should not insure deposits or
regulate lending in any way. There is no role for a central bank in this
system either. This is laissez faire banking based upon market
generated money. This is freedom. This is the cure.
Posted by PatrickBarron@msn.com at 1:06 PM 1 comment:
Labels: Monetary Issues
SATURDAY, DECEMBER 1 9 , 2 009
The Path to Sound Money and a Vibrant Economy
The greatest challenge facing the United States and Western
Civilizationwhich includes all those countries engaged in
international trade in order to facilitate social cooperation through
the division of laboris the destruction of money by central banks
who have the power to expand their fiat money supply to unlimited
proportions. Such fiat money expansion destroys the usefulness of
money as a vehicle for communicating value through time and space.
What will the dollar be worth in terms of apples and oranges in the
future and around the world? No one knows, even when we may
predict with a great deal of certainty the quantity of apples and
oranges that will be produced in the future and market demand for
them. It is not the quantity of apples and oranges that makes future
exchange problematic; it is the quantity of money that makes it so.
Because societies have recognized that only a stable quantity of
money may perform these crucial services to the economy has
money always been a commodity itself with certain characteristics,
chiefly among them being its scarcity in nature. For, as Ludwig von
Mises has explained, any quantity of money may serve all the
functions that are required of money regardless of the size or
complexity of the economy. It is the crucial characteristic of scarcity
that is, its quantitythat has been undermined by central banks.
Already we have seen the deleterious effects of this debasement of
money in the form of repeated and ever more violent boom-bust
business cycles. These cycles are the external manifestation of sick
money; they are NOT the external manifestation of excessive greed
or any other failing of societys citizenry. Sick money has
transmitted its disease to society, not the other way around.
Therefore, it is imperative that the United States and other Western
nations end the expansion of their money supplies and re-anchor
them in some commodity of lasting value, namely gold, silver, or
some combination of the two. Buthow can this be done? That is the
crucial questionthe elephant in the living room, so to speak.
Let us first establish that the goal of any currency reform is to end at a
stroke the further expansion of the money supply. The expansion of
money confers no societal benefit whatsoever. More money does not
bring into existence, either in the near term or in the longer term,
more goods and services than would be produced without its
expansion. The truth of this statement lies in its logic and also in
historical experience. But these are subjects for another day. The
important point is that ANY further expansion of the money supply
causes harm; therefore, it is not a question of gradually reducing the
expansion of money. No, we must stop any further expansion by even
a very small amount.
First, End Fed and Bank Fiat Money Expansion
In our current fiat money environment, two institutions have the
legal ability to expand the supply of moneythe Federal Reserve
Bank (the U.S. central bank) and commercial banks. Most people
understand that the Fed can increase the money supply, but few
understand that privately owned banks themselves also have the
legal ability to increase the money supply. Although the manner in
which money expands can be rather complicated (and needlessly so),
I will explain the basics. The Fed can inject money into the economy
by monetizing the federal debt; that is, it accepts the governments
promissory notes and credits its checking account. Then the federal
government spends the money. This in itself increases the supply of
money, as can be easily understood, but there is more. When the
recipients of the governments money deposit their checks, bank
reserves increase when the bank of deposit sends the check to the Fed
for deposit in its reserve account (a checking account at the Fed that
is owned by the commercial, private bank. The Fed is the bankers
bank.) Now the banking system has excess reserves upon which to
pyramid more loans and deposits by a magnitude of from ten times to
over one hundred times! All the bank must do is make a loan and
credit the loan customers checking account. It is restricted in the
extent to which it may expand its loans and deposits (in equal
amounts) only by the amount of its excess reserves. Remember, the
Fed created excess reserves when it monetized the governments
debt. Here lies the dangerunder normal conditions banks try to
remain completely loaned up, utilizing every penny of their excess
reserves by making loans and, in the process, creating money out of
thin air. In our large economy, excess reserves normally amount to
fewer than two billion dollars, an amount considered to be the
frictional amount that cannot be fully utilized. Over the past year the
Fed has injected massive reserves into the banking system, and now
excess reserves stand at over a TRILLION dollars, or five hundred
times the historically normal amount!
The Reisman First Step to Neutralizing Excess Reserves
At a Mises Institute Seminar in Long Beach, CA last month, Professor
George Reisman presented an intriguing plan to prevent the banks
from expanding their lending against this massive amount of excess
reserves. He recommended that the Fed create even more reserves!
But heres the twistthe Fed should insert enough reserves of fiat
money into the banking system to equal the current level of bank
checking accounts, BUT at the same time also require 100% fiat
reserves against those checking accounts and prohibit the Fed from
creating any more reserves thereafter. This step would do two things.
Number one, and most importantly, the banks would not be able to
convert those trillion dollars in excess reserves into ten to one
hundred trillion dollars of new money. Secondly, it would force the
federal government either to tax the people for what it spends or
borrow honestly from them. Either method would create a natural
limit on government spending, forcing it to prioritize and moderate
its plans to those more in line with societys means.
The Barron Second Step--Convert Fiat Money to
Commodity Money
Governments cannot be trusted to refrain from violating their own
laws. They do so, of course, by passing another law to suspend
temporarily the previous law which put what it considers to be an
undue restraint upon its actions. Therefore, we must return to
commodity rather than fiat money. The government could do this by
simple arithmetic; it could divide the money supply by the number of
ounces of gold it holds to establish a legally binding exchange rate of
dollars for gold. Currently the most widely used definition of money
M2stands at $8.4 trillion, and the government owns 260 million
ounces of gold. Therefore, it could provide 100% backing of M2 with
gold by agreeing to pay out an ounce of gold for $32,308 and,
conversely, to buy gold for the same amount. Presently the price of
gold has fluctuated between $1,000 and $1,200 per ounce, so a
decision to support the dollar at this dollar-to-gold ratio would have
unknown economic consequences. Better for the government to
establish the ratio at a level closer to the current market level for
non-monetary gold. But how can the government do this? If it prints
more money to buy gold in the open market, it would not solve its
problemit would have even more fiat dollars to back by the new
quantities of gold it received. But, the government has other
resources! The government is like a cash-poor but property rich
relative--it owns vast expanses of valuable land. In fact the
government owns roughly 30% of the landmass of the United States,
mostly in sparsely populated areas west of the Mississippi and in
Alaska. This is its ace-in-the-hole.
