Returning to a Gold Standard Is a Bad Idea 200 comments
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Inflation is coming...
For as long as I can remember, Jim Grant has never been a cheerful fellow. In fact, there was a standing joke in my office that after reading Grant you could cheer up by reading King Lear.
The thinking in Grant’s latest missive in the WSJ runs parallel to my recent post Giving inflation a chance that with the massive fiscal and monetary stimulus coming down the pipe, inflation is inevitable. Jim wryly notes that “Frostbite victims tend not to dwell on the summertime perils of heatstroke.” He continued:
Prescience is rare enough in the private sector. It is almost unheard of in Washington. The credit troubles took the Fed unawares. So, likely, will the outbreak of the next inflation. Already the stars are aligned for a doozy. Not only the Fed, but also the other leading central banks are frantically ramping up money production…It is far less certain that, once the cycle turns, the central banks will punctually tighten.
A return to the gold standard would be disastrous
Given the enormity of the recent crisis, there have been calls for radical solutions. The hard money crowd, for example, has called for the return of the gold standard. However, a return to the gold standard would be disastrous. It would be a prelude to a global downturn of unprecedented proportions and doom future generations to heightened economic volatility.
First, a history lesson: Many years ago, people decided on the use of gold as a monetary standard. It turned out that gold has many nice properties that could be used as a store of value. Throughout human history, money has been predominantly based on gold but not always. It has also been based on other commodities. Peter Bernstein’s book The Power of Gold details the history of gold and commodity based monetary standards throughout history, from salt to large stones, some of which lay at the bottom of the sea.
As time went on, people found that gold, along with other commodity based monetary standards, was hard to carry around. Used in coinage, they could be difficult to divide and this division problem was a hindrance to commerce.
Then came the financial innovation called banking. You could deposit your gold in a bank. The bank would issue you a receipt and you could use that paper receipt for trade and commerce. The bank would lend out your deposit of gold to others. This was credit creation, which expanded the money supply. For every ducat lent out, that ducat would usually wind back up in the banking system, creating another ducat available to be lent out. Even with the imposition of reserve requirements that constrained the amount of loans they could make based on their deposit base, this form of fractional bank lending expanded credit and created an enormous number of jobs and raised prosperity.
When kings and political rulers got into financial trouble, there was always a temptation to debase the currency. The current episode of paper money debasement began in earnest when Richard Nixon took the U.S. off the gold standard and the world went to a dollar standard for monetary reserves. The trouble was, the U.S. dollar wasn’t based on anything, other than the good name of the U.S. government.
Today we stand on the edge of a precipice. America is in recession but deeply in debt. It is about to print money to try to climb out of its hole. This consensus has been supported by pretty much all of the central banks and governments around the world. Some analysts have argued that the imposition of a gold standard would create the discipline on the monetary authorities from debasing the currency in this manner.
What does a gold standard really mean?
Let’s think this through – what does a gold standard really mean? Does the hard money crowd want us to go back to carrying around pieces of gold coinage? In that case, how do we facilitate global trade?
Do we just want to revive a gold backing for money? There isn’t enough gold around in the world to support a gold standard at current gold prices. Rough back of the envelope calculations show that the Fed’s holdings of gold, assuming that it is unencumbered and not lent out, is worth around $200 billion at current prices. Remember that the U.S. Federal Reserve is one of the larger central bank holders of gold in the world. While that change might satisfy the gold bugs, it wouldn’t help the vast majority of the population around the world.
One of the assumptions of a gold standard is that the currency is backed by gold at a fixed rate. Anyone could turn in their dollars, euros, yens, pound sterling and so on, to the appropriate central bank and get gold at a fixed gold price. Such a monetary regime also implies a fixed exchange rate arrangement like Bretton Woods. Instead of allowing the market to determine currency prices, the world would return to fixed exchange rates and periodic exchange rate revaluations. Is that really the regime that we want to return to?
A gold standard also creates economic volatility in the economy. Monetary theory is based on the elegant formula MV = PQ. Holding V (monetary velocity) constant, changes in money supply directly changes the GDP level. Under a gold standard, money supply is restricted by the supply of gold, based on world mine output. National gold supply could shrink because of shocks. As an example, the Roman empire was subjected to credit crunches during wartime when hostile forces captured Roman gold and territory.
The problem of fractional lending remains under a gold standard. The banking system could still create credit. Under such a regime, if everyone decided to redeem their paper currency for gold, the money supply would collapse and the result would be another Depression. Do we want to get rid of the banking system?
If we were to take the radical step of eliminating fractional lending, going to a gold standard would mean a drastic shrinking of world GDP given the amount of money sloshing around the world today.
Culling the herd?
This is financial Armageddon. The result would be the financial equivalent of mandatory infection of the population with the Ebola virus. Maybe we could get Disney to lend a PR hand as we play “The Circle of Life” while we infect everybody with Ebola so people would be persuaded to sacrifice themselves for the Common Good.
The end of the Dollar as THE Reserve Currency
Let's face it, the days of the USD as the principal reserve currency are numbered. Roger Ehrenberg over at Information Arbitrage believes that the US is at a strategic inflection point and the start of a downward spiral and I would tend to agree. The long term path of the dollar and US influence is downward. Investors should prepare themselves for that eventuality.
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This article has 200 comments:
Accountability.
We can't have that now can we? That means if we have accountability in our finance system, we have to have accountability in government. If we have accountability in government, that means our citizens have to be more accountable, and return to an ethical and moral country.
We can't have that though. That means minimal corruption, less graft and greed. Our country would have to do what is best for the majority instead of what is best for the select few.
Good golly we can't have that now can we????
So on or off, now and then we got over-extended both publicly and privately on credit encouraged by a consumer driven Non-Term-Limited Congress who will never want the punch bowl taken away
A hangover is to remind you that you overindulged. A recession reminds you that you are overextended. Both are good for you in the longer run if you pay attention the their message, which is another problem.
"Let’s think this through – what does a gold standard really mean? Does the hard money crowd want us to go back to carrying around pieces of gold coinage? In that case, how do we facilitate global trade?"
If anyone can think up such a world, and how it would be better than what we currently have, I'm all ears.
"This is financial Armageddon. The result would be the financial equivalent of mandatory infection of the population with the Ebola virus."
I think gold bugs would agree with this, since they hold gold as a doomsday hedge. So, what's the bright side when it comes to "investing" in gold?
1) Are you saying that money - as a means of facilitating the exchange of goods and services - should be backed by nothing other than an empty promise?
2) Why is getting rid of fractional reserve banking so radical in your opinion? It's essentially the same thing as creating money out of thin air.
I think your reasoning is flawed where you state that returning to a gold standard "would mean a drastic shrinking of world GDP " - if money is returned to a note that is redeemable as some real commodity (gold, oil, or anything with a limited supply) - then the value of the commodity goes up, certainly, but that doesn't diminish the reality of the items being exchanged with those notes.
And I think you make a good case for returning to a gold standard - albeit unwittingly - the Roman empire lost a good chunk of its gold when it was invaded, and it was invaded BECAUSE it was a militaristic empire. Forcing a powerful nation to be restricted to a gold standard does two things: 1) it minimizes its ability to fund aggression through fiat currency, and 2) it forces a nation to be wiser in its foreign relations and focus on its defensive capabilities rather than its offensive capabilities.
When the Roman empire suffered a credit crunch, that may have been bad for the Romans, but it was probably a relief to the rest of the known world which had a short breather from Roman imperialism. Of course, the Romans, due to their militaristic imperialism, probably responded by starting up new campaigns to loot the gold from less powerful nations. Hmm...I wonder if there could be some parallels in this for our times...
If we were on the gold standard during this crisis, gold itself wouldn't have prevented the majority of Americans from borrowing to the hilt. Gold may bring your much-sought-after accountability, but it wouldn't have prevented the leverage that destroyed so much wealth.
In this case, your accountability would have dire consequences. America would have been stripped of its gold by foreigners as they redeem their dollars for gold instead of Treasuries, and we would only have one way to regain it back: war. If we do not wage war, our economy would have been so crippled from this bout of euphoria that we would have not only lost our pre-eminence, but quite possibly our nationhood due to the subsequent lowering of our per capita consumption. Remember, we don't really produce as much anymore, and without large gold stocks, it would cost us dearly as a percentage of gold stocks remaing to purchase what others produce.
This doesn't sound like a reasonable solution for fiat to me. Your "accountability" only comes as the consequence of inane choice. It does not counsel or deter stupidity.
On Dec 30 08:56 AM archman82011 wrote:
> Return to the gold standard would mean one thing:
>
> Accountability.
>
> We can't have that now can we? That means if we have accountability
> in our finance system, we have to have accountability in government.
> If we have accountability in government, that means our citizens
> have to be more accountable, and return to an ethical and moral country.
>
>
> We can't have that though. That means minimal corruption, less graft
> and greed. Our country would have to do what is best for the majority
> instead of what is best for the select few.
>
> Good golly we can't have that now can we????
>
>
The result is that adoption of a gold standard means continuous deflation and the serious impediments to financial growth this entails. It would be a disaster to revert to a gold standard.
Prior to the Great Depression there were several major world wide depressions during the 19th century. These all had one thing in common - a shortage of money because the gold standard did not allow expansion of
the money supply fast enough to support the economic growth of the time.
Gold has no intrinsic value. Its use as currency is based merely on tradition and habit. In famines gold has no value - people will not sell food or the means of producing it. Gold is just like any other money, fiat or not - its value is dependent on the idea that at some future time you will be able exchange it for goods and services. If people lose interest or faith in gold, its value decreases. It has no guarantee of value any more than any other proxy for real goods and services.
2) A citizenship outsources it's governance in this era. Ultimately, it is the citizenship itself that becomes educated through financial pain which is a powerful catalyst. Our Republic form of government works, the citizenship will oust the corrupt and lazy, this is called voter revolution and occurs historically four years after the start of a deflation/depression.
3) America as a model outsources almost everything. The middlemen get cut during depressions and producers are once again rewarded in full for there efforts. America will become a producer once again at a certain point in time, I guess this transition period to be 2013 where it will be the best time to invest and the start of a true bull market.
4) I agree with your analysis Mr. Hui.
The problem with a gold standard is that there is no single person in charge, what a shock! Politicians and those in academia cannot fathom having a monetary system where there isn't one enlightened person running the show. Central planning is loathed and has been discredited for every single industry yet miraculously everyone thinks we NEED it for our money.
As another commenter said, gold, wampum, I don't care. We just need to take the power to create money out of thin air away from governments.
"Then came the financial innovation called banking. You could deposit your gold in a bank. The bank would issue you a receipt and you could use that paper receipt for trade and commerce. The bank would lend out your deposit of gold to others. This was credit creation, which expanded the money supply."
While this is a good description of modern banking, what is left unsaid is that your gold now has two claims upon it. Your bank has loaned it to others (who now "own" it) and the depository receipt which you hold. If you attempt to regain possession before the loan is paid off the bank cannot make good on your receipt without taking gold from another depositor.
"Even with the imposition of reserve requirements that constrained the amount of loans they could make based on their deposit base, this form of fractional bank lending expanded credit and created an enormous number of jobs and raised prosperity."
The 'prosperity' is an illusion because there are now more units of gold receipts circulating than actual gold. The 'fake' receipts have enabled the "raised prosperity" at the equivalent cost of the burden of debt taken to borrow the gold which doesn't really exist. The 'excess' gold will also bid up general price levels and possible create bubbles in some asset classes. If continued to an extreme, the borrowers will eventually not be able to service the debt payment required to support the system and the excess debt will overhang the entire economy. This is how we got to where we are in today's economy.
As an historical aside: Bank reserves were much higher during the free banking era prior to the creation of the FED and its reserve requirements. Free banking reserves were rarely below 50% compared with today's requirement of 10%. (Current day banks with reserves above 30% are very rare.) Now instead of two people having a claim on your gold, there are 10 people with a claim to it. If that's progress then I'm a monkey's uncle.
"When kings and political rulers got into financial trouble, there was always a temptation to debase the currency."
Ah, so it's bad when Kings or political leaders debase the currency, but it's good when bankers do so via 'expanded credit'. Both avenues lead to the same end point. This is one of the main blind spots in the author's reasoning. Debasing the currency is not a good thing in general, whether done by politicians OR bankers via 'expanded credit'. Debasing the currency robs every saver in the economy of purchasing power by lowering the value of prior money.
There are several other areas in the author's article where his grasp of economic cause and effect are tenuous, but there isn't enough room here to address them all. The author would be well rewarded by a more thorough search through Rothbard's books on banking.
While it would be quite painful to implement, the most stable base for a sustainable and growing economy would be one based on a fixed money supply (such as gold or silver) with a strict ban on any sort of fractional reserve lending. This would restrict the use of savings to uses which were most likely to satisfy actual consumer demand.
The comments above regarding issuing notes denominated in weights of gold would be a good start. Divisibility is a non-issue with today's compters (and absent fractional reserve tom-foolery).
Of course, GLD is pretty volatile--it has quite a fever-chart--which would make it undesirable for businesses that want stability. But, OTOH, if it were being routinely used as a hedge, the massive offsetting positions involved would (or should, I speculate) stabilize its price level. Further, half (??) of gold's volatility is really a reflection of currency fluctuations--and that kind of volatility is really stability in disguise.
The 'authorities' who would supposedly stand guard over sound money are the very same people who presently stand guard over the SEC, Fed and Treasury. Wall St investment banks figured out how to tie their money creation multiplier to volatility measurements in order to massively exceed commercial bank asset:capital ratios to create all those now evaporating trillions of derivatives. This was all done under the watchful eyes of people who were appointed to make sure this didn't happen.
The Euro is kind of like a European gold standard, but to save themselves now that the s___ has hit the fan the member nations are all willing and able to abandon the monetary discipline Euro membership legally or theoretically imposes. People figure out ways to cheat. We always have. We will not accept the discipline.
Mr. Hui makes a good point about the "financial Armageddon" that would occur in the US if we had a gold standard and a multi year balance of trade deficit. About half of the US trade deficit is from oil imports. As oil flows into the US gold flows out. When you run low on gold you cannot create new money to buy more oil. Without oil your economy is dead in the water. So you go to war rather than accept the "discipline" of a collapsed economy. Debt may not be great but I think it's preferable to this kind of money-wars.