Selling Government Land for Gold Is Doubly Beneficial!
The government has no just cause for owning more land that its
normal day-to-day operations require, such as enough land for its
military bases and other government office buildings. Its ownership
of lands in the western United States and in Alaska has prevented the
development of the resources on these lands for the benefit of the
U.S. citizens and the world. Like an anorexic who prefers to starve
with nutritious food close at hand, the government refuses to allow
the development of valuable resources from its land holdings to feed
the resource starved economy of the United States. These lands are
potentially the most valuable on the face of the earth. Not only do
they hold much mineral and vegetable wealth, but they are located in
a capitalist country of entrepreneurs, skilled workers, an honest
court system, good infrastructurein essence, all the factors
necessary for successful capitalist development. So, not only would
the sale of government land for gold allow for the backing of the U.S.
dollar by more ounces of gold and, therefore, ease the transition to a
100% gold standard at a better dollar to gold ratio, it would unleash
the productive capacity of 30% of the nations land resource! This is
not rape of the land any more than a farmer rapes his fertile soil or a
timber company rapes its well-managed forests. Selling land allows it
to be capitalized and managed for productive benefit into perpetuity,
the opposite of governments so-called management, which is nothing
more than locking land away as if it did not exist.
In conclusion, the U.S. can quickly take the necessary steps to return
to sound money and at the same time unleash a new, real economic
boom. It needs to take steps first to freeze expansion of the money
supply, followed by a judicious sale over time of its valuable land
holdings for gold. The gold proceeds of the sale would allow the
government to back its currency 100% by gold at fewer dollars per
ounce. The U.S. would once again have the worlds strongest
currency and most productive economy. There is nothing preventing
us from taking this action but our own foolish adherence to failed
economic theory.
Posted by PatrickBarron@msn.com at 1:04 PM No comments:
Labels: Monetary Issues
MONDAY, NOVEMBER 9 , 2 009
Reserves Poised to Destroy the Dollar
Our prosperity rests upon cooperation under the division of labor.
We all produce just one or a few things, but we produce them in
massive quantities. Our productivity rests upon capital accumulation
applied to our work. We command the output of others work efforts
by use of money, the indirect medium of exchange. Without money
we would be reduced to a primitive barter economy. Most of us
would die. This is the bald fact about the need for a money economy.
The Price Level Determined by the Supply and Demand for
Money
How much money is required to purchase the output of society is
called the price level, which is determined, in broad terms, by only
two thingsthe quantity of goods available for sale and the quantity
of money available for purchasing societys output. Because we use
money as the mechanism for exchanging the goods and services
produced in our division of labor society, economists refer to the
price level as being determined by the supply and demand for money.
But this does not change the nature of the issue. Money merely
represents the value the market places upon previously produced
goods. Rather than price things in terms of the number of apples an
apple grower must exchange in order to purchase his necessities, he
uses money. Therefore, its quantity and its demand determine the
purchasing power of money.
Says Law Explains Purchasing Power
Jean Baptiste Say explained this as clearly as anyone, when he stated
that all economic activity tends toward the equilibrium level at which
all supply is demanded by purchasers. Most people understand this
economic lawSays Lawas supply creates its own demand. This is
merely shorthand for explaining that it is what we produce that
becomes the means by which we buy things. Instead of the apple
grower exchanging apples for a necessity, he sells his apples for
money and then buys his necessities with that money. Money is the
intermediate exchange mechanism, but it was his apple production
that gave the apple grower purchasing power in the market.
One can now understand the importance of money. Not only do we
need something to use for intermediate exchange, but its quantity is
critically important too. Expanding the quantity of money provides
society with no utility; it merely lowers its purchasing power on the
market, disrupting commerce and making it more difficult to plan for
our economic future. If we do not know what money will buy in the
futurebecause its supply has been expanded or may be expanded
arbitrarily to some unknown levelthen investment in long term
production processes becomes very risky and we get less of it. And
the only way to have more goods available in the future is to expand
long term production.
One can see from the above brief discussion of the nature of money as
a medium of exchange that it is crucial that the quantity of money
remain stable in order for it to provide us with its primary service,
which is as a communication mechanism of peoples preferences not
only in the near term but also in the future. Unfortunately, it is the
quantity of money that is under severe attack today.
Expanding Reserves Means Expanding Money Supply
The quantity of money available in the U.S. is controlled by our
central bank, the Federal Reserve Bank (the Fed). Its primary means
of control is by manipulating bank reserves, either by changing the
ratio of reserves banks must keep at the Fed (increasing the reserve
ratio would be deflationary and decreasing the reserve ratio would be
inflationary) or by adding to or subtracting from the level of bank
reserves. The latter method is the more important of the two. There
are several methods that the Fed uses to add to bank reserves--but it
is not important to explain HOW the Fed adds reserves as is the fact
that the Fed has added MASSIVELY to bank reserves in the past year
and continues to add to reserves. The outcome could be catastrophic.
Here are some statistics taken from the Feds own website. I will
explain their importance further down. All numbers are billions of
dollars.
M2 (Cash, checking accounts, savings and money market accounts):
$8,333
Total Reserves: $1,122
Required Reserves $62
Excess Reserves $1,060
Notice the level of excess reserves. These are reserves of the banks
that may be used in the future to increase the money supply.
Currently the level of required reserves is only $62 billion to
support $8,333 billion of the most widely used measure of the money
supply--M2. This means that the ratio of reserves to money is only
.7 4%-- less than one percent. Under normal circumstances the
amount of excess reserves banks hold is around $2 billion; this small
amount relative to our money supply being considered the frictional
amount that cannot be utilized in a dynamic banking system. Excess
reserves are now a whooping $1,060 billion! Just consider this fact: if
a money supply (as defined by M2) of $8,333 billion can be
supported by required reserves of only $62 billion, then the
current level of total reserves--$1,122 billionwill support a money
supply of $149,7 84 billion, eighteen times the current level!
Remember our discussion earlier about how the price level is
determined by the quantity of money and the demand for money,
where the quantity of money commands all the supply of a societys
output (its demand, as we now understand it according to Says
Law). If the quantity of money can expand by a factor of eighteen, the
price level will expand right along with it, because no one expects
Americas output--as measured in the number of real things, not its
inflated monetary valueto expand by eighteen times its current
level. If anything, the environmental movement has brainwashed a
large percentage of our citizens to oppose any increase in American
production as harmful to Mother Earth. But this is another issue.
End the Fed
Since the establishment of the Fed in 1913, there has been only one
prolonged time period in which the banks kept a significant amount of
excess reserves. You guessed itthe Great Depression years of the
1930s. It is in their nature for banks to expand lending, which
concomitantly expands the money supply, until all of the excess
reserves become part of their required reserves. This is how banks
expand their business and their profits.
The current very high level of excess reserves means that there is
no institutional brake upon hyperinflation. The level of bureaucratic
irresponsibility at the Fed is bewildering, since the Feds primary
commission is to safeguard our money. If the Fed bureaucrats have
so inflated reserves to the level that our money supply can increase
by eighteen times its current level, one is left to conclude either that
they are hopelessly incompetent or that there is some malevolent
intent to throw the nation, and the world, into chaos. Whatever the
reason, we now can see clearly why there is a growing movement in
America to End the Fed. For so many reasons in addition to the
primary one I have discussed here, the Fed has become what
President Andrew Jackson called a corrupt institution. Jackson did,
in fact, End the Fed of his era, the Second Bank of the United States.
His was a heroic effort that took both terms of his very popular
presidency. Ours is a much more difficult task, since our president
shows little understanding of the danger the Fed posses to the
American economy and may actually be in favor of taking advantage
of the corrupting powers of the Fed, such as the ability of government
to spend without taxation or honest borrowing in private financial
markets.
Posted by PatrickBarron@msn.com at 11:58 AM No comments:
Labels: Monetary Issues
FRIDAY, AUGUST 2 8, 2 009
WHAT IS FRACTIONAL RESERVE BANKING? And
why do most Austrian economists want to end it?
There are few things more misunderstood than the practice of
fractional reserve banking and its impact on our economy. There are
reputable Austrian economists on both sides of this issue. Most, like
myself, believe fractional reserve banking to be fraud and injurious to
the efficient and ethical working of the economy. (Read Jorg Guido
Hulsmanns excellent The Ethics of Money Production, available at
the online bookstore at Mises.org.) Others, such as Ludwig von Mises
himself, would not ban fractional reserve banking but would allow the
market to regulate it. Mises was more concerned with the prospect of
government intervention in the monetary system and feared that
laws against fractional reserve banking would be the camels nose
under the tent mitigating in favor of more regulation.
It is difficult to understand fractional reserve banking without
understanding some of the history of banking and how fractional
reserves originated, for our current system maintains a fiction that
has long since been made irrelevant. That irrelevancy is that
something of lasting value backs our money; that is, something that
would exist even if the nation/state that issued the monetary unit
ceased to exist. Think of the difference in value between a gold coin of
ancient Rome and the Confederate dollar, for example.
Fractional Reserves and Bank Runs
Historically banks came into existence as warehouses for gold and
other precious commodities. Gold has always been a universal
medium of exchange, even when other commodities competed with it
for acceptance in the market. The first bankers were goldsmiths, who
owned safes in which to store the raw materials of their profession.
Wealthy individuals paid goldsmiths a fee to store their gold, and
goldsmiths issued them receipts. Eventually these individuals started
using the warehouse receipts as fiduciary media; meaning that rather
than go to the goldsmith and redeem ones gold in order to purchase
something, these individuals started endorsing over their warehouse
receipts. Thusly, the warehouse receipts circulated in the economy
rather than the gold itself. Over time the goldsmiths realized that they
could issue warehouse receipts in excess of the gold held in their
vaults and reap a profit, because at no time did all the people who
owned warehouse receipts for gold travel to the bank at the same
time to redeem their certificates for gold specie. Now, the goldsmiths
did not simply spend the excess receipts on consumer goods; rather,
they lent them to borrowers and earned interest. (Doubtless the
goldsmiths and even some economists today do not consider this
practice to be fraud.) Since there now were more warehouse receipts
for gold circulating in the market than gold in the vault to back them,
it was said that the gold reserves amounted to only a fraction of the
outstanding claims. Notice that two things had happened. One, the
goldsmith gains from his fraud; that is, he made a profit (if the loan
was repaid on time) from the use of goods that he did not own. Two,
the money supply increased by the amount of the excess warehouse
receipts. However, the money supply could not increase by very
much, as we shall see.
The goldsmith, now transformed into a banker, was limited by the
market in how many fractional reserve receipts he could issue. All
would be well until the public became concerned that the bank had
over-issued certificates. (Sometimes rumors were started by his
competitors.) Then the holders of the certificates would run to the
bank to redeem them for gold. A bank run had been born. Then the
banks only course of action was to call in its loans, get paid in gold,
and then pay its depositors in gold. If his borrowers could not repay,
the banker would be forced to declare bankruptcy.