In recent SA articles it has been both argued theoretically and shown historically that money creation and economic prosperity go hand in hand. There have always been booms and busts throughout known history, regardless of what kind of money was in use. But money creation and debt and economic prosperity are historically linked.
Fractional reserve banking is where the money-creating rubber meets the economic road. Millions of loans officers at banks across the world micromanage the creation of money via the loans they make. I think this is about as close to a 'market' approach to money creation as we could realistically hope for.
Remember, the conditions for this whole financial meltdown were set in place by government social housing policy that compelled and induced bankers to make mortgages to people who didn't qualify under normal prudent banking practices. Banks could then sell these bad loans to Fannie and Freddie and Wall St could package them into MBS and sell them to the world. You can't blame bankers and dealers for making money in ways the government who regulates them tells them is just fine, especially when government removes banker's risk by immediately buying the crappy loans and stamping AAA on them. Markets don't care if they profit from good policy or bad. Policymaking is up to government, not commercial bankers and investment dealers.
It has recently been established (I think this came out of the Chicago School) that homo economicus, economically rational man, is a fiction. Entire nations, even the whole world, get caught up in irrational exuberance and irrational gloom. Bankers are no more rational than you or me. In a boom the loans, and the purchases or investments the money is to be used for, look just as viable to the banker as they look to the borrower. They looked good to Chairman Greenspan, too, and the Bush government.
I've said before, we have no gods or rational machines to control the creation and use of money. It's just us, in all our wisdom and flights of fantasy. For the most part we do a pretty good job of it, I think. No period in the history of this planet has achieved the level of broad based economic prosperity that we have today.
Sure, it's not perfect. We are not perfect. Maybe we can tweak the money system to make it better. But from what I am seeing fractional reserve bank-money is the most successful and economically beneficial kind of money we've ever invented.
While the US economy may be at an inflection point so are the economies of everyone else and it is hard to see a real rival to the greenback in the forseeable future. The Euro is just celebrating 10 years of history and there are some awkward divergences within the eurozone economy that could make it difficult to continue with a single central bank and monetary policy for the diverse set of states that have adopted the Euro. Sterling is hardly a contender and I suspect that looking towards the Japanese yen as a reserve currency would have even more damaging unintended consequences than staying with the dollar
It does not look feasible for the Chinese currency to take on any leadership role until it develops much greater depth in its capital markets which is probably a generation away at least.
Who are the only ones to gain from an inflationary credit system? Governments, central banks and fractional reserve banks. Do you think there may be some connection here?
Inflation takes money from the pockets of the non-government, non-banking public and gives it to the legal money counterfeiters. The article is entirey one sided and ignores the severe inflationary credit cycles (typically misunderstood as the business cycle) which arise from monetary policy. The accordian effect of fractional reserve banking greatly magnifies the inflationary and deflationary effects which are inevitable due to the Fed's and other central banks corrupt practices.
But the U.S. doesn't have a currency problem today as much as it has a political problem. Without the need for Treasury to borrow, the Fed would not need to print massive sums of paper. The end of the gold standard came at the inauguration of the Great Society and the end of the Vietnam War. The current crisis arrives following the Medicare prescirption drug bill, retiring boomers, and a War on Terror.
The U.S. could have a workable fiat system, if it was run by a tight money Fed that refused to purchase U.S. Treasuries, essentially making a political decision to withstrain U.S. political ambitions. Since no person can withstand the public in a democracy (or the King in a monarchy) every society eventually turns to the one thing that can: gold.
On Dec 30 12:35 PM Socialism cannot compete! wrote:
> Mr Hui actually states points FOR gold-backed currencies, though
> he does not realize it!! It is precisely the case that going off
> the gold standard has created an economic bubble of artificial growth,
> triggered by manipulation of the money supply!! How can anyone deny
> that the easy money policies of the Fed are a core component of this
> current debacle?? We are now seeing the disastrous effects of fiat
> currencies. His argument that there is not enough gold to back current
> money supplies, except at much lower values is PRECISELY an argument
> FOR gold-backed currencies -- the growth in our economy has been
> ARTIFICIAL. It's time to end the manipulation of the currency for
> the benefit of the few.
1) The definition of money as a social or psychological phenomenon that allows us to get beyond the horribly inefficient barter system by attaching value to practically useless objects like currencies or metals that were easier to trade.
2) A description of how money supply is controlled by the issuing government via interest rates, open market activities, and reverve ratios.
3) A review of history comparing the economic performance and currency stability of the US on the gold standard with the US post-gold standard, a review of how fractional-reserve banking allowed for the growth of both industry and consumption by freeing people from the sharecropper society that came before, and a review of currency history such as the economically devastating bouts of uncontrollable deflation and inflation in the gold standard era, episodes of past hyperinflation and high inflation, and the deflationary era of the depression and Japan in the 90's and why that occurred.
Of course, some people won't be interested in mere facts, having read a book or blog one time that made up their mind, but many readers who have only been exposed to economics information on the internet would appreciate the summary. Misinformation is everywhere online and in popular media too.
In theory I totally agree with a gold backed monetary system. However, in reality I agree it would be a disaster at this time in history and here's why:
Out of control corruption and power grab in the public sector; would you trust today's governing representatives and/or Fed Reserve to honor this system? with all the existing corruption, I believe a return to gold standard this would only truely serve as a front for gold confiscation from private citizens. After all the polititions fancy footwork I guarantee their "new gold standard" would NOT allow anyone to go into a bank and trade their gold certificates for real metal, no chance... We'd just have to have trust and faith that our notes are truely backed by gold (which we would never get to see or touch again, in fact it would be illegal for private citizens to own at this point).
I see a return to gold standard as a PERFECT ENDING CHARADE for the elite ruler dynasties as it would seemingly satisfy everyone: (1) the massess - because we'd finally get our so called "gold standard" back, (2) the central banks - because they'd finally get all the gold (no longer the need to manipulate it or fear it), (3) government elite rulers because they would get full control and power over the citizens as gold would no longer be legal for private citizens to possess (No longer act as a competitive threat against the goverenment currency). Best of all, this would certainly go down simiilar to how it did in the 1920's (i.e. confiscate from citizens first, then devalue the dollar on the order of 10-50x (only after they have all the gold)).
Also there would still be the fractional reserve issue as raised by the author (money would need to be broken into two or more classes, i.e. debt backed fractional reserve vs. gold backed). A nightmare, and an open window for more financial magic tricks and slick maneuvers.
So if you appreciate the fact that today YOU can own and hold gold. Then be extremely cautious about getting behind a new gold standard. it would be a wolf in sheeps clothing at this point in history.
Please do think about this.
"Money is only as 'sound' as the people who regulate it." - derryl
While this is true as far as it goes, it does not go far enough. Our problems today are the result of gub'mint control of the money supply. Correcting that problem will require thinking outside the box of having any sound money 'regulated' by the gub'mint.
The only true regulation that will work must be supplied by the market itself. This is one reason why a money denominated in weights of gold is a good idea. You can't debase weight and fineness of gold as long as you are allowed to test the metal personally (it's not that hard, you can buy a tester for about 1/4 oz of gold).
www.goldtestsolution.c...
The goal for sound money would be to allow free circulation of gold coin (or receipts for same with exchangability) and for everyone to have the opportunity to test the gold they receive if they desire and demand full payment if it is diluted in any manner.
That would be more work, but you would know that you can always ensure your money is 'whole'. Once money has a known 'stable' value, then you won't have to worry that your savings are being eroded via inflation and prices on most items will stabilize or drift downward over time as your money becomes more valuable (more efficient production = more goods with same inputs, fixed supply of money + more goods = the price of goods declines = same money will buy more stuff).
The nice thing about a fixed money supply and declining prices is that the same salary will buy more stuff next year than it did this year. No more need for a raise just to break even next year.
History proves this is the case. Go google the history of the CPI. From 1800 to 1900 when the US was on a strict gold standard the CPI dropped by 50% from 51 to 25. You could buy twice as much stuff with the same income in 1900 as you could in 1800.
Look at what has happened since the FED was founded in 1913 however, CPI has increased from about 30 to over 582 in 2005, and increase of 19,400+%.
So, with gold backing the purchasing power of money doubled in 100 years and without gold backing the purchasing power of money dropped nearly 95% in 95 years (most of the drop in the past 50 years).
I don't know about others, but if I want to save money I'd much rather have it buy twice as much stuff in the future as have it buy 1/20 as much.
Wouldn't you?
It means that trade deficits lead to an outflow of gold from america to other countries,
AND
THE MONEY SUPPLY HAS TO SHRINK AS A RESULT,
LEADING TO DEFLATION.
The 1946 full employment act opposes this type of action,
not to mention current political realities.
Don't you think that companies cutting prices every year might lead to reduced employment? Declining prices during the Great Depression were great for the employed, not so great for the unemployed.
"History proves this is the case. Go google the history of the CPI.
From 1800 to 1900 when the US was on a strict gold standard the CPI
dropped by 50% from 51 to 25"
Or you could google the Cross of Gold speech?
"CPI has increased from about 30 to over 582 in 2005, and increase
of 19,400+%"
From 30 to 582 is an increase of 1840%.
On Dec 30 02:37 PM Smarty_Pants wrote:
> Several good comments in the discussion.
>
> "Money is only as 'sound' as the people who regulate it." - derryl
>
>
> While this is true as far as it goes, it does not go far enough.
> Our problems today are the result of gub'mint control of the money
> supply. Correcting that problem will require thinking outside the
> box of having any sound money 'regulated' by the gub'mint.
>
> The only true regulation that will work must be supplied by the market
> itself. This is one reason why a money denominated in weights of
> gold is a good idea. You can't debase weight and fineness of gold
> as long as you are allowed to test the metal personally (it's not
> that hard, you can buy a tester for about 1/4 oz of gold).
>
> www.goldtestsolution.c...;cPath=13&prod...
>
>
> The goal for sound money would be to allow free circulation of gold
> coin (or receipts for same with exchangability) and for everyone
> to have the opportunity to test the gold they receive if they desire
> and demand full payment if it is diluted in any manner.
>
> That would be more work, but you would know that you can always ensure
> your money is 'whole'. Once money has a known 'stable' value, then
> you won't have to worry that your savings are being eroded via inflation
> and prices on most items will stabilize or drift downward over time
> as your money becomes more valuable (more efficient production =
> more goods with same inputs, fixed supply of money + more goods =
> the price of goods declines = same money will buy more stuff). <br/>
>
> The nice thing about a fixed money supply and declining prices is
> that the same salary will buy more stuff next year than it did this
> year. No more need for a raise just to break even next year.
>
> History proves this is the case. Go google the history of the CPI.
> From 1800 to 1900 when the US was on a strict gold standard the CPI
> dropped by 50% from 51 to 25. You could buy twice as much stuff with
> the same income in 1900 as you could in 1800.
>
> Look at what has happened since the FED was founded in 1913 however,
> CPI has increased from about 30 to over 582 in 2005, and increase
> of 19,400+%.
>
> So, with gold backing the purchasing power of money doubled in 100
> years and without gold backing the purchasing power of money dropped
> nearly 95% in 95 years (most of the drop in the past 50 years).
>
>
> I don't know about others, but if I want to save money I'd much rather
> have it buy twice as much stuff in the future as have it buy 1/20
> as much.
>
> Wouldn't you?
"Don't you think that companies cutting prices every year might lead to reduced employment? Declining prices during the Great Depression were great for the employed, not so great for the unemployed." - Jim Myrtle
This is the nature of capitalism, increased efficiency increases productivity and lowers the labor needed to produce the same amount of goods. However, some of that labor will be retained to produce a larger amount of goods to meet increased demand at lower prices while other parts of that labor will have to become productive at another task.
To say this is a bad thing is the equivalent to saying Ford should still be hand assembling cars at a rate of 10 per day because automating would have resulted in laying off a dozen people 100 years ago.
Instead automating has allowed Ford to manufacture tens of thousands of cars a day employing orders of magnitude more employees than when Henry Ford started up the assembly line AND a larger segment of the population can afford to buy a car as a result. (Ignoring the fact that Ford is nearly bankrupt the principle remains valid, productive efficiency means lower costs to the consumer, more consumers can afford to buy so more need to be produced and thus more labor is kept employed)
If maintaining jobs were the prime goal of an economy we would all still be subsistence farmers. Division of labor and the constant improvement in productive efficiency is what improves the general standard of living for everyone. That means that there will always be people who lose jobs and have to find other lines of employment. It's part of life. I've been laid off twice myself. I survived it and am better for it.
Do you think your standard of living would be as good as it is if you had to build everything you own? Plasma tv? Car? Clothes? iPod? I don't think so, and I'm pretty sure you'd rather pay less for any of them next year than it would have cost this year.
It's probably a good bet you don't really care if 5% of the company's work force got laid off when you see the lower price at Best Buy next month, isn't it? Not enough to stop you from buying it anyway.
As a general rule consumers are pretty harsh and selfish. They only have their own self interest in mind and couldn't care less about cost of production, transportation, labor, tarrifs, or profits. They want a specific good at the best price possible. Period.
The most efficient way to provide those goods is a free market with sound money.
The Cross of Gold speech as I understand it was in support of a plan to debase the currency (replace gold standard with bimetallism) as an aid to farmers who had encumbered debts they couldn't pay off. The intent is the exact opposite of sound money and is more in accord with supporting a fiat currency - creating money because the circumstances "require" it.
I maintain that honest money must also entail acknowledging failure as well as success. If you use credit for an unprofitable purpose and cannot repay the debt then you should have to endure the consequences and not expect to save the day via debasing the currency as William Jennings Bryan urged in his speech.
What Bryan tried to do in 1896 is not much different than what the FED is doing with the TARP today, using monetary debasement to favor one group at another group's expense.
"While it would be quite painful to implement, the most stable base for a sustainable and growing economy would be one based on a fixed money supply (such as gold or silver) with a strict ban on any sort of fractional reserve lending. This would restrict the use of savings to uses which were most likely to satisfy actual consumer demand. "
"The nice thing about a fixed money supply and declining prices is that the same salary will buy more stuff next year than it did this year. No more need for a raise just to break even next year. "
Smartypants, you apparently condemn the current education that college students receive in basic economics. To you, deflation is better than inflation.
Wow. Well, let's see. First of all, Jim Myrtle is absolutely correct:
"Don't you think that companies cutting prices every year might lead to reduced employment? Declining prices during the Great Depression were great for the employed, not so great for the unemployed. "
Not to mention that deflation probably exacerbated the Depression to no small degree.