Sound Money and Credit Money
Notice that the certificates backed 100% by gold could always be
redeemed without any difficulty. Thusly, such money could never be
the source of inflation or deflation. But the excess certificates were
not back 100% by gold; they were backed by the promise of the
borrower to repay--that is, this money was backed by DEBT! If the
debt could not be repaid, these excess money certificates could not
be redeemed for gold. The money supplycomposed of
indistinguishable certificates, some backed 100% by gold and some
backed only by debthad been expanded when the goldsmith issued
the excess certificates. Now the money supply shrank back to its
former, sounder level.
Of course, money certificates today are backed by nothingnot gold,
nor silver, nor cockleshells. The money we use is fiat money, and yet
governments everywhere maintain the fiction that banks must hold
reserves in some small percentage amount in order to cover their
customers deposits. But what are these reserves? These reserves are
debt, too. Let me explain.
The Basis of All Fiat Money Is Debt
In the U.S. the only money that may be used legally for all debts
public and private is a Federal Reserve note. These notesthe
money we carry in our walletsare referred to as standard money.
There is no recourse to anything beyond these paper notes. If a
person wished to redeem his Federal Reserve note, he could go to
the nearest Federal Reserve Bank and redeem it foranother Federal
Reserve note. It might be one that was brand new off the printing
press, but it would be the same type of note. If that person deposited
his Federal Reserve note in a bank, the bank would create a demand
deposit, also known as a checking account. The bank would send to
the Federal Reserve Bank the Federal Reserve notes that it collected
whose numbers were above what it deemed necessary to meet the
normal needs of its customers for pocket cash. These notes would be
deposited in the banks reserve account at the Fed. (A banks reserve
account is nothing more than a checking account.) But the bank
would not be required to maintain a 100% reserve account balance to
match the total of all of its demand deposits. It is required to hold
only a fraction in reserve--along a sliding scale, the fraction becoming
greater for larger banks--to meet the withdrawal needs of its
customers. The rest of his reserve account balance is excess,
meaning not required to meet his reserve requirement.
Excess Reserves Become the Building Blocks of the Money
Supply
So what can a bank do with its excess reserves? It can create a loan
to another of its customers, credit that customers demand account,
which will increase its reserve requirement and reduce its excess
reserve position at the Fed by a fraction of the amount of the loan.
The bankactually, the banking system--can continue to lend and
create demand deposits in this fashion until its reserve account
balance matches its reserve requirement. This is how banks create
money out of thin air, and one can readily understand the enormous
ability of the banks to expand the money supply from this updated
fractional reserve banking practice.
The key point is that the bank created the new demand deposit by
creating a loanthe loan is an asset on the banks books and the
demand deposit is a liability. Thusly, money in our bright new world
of fractional reserve banking is backed by DEBT! In order for a
deposit to be redeemed would require that the loan be repaid. If the
loan cannot be repaid, the bank cannot meet its withdrawal
obligations and goes bankrupt. This has been the cause of bank
failures since the inception of modern banking.
The Central Bank Creates Reserves and Makes the Banks
Bankrupt-Proof
But, enter a new player--the central bank. Our Federal Reserve Bank
(or European Central Bank, or Bank of England, or Bank of Japan, or
Bank of China) was created to prevent bank insolvency. The central
bank stands ready to loan our bank unlimited funds so that it may
honor its deposit withdrawal obligations. There are several ways that
the central bank can accomplish this, such as purchasing bank assets
or simply by a direct loan (called the discount window). It really
doesnt matter as long as the Fed can place the proceeds in the
reserve account of our troubled bank. Ah, but where did the Fed get
the funds to place in our troubled banks reserve account? Why, it
created them out of thin air, too! For example, it can credit the
federal governments checking account in exchange for federal debt
called monetizing the federal debtor it can buy assets as discussed
above, or it can lend directly to the banks at favorable terms. The
central bank has become a money creation machine.
A Thing of Frightening Beautya Siren Song to Bankers and
Politicians
Thusly, all central banks are the source of what the public calls
inflation, creating money out of thin air to prop up bank credit
expansion made possible by fractional reserve banking. The entire
Rube Goldberg mechanism is a thing of frightening beauty, beloved
by college professors who force their students to understand all the
gory details, but especially beloved by bankers and politicians who
can literally paper over bad debt with massive increases in the money
supply. It does seem as if we have entered a new era in which it can be
made impossible for banks to go bankrupt and fail to pay off their
depositors. The central bank need only to invent some new rationale
for replenishing the troubled banks reserve accounts; thus, the
Troubled Asset Relief Program (TARP) and other such programs were
born. The long-term harm to the economy is found on many fronts,
from higher prices (perhaps even hyperinflation) to moral hazard to
civic unrest as interest groups fight one another to feed at the
governments feed trough. Each dollar of new money, born of debt
and not production, reduces the purchasing power of all other dollars
already circulating in the economy. Nothing has been produced, not
one nut or bolt, not one new carnothing. But more money creates
the temporary illusion of prosperity. Ones home increases in value.
Ones 401K increases in value. Jobs are plentiful. New office buildings
pop up to house all the new businesses that are born. The only
problem is that nothing has been built on true savings, only debt.
Yes, it is a brand new world, but it is a frightening one that cannot
last.
Posted by PatrickBarron@msn.com at 5:16 PM 2 comments:
Labels: Monetary Issues
TUESDAY, AUGUST 2 5, 2 009
A Glimpse of Things to Come
Officials from the Federal Reserve Bank are touring the countryvery
quietly, it turns outto gauge populist opinion of its handling of the
current financial crisis and to garner support to increase its
regulatory power to become the sole financial regulator in the
country. I attended one such event in Des Moines, Iowa, which was
hosted by Iowa Citizens for Community Improvement (CCI). This
group has been around for several decades and is aligned with a
national organization called National Peoples Action (NPA). NPA
claims to have been instrumental in passing the Community
Reinvestment Act in the 197 0s, which extorted banks to make loans
to those with less than stellar credit records and to make mortgages
on properties in blighted areas. Both CCI and NPA are proud of their
achievements and see no linkage between their lobbying efforts to
force banks to make marginal loans and the resulting sub-prime
lending crisis.
Several hundred peoplemy estimate is at least five hundred
crowded into a Des Moines church and sat for two and a half hours
while CCI and NPA officials berated the hapless consumer affairs
representatives from the Federal Reserve Banks Board of Governors
in Washington, D.C. and consumer affairs representatives from the
Federal Reserve Bank of Chicago, the local Fed office for Des Moines.
About a dozen people were paraded before the Fed panel, telling their
tale of financial woe. In this day of the tell-all reality show, no one
seems embarrassed to confess his personal financial ineptitude in
front of hundreds of people and the recording cameras. And sorry
tales these were. And like all tell-all reality shows, no one took
personal responsibility for his actions, which was just fine with CCI
and NPA.
The Link Between Personal Irresponsibility and Big
Government
A Ms. Kathleen Keest, currently of the Center for Responsible Lending
and a CCI board member from its founding in the 197 0s, listed four
supposed fallacies that prevent the common man from getting his fair
share of societys goodies: the acceptance of personal responsibility,
the desire for personal choice, concern over unintended
consequences, and the free market. According to Ms. Keest, all four
are false gods. It is impossible for man to take personal responsibility
for something as complex and important as borrowing money;
personal financial planning is too complex to allow the common man
to exercise his free choice; the concern over the unintended
consequences of government action should be dismissed out of hand;
and, the free market is the cause of all our problems in the first place.
Now, consider how wonderfully Ms. Keests analysis dovetails into
the Feds desire to increase its power. True, the poor punching bags
from the Feds consumer affairs offices had a rather nasty day being
yelled at for over two hours, but the benefit is that Ms. Keest and the
other professional busybodies actually called for INCREASING THE
FEDS POWERS! Undergoing hours of tongue-lashings is worth the
price of obtaining even more power and bigger budgets.
Of course most of those in attendance at this meeting did not
understand that the Fed itself is the underlying cause of our
problems. Speaker after speaker laid the blame squarely on the
shoulders of the lenders, who forced their money upon an
unsuspecting public, all the while knowing that the public could not
repay the loans. The logic of this argument is so ridiculous that I will
not take the time to refute it. But let me at least point out that all the
many regulatory agencies also failed to detect the crime of
irresponsible lending at its inception. Now everyones hindsight
vision is 20/20.
Despite the fact that few in the audience understood that massive
money expansion, which led to massive credit expansion, was at the
heart of the current crisis, there is one thing that everyone
understood perfectly clearly; that is, that the Fed has enormous
power to transfer wealth. Speaker after speaker stated this fact as the
reason for inviting the Fed to the meetingthey all want the Fed to
shower its benevolence upon themselves and not others. The
common mantra was that it is time for the Fed to help Main Street and
not Wall Street. The Fed bailed out Wall Street and now all the big
banks are paying big executive bonuses with their bailout money. Its
time for the same thing to happen on Main Street. Exactly what this
means was not made clear, and I believe it was left unclear on
purpose, so as not to alienate potential allies in calls for more money
creation and more government economic intervention.
The Slippery Slope to Tyranny
This travesty of a supposed public meeting to gain the peoples input
perfectly illustrates the kind of society to which we are plunging
headlong. It has taken the demagogues a hundred years to realize that
control of the money supply is control of people. Therefore, special
interest groups like CCI and NPA do not focus their efforts on the
peoples representatives. They lobby for increasing the power of
government agencies who then can be browbeaten into doing their
bidding. One of the most frightening moments of the meeting
occurred when a George Goehl, executive director of NPA, whipped
the crowd into a frenzy by showing a short video of NPA
demonstrating in front of Fed Chairman Bernankes Washington, D.C.
home. The demonstrators eventually obtained a promise from
Bernankes Secret Service bodyguards that they would deliver a list of
demands to the Fed chairman. Then Mr. Goehl told the audience that
just hours before the meeting we were attending he had exacted a
promise from the Fed consumer affairs representatives that Fed
representatives would meet several times a year with CCI and NPA
representatives. The audience cheered wildly and Mr. Goehl basked
in the adulation.
So, welcome to the future, where public policy will be made by non-
elected bureaucrats who make deals with special interest groups who
intimidate public officials in their private homes. Do our bidding and
we will support your efforts to obtain greater power and prestige for
yourselves. Of course, you must give us what we want and not what
other special interest groups want. Like the Bolshevik revolution in
Russia, the most radical groups will work cooperatively with other
special interest groups, such as farmers and small businessmen, to
form a coalition with greater lobbying power. But such coalitions are
temporary. The most radical groups will take over, just as the most
radical and charismatic members will take over the surviving
pressure group. This is consistent with Friedrich Hayeks explanation
of why the worst rise to the top in politicsonly the most amoral
individuals lacking all concern for the rights of others are willing to
persecute their fellow man in the name of some supposedly greater
societal good.
But, of course, there is no greater societal good that justifies the use
of power and coercion to control the lives of the many for the benefit
of the few. Ms. Keest and Mr. Goehl struck me as of the type who
always rise when a foolish people are willing to give control over their
lives to self-designated masters in the hope of trading freedom for
security. It is only just that such a people lose both their freedom and
their security.
Posted by PatrickBarron@msn.com at 9:43 AM 9 comments:
Labels: Monetary Issues
WEDNESDAY, JUNE 1 0, 2 009
Dumping the Dollara Case of Government
Schizophrenia
(This essay was written in collaboration with Benjamin Harnwell,
Secretary General of the Working Group on Human Dignity, European
Parliament)
Many economists, both inside and outside of government, are very
worried that foreign governments may dump their dollar holdings,
touching off massive price increases in the U.S. and possibly bringing
down our financial system. It is a real danger.