About your ban on fractional reserve banking....How would one earn interest? Gold doesn't just magically multiply by 5% a year. Or would there be no banks as well? Maybe we should go back in a time machine to ancient Rome and put all of our money into the Temple of Jupiter, because Apollo told me to.
I'd like a fuller picture of your world without banking...something tells me it would involve a toga and some really wild parties.
I also think his argument is flawed and his argument for how inflated money has benefited society. It has only benefited a segment of society, in this case Wall Street, Corporate America and a few favored entities. Since Mr. Nixon took us off the Gold Standard, it appears that living standards have risen but that is largely (in the U.S. anyway) because households now have two earners. It used to be that most households were supported by one wage earner. Now, two-income families are necessity except for those fortunate enough (or good enough scam artists) to be on Wall Street.
It's always pontificators like Mr. Hui, Greenspan, Bernanke et al. who want to tell us how big a disaster an alternative monetary system would be.
Oh YEAH!!! I forgot: you guys have been so successful with the current one, we should just keep listening to you.
"I maintain that honest money must also entail acknowledging failure as well as success. If you use credit for an unprofitable purpose and cannot repay the debt then you should have to endure the consequences and not expect to save the day via debasing the currency as William Jennings Bryan urged in his speech."
I cannot agree more with your first sentence. But, I must profess, I don't know the difference between currency debasement and today's alternative: mass foreclosures and unemployment. Either way, you will lose great standing amongst other nations (since they own the mortgages), except with the latter, you have civil unrest to boot. Something tells me the Fed is choosing between the lesser of two evils, and future inflation seems less toxic than rioting in the streets.
For all of those savers that may feel robbed by future inflation, it stands to see whether or not we are capable of protecting ourselves from it. TIPS sound better and better, I think.
Notice how none of this had anything to do with gold.
Two comments:
1) If general price levels are decreasing you are getting ahead even without interest as every piece of gold you can manage to save will buy more tomorrow than it does today.
2) You can still earn interest on your gold deposits, but it will entail giving up your right to claim the gold at any time. Without fractional reserve banking only one person may have a claim to any piece of gold at a given point in time.
If you want to earn interest you would have to deposit the gold in a Certificate of Deposit (CD) equivalent (ie. interest bearing time deposit of known duration) that you cannot redeem until the end of the time period. This releases the 'title' to the gold for that duration and allows the bank to lend it out at interest for the time period specified. When the time period is up, the borrower must repay in gold or be foreclosed upon.
I would imagine banking would change so that your local banker would find loan opportunities for your money and arrange for you to move it from a demand account to a CD for the purpose of loaning it out at interest.
Naturally the bank would have to charge fees to earn their income, but there's no reason you couldn't arrange the loans yourself other than convenience.
You could also invest your gold in capital projects (buy equity in a business) and earn a return there (ie. dividends or profits) instead.
"Smartypants, you apparently condemn the current education that college students receive in basic economics." - Ricard
I received the same college economics education myself and, yes, I do condemn it. The Keynesian drivel doled out in today's colleges presumes that only the gub'mint can 'regulate' the economy, from soup to nuts, money included.
What is never allowed to be discussed in those classes is the cost imposed on the economy by the Federal Reserve system and fractional reserve banking. Most economists still won't admit that the FED's easy money policies of the last 6 years are the source of today's economic 'crisis' and that the 'deflationary' environment is the market's means of correcting the misallocation of resources during the easy money boom period. The country went on a borrow and spend spree and now we're paying the piper. The idea that borrowing even more to 'fix' the problem with ever more spending is ridiculous.
"To you, deflation is better than inflation."
More properly stated, to me sound money is better than depreciating money.
I'd prefer my money to have the same purchasing power tomorrow, next week, next month, and next year, that it has today. Given that, I will make do with whatever productive improvements my fellow man may devise to help lower my cost of living and be happy about it.
I find that much preferable to having my purchasing power decline continually while bankers and politicians print ever more money to spend on wasteful pork projects at my expense.
And so remaining in the fiat system we have will not be disastrous?
A new and improved gold/silver standard could be created to coexists with debt money and innovatative ways to do this could evovle. People could choose whatever currency they felt confident with. Debt currency could carry a risk but pay a reward. For example bonds could be issued to finance a government project or whatever and currency could be issued against this. This currency could circulate with the understanding that it will receive interest at maturity of the bond and could be retired at that time. A lot of thought and ideas could be tried and over time would evolve. 1st step thought is get rid of the Federal Reserve System.
Please ignore the global downturn of unprecedented proportions dooming future generations to heightened economic volatility behind the curtain.
It wasn't that the farmers and small businessmen of William Jennings Bryan's era were being irresponsible in taking out mortgages to build farms or businesses, it was that the price of gold suddenly fluctuated upwards, which caused the dollar to rise in value uncontrollably as its value was tied to gold (massive deflation), which caused the prices the farmers could get for their goods to fall and the cost of their mortgages to rise, which wiped out a lot of dirt-poor farmers and businesses. The only winners were the Wall Street holders of these debts, which had to be paid back in more valuable, deflated dollars. The result was populist outrage about how the masses had been ruined just because the price of one commodity, gold, had risen - on Wall Street - and the perception that the bankers who established the system were profiting from their poverty and bankruptcy. High inflation occurred a few years later, as the price of gold fell, causing a bank crisis. As you can see, there was a reason the gold standard was abandoned - the currency swings were as uncontrollable as a commodity price, and these swings ruined banks, businesses, and farms regularly.
The gold standard was abolished in steps over several decades. Not surprisingly, the dollar has become more stable and controllable, not less, and we just don't see the destructive monetary swings of the 1800's, current fluctuations notwithstanding. Economic growth and productivity in recent decades has skyrocketed compared to the past. This is not a coincidence - a stable currency is critical for a strong economy. History says gold doesn't provide it.
On Dec 30 04:02 PM Smarty_Pants wrote:
> The Cross of Gold speech as I understand it was in support of a plan
> to debase the currency (replace gold standard with bimetallism) as
> an aid to farmers who had encumbered debts they couldn't pay off.
> The intent is the exact opposite of sound money and is more in accord
> with supporting a fiat currency - creating money because the circumstances
> "require" it.
>
> I maintain that honest money must also entail acknowledging failure
> as well as success. If you use credit for an unprofitable purpose
> and cannot repay the debt then you should have to endure the consequences
> and not expect to save the day via debasing the currency as William
> Jennings Bryan urged in his speech.
>
> What Bryan tried to do in 1896 is not much different than what the
> FED is doing with the TARP today, using monetary debasement to favor
> one group at another group's expense.
We already have mass foreclosures and growing unemployment (higher than 'official' gub'mint numbers - see shadowstats.com). It is an unfortunate truth that we have travelled a long distance down the wrong path of monetary policy. Any choice we make now will be extremely painful, but opting for the easy way out without making the end goal the optimum solution will only kick the can down the road and make the problems worse in the future.
My great fear is that it may be too late to 'save' the system by any means. If we continue on down the TARP-esque print and spend path we will eventually discover that our foreign creditors will stop buying our debt and start selling it instead along with their dollar reserves. We could devolve into a banana republic economy whose currency is shunned world wide. What happens then?
Rioting could only serve to bring out the swat teams and push us toward a 'national emergency' which "requires" a dictatorship (only for a while naturally) to resolve.
Every perceived problem today is already addressed by swarming it with gub'mint agents.
Think TSA. How many billions do we need to spend on preventing hijackings? Give every passenger a club and tell them anything goes between takeoff and landing and you will find no hijacker will ever make it to the cockpit alive. Inflight manners would improve greatly too for fear of being mistaken for a highjacker.
Think Waco. Was it really necessary to swarm a peaceful compound with dozens of armed agents to arrest a man who went jogging alone every morning? And then to burn the place to the ground killing nearly everyone inside after the shooting stopped for a couple days when the original intent was to arrest Koresh? Wasn't that overdoing it just a bit?
Think Northcom. Suddenly, after 230+ years with posse comitatus we need to station regular army units in the continental US for 'homeland defense' when there are enough bubbas with rifles to keep an entire foreign army busy should they be foolish enough to invade. Our army is having a pretty tough time with the Iraqi resistance fighters.
I'm not saying things are going to fall apart, but we getting closer to that point than we ever have been. If things are really that bad, then our goal should be to restructure the system so that it is sustainable and avoid repeating the mistakes that got us to where we are now.
Yes, that would be very painful, but pain cannot be avoided at this point. We will just have to grit our teeth and move forward if we ever hope to make this a better place in the future.
The private sector will set up its own parallel gold system, such as that which now exists at GoldMoney.com. It's basically an electronic currency pegged to physical gold bullion in vaults over in London (an electronic "Gold Certificate" concept, using the convenience of a PayPal-like system to transfer ownership of real gold grams among account holders worldwide.
In effect, those who are concerned about the value of their money will migrate over to such parallel systems, making the "official" government-issued money less relevant, especially after the big inflation-bang occurs.
Increased efficiency? You mean maybe borrowing huge sums of money to automate your factory? Knowing that money you borrow in a deflationary environment is paid back with more expensive money in the future? Knowing that every year, your prices for goods sold must decline?
"However, some of that labor will be retained to produce
a larger amount of goods to meet increased demand at lower prices
while other parts of that labor will have to become productive at
another task"
And some will stay employed, at a lower salary. Kinda ruins your original point.
"To say this is a bad thing is the equivalent to saying Ford should
still be hand assembling cars at a rate of 10 per day because automating would have resulted in laying off a dozen people 100 years ago"
Let me know how the UAW reacts when you explain that due to deflation, their salary and benefits will be reduced 3% each year.
"Instead automating has allowed Ford to manufacture tens of thousands
> of cars a day"
Lower prices due to productivity gains is different than lower prices due to deflation.
"Do you think your standard of living would be as good as it is if
> you had to build everything you own? Plasma tv? Car? Clothes? iPod?
> I don't think so, and I'm pretty sure you'd rather pay less for any
> of them next year than it would have cost this year"
I'd love to pay less next year. You think that might lower demand for those goods as people delay their purchases? So now you see another problem with deflation.
"The Cross of Gold speech as I understand it was in support of a plan
> to debase the currency (replace gold standard with bimetallism) as
> an aid to farmers who had encumbered debts they couldn't pay off."
Yeah, farmers crushed by debt selling their goods for less each year. I wonder if that might cause any problems?
"The intent is the exact opposite of sound money and is more in accord with supporting a fiat currency - creating money because the circumstances "require" it."
As opposed to creating less (or no) new money as the economy grows?
"What Bryan tried to do in 1896 is not much different than what the FED is doing with the TARP today, using monetary debasement to favor one group at another group's expense"
The gold standard was favoring the Eastern bankers at the expense of everyone who owed money or who produced goods for sale. Keeping prices steady by adding silver to the money supply sounds fair to everyone, or do you disagree?
On Dec 30 04:02 PM Smarty_Pants wrote:
> Good catch on my math error Jim. I forgot to adjust for the initial
> 100% and slipped a decimal place too far. Still 1840% is a significant
> loss of purchasing power.......
>
>
.
Lower prices, bankruptcy, massive unemployment and reduced GDP due to a deflating money supply is a bad thing. A very bad thing.
On Dec 30 04:51 PM huangjin wrote:
> If deflation is so terrible, how does the electronics industry survive?
> Deflation isn't better than inflation because of a value judgement.
> Deflation is better because it is the natural state of affairs.
Apparently we're not discussing the same topic or we are using different definitions for the same words.
If there were an actual fixed gold standard and no fractional reserve banking, exactly how does the money supply 'deflate'?
The amount of gold is nearly fixed except for losses of very small amounts used in industry and additions of mining output. I would expect that mining output would outweigh industrial use and leave a slowly growing supply of gold. Not what I would call 'deflation' which is usually defined as a decrease in the money supply.
The only 'deflation' I can forsee under a gold standard is falling prices resulting from lower costs of production.
The only ways I am aware of to 'deflate' a money supply are:
1) to use fractional reserve banking to inflate the money supply via credit, then offset the fractional reserve credit and extinguish the 'excess' phony money you created
2) Print unbacked currency and spend it (or debase metal content of coins), then reverse the process by gathering up the 'excess' currency or coin and destroying them.
Either way requires the initial INFLATION of the money supply before it can be DEFLATED. Under a fixed gold standard without fractional reserve banking there isn't an initial inflation, hence no deflation will follow.
Am I missing something? How do you see a 'deflation' in a 100% gold backed monetary system without fractional reserve banking occurring?
I cannot see how it is possible to 'deflate' a money supply that is 100% based on a tangible asset and not allowed to be leveraged via fractional reserves.
(Well, I guess Spanish galleons could sink off the coast of Burmuda, but that would only 'lose' a very tiny fraction of the entire money supply, and it could be salvaged eventually.)
If there were an actual fixed gold standard and no fractional reserve banking, exactly how does the money supply 'deflate'? "
Deflation is a general decline in prices.
Thanks for your replies. I really wasn't sure if you were serious about throwing the econ 101 textbook out the window.
"How would one earn interest? Gold doesn't just magically multiply by 5% a year." - Ricard
"Two comments:
"1) If general price levels are decreasing you are getting ahead even without interest as every piece of gold you can manage to save will buy more tomorrow than it does today.
"2) You can still earn interest on your gold deposits, but it will entail giving up your right to claim the gold at any time. Without fractional reserve banking only one person may have a claim to any piece of gold at a given point in time. "
I'm going to return to this point, because I'm still not sure where the "interest" will come from. In fiat, it is obvious because we have an expanding money supply...we "create" interest. But, in something as rigid as a gold standard, let's say we deposit 100 ounces of gold in a "bank", and after a year, we get 105 ounces of gold. Where did those five ounces come from? Gold dug from the ground will more than likely be 1) erratic and 2) not enough to pay simple interest payments, let alone account for productivity gains. I suppose this is where your argument comes in that the same gold would be worth more later...but here's the paradox. If my gold is worth more later, and there is about the same amount of gold later, what makes it worth more? It's certainly not interest, because gold doesn't grow at 5% a year if we put it in a bank, or bury it in our back yard and water it. It stays the same. Therefore, for someone to "earn interest" on their gold, someone else's gold would have to...be worth less?