According to the U.S. Treasury Departments own figures, as of June
of 2008 foreigners hold over $10 trillion as currency reserves. China
and Japan each hold $1.2 trillion. The U.K. holds $.8 trillion. Tiny
Luxembourg and Ireland hold $.6 and $.4 trillion respectively! Even
Russia holds huge amounts of dollarsover $.2 trillion.
Contrast these overseas dollar holdings with the Feds official tally of
the domestic money supply as of April 2009. M1 (currency and other
checkable deposits) totaled $1.6 trillion. M2 (M1 plus savings, money
market funds, and small time deposits) totaled $8.3 trillion. So even
compared to the most expansive measure of the domestic U.S. money
supply (M2) foreigners hold more dollars than domestic holders.
If any country with significant dollar holdings decided to dump them
for some other currency, the result would be inflation in the U.S. on
par with the worst days of the Carter administration and, if panic sets
in and others join, hyperinflation and the destruction of our
economy.
Jorg Guido Hulsmann explains the process with this example in The
Ethics of Money Production. (Just insert the name "China" or "Japan"
for his hypothetical country Ruritania.)
"If we assume that Ruritania is a very large country with substantial
dollar reserves even by world standards, then the mere
announcement that the Ruritanian government will switch to the
euro standard might incite other member countries of the dollar
standard to do the same. This could precipitate the dollar into a
spiraling hyperinflation. The dollars would sooner or later end up in
the United States, the only country where people are forced to accept
them because of their legal-tender status. Here all prices would soar,
possibly entailing a hyperinflation and collapse of the entire
monetary system." (Pages 232/3)
As Hulsmann explains, the "leadership of the U.S. Federal Reserve is
aware of this situation." (Page 233) OK. Thats reassuring. But if U.S.
officials are concerned about the terrible consequences of a
POSSIBLE dumping of dollars on the U.S. market, why are they
UNCONCERNED about the consequences of their own efforts to
stimulate the economy, which involves the same mechanism that
they so fear from foreign actions; that is, massive expansion of the
money supply?
The government has taken two actions that will expand the money
supply every bit as much as possible foreign actions to dump the
dollar--expansion of the monetary base by the Federal Reserve Bank
and the Obama administrations spending spree. Currently excess
reserves held by banks in their accounts at the Fed total close to $1
trillion. Reserves are the building blocks of the money supply.
Through their lending actions, commercial banks can create money
up to many multiples of their reservesa good rule of thumb is ten
times. So the money supply could be increased by a factor of ten or
more when the banks start lending, as surely will happen over time.
Furthermore, the Obama administrations stimulus package of $.8
trillion is funded entirely by fiat money; that is, money printed from
thin air. Compared to the current level of M1 at $1.6 trillion, this
action alone will expand the money supply by 50%.
None of this makes sense from the perspective of economic
fundamentals. Ah, but it makes perfect sense from the perspective of
expanding government power and control!
Through its stimulus program, the government can shower funds on
its friends. It can buy votes. It can reward labor unions by bailing out
the very industries that union action did so much to destroy. It can
create bureaucratic jobs for its sycophantic hangers-on. Finally, the
resulting budget deficits become justification for punishing ones
enemies through tax increases.
If foreigners dump their dollars, the government will have no control
over where they will enter the American money supply, and,
therefore, the government will not be as able to direct the influx of
money to politically connected friends. This is the only difference.
The American price level will rise tremendously, regardless of the
source, and hyperinflation and economic chaos are real possibilities.
Of course, no nation would be in this predicament had it remained on
the gold standard. Money spent on overseas goods (imports) would
have reduced the domestic money supply, lowering domestic prices,
and causing a reversal of the gold flow (via exports) as that countrys
products became bargains on the international market. But under the
fiat money supply, by which the supply of money is limited only by
the prerogative of the monetary authoritieswhich means that there
is no real limitthe domestic money supply can continuously expand
even as dollars are sent overseas for decades, accumulating in the
coffers of foreign central banks until the dam bursts, so to speak.
The U.S. must take three actions immediately to prevent
hyperinflation. Number one, it must rescind the stimulus package. So
far less than five percent of the stimulus package has been released.
Good! Rescind the rest of it. Number two, the Fed must take back the
$1 trillion in excess reserves before the banks start lending. It can do
this buy raising the interest rate through open market operations,
offering to sell the banks its huge holding of government bonds at
reduced prices. Number three, the U.S. must reform its monetary
systemit must peg the dollar to gold, abolish the Fed, and prosecute
fractional reserve banking. This will end the politicization of the
money supply.
With a gold dollar, inflation and deflation will become things of the
past along with the boom/bust business cycle that credit expansion,
not based upon true savings, is the primary cause. Unable to
monetize its debt, the government will be forced to control its
budget. We will return to a limited rather than an activist, destructive
government. Our Founding Fathers will look down upon us with
approval.
Posted by PatrickBarron@msn.com at 5:22 PM 1 comment:
Labels: Monetary Issues
SATURDAY, MAY 1 6 , 2 009
The World Does Not Need a Reserve Currency
In last weeks essay I explained that the failure of the U.S. to uphold
its commitments under the Bretton Woods Agreement to redeem the
dollar for gold at $35 per ounce was the primary cause of the great
inflation in all the worlds currencies. Just to recap events: In 1944
the allied powers agreed that the dollar would serve the same role as
gold for the purposes of international currency settlements after
World War II. At that time the U.S. owned (or safe kept for allied
governments who were at war and whose territories were threatened
by invasion) most of the gold reserves of the allied central banks. As
long as the U.S. would keep its dollar to gold ratio at the agreed-upon
$35 per ounce ratio, central banks around the world could settle
their trading accounts in dollars. These central banks would maintain
an agreed-upon ratio of dollars to their local currencies just for this
purpose. The world would be on a "gold exchange standard". If one
country inflated its currency, its trading partners would demand
dollars in exchange far in excess of the profligate countrys ability to
pay. It would be forced to deflate. Just as the case under a true
international gold standard, that countrys prices would fall, its
exports would increase, thus generating dollar reserves and all would
be back to equilibrium. The key to this whole program was the
promise of the United States itself not to inflate. But, of course, this is
exactly what it did.