I think the answer to this is that gold itself becomes deflationary. Without the fractional reserve banking we have in place today, gold held for any amount of time would not yield any benefit - it is still that yellow coin or bar that it was last year. It cannot grow, and yet we have lost time - in fact, the longer we wait, the more time we lose, while that gold still just sits there. As we would be living in a deflationary environment, it would follow that whatever currency we use would deflate as well. This sounds like a self-defeating ideology to me - society would have one objective - head to 0.
Jim Myrtle also made a great point:
"This is the nature of capitalism, increased efficiency increases productivity and lowers the labor needed to produce the same amount of goods."
- "Increased efficiency? You mean maybe borrowing huge sums of money to automate your factory? Knowing that money you borrow in a deflationary environment is paid back with more expensive money in the future? Knowing that every year, your prices for goods sold must decline?"
When the money supply remains steady and output grows, each dollar will buy more.
On Dec 30 09:16 PM Ricard wrote:
Jim,
I can tell you're a very patient person LOL.
On Dec 30 09:35 PM Jim Myrtle wrote:
> " If my gold is worth more later, and there is about the same amount
> of gold later, what makes it worth more?"
>
> When the money supply remains steady and output grows, each dollar
> will buy more.
>
The beef is, you cannot do any level of realistic planning on this basis when the measuring stick (the money) is constantly fluctuating in value. The lion's share of the "money supply" isn't currency issued by the government, it's bank deposits lent out at interest. If I didn't care about interest, I can of course simply buy assets, including gold, and hope to swap them later for a share of other goods and services I really need. In this way, we could possibly function without government-issued money of any kind. But whatever asset was chosen, there is a risk that it's value will not be constant with respect to other things you'll need to consume in the future. Like all assets, even gold's value can fluctuate.
I think the key point in the above essay is that it would be difficult to function without any form of debt or lending, i.e. with a 100% equity/asset-based system. Everyone would always have to lay claim to some share of annual production, even if unneeded, as a means of bartering it for something else in the future. And anyone needing to temporarily consume more than their share (for example, to start a new business, or do anything that will improve production in the future) would have to either sell shares in their enterprise, or engage in some sort of direct or indirect loan agreement. Banking would be reduced to depositors putting money into irredeemable certificates of deposit with fixed, longish terms, geared to match the loan portfolio's term structure. We'd lose the flexibility of being able to lend short (as depositors) to people who are borrowing long, relying on the collective rate of inflow/outflow to bridge the gap. This seems like a recipie for a much more constricted, low-tech economy to me.
Fantastic comment! You nailed it with each swing! Thank you.
On Dec 30 05:15 PM Smarty_Pants wrote:
> My great fear is that it may be too late to 'save' the system by
> any means. If we continue on down the TARP-esque print and spend
> path we will eventually discover that our foreign creditors will
> stop buying our debt and start selling it instead along with their
> dollar reserves. We could devolve into a banana republic economy
> whose currency is shunned world wide. What happens then?
>
> Rioting could only serve to bring out the swat teams and push us
> toward a 'national emergency' which "requires" a dictatorship (only
> for a while naturally) to resolve.
>
> Every perceived problem today is already addressed by swarming it
> with gub'mint agents.
>
> Think TSA. How many billions do we need to spend on preventing hijackings?
> Give every passenger a club and tell them anything goes between takeoff
> and landing and you will find no hijacker will ever make it to the
> cockpit alive. Inflight manners would improve greatly too for fear
> of being mistaken for a highjacker.
>
> Think Waco. Was it really necessary to swarm a peaceful compound
> with dozens of armed agents to arrest a man who went jogging alone
> every morning? And then to burn the place to the ground killing
> nearly everyone inside after the shooting stopped for a couple days
> when the original intent was to arrest Koresh? Wasn't that overdoing
> it just a bit?
>
> Think Northcom. Suddenly, after 230+ years with posse comitatus
> we need to station regular army units in the continental US for 'homeland
> defense' when there are enough bubbas with rifles to keep an entire
> foreign army busy should they be foolish enough to invade. Our army
> is having a pretty tough time with the Iraqi resistance fighters.
>
>
> I'm not saying things are going to fall apart, but we getting closer
> to that point than we ever have been. If things are really that
> bad, then our goal should be to restructure the system so that it
> is sustainable and avoid repeating the mistakes that got us to where
> we are now.
>
> Yes, that would be very painful, but pain cannot be avoided at this
> point. We will just have to grit our teeth and move forward if we
> ever hope to make this a better place in the future.
On Dec 30 09:59 PM Ricard wrote:
>
> Jim,
>
> I can tell you're a very patient person LOL.
>
> On Dec 30 09:35 PM Jim Myrtle wrote:
The entire legal system in the United States would have to be re-written. How much Gold would a speeding ticket cost?
What if some group that controlled a particular asset (ie OPEC and Oil) decided they wanted more gold for their oil than it was worth in the eyes of the public? Or milk or corn or whatever?
If their is money (gold or fiat currency) involved, people are going to try and will ultimately succeed at maniuplating it. Switching to a gold standard will not get rid of GREED. Accountability? What does Accountability mean? There is a guy that robbed people out of $50 billion dollars sitting in a mansion right now laughing at all of us. He will never go to jail. Just like the guy from Enron...died of a heart attack...yeah right!! He is probably chilling on a tropical island somewhere.
The one thing this whole "crisis" has uncovered is that the markets are manipulated and corruption is rampant. It will never change no matter what the currency standard is.
There will always be a group of people sitting in a dark room smoking cigars deciding how to slice up the big piece of the pie.
If you want to do something about it then gather up your friends, grab your pitch forks, and head to Washington.
Lots of good comments. I don't know where to begin exactly.
"We'd lose the flexibility of being able to lend short (as depositors) to people who are borrowing long, relying on the collective rate of inflow/outflow to bridge the gap. This seems like a recipie for a much more constricted, low-tech economy to me." - DougM
Doug, you made several astute observations. Money isn't the end all, whether fiat or asset backed. What counts is wealth. With a fixed money supply there would be a much smaller debt market, but the competition for the money available would be fierce and interest rates would be set by auction and change with the amount of savings available to lend.
While this would mean some projects requiring borrowed funds would not get off the starting line, it also means that only projects which prove to be most profitable would be able to afford to outbid others for the loans.
This money rationing mechanism would mean that available funds (savings) would be directed toward creating items or services that were most desired by the consuming public (ie. more demand for the product means higher prices and bigger profit margins, hence the better ability to pay higher interest on the loan).
The end effect of this rationing is that scarce resources (all resources are 'scarce' by definition since they are finite) will be directed to the products or services that the consumers most desire until the available savings run out.
The scarcity of money reflects the fact that consumers wish to spend now at current prices (ie. little or no savings) and so less money is available to improve productivity by spending savings on automation which would lower prices in the future.
If the consumers would rather spend later more of their money would be available for use in improving productivity that would lower the future prices of goods.
The amount of excess money (savings) drives the increases in productivity to reflect the desires of consumers.
While that may seem "restricted" compared to today's fractional reserve system, it is also much more stable. It would be impossible for asset bubbles to form as there wouldn't be enough money to support the leverage necessary to inflate the bubble.
Any irrational pricing would either be resolved via increased production (higher profit margins due to bigger demand) or by loan defaults and bankruptcies for a small number of participants. While those participants would suffer, the entire system would not. The lack of extra money would prevent many from entering the bubble in the first place.
Instead of 'restricted' think 'slow and steady'.
Today, with fiat money, derivatives, fake off-book Base I balance sheets that hide losses, money being pumped up and sucked out in tidal waves by the Fed, and sheer crookery by loaning more than you can after the abolishment of Glass Stegal, the same thing is happening. All banks keep much less than 10% of their assets in reserve. In fact I'd be surprised if they even had 3%. This is because they have convinced everyone to put it in accounts where no reserve requirement is required.
If the government backs all accounts regardless the banks are safe at the cost to the taxpayers which is what's happening. It amounts to free insurance, save all money becomes worth less as more money is printed to back the surge of lost money that is magically made to pay for the money that never really existed.
In summary, crookery and financial deviousness becomes nothing more than a farce, and those running the show are but charlatans. It is not suppose to be this way. As other posters pointed out more succinctly, money is based on trust. If there is no trust it doesn't matter what money is based or backed on because the accounts won't match up no matter how you calculate them.
What if they decided tomorrow that they wanted more dollars for the same products?
You either buy it or you don't. Haggle until you agree on a price that suits you both. Same with gold, just different units.
Very true. The entire economy is based in trust at some point unless everyone is completely self sufficient. Does your employer pay you every day? No? You are trusting that he will pay you at the end of the pay period then, aren't you? Otherwise you would think that you are working for free.
When you pump gas into your car either the station attendant is trusting you to pay after you pump, or you are trusting him to properly charge your credit card after you swipe it (before you pump).
Division of labor requires trust. The problem with fractional reserve banking is that the banker takes advantage of that trust for his own benefit by lending your money out multiple times and counting on the fact that enough depositors will leave enough money in the bank to cover all withdrawls.
A gold standard without fractional reserve lending would minimize this (some would try anyway, but be caught and imprisoned eventually) as it would not be allowed for any piece of money (gold) to have more than one claim on it at any instant. Since the banker can't "print" more gold they can't cheat the depositors for their own gain. This puts a firm lid on starting and inflating manic behavior in the market.
Besides, physical exchange would give depositors the power of a bank run. This is an important means of keeping banks in line.
PS. Those who wish to claim that banking was on the gold standard for the great depression are only partially correct. When the FED was established in 1913 they started printing more paper money than there was gold to cover (much smaller amounts than today).
This is what fueled the Roaring 20s, excess money that was unbacked by gold and loaned into the economy. This was the first FED induced economic bubble whose deflating led to the Depression when tariffs were raised and even more money printed and spent on public works. The Great Depression was a deflating bubble just like our financial crisis today is.
Even though we were officially on the gold standard with convertibility, the banks were using fractional reserve banking to blow a bubble.
at the cost to the taxpayers which is what's happening. It amounts
to free insurance"
Banks pay for FDIC coverage based on their risk as well as assets under management.
On Dec 30 11:23 PM constructe wrote:
I'll start with a simple economy that only produces consumable goods, like food and clothing. Every year, all participants produce a certain amount of these items, and then consume them. We don't all produce the same things - some people raise cattle, some raise corn, etc. We could inefficiently barter these items, or we could trade them in a more efficient "hub-and-spoke" manner with one of the goods standing in as a unit of value against which all others are measured. Loans in this world would take the form of someone foregoing some portion of his consumption to enable someone else to consume more, receiving an IOU from the other person.
Throw in services, things don't really change. After all, the workers in the earlier economy were doing things like growing corn and raising cattle. The folks working on the cattle ranch will accept from the ranch's owner some portion of the eventual cattle sales. The rancher doesn't really have any other way to "pay" them except in the form of either actual goods from a stockpile laid in earlier, or in the form of IOUs that can be redeemed when the cattle are marketed. Now this situation doesn't really change no matter what the service is.
Throw in more durable items, things change a little. For example, someone has to put in the time to construct the bulidings making up the cattle ranch, and has to do this well before any cattle will actually be sold. We're well beyond the point where a single person or family can construct such businesses entirely by their own efforts. Somehow, other actors in the economy have to be encouraged to help construct the ranch. Once again, we have the problem that either a stockpile of goods is available to pay them with, or they can be paid with IOUs, or (and finally a difference from the original example) they can be paid via part-ownership in the ranch and a claim on its future productivity.
I don't actually need money per se for any of the above. In a sense, "money" has shown up once we instituted the "hub-and-spoke" valuation system, but no actual quantities of the hub commodity need to be in "circulation" to support the system described. It's true that a durable commodity such as gold could take the place of the hand-waived "stockpile of goods" with which to pay various actors, eliminating the need for IOUs. But what exactly are "savings"? Is the definition simply to stockpile some goods? Or just particular goods, namely quantities of the hub commodity? How does a stockpile of the hub commodity differ, fundamentally, from a stockpile of any other commodity? Do all savings have to be in the hub commodity? For that matter, the hub commodity was produced through some amount of effort. So was the ranch, though. Except the ranch has the potential to produce more value in the future (more than going out and hunting wild cattle, say). Isn't this also a form of savings (an investment)?
Specifically to the inflation/deflation question, it strikes me that even with a hub commodity such as gold, that had to be physically circulated, you might nevertheless have inflation if the velocity of transactions was high enough. In other words, the speed at which it was flowing in and out of different stockpiles. And I don't see how you've eliminated fractional reserve banking. Consider again the workers at the ranch. Suppose the rancher has to borrow gold from someone who has a large stockpile and is willing to lend out their gold in exchange for a share of the ranch's future profits. Now suppose that the workers are going to "save" some of their "money". Where, exactly? The instant that they decide they'd rather earn some "interest" on the "money", you are back to banking again, as their savings collectively form the large stockpile that was in part lent to the rancher. By choosing to "save" some of the gold they were paid, the workers are saying (to the economy as a whole) "please produce less consumable items such as food, and please hire more people and engage them in the business of constructing things (like the ranch) that will provide even more food in the future. And this then creates more "supply" of money to accept the projects that are "bidding" for loans.
So even with gold as the hub commodity, you'd still IMO end up with lending, and therefore an expansion of the effective "money supply", as well as velocity effects that could drive the relative prices of things up or down relative to the currency. Although obviously the big danger is that the velocity would be too slow, and the economy would be held back or even slide into deflation as people began to over-value the hub commodity, which is in limited supply relative to it's special role, even though it's in abundant supply relative to actual (industrial) uses. This is IMO the big danger of sticking to a gold-based system.
So where's the problem here? Presumably the amount of lending wouldn't just expand to infinity even if there were no lower limit on bank reserves. Reason: you'd run out of projects looking for loans at some point (or at least, reasonable projects). Where else might there be trouble? One big problem is "human capital". Every actor in the system has some economic value based on their expected future contributions to the overall production. This future value is very high compared to what most people have in stockpiled "savings". There is a temptation to overconsume now at the expense of future consumption, given a lending mechanism that facilitates this. Some of this is good (borrowing to acquire productive or durable assets), and some isn't (borrowing to fuel short-term consumption). Indeed, arguably the government is the worst actor of all on this score.
I would still argue that it's best to manage the money supply (whatever the money's based on) to grow in line with the economy, avoiding both inflation and deflation. I'd define the money supply in terms of the amount of IOUs in the system (including the ones issued by the government itself, otherwise known as currency).
It appears to me that you are equating lower prices with lower profits, but that doesn't have to be the case if productivity gains are involved.
Example:
Say I own a lumber harvesting business. I buy the trees from the land owner, have hired help cut them down, and transport them to a sawmill whose owner buys them from me for his own lumber producing operation.
Let's assume there is plenty of work to support my business and several others for many years within a reasonably small area and that current technology consists of using axes and hand saws to harvest the trees.
Let's say that, in a big picture sense, the money breaks down like this:
Costs are per tree.
buy the tree: -- $10
labor: ----------- $5
transportation: - $2
Supplies: --------$1
Net Cost: ----- $18
I sell each tree to the sawmill for $20, and net $2 profit per tree. My competitors have the same general numbers and skilled labor as I do.
Now lets say one of my workers dreams up the idea for a chainsaw and builds a sorta-working prototype at home on the weekends. I see the utility in his invention and borrow $500 to perfect it and build a couple that work reliably.
Using the chainsaws my workers can cut down twice as many trees in the same time. Now my numbers look like this:
buy the tree: -- $10
labor: ----------- $2.50 (half the labor per tree)
transportation: - $2
Supplies: --------$1
Net Cost: ----- $15.50
I still sell the trees for $20 so I now net $4.50 per tree instead of $2.
I can raise my bid to landowners to $11 per tree and still make more money than before. This extra profit ($1.50 per tree) will pay for the cost of the chain saws in the first 335 trees we harvest. After that it will become extra profit.
I can even lower the price I sell to the sawmill by $0.50 if I want and still pay off the cost of the chainsaws in 500 trees, at which point I can use some of the extra profits to pay my workers more money while still receiving more profit myself.
I will get more business than my competitors because they cannot afford to bid $11 per tree and maintain their profits even while my profits grow at that price. I will attract some of their workers to my business for more pay than they get now.
Eventually everyone will figure out what I'm doing and begin to copy it, if they can figure out how to make chainsaws. Some lumber cutters will lose their jobs as there won't be enough work to keep them all busy with the increased productivity a lot of chainsaws will support.
But they can go into business making chainsaws! Either they can start their own business or I will start one. This will put my extra profits to work improving productivity for other businesses too in areas farther away, lowering prices in a wider circle while increasing their profits just like I did.
The landowners will also have more money to spend. The sawmill will make more money with a lower cost of logs, so he can lower his prices too and still make more profits.
Everyone can afford to buy more lumber on their same old pay.
It becomes a mutually supporting system. Productivity improvements lead to higher profits and more opportunity to improve productivity elsewhere.
Saying that lower prices from productivity increases will destroy the economy is taking a very limited view of a small piece of the puzzle.
Lose a job hand building cars due to automation? Hey, figure out how to make better headlamps, or brakes, or tires and sell them to your old boss.
That's capitalism, use one successful improvement to begin a new improvement. Meanwhile, everyone benefits from the lower prices on products which are produced less expensively than before.
I disagree with the assessment on the predicted downfall of the dollar as a reserve currency. The worldwide meltdown has resulted in a much larger flight to US Treasuries than a flight from the dollar. Sure there was a lot of talk, but it was mostly that. Until someone (not a gold freak) can point out a safer currency, the dollar will be the default choice.
There isn't room to respond sufficiently here, but I would suggest you try reading through 'Human Action' by Ludwig von Mises.
You can download the book in .pdf here:
mises.org/humanaction/...
or peruse the table of contents here:
mises.org/resources/32...
I must warn you that this is a very long book (about 1,000 pages). The first three chapters are devoted to defining concepts which form the basis of the remainder of the text.
It covers a great many aspects of economics starting with the classic 'Robinson Crusoe on an island' scenario and building from that to a very complex economy in a systematic method that makes sense.
Plan to spend several weeks (it took me 6+) working your way through it, but you will learn a great deal if you persevere.
Given your comments and questions above I would guess you will eventually get to a point where the lightbulb goes on while reading and everything makes a lot more sense.
Smarty_Pants understands and uses both definitions and is referring to a potentially stable alternative money supply, while Jim Myrtle is referring to price deflation only and is using the example of the Great Depression which took place in the setting of an unstable money supply managed by the Fed and its fractional reserve banking system. The problem is that Jim Myrtle is using the example of the terrible deflation of the Great Depression as an example of what would go wrong with Smarty_Pants potentially stable alternative money supply, when it is very possible that a stable money supply would have prevented the rampant speculation that led to the stock market bubble, subsequent crash, and disastrous deflation.
In 1929, due to the immense amount of credit created under the Fed’s fractional reserve system, it was possible for a self-reinforcing deflationary spiral in the money supply to occur. When money = credit = debt, and credit is tightened, that is exactly what occurs, and it has occurred repeatedly since the establishment of the Fed, despite the Fed being established precisely to prevent such “business cycles”. It happened in 1929 and it is at risk of happening again in 2008/2009.
The Great Depression was certainly bad, but characterizing all price deflation as bad because of it is as wrong-headed as characterizing all price inflation as bad, because of the example of hyperinflation in Germany. Modest price deflation, due to productivity increases in an economy with a stable money supply is no more problematic than modest inflation and has nothing in common with the sharp monetary deflation that led to the Great Depression.
To give a realistic example of benign deflation in today’s world is very difficult, because we are all just so conditioned by perpetual inflation to think that prices always go up. But, to make it as simple as possible, just imagine a society that just farms and mines in the country and manufactures in the cities. If farm and mine productivity go up, food and mineral prices drop, but profits do not drop, because farm and mines sell more and their own costs drop. They have to eat, too. If they can’t sell all their product domestically, they can export. Also, the city factory margins improve because they are paying less for food and minerals; they can lower the prices of their products and keep wages stable simultaneously. Reduced prices for manufactured goods also improve farm and mine margins. Farm and mine wages can remain stable too.
The reason the Great Depression was so bad is that the price deflation was not the result of a beneficial increase in productivity in a stable currency regime; it was a catastrophic drop in the money supply due to a bank and brokerage credit freeze.
With our financial sector so screwed up at the moment, it is time that people learn that our monetary system isn’t some incomprehensible irreplaceable perfect system we cannot discuss or change. It is a private for-profit business cartel, not unlike OPEC, and it is not in business to help the average Joe.
Maybe a gold standard isn't the answer, but letting gold and silver circulate in parallel with the dollar as an alternative to legal tender paper would certainly be an interesting experiment. It's not the only alternative either, but this missive is too long already.
"The problem with fractional reserve banking is that the banker takes advantage of that trust for his own benefit by lending your money out multiple times and counting on the fact that enough depositors will leave enough money in the bank to cover all withdrawls.
A gold standard without fractional reserve lending would minimize this (some would try anyway, but be caught and imprisoned eventually) as it would not be allowed for any piece of money (gold) to have more than one claim on it at any instant. Since the banker can't "print" more gold they can't cheat the depositors for their own gain."
Technically, the banker's aren't doing this, the system as a whole is. When gold is lent to another person, the lender doesn't have a claim on that particular piece of gold anymore, the lender has a claim on the borrower, and/or on any collateral posted for the loan.
When the gold eventually gets redeposited in a bank, it's indistinguishable from a piece of gold that was, say, panned from a river and deposited. There's still only one claim on it, by the depositor.
Even there, the depositor gives up a direct claim on gold when he/she crosses the line from simply asking that the gold be stored, and agrees to lend out the gold, or have it lent, in exchange for interest. The depositor is now in the same position as the bank with respect to lending out gold - he has a claim on the bank, or the bank's collateral, but not on the gold per se. The depositor has, in effect, become a lender, without a direct claim on gold. The bank may well have collateral, in the form of a loan portfolio, to back up the depositor's claim. The depositor could, of course, have lent his or her gold directly to a borrower, and the state of affairs would, in the aggregate across the entire system, be no different.
Why then have the bank as an intermediary? It strikes me that the bank serves several economically useful functions in this example:
1. It serves, system-wide, to pool risk, so that no single depositor is exposed to a single bad loan. This is similar in principal to the economic value provided by insurance.
2. It is more efficient to centralize (for a fee, of course) the function of checking the credit of borrowers, servicing loans, and collecting on bad loans.
3. It allows for a decoupling of maturities that is useful but potentially dangerous - namely, it allows a large enough number of short-duration deposits to fund a smaller number of long-duration loans.
It's point (3) that you seem to argue most strongly against, so I'd like to drill into it. I'll assert that people need a goodly amount of gold in relatively short-duration deposits to fund day-to-day and month-to-month activities. In fact, there may be more gold of this sort in a large economy of relatively small actors than there is gold in the hands of very wealthy actors able to directly make investments or long-duration loans. Banks can make these short-duration deposits available for loans that almost always have longer duration, relying once again on pooling to ensure that demands are met with a smaller amount of gold kept on reserve. This is economically valuable because more worthwhile projects can be funded through loans, benefitting both the borrowers and, through the interest they earn, the depositors as well. The depositors must agree to this, of course - otherwise they can still choose to earn no interest by simply stockpiling their gold and making it unavailable to the pool. This system of using short-term money to fund long-term projects is obviously inherently unstable - as has been discovered many times, including recently, it depends on pool statistics, and is vulnerable to runs. Society has decided that this economic function of banking has enough value that we don't want to lose it, and so we have various mechanisms for preventing runs, namely government insurance on the deposits coupled with reserve requirements and regulations regarding prudent lending practices. Sadly, this last bit has been neglected recently. The old rules for trying to support this included having depositors wait for their withdrawals and allowing banks to call in loans. These rules were found to have disastrous consequences in the 1930s, so we abandonded them.
So either we forgo the economic benefits of (3), or we find a better system than the one we have now. If there's one in the book, I'll be glad to read about it. All I know now is that (3) appears to have benefit (I personally benefit from it as both a depositor and a borrower), and the current set of rules to fix the inherent vulnerability is better than what we had in the past.
All actors in the economic system will have to have a certain amount of gold to meet necessary short-term transactions. Small actors will have enough gold for a few days/weeks/months of food/rent/energy, large actors will have enough gold to meet their next payroll run, fund major purchases, or whatever. The problem is, there's not enough gold to support the one-to-one claim. In the distant past, perhaps, but the rate at which gold is being mined is much slower than the rate of economic growth. Even if productivity improvements cease, the rate of increase in the population ensures that the gold supply is eventually going to be challenged.
What happens when the supply of gold isn't keeping up with the economy? Lots of bad things. At first, the value of gold relative to all other goods and services goes up. This takes the form, eventually, of ever-decreasing wages and prices. Actors in the system early on benefit because their gold buys more and more. New actors have some trouble, though. What's worse, everyone can now see that by waiting, the value of everything relative to gold goes down. People begin to defer their consumption, holding their gold to buy things later. This reduces economic activity, eventually causing some actors to become unemployed. The potential wealth they might have created is lost - their time is a wasting asset similar to an unsold hotel room or airline seat. Things are worse still for debtors, who discover that they must pay back their loans in increasingly hard-to-obtain gold. People stop borrowing, knowing they cannot pay back, and so worthwhile projects begin to go unfunded. Lenders discover that simply storing their gold earns a better return than funding projects that might improve productivity, in terms of the goods and services that can be claimed later. Of course, huge numbers of people and resources are thrown at the gold-mining industry in a futile effort to wrest more gold from the earth, effort that is disproportionate to the actual value of gold as a commodity. This economy spirals down until people eventually get the gold monkey off their backs. At first, they begin to barter goods and services, bypassing the gold mechanism entirely. This is of course very inefficient, and so they begin to use IOUs backed by either assets or future productivity of known actors in lieu of gold. Eventually they realize that they could have kept the gold-based standard of measure for money but without restricting the supply of money to the physical amount of gold available, simply by allowing the gold necessary for short-term transactions to be lent out.
Further, if several countries would adhere to a gold standard, we would immediately have a world currency. Any country could join unilaterally, without approval by some central body and restrictions.
I fail to see the disaster imagined by the author.
don't adopt a gold standard unless you want to create a lot of pain & suffering.
as a standard of value, uranium has real value. gold is for jewelry, including your teeth.
> jack
"Saying that lower prices from productivity increases will destroy
the economy is taking a very limited view of a small piece of the
puzzle"
Where do you imagine I said anything like this?
Using your example, pretend prices were deflating 3% a year, because the money supply wasn't keeping up with GDP growth. Your $500 loan was at 5% and was 9 years interest only with a balloon payment in the 10th year. The first year your interest payment was $25. The second year the equivalent of $40, third year $55, fourth year $70, fifth year $85, sixth year $100, seventh year $115, eight year $130, ninth year $145. The last payment is $160 in interest and $672 in principle.
The trees that you sold for $20 at the end of the 10 year period only sell for $15. The loan that cost you $500/$20, 25 trees on day one cost you $672/$15, 45 trees in year 10.
Now, the mill that buys your trees makes lumber for the housing industry and for Home Depot, Lowes etc.
The retailers don't want to finance inventory that loses 3% in value every year, so they reduce purchases by 20%, to work off inventory. The housing industry shrinks as well, who wants to buy a house that will be 3% cheaper next year, 6% cheaper the year after that. Banks refuse to finance homes with less than 20% down.
Your mill goes out of business. The nearest mill is now 200 miles further away and your cost to transport the trees doubles. Demand for your lumber drops 50%. Your increased efficiency may leave yours as the last remaining lumber harvesting business, but the economy is killing your business too.
Do you understand why lower prices due to shrinking money supply (vs. GDP growth) are bad while lower prices due to increased productivity are good?
On Dec 31 12:24 AM Smarty_Pants wrote:
You could be "technical" and say we were "suffering" 1% inflation, but all people care about is the impact that 1% "inflation" has on prices, in this case it causes them to fall 2% a year.
And you can pretend that there was no inflation or deflation (in prices)while we were on the gold standard, before the Federal Reserve was created, but you'd be wrong.
On Dec 31 01:21 AM asleeper wrote:
Smarty_Pants understands and uses both definitions and is referring to a potentially stable alternative money supply, while Jim Myrtle is referring to price deflation only and is using the example of the Great Depression which took place in the setting of an unstable money supply managed by the Fed and its fractional reserve banking system. The problem is that Jim Myrtle is using the example of the terrible deflation of the Great Depression as an example of what would go wrong with Smarty_Pants potentially stable alternative money supply, when it is very possible that a stable money supply would have prevented the rampant speculation that led to the stock market bubble, subsequent crash, and disastrous deflation.