Theoretically, the U.S. should have been placed in the same position
as any other country that inflated its currency--instead of running
out of dollars, the U.S. would run out of gold. Its gold reserves did
dwindle, which should have set off alarms at the International
Monetary Fund, which was charged with the job of auditing the gold
supplies of the U.S. and ensuring that it honored its obligations. But
the IMF did not do its job. Why? This enters the arena of psychology,
but I imagine that the Cold War had something to do with it. The U.S.
alone was capable of protecting the Allies from the growing Soviet
threat. Perhaps the Allies and the IMF felt an obligation not to
criticize their protector. Who knows? But once France got the atomic
bomb and a presidentCharles de Gaullewho felt comfortable
acting as an equal on the international stage, it no longer felt that it
needed to cow tow to the U.S. So in 1963 France demanded to be
repaid in gold for its ever-increasing stockpile of dollars. This should
have instilled much needed fiscal and monetary discipline in the U.S.,
but it did no such thing. President Johnson committed the U.S. to
fighting a foreign war AND instituting new welfare entitlementshis
"guns and butter" policy. In 1969 President Nixon could have
reversed this policy, but he feared that the inevitable recession would
mean the loss of a second term, so he simply reneged on Bretton
Woods and "closed the gold window" in 197 1. So much for U.S. honor
and prestige!
The world kept spinning round, though, and the dollar continued to
be used as a reserve currency--there simply was no other. In the
1980s President Reagan and Federal Reserve Chairman Paul Volcker
put Americas economy on a two decade long, inflation-free growth
path. It appeared that the world could indeed operate with a fiat
reserve currency; that is, one not tied to gold. But administrations
change and now it is apparent to our trading partners that our
continued inflation means that the dollars they hold will become
increasingly less valuable. We are cheating our trading partners.
China was so concerned that it floated the idea of creating an IMF-
issued "super reserve" currency to replace the dollar. Although the
Chinese government later claimed that it wasnt really serious, no one
believes them. But China has pegged its yuan to the dollar at too low a
(yuan) rate. Many state-owned industries in its export-oriented
economy would go bankrupt if China revised its exchange ratio with
the dollar. This would mean lower spending in China and probably
would trigger a recession. So China demursat least for awhile.
But the answer to the problem--that has been brewing for more than
six decades now--is NOT to cobble together some new Frankenstein
monster than no one will be able to control. The answer is right
before our eyesreturn to gold. Each country should set its own ratio
of local currency to gold and settle all trades in the actual
commodity. Then no countrynot the U.S., not the European
Community, not China, nor Japanwill be able to inflate its currency
without destroying its ability to import goods. It will run out of gold
for settlement purposes and be forced to deflate. No special
governmental agreements are needed. Gold would settle just as
checks settle todayby debiting and crediting each nations gold
accounts wherever they may be. Just as no business can operate with
zero moneyit is forced to economizeno nation would be able to
import continuously by papering the world with its currency, as the
U.S. does today. As the profligate nations gold reserves dwindled, its
ability to import would dry up; prices would drop, making its goods a
bargain for export; its gold reserves would start to climb and all
would be well. Just as explained by Jean Baptiste Say, all trade tends
toward equilibrium.
IMF bureaucrats managing a super currency will be no more reliable
than were U.S. bureaucrats managing the dollar. They, too, will
succumb to political pressure to over-issue an IMF reserve currency,
and the entire world will be off and running in an inflationary binge
that will destroy world trade. As Professor Thorsten Polleit of the
Frankfurt School of Finance and Management says, we all must make
our peace with gold. It is in the best interest of the common man,
because no one can manipulate it. Gold is money and money is gold.
Gold is inflation and deflation proof, because it is not built upon debt,
as is the current case with all the worlds fiat currencies. So it cannot
be inflated when banks lend against a small reserve and it cannot
suffer deflation when those loans are not repaid. This is the cycle
through which we have just passedmoney supplies inflated by
profligate lending and now money supplies deflated when those loans
go sour. This cannot happen with gold as long as governments strictly
enforce currency convertibility and shut down banks that engage in
fractional reserve banking.
So why doesnt the world return to gold? Because governments
benefit the most. The fiat money that we all use may be manufactured
in infinite amounts by governments. Would we expect a
counterfeiter, who was protected by law in his ability to print money,
to deny himself its benefits? Of course not. Governments are no
different. They are the primary beneficiaries of their fiat money
monopoly. They may spend as they please. They are not obliged to
tax the people or borrow honestly from them. It is a heady and
corruptive power that appeals to the tyrants among us. No, reform
must come from the people. Either that or reform will come only after
a total collapse of our monetary system, which would cause untold
hardships and possibly even massive death around the world as the
ability of the people to engage in indirect exchange was destroyed. So
monetary reform is no academic issue. It is a life and death issue.
A good start to reform would be for the citizens to become informed
of monetary matters. Demand that real economics be taught in our
schools. Demand that our politicians stop lying to us about the causes
of our problems. End the demagoguery that seeks out enemies in the
business class and attempts to place guilt upon the public, calling us
"addicted to spending" and/or too "consumer oriented". This is
nonsense. The people are perfectly capable of determining and
guiding their own financial futures as long as the medium of exchange
allows them to plan and understand the reality of their situation. Our
government is the problem. We should demand that it confine its
actions to those enumerated in the Constitution. Our founding
document, the highest law of the land, does NOT give the government
the power to print money. It assigns government the
RESPONSIBILITY of protecting us from counterfeiters; it does not
give government the power to BECOME A COUNTERFEITER. Enforce
the Constitution. End the Fed. Return to gold. Restore our freedoms
and our rights. Is this really such a radical demand?