On Dec 30 11:43 PM Smarty_Pants wrote:
The problem with fractional reserve banking is that the banker takes advantage of that trust for his own benefit by lending your money out multiple times and counting on the fact that enough depositors will leave enough money in the bank to cover all withdrawls
> "In summary, crookery and financial deviousness becomes nothing more
> than a farce, and those running the show are but charlatans. It is
> not suppose to be this way. As other posters pointed out more succinctly,
> money is based on trust. If there is no trust it doesn't matter what
> money is based or backed on because the accounts won't match up no
> matter how you calculate them." - constructe
>
> Very true. The entire economy is based in trust at some point unless
> everyone is completely self sufficient. Does your employer pay you
> every day? No? You are trusting that he will pay you at the end of
> the pay period then, aren't you? Otherwise you would think that you
> are working for free.
>
> When you pump gas into your car either the station attendant is trusting
> you to pay after you pump, or you are trusting him to properly charge
> your credit card after you swipe it (before you pump).
>
> Division of labor requires trust. The problem with fractional reserve
> banking is that the banker takes advantage of that trust for his
> own benefit by lending your money out multiple times and counting
> on the fact that enough depositors will leave enough money in the
> bank to cover all withdrawls.
>
> A gold standard without fractional reserve lending would minimize
> this (some would try anyway, but be caught and imprisoned eventually)
> as it would not be allowed for any piece of money (gold) to have
> more than one claim on it at any instant. Since the banker can't
> "print" more gold they can't cheat the depositors for their own gain.
> This puts a firm lid on starting and inflating manic behavior in
> the market.
>
> Besides, physical exchange would give depositors the power of a bank
> run. This is an important means of keeping banks in line.
>
>
> PS. Those who wish to claim that banking was on the gold standard
> for the great depression are only partially correct. When the FED
> was established in 1913 they started printing more paper money than
> there was gold to cover (much smaller amounts than today).
>
> This is what fueled the Roaring 20s, excess money that was unbacked
> by gold and loaned into the economy. This was the first FED induced
> economic bubble whose deflating led to the Depression when tariffs
> were raised and even more money printed and spent on public works.
> The Great Depression was a deflating bubble just like our financial
> crisis today is.
>
> Even though we were officially on the gold standard with convertibility,
> the banks were using fractional reserve banking to blow a bubble.
>
Just to clarify, my example rests on the idea that the money supply is stable (ie. gold backed and no fractional reserves). I think my use of $ in the example may be leading people off on a tangent.
While my example shows that prices on goods would decrease, it also shows that the improved productivity allows me to pay my workers more, not less because my profits are increased.
Think of wages as being paid in gold, not $ (ie. 1 oz./ week).
Substitute some symbol for gold money instead of $, then you will see that as productivity gains outpace increases in the supply of gold, the same income will buy more stuff.
I will be able to pay my workers 1.1 oz/week instead of 1 oz/week due to productivity gains, while my business profits increase at the same time. Meanwhile the price of lumber (in gold) drops by 2%. My workers are much better off as long as I can keep them employed harvesting timber (ie. while demand for timber continues).
What logic do you use to deduce lower incomes for the workers? My example shows that I can afford to pay them more after productivity gains. If that pay is measured in gold, then their standard of living increases with increased production and the lower prices it brings, even if they continue to earn 1 oz/week instead off 1.1 oz/week.
Jim: I would make a similar argument for your comments. Think in terms of weight in gold and not dollars. Reprice everything in my example in terms of gold weight.
My loan payments, and interest, will be paid in gold. Granted, an ounce of gold tomorrow will buy more than it will today due to lower prices brought about by productivity gains, but I do all of my calculating in weights of gold.
If my effective payment cost due to lower prices increases by 3% annually as you suggest, but my profits increase by 50%, isn't that a good deal for me? The extra 50% of profit in year #1 is gaining in purchasing power by 3% per annum as well. If my initial annual profits exceed a gold equivalent of $1000 then I will GAIN over time because the extra profits will gain more in purchasing power than my payments cost me in purchasing power.
Let's extend my above Example and use weights of gold for everything:
Assume my original pre-chainsaw profits were 100 oz of gold annually and that my loan was for 10 oz of gold to 'upgrade' to chainsaws with a 10 year repayment plan of 1.1 oz/year (that's higher than 5% interest but it makes calculations easier).
Now after productivity improvements, my workers earn 10% more in gold, my landowner earns 10% more in gold, the sawmill saves 2.5% in gold on cost of logs, and my profits still increase by 50 oz of gold annually.
Let's look at my end results year by year and adjust for the effects of deflationary pricing at 10% annually (again for ease of calculation though it should exacerbate any problem you posit). The 'base' columns are the purchasing power in first year terms to account for price deflation.
--------------Base----...
Loan-------Equiv------...
Pmt---------Pmt-------...
-1.1 ------ -1.1 ---------- +50 ---------- +50 --------- +48.9
-1.1 ------ -1.2 ---------- +50 ---------- +55 --------- +53.8
-1.1 ------ -1.3 ---------- +50 ---------- +60.5 ------- +59.2
That's the first three years of my net result. Did the payments on my loan 'cost' me more in purchasing power? Sure did. But the gain in purchasing power of my extra profits far exceeded thoses losses.
I will happily pay that 1.1 oz of gold on the loan if it realizes 50 oz of extra profits each year. I am getting ahead faster and faster because my profits are increasing in purchasing power more than my payments are costing me in lost purchasing power.
At the same time:
1) my workers have a 10% increase in (gold) wages whose purchasing power is increasing every year;
2) The landowners have received 10% more for their timber whose purchasing power is increasing every year;
3) the sawmill is buying his logs for 2.5% less in gold, which he can split between lower his prices and increasing his profits.
4) Anyone who buys lumber will save by the amount the sawmill lowers prices.
Everyone involved is getting more gold out of the deal because of my productivity improvement, either through higher pay, larger profits, cost savings due to lower prices, or some combination of the three. Even the sawmill is making bigger profits because of MY productivity improvement.
Jim's other comment is an over-exaggeration:
"The housing industry shrinks as well, who wants to buy a house that will be 3% cheaper next year, 6% cheaper the year after that."
Well, computer prices today continue to fall rapidly for the processing power you buy. Are you implying that nobody will buy a computer this year because they know they can get a better deal next year? Same for cell phones or iPods or plasma tvs?
NO! Some people may wait, but most will buy because their time preference is such that they would rather have something NOW than wait a year to buy it 3% cheaper. The market will adjust to the demand for the products just like it does now.
Will an increase of purchasing power reduce sales? Probably some, but sales won't stop. If they did, then Dell would be out of business today rather than selling $billions of PCs every year.
Jim also stated:
"The trees that you sold for $20 at the end of the 10 year period only sell for $15."
No, they sell for a given weight of gold. That 'price' will be determined by supply and demand. If demand for lumber falls, the sawmill may only be willing to offer 15 gold weight units, but if I cannot buy, cut, and deliver the logs for less than that price I would decline to participate, closing down my business if things got that bad. Why continue if it costs me 16 gold weight units to produce something I can only sell for 15 gold weight units? That's how business works now. No profit, no deal.
However, the sawmill may also be improving productivity via better machinery and be willing to increase what it pays for logs, just as I was able to increase my payment to landowners. If the sawmill's improvements will generate larger profit margins it will be willing to outbid other sawmills to get more business and make extra profits from more volume.
Actually they can make a loan of $1000 with it. Which, if that loan is redeposited into the same bank, they can make another loan of $1000 against. If every loan is redeposited they can loan up to $2,000,000 in that fashion, at which point they will hit the 'exemption limit'.
It would work the same way if the original $1000 loan were deposited into a different new bank (as the only deposit). That bank could loan the entire $1000 out as well. If each loan is deposited in a different new bank as the only deposit, each iteration could lend $1000 against the new deposit. An infinite amount of loans could, in theory, be created based on the original $1000 (and a whole lot of new banks).
Until somebody tried to remove some money from one of the banks. Then the system would start to unravel and a huge monetary deflation would occur (decrease in the supply of money deflation, not lower prices).
Beyond the $2 million mark in deposits (assuming all loans are deposited in the same bank) they can only lend out $970, then $940.9, etc. decreasing by 3% each iteration until the 'low reserve' limit of $25 million in deposits is reached or the loan amount becomes so small as to be considered a loan of $0.
www.federalreserve.gov...
Col 1 is nominal loan payment
Col 2 is deflated loan payment
Col 3 is nominal profit
Col 4 is deflated profit
Col 5 is deflated net
As you can see the purchasing power gains of my extra profits easily outweigh the purchasing power losses of my payments and will increasingly do so over time.
That doesn't change my point. The gold you use to repay your loan gets more valuable each year, increasing the real interest rate of your loan.
"If my effective payment cost due to lower prices increases by 3% annually as you suggest, but my profits increase by 50%, isn't that a good deal for me? "
You bet.
"Jim's other comment is an over-exaggeration:
"The housing industry shrinks as well, who wants to buy a house that will be 3% cheaper next year, 6% cheaper the year after that."
Well, computer prices today continue to fall rapidly for the processing power you buy. Are you implying that nobody will buy a computer this year because they know they can get a better deal next year?"
Are you implying a computer purchase is equivalent to a home purchase? Did you take out a 30 year mortgage when you bought your last Dell?
"Jim also stated:
"The trees that you sold for $20 at the end of the 10 year period only sell for $15."
No, they sell for a given weight of gold. That 'price' will be determined by supply and demand"
But the supply and demand of money works the same way. If output increases 3% and money supply remains the same, prices must fall 3% on average. Obviously some will fall more, some will fall less and some will rise. But on average, down 3%.
When housing collapses, will lumber fall 3%, or 20% or 50%?
And forget your massive productivity increase for a moment, what about firms that have to make huge investments, just to maintain current output or to make very small productivity gains?
What about GM? Will they be more likely to stay in business if they had to reduce prices each year? Would car sales fall if people could wait knowing prices would drop?
"If demand for lumber falls, the sawmill may only be willing to offer 15 gold weight units, but if I cannot buy, cut, and deliver the logs for less than that price I would decline to participate, closing down my business if things got that bad. Why continue if it costs me 16 gold weight units to produce something I can only sell for 15 gold weight units? That's how business works now. No profit, no deal"
Exactly, even with your productivity rising, demand crushing deflation could even make your firm unprofitable.
On Dec 31 11:25 AM Smarty_Pants wrote:
On Dec 31 11:40 AM Smarty_Pants wrote:
> "If a brand new bank opens today and I make the only deposit of $1000,
> how much do you think the bank can loan?" - Jim Myrtle
>
> Actually they can make a loan of $1000 with it.
On Dec 30 08:56 AM archman82011 wrote:
> Return to the gold standard would mean one thing:
>
> Accountability.
>
> We can't have that now can we? That means if we have accountability
> in our finance system, we have to have accountability in government.
> If we have accountability in government, that means our citizens
> have to be more accountable, and return to an ethical and moral country.
>
>
> We can't have that though. That means minimal corruption, less graft
> and greed. Our country would have to do what is best for the majority
> instead of what is best for the select few.
>
> Good golly we can't have that now can we????
>
>
The principle is the same, however given the size of the purchase the difference in absolute price would be much larger for a house as you note. I would add that under a fully gold backed, no fractional reserve system there would be very few mortgages.
Most 'unused' money would be directed toward productive uses where payments could be funded from profits the loan generates. There's no profit in owning a home, so the homeowner doesn't really have a means of out-bidding a commercial borrower who expects to realize a return on the loan.
Any home mortgages would either be family funded (ie. fully owned family farm 'sold' to #1 son for stream of payments until bequeathed at death of parents) or from personal friends who had the money.
I would guess that most homes would be purchased for cash and funded by savings. It would certainly be a different world.
"what about firms that have to make huge investments, just to maintain current output or to make very small productivity gains? "
They would likely be shut out of the credit markets for lack of ability to outbid competing borrowers with high interest rates. If they can't make a profit without the loan, then they would fail and go under for lack of sufficient consumer demand (or poor management).
The market is a harsh place. A financial 'law of the jungle' applies. Compete and win, or die. The judges are consumers and their wallets.
"What about GM?"
GM deserves to go under even with our current fractional reserve, fiat monetary regime. They have squandered billions and have nothing but debt to show for it. They would fail without question in a gold backed, non fractional reserve system unless restructured from the ground up.
As for prices of anything and everything presuming a transition to a gold backed, non fractional reserve system, I will agree that there will be enormous discontinuities that occur. Homes will be foreclosed, businesses will go under, bond holders will lose everything, etc. etc.
But that's what we're getting now, and we're repeating the actions which brought us to this point on a larger scale to 'prevent' it. Things will only be worse at some point in the future if we continue as we have been.
If we're going to suffer those problems anyway, why not make the final goal a stable system like a gold backed, non fractional reserve system?
"The principle is the same, however given the size of the purchase the difference in absolute price would be much larger for a house as you note. I would add that under a fully gold backed, no fractional reserve system there would be very few mortgages"
That should help you sell your idea to the public. LOL!
what about firms that have to make huge investments, just to maintain current output or to make very small productivity gains?
"They would likely be shut out of the credit markets for lack of ability to outbid competing borrowers with high interest rates. If they can't make a profit without the loan, then they would fail and go under for lack of sufficient consumer demand (or poor management)"
What do you imagine unemployment would be in your deflationary world?
"GM deserves to go under even with our current fractional reserve, fiat monetary regime"
I agree, GM must restructure or die. But there are tens of thousands of much better run businesses that would be crushed by a long term deflationary environment.
"As for prices of anything and everything presuming a transition to a gold backed, non fractional reserve system"
I still don't understand why you think we can have a 100% reserve system. Even under a "pure gold & silver standard" we had fractional reserve banking. Why would it be different now?
" I will agree that there will be enormous discontinuities that occur. Homes will be foreclosed, businesses will go under, bond holders will lose everything, etc. etc.
But that's what we're getting now, "
Doctor, the patient has an irregular heart beat....quick, use this gun, maybe inserting a high speed bullet will help.
"and we're repeating the actions which brought us to this point on a larger scale to 'prevent' it"
The actions which brought us to this point were government regs to force unsound loans. Wall Street "innovations" to make these crappy loans "safe" and a reach for yield that made these MBS appear desirable.
Do you really think banks are eager to make risky loans today? People are eager to buy high yielding MBS?
"If we're going to suffer those problems anyway, why not make the final goal a stable system like a gold backed, non fractional reserve system?"
Not enough gold in the world. Not enough new supply to keep a large economy liquid and growing. It didn't work before, it really won't work now.
More like:
1st Mate: "Captain, the ship is taking on water and the pumps can barely keep up."
Captain: "Keep pumping and change course toward the nearest land mass and start plugging the holes." instead of "Drill more holes in the hull to let the water out and head out to open ocean."
One other item which enabled the mess today has been the extreme use of fractional reserve lending for leverage to fund all the crappy loans, etc. Absent the ability to make loans based on nothing there wouldn't have been enough money to drive the housing bubble to such insane heights.
"Not enough new supply to keep a large economy liquid and growing. It didn't work before, it really won't work now."
1) The US went from agrarian backwater in 1800 to financial superpower by 1900 with an exchangable, fully backed gold based monetary system and we still held less than 20% of all the gold ever mined. Free markets and {semi-} sound money (see below) worked wonders without incurring huge amounts of public debt except during wars.
2) Even under the prior gold system private banks were allowed to issue fractional reserve loans, so you can't say "it didn't work before" because it really hasn't been tried since the onset of the industrial revolution and the birth of 'modern' capitalism. All of the 19th centuries 'panics' can be traced to excessive lending via fractional reserve banking at private banks and the eventual unwinding of those loans gone bad.
Adding new liquidity is the difference between trying to pump the water out and scuttling your ship immediately.
"The US went from agrarian backwater in 1800 to financial superpower by 1900 with an exchangable, fully backed gold based monetary system"
Imagine how much better we would have done without the periods of crushing deflation.
"Even under the prior gold system private banks were allowed to issue fractional reserve loans, so you can't say "it didn't work before" because it really hasn't been tried since the onset of the industrial revolution and the birth of 'modern' capitalism"
So explain again how 100% reserve banking would work.
"All of the 19th centuries 'panics' can be traced to excessive lending via fractional reserve banking at private banks"
Since there were no "public" banks, why use the word "private"?
On Dec 31 03:24 PM Smarty_Pants wrote:
Proposed 100% Reserve, Equity Backed Money and Banking Model
Comments welcomed and appreciated.
mb
The only reason those periods had "crushing deflation" was because banks first created money out of thin air via fractional reserve lending and issued it into the economy, thereby inflating prices above prior levels due to the extra money created. The "crushing deflation" was an unwinding of the effects of fractional reserve lending.
"Crushing Deflation" that results from liquidation of fractional reserve based loans is very much different than lower prices brought about by improvements in productivity. What we saw in the 19th century and are experiencing today was/is the former, not the latter. Under a gold backed, non fractional reserve lending system you wouldn't get the former, just the latter as in my logging example.
Please identify which party in my example was "crushed" by the deflation my productivity improvement brought about. Was it the workers who got a 10% raise and increasing purchasing power? Or the landowner who got 10% more for his trees? The sawmill who saved 2.5% on the logs I sold him? The consumer who could purchase lumber for less? Or was it me, whose profit increased by 50%? None of those were harmed at all and in fact all gained by my improvement.
The only parties who were adversely impacted were the hired workers whose labor was rendered unecessary through the use of chainsaws. But even they had a ground floor opportunity to get into the business of producing the latest 'high tech' tool in the chainsaw, where margins would be high for some time.
I see no party who does not have an opportunity to get ahead. Can you identify one from the example? Every person winds up with more money than they got before the improvement and that money has more purchasing power. How is that being 'crushed'? Or do you just like using the phrase "crushed by deflation" without any specifics?
From steady state conditions before the improvement to steady state conditions after the improvement, the parties wind up better off, not 'crushed'.
I too wish to avoid 'crushing deflation' but I believe in order to do so you must first remove fractional reserve based growth in the money supply in order to prevent the prior inflationary bubbles which then 'deflate' as the debt is liquidated.
"Since there were no "public" banks, why use the word "private"?"
By 'private' I mean independent and not part of the Federal Reserve system. Prior to the FED's establishment, each bank could (and did) issue its own currency based on it's deposits. They chose their own reserve ratios as decided by the owner(s) of the bank.
There was no 'lender of last resort' to paper over a shortfall exposed by a bank run like the FED does today. The bank was responsible to its depositors and required to provide exchangability for its notes. The fact that they were on their own in this regard is what greatly limited the fractional reserve lending they undertook (compared to today).
Even at the height of the bubble in 1837 the average bank had issued only $1.8 in notes for every $1 of gold, averaging 55+% reserves. This was the "towering" peak from which your "crushing deflation" took place under the gold standard. Hardly a molehill compared to today's <10% reserve levels.
Tell me again, how is it that the gold standard's "crushing deflation" with 55% reserves is worse than the "crushing deflation" the Federal Reserve system has foist upon us with less than 10% reserves?
Seems to me that the fiat standard is doing far more in the way of "crushing" than the gold standard ever did. There are certainly a lot more unbacked loans to liquidate now than the gold standard ever created, more than 4x as many. That's a lot of crushing.
mb
Once more time.
Enjoy your New Year's celebration everyone.
Drive safely and watch out for the dummy who isn't.
See you next year.
Why would banks want to create money out of thin air? Why would there be demand for this "thin air" money? Is it possible the economy was growing faster than the gold supply?
"Please identify which party in my example was "crushed" by the deflation my productivity improvement brought about"
Instead of a 50% increase in productivity, why not make a more realistic assumption? How about 100% or 200% increase in productivity?
Let me say it again, increased productivity is great. Lower prices from increased productivity is great. Lower prices because you strangled the money supply, not good. Shrinking GDP, because you're choking off money supply, not good.
"Even at the height of the bubble in 1837 the average bank had issued only $1.8 in notes for every $1 of gold, averaging 55+% reserves"
Even under the gold standard, we had fractional reserve lending.
So explain how 100% reserve banking would work.
"Tell me again, how is it that the gold standard's "crushing deflation" with 55% reserves is worse than the "crushing deflation" the Federal Reserve system has foist upon us with less than 10% reserves?"
The Panics we had every 10 years or so resulted in huge drops in GDP, much worse than the recessions we've had since the Great Depression.
Second, as Churchill said about democracy, the U.S. is very probably still the only economic game in town because all the alternatives are worse.
China is a tempting dream but only a dream as you probably know already.
Europe has proven, and continues to prove, that it can never unify under any banner, whether it is spelled Hapsburg, Hitler, de Gaulle or Euro.
What does that leave us? Russia?
At present, America is going through a similar dislocation that the technological advances of the 1920s and 30s produced during the Great Depression, as far as I can see, and we'll feel the consequences for some time before we learn to live in this brave new, and constantly changing, technological world.
In the meantime, work less and work at home and learn to love it. The leisure that technology promised to give us for so long is finally here.
It's up to us to make use of the new opportunities for happiness and not run into the street and shoot guns at each other out of confusion, fear and boredom, the way we have in the past.
(By the way, gold is excellent for filling teeth with. Tell your dentist about it if he hasn't heard yet.)
First, deflation and inflation are at all times, as Milton Freedman said, a MONETARY phenomenon. Here is the fractional reserve banking model in a nutshell:
1. Create money from NOTHING. This is inflation.
2. Loan it out for interest.
3. As the loans are repaid, the money goes goes back to NOTHING. This is deflation.
So, the only thing needed to cause deflation in our economy is for the banks to lend new money at a slower rate than old loans are repaid. Now a look at MV = PY:
M = total money supply
V = average no. transactions per year
P = price level
Y = aggregate output
An increase in Y, aggregate output, for constant MV must cause a drop in P, the price level to keep the equation balanced. This is normal progress. All to the good. But now look what happens when M drops (deflation):
A decrease in M (total money supply) must cause PY to decrease by the same amount to keep the equation balanced. Y is aggregate output and is relatively insensitive due to inertia. Thus we expect P, the price level, to drop one for one with M. Is this bad? Not permanently as long as production costs are allowed to drop too. But can they? Not always, as in the case of wages, which tend to be "sticky" as someone once said. So what happens instead is that marginal production is reduced to keep cost per unit in line with the new price level. This would involve layoffs of marginally productive employees. So Y, aggregate output, now drops by the reduction of marginal production. Also, as might be expected, V must drop too since both P and Y have now decreased to keep the equation balanced.
So, simply a decrease in the the rate of new FRB loans can cause a drop in aggregate output. This is the economy running backward. The culprit is FRB which must deflate eventually to prevent runaway inflation.
First off, my example was a 100% increase in labor productivity, doubling the number of trees in a given time.
Secondly, you ever try to chop down a tree with an axe or a hand saw? You can easily cut the time in half using a chain saw, especially when you consider the amount of time it takes to limb the fallen tree. In the example my 100% increase in labor productivity is probably on the conservative side, based on personal experience.
"Why would banks want to create money out of thin air? Why would there be demand for this "thin air" money? Is it possible the economy was growing faster than the gold supply? "
If what you're trying to suggest is that the economy is "strangled" BY DEFINITION whenever the amount of goods is growing faster than the money supply, then I disagree, and so did Murray Rothbard who believed that expanding the money supply at a fixed rate equivalent to the underlying growth rate of the economy can't work because it requires impossibly precise assumptions.
How does your local banker know whether there's "enough" unbacked credit based fractional reserve money in circulation to match GDP growth when someone comes in to get a loan at his bank? GDP numbers aren't released until well after they are measured, only released now and then (ie. not daily), and they are often revised after the fact.
If a banker makes a loan when there have already been "too many" made for the amount of growth in GDP, how do you get that money back out of circulation to prevent inflation? Multiply those issues by tens of thousands of bankers. How do they coordinate to limit the amount of loans they issue to "match" GDP growth when they have no way of knowing what that growth is at any point in time?
Seems to me that it's easy to say money supply should match GDP growth, but it's not really possible to do so in reality. Everyone will issue the loan if there's any doubt. Err on the side that makes the bank money. It turns into a loan-fest and degrades into the maximum money creation at whatever the minimum reserve requirement is set at for every bank, regardless of GDP. This is how bubbles are created.
No offense, but I'll side with Rothbard unless you can persuade me otherwise.
"Lower prices because you strangled the money supply, not good. Shrinking GDP, because you're choking off money supply, not good."
How is having a relatively constant supply of money "strangled"? How exactly in my example is the 'strangled' money supply shrinking GDP?
The supply of money is the same from beginning to end, yet it will support the purchase of more goods at the end than at the beginning. Is that not a larger GDP? Even if the GDP (amount of purchases) remains the same the economic actors will have more money left over after the purchases than they would have prior to the use of chainsaws.
Hmmm. Buy the same amount of stuff, have money left over, OR, spend the same amount of money and get more stuff.
Where exactly does this 'strangling' happen? I don't see it. Let's hear the specific details in relation to my example instead of vague claims of a 'strangled money supply'.
"Even under the gold standard, we had fractional reserve lending."
Yes, and that's what produced the overextended monetary conditions that led to the 'deflating' money supply in the periodic panics. That's also the reason why I believe that a non fractional reserve system is also necessary in addition to a gold backed standard. To prevent over expansion of the money supply and burdening the economy with excessive and unbacked debt which needs to be unwound via liquidation.
The reason there were periodic deflations under the gold standard was because fractional reserve lending was used. Unbacked money was 'created' and loaned into the economy and spent non-productively. The borrower "wasted" the money, and then couldn't service the underlying debt, which had to be liquidated.
No unbacked credit based money = no liquidation = no deflation.
For details on how a gold backed, non fractional reserve system would work see my previous comments with regards to fixed duration, non redeemable Certificates of Deposit for making loans of personal savings.
Best wishes for the New Year.
On Dec 31 08:01 PM moonbat1775 wrote:
Here is the fractional reserve banking model in a nutshell:
1. Create money from NOTHING. This is inflation.
I'm sure you know the formula, MV=PY
If M and V remain constant while Y increases, P must fall. Not a problem for you, your productivity just doubled. It is a problem for someone who needs to borrow heavily while their output drops in price.
Farmers after the Coinage Act of 1873 were especially hurt.
As prices continually fall, assuming M remains constant, V can also decrease. This can cause Y to decline, even as prices fall further.
Difficult to get out of a deflationary spiral once it starts. See pushing on a string. Or Japan in the 1990s.
"For details on how a gold backed, non fractional reserve system would work see my previous comments with regards to fixed duration, non redeemable Certificates of Deposit for making loans of personal savings"
Interesting idea, but that sounds like zero reserve banking.
Happy New Year to you as well.
I always enjoy an interesting discussion.
You admitted housing would suffer, not to mention any sector that requires lots of capital with little chance for large productivity gains (think utilities, as just one example).
On Dec 31 08:39 PM Smarty_Pants wrote:
Any method that allows money to be in two places at once creates money. For instance, with a 10% reserve requirement, a bank can loan out 90% of its depositor's money while retaining a 10% reserve. Since the depositors money is available on demand, the bank has thus nearly doubled the money supply of the bank. That 90% can be deposited in another bank and 90% of that 90% lent out (81%) and so forth. With a 10% reserve requirement, ten times depositors account balances can be lent out. See why we don't have many savers? Who needs them anyway with leverage like that? And FRB drives down the interest rates savers would be paid, thus discouraging them and encouraging them to get loans themselves and speculate. The whole purpose of FRB is to BYPASS the need for savers.
"Priming the pump". I recon this means increasing the money supply by investment loans to increase productivity. However if M is increased (money supply) then P (the price level) must also increase since Y aggregate output has inertia. Eventually, aggregate output will increase due to the "investment". Let's use some number to show a problem with this approach:
delta M = 5%
delta P = 5%
delta productivity must then be at least 5% JUST TO BREAK EVEN. So much for pump priming?
Loaning money isn't creating money from nothing.
"Since the depositors money is available on demand, the bank has thus nearly doubled the money supply of the bank"
You have the depositors money and the borrowers IOU. Which is as good as money.
"That 90% can be deposited in another bank and 90% of that 90% lent out (81%) and so forth"
Yes, banks loan out less than deposits, not multiples (as I've heard claimed before).
"See why we don't have many savers? Who needs them anyway with leverage like that?"
Excuse me? Without the first dollar in savings, there is nothing to leverage.
On Dec 31 10:00 PM moonbat1775 wrote:
I thought you might bite at that. OK, good call. How about "The need for savings is reduced by up to 1/10."?