Posted by PatrickBarron@msn.com at 6:58 PM No comments:
Labels: Monetary Issues
SUNDAY, APRIL 1 9 , 2 009
CAN WE RETURN TO SOUND MONEY?
No one alive today has ever experienced sound money; that is,
money backed by a commodity of lasting value, such as gold or
silver. So it is not surprising that even many who understand the
concept and advantages of sound money have many serious
questions about the possibility of reinstating a gold standard. Their
questions usually occur in this order: Is fiat money so ingrained in
our economy and our way of life that re-conversion is not possible?
What are the obstacles? Would the U.S. be able to reconvert on its
own or would most of the world have to join us? What would a
transition entail?
If it really isnt possible to reconvert and/or the obstacles and
transition costs are too great, lets just forget the whole thing and
concentrate our efforts on getting reformist politicians and
bureaucrats in positions of power. In other words, get better men to
rule in a benign dictatorship. Regrettably this really is not an option.
Our current fiat money system will fail. No such system has ever met
the test of time. Alllet me repeat thatALL such fiat money
experiments have failed. Once men realize that they hold the power
to create and spend money in unlimited amounts, no appeal to the
better angels of their nature will prevent them from abusing their
commissions. So, our only option is to reconvert.
Fortunately, fiat money is not so ingrained in our economy that it
cannot be replaced by a gold standard. The main obstacle to doing so
is not some mechanical barrier. Although such a transition would be
easier the more countries that agreed to participate in a coordinated
re-conversion, the U.S. could go it alone. And, finally, there are
several intellectually solid transition strategies from which to choose.
There is no question that many American institutions cannot survive
in their present form under a sound money environment. It is these
beneficiaries of our fiat money system that present the most serious
obstacle to re-conversion. I refer, of course, to government itself. A
fiat money system enables government to expand its power by
stealing the product of the peoples effort without overt taxation or
honest borrowing. Such is the situation today. Our government--with
the cooperation of our central bank, the supposedly independent
Federal Reservespends money created out of thin air and
intervenes to drive down the rate of interest. So far this strategy
appears to work, and this is a shame. For the inevitable rise in prices
and the interest rate will be delayed, perhaps for more than a year.
Then the governments apologists will blame price rises on everyone
but themselvesgreedy oil companies, greedy oil sheiks, greedy
merchants, etc. If you think that the people will not be so foolish as to
believe such nonsense, this is exactly the message that the
government has so successfully spread as the cause of our current
financial crisis. Therefore, you can imagine the tremendous
propaganda effort from our government to discredit efforts to end
their gravy train. Our response should acknowledge the sourcesuch
cries of panic are to be expected and should be ignored.
So, we have determined that there really is no choice but to re-
convert to sound money, and we have discounted the objections
from government itself, the primary beneficiary of our fiat money
system. Can we go it alone or do we have to get the cooperation of our
major trading partners? Professor George Reisman has addressed this
issue (and more) in great detail in his magnum opus Capitalism and
many other venues. He concludes that an internationally coordinated
re-conversion would prevent the likely rise and subsequent fall in
prices in the U.S., a one-time cycle caused initially by "outside gold"
flowing into the U.S. and inflating the U.S. money supply to be
followed by a later fall in U.S. prices as our sound money regime takes
hold. If the European Central Bank, the Bank of Japan, the Bank of
England, and the Bank of China coordinated re-conversion with us,
Older Posts
there would be no such "outside" gold to initiate the cycle. But, even if
these countries demurred in our re-conversion effort, Reisman
explains that the U.S. would be the eventual winner, because the
cycle would end and the dollar would gain against all other currencies
as time progressed. Furthermore, the U.S. would not suffer the
frequent boom/bust business cycles caused by our current,
manipulated fiat money system.
Finally, how would we do it? There are several scenarios. Some
economists claim that all the U.S. has to do is repeal its legal tender
laws (laws that prohibit any other money from circulating within the
U.S. other than our fiat dollar). A free money environment would
allow the wonders of competition to work. The best monies would
drive poor ones from the marketplace, a reverse of Greshams Law.
Good money would drive out bad in the same way that any superior
good drives lesser ones from the market. Whether only those
currencies backed 100% by gold would circulate or if some lesser
currencies also would circulate would be at the discretion of the real
rulers of the marketplacethe consumer.
Most other scenarios give some role to government, at least for the
transitional period. The U.S. confiscated the gold of the U.S. citizenry
in 1934, forcing them to surrender their gold in exchange for
depreciating federal reserve notes. So government, in effect, stole the
nations gold and still holds vast quantities of it in its vaults. This gold
would be returned to the people in proportion to their money
holdings via some mechanism, of which there are many worthy ones.
Then the U.S. dollar would be fully convertible to gold at some
market determined parity price, such parity price then established by
law as the legally enforced price of the dollar. Any dollar holder could
redeem his dollars for gold at the parity price. At this point the U.S.
dollar would become, in essence, a warehouse receipt for gold. The
U.S. would be on the gold standard.
The sooner the U.S. re-converts to the gold standard, the sooner the
U.S. economy will recover and, more importantly, the sooner the
liberties of the people will be restored. No longer will the government
be able to hide the true cost of its spending and blame others for the
inevitable deleterious consequences. It must either tax the people or
suffer higher interest rates. Then the people can decide whether such
spending is warranted, because they will see first hand that they must
pay the cost of such spending. Of course, it has always been the case
that the people must pay for government spending, but now this fact
will be immediately discernable and subject to the peoples control.
That is the America in which I want to live. How about you?
Posted by PatrickBarron@msn.com at 6:34 PM No comments:
Labels: Monetary Issues
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