"Loaning money isn't creating money from nothing. " Jim
Correct, but I already pointed out how banks create money. The IOU has to do with solvency not the money supply. I have said nothing about whether a backing for money was necessary.
What if the first loan buys something and the money is used to pay off an outstanding loan? Now the money supply shrinks. :^)
"Loaning money isn't creating money from nothing. " Jim
Correct, but I already pointed out how banks create money.
As long as you're off the "money out of nothing" idea.
"The IOU has to do with solvency not the money supply"
The IOU is the new money supply.
Happy New Year!
On Dec 31 10:43 PM moonbat1775 wrote:
Nope. The banks creates money out of nothing and loans it out with the IOU as collateral. As the loan is repaid it goes back to nothing.
The IOU is a diversion. And it works pretty well, too.
Happy New Year to you.
"Asset"-backed fiat:
To "make" money,
make money
and loan for a fee.
"Asset"-backed fiat:
Use inflation to "grow"
and (except for Zimbabwe?)
deflation to pay.
"Asset"-backed fiat:
"We can make it work.
It steals, we admit,
but gives everyone work."
"Asset"-backed fiat:
a "loan" from
future savings
in this "real" economy?
"Asset"-backed fiat:
Booms/busts,
build new factories;
then watch them rust?
"Asset"-backed fiat,
in a monopoly money,
"borrow" from everyone;
repay with poverty?
I would think that increasing Y would push both P and V lower if M was fixed. If your money is gaining purchasing power then after spending "less" of it on necessities some portion of the population would save the left over money and not spend it. Velocity of the fixed money supply would slow down over time as disposable income (ie. total income minus spending on necessities) increases.
The entire dynamic of money would change once everyone realized that there wasn't an endless pile of money to borrow and that they would have to pay much higher interest than now to get use of the limited savings of others. Savings would increase as interest rates got higher, but it wouldn't approach the levels of lending we have in our current FRB system.
To make major purchases people would have to save up or gang up. Of course over time it will take less money to buy the necessities and you can save a larger portion of your income.
The use of MV = PY is only a static tool which I don't feel entirely represents what would happen when the entire approach to handling money changes. For a 'quick and dirty' idea of immediate impacts of small changes in those values, sure it will give you an idea, but there are too many moving parts in the system for a good long term impact assessment.
As far as "money from nothing", Rothbard used the phrase 'money from thin air' in describing the functioning of FRB. See his book Mystery of Banking.
mises.org/mysteryofban...
See the section on FRB that starts on page 116 of the pdf document (page 97 of the book).
He also defines the reserve ratio as:
Money in the vault / claims to money in the vault
So if the bank got a deposit for $1,000 and then made a $1,000 loan to another person, the reserve ratio would be 1000/2000 or 50%. The loan IOU doesn't count as 'money in the vault', but the borrower does have a claim to the money in the vault. As far as the rest of the economy knows there are now $2,000 being spent where there is only $1,000 'in the vault'. If both the depositor and the borrower kept their 'money' in a checking account, theoretically they could both write a check for the full amount on the same day. The bank would have to honor both checks, but only has enough money on hand to honor one.
Half of that $2,000 'came from thin air'.
Rothbard goes into a lot more detail than that. It's an interesting read.
You're killing me! I open a new bank, you make the only deposit,
ten $100 bills. Smarty_Pants borrows $900 and I hand him nine $100s.
$100 remains in the vault as my reserve.
The bank's assets are $100 in vault cash and a $900 IOU, the bank's liabilities are the $1000 deposit you made.
The money supply is now $1900 and the bank didn't create anything out of thin air.
"As the loan is repaid it goes back to nothing"
As the loan is paid, vault cash increases, your IOU decreases and the money supply decreases.
On Dec 31 11:50 PM moonbat1775 wrote:
"So if the bank got a deposit for $1,000 and then made a $1,000 loan to another person, the reserve ratio would be 1000/2000 or 50%."
The money is now in the hands of the borrower. Nothing left in the vault.
Reserve ratio is $0/$1000. That'd be 0%.
On Jan 01 12:28 AM Smarty_Pants wrote:
1) No banks, at least not as we know them. There would be no interest (or yields on lending) as well, unless there was some sort of government mandated forced deflation to reallocate wealth, and
2) A lot less risk-taking, orders of magnitude less.
Otherwise, I found it to be very similar to what we already have, which surprised me. The government's involvement in our economy would probably remain constant when compared to what we have now, although it would be even more painfully obvious.
People would still spend as they do today, not because they are ignorant about how their money would be worth more in the future, but because they would be acutely aware of how the government would have to forcibly deflate their earnings in the future to account for things like productivity and successful entrepreneurship. (No self-respecting business would self-deflate their prices without outside pressure) One way or another, their spending power will decrease in time, to account for the wealth rewarded to those who added value to the system.
I suppose the only argument would be whether or not such a system would fare better or worse against another economy with fractional reserve lending. The only real difference would be that the other system would, at the very least in the short run, be much, much more robust than the one that did without, and if it came to fists or tanks, the FRB system would easily win. War is inflationary, as they say.
Well, regardless, this has been quite interesting. The intricacies of the gold standard are certainly not my forte - I just wanted to know if more than the standard allocation was warranted in this environment. Given that the US's currency reserves are largely gold, it's a hard argument to ignore.
I hope Mr. Smartypants et al and Mr. Myrtle reach some sort of agreement. Happy new year!
I deposit $1000 and the money supply is now $1900? The "money from nothing" is $1900 - $1000 = $900.
The purchasing power for that $900 comes from the public at large. How is that not theft?
So what if assets = liabilities + equity? What does book keeping have to do with honesty? A counterfeiter who lent out his "money" would keep books too, wouldn't he? FRB started out as a cheat by a goldsmith and ended up a government-backed cartel. Besides being dishonest it is also unstable (probably because it is dishonest).
There is an alternative that is 100% honest and should outperform FRB without the boom/bust cycle. Just click on "My Website" for a complete description of a new money and banking model based on equity.
The growth that has taken place in the world's standard of living, especially that in America, has been build on credit and money expansion. It does seem logical to conclude that a major contraction would take place if the dollar was pegged to gold. Again, this might not be catastophic, providing gold becomes valued in the $30,000 per ounce range. I used loose numbers but based on 14,500 tons of gold extant, converted to standard ounces (I realize that troy is different), divided into an M3 number of $13.5 Trillion. I'm no expert so mess with your own numbers but that's what I come up with.
nothing" is $1900 - $1000 = $900"
Your IOU is as good as cash. Sorry. Not from nothing.
"The purchasing power for that $900 comes from the public at large.
How is that not theft?"
Inflation is too much money chasing too few goods. Right? How is the $1000 in the bank chasing any goods?
"So what if assets = liabilities + equity?"
If a bank could create money out of nothing, assets would grow without any change in liabilities.
On Jan 01 01:18 PM moonbat1775 wrote:
How is that not theft?" mb
"Inflation is too much money chasing too few goods. Right? How is the $1000 in the bank chasing any goods? " Jim Myrtle
I said nothing about inflation. I am talking about honesty. The purchasing power of that $900 created from nothing comes from the general public without their permission.
The purchasing power for that borrowed $900 (not from nothing) comes from the depositor, who cannot buy anything with it right now. No theft. No involvement with the public, at large or otherwise.
On Jan 01 03:21 PM moonbat1775 wrote:
> "The purchasing power for that $900 comes from the public at large.
>
> How is that not theft?" mb
>
> "Inflation is too much money chasing too few goods. Right? How is
> the $1000 in the bank chasing any goods? " Jim Myrtle
>
> I said nothing about inflation. I am talking about honesty. The purchasing
> power of that $900 created from nothing comes from the general public
> without their permission.
Andrew Mellon, the American Secretary of the Treasury during the time of the Great Depression, said (as quoted in Herbert Hoover's memoirs) the country needed to "liquidate labor, liquidate stocks, liquidate the farmers , liquidate real estate."
And (quoted from John Kenneth Galbraith's book, Money) Lionel Robbins, the most admired voice of British economic orthodoxy of the time, said "Nobody wishes for bankruptcies. Nobody likes liquidation as such ... [But] when the extent of mal-investment and over-indebtedness has passed a certain limits, measures which postpone liquidation only tend to make matters worse."
Schumpeter had also been the president of the Austrian Biederman Bank which went bankrupt in 1924 due to hyperinflation. He himself went bankrupt also.
Schumpeter and the Biederman Bank went bankrupt because of hyperinflation which was caused by German, Austrian and Hungarian officials flooding their economies with money to pay impossible bills that resulted from the dislocations caused by their defeat in World War I along with absurdly high reparations payments imposed by the victors of the war. Schumpeter and others argued that these economies should have been allowed to collapse and then work their way back to economic health instead of being propped up by governments who basically printed money for everyone who thought they needed it.
This helps explain why, until 1932 under Schumpter's influence and the influence of other respected voices of the time, such as Andrew Mellon and Lionel Robbins, virtually nothing was done to inject money into the system and protect banks from failure: They had an excessive fear of inflation along with a view that depressions were necessary correctives for booms.
The number of banks allowed to fail from 1929-31 was about 3500.
Contrary to popular belief, Herbert Hoover had the courage and intelligence to fight against the then prevailing attitude of business and created the Reconstruction Finance Corporation in 1931, which built the Hoover Dam and the Golden Gate Bridge.
Roosevelt created the National Reconstruction Administration in 1933 but it was ruled unconstitutional by the Supreme Court, two years later, in a unanimous decision which reflected the prevailing attitude of economists and businessmen of the time.
I think the causes of the Great Depression, along with the policies that got us out of it, are still obscure however, and that it is only hindsight that makes them seem clear, which is also the case for events in our own lives and the history of human affairs in general.
On Dec 31 01:21 AM asleeper wrote:
> It is very frustrating when two people use different definitions
> and frames of reference and pointlessly argue as though they are
> discussing the same thing. There are two definitions of deflation
> in common use. One is a decline in the money supply. The second
> is a general decline in prices. Economists use both definitions,
> but when they get technical, they use the first one because the first
> one drives the second one in the long run. Government, the banks,
> educational institutions, and the media, almost invariably use the
> second definition because the second definition obscures what is
> causing what. The public is conditioned to use the second definition
> because they don’t read technical economics papers.
>
> Smarty_Pants understands and uses both definitions and is referring
> to a potentially stable alternative money supply, while Jim Myrtle
> is referring to price deflation only and is using the example of
> the Great Depression which took place in the setting of an unstable
> money supply managed by the Fed and its fractional reserve banking
> system. The problem is that Jim Myrtle is using the example of the
> terrible deflation of the Great Depression as an example of what
> would go wrong with Smarty_Pants potentially stable alternative money
> supply, when it is very possible that a stable money supply would
> have prevented the rampant speculation that led to the stock market
> bubble, subsequent crash, and disastrous deflation.
>
> In 1929, due to the immense amount of credit created under the Fed’s
> fractional reserve system, it was possible for a self-reinforcing
> deflationary spiral in the money supply to occur. When money = credit
> = debt, and credit is tightened, that is exactly what occurs, and
> it has occurred repeatedly since the establishment of the Fed, despite
> the Fed being established precisely to prevent such “business cycles”.
> It happened in 1929 and it is at risk of happening again in 2008/2009.
>
>
> The Great Depression was certainly bad, but characterizing all price
> deflation as bad because of it is as wrong-headed as characterizing
> all price inflation as bad, because of the example of hyperinflation
> in Germany. Modest price deflation, due to productivity increases
> in an economy with a stable money supply is no more problematic than
> modest inflation and has nothing in common with the sharp monetary
> deflation that led to the Great Depression.
>
> To give a realistic example of benign deflation in today’s world
> is very difficult, because we are all just so conditioned by perpetual
> inflation to think that prices always go up. But, to make it as
> simple as possible, just imagine a society that just farms and mines
> in the country and manufactures in the cities. If farm and mine
> productivity go up, food and mineral prices drop, but profits do
> not drop, because farm and mines sell more and their own costs drop.
> They have to eat, too. If they can’t sell all their product domestically,
> they can export. Also, the city factory margins improve because
> they are paying less for food and minerals; they can lower the prices
> of their products and keep wages stable simultaneously. Reduced
> prices for manufactured goods also improve farm and mine margins.
> Farm and mine wages can remain stable too.
>
> The reason the Great Depression was so bad is that the price deflation
> was not the result of a beneficial increase in productivity in a
> stable currency regime; it was a catastrophic drop in the money supply
> due to a bank and brokerage credit freeze.
>
> With our financial sector so screwed up at the moment, it is time
> that people learn that our monetary system isn’t some incomprehensible
> irreplaceable perfect system we cannot discuss or change. It is
> a private for-profit business cartel, not unlike OPEC, and it is
> not in business to help the average Joe.
>
> Maybe a gold standard isn't the answer, but letting gold and silver
> circulate in parallel with the dollar as an alternative to legal
> tender paper would certainly be an interesting experiment. It's
> not the only alternative either, but this missive is too long already.
It depends. Is the deposit a demand deposit or a time deposit that that cannot be withdrawn from for a certain period of time?
Money cannot be in two places at once. To attempt to do so creates new money from nothing. So who has possession of it? Just think of money as a material object if you have to. If I loan you a brick can I have it at the same time? The answer is no until the agreed upon period of the loan has elapsed.
is folly indeed.
It's just theft by another name
called FRB.
To loan without savers,
so sad to see.
Who'll buy the production
from your new factories?
The game is up
though it lasted long.
Ignorance was bliss
for those who do wrong.
But FRB's sins have mounted;
the model is disgraced.
Just a little dishonesty
it seems has no place.
that cannot be withdrawn from for a certain period of time?"
Doesn't matter. At the time of the loan, the deposit is not available for the depositor to spend.
"Money cannot be in two places at once"
It's not. See my example above with the deposit of ten $100 bills.
" To attempt to do so creates new money from nothing"
Wrong.
"So who has possession of it?
Just think of money as a material object if you have to"
Great idea. One $100 bill is in the vault, the other nine are in the hands of the borrower.
On Jan 01 05:20 PM moonbat1775 wrote:
mises.org/mysteryofban...
See the section on FRB that starts on page 116 of the pdf document (page 97 of the book)."
Thanks for the link. The only thing is, modern banks don't issue warehouse receipts for gold. I agree, that would be "money from thin air", but since that no longer occurs, I don't think it's relevent to our discussion.
On Jan 01 12:28 AM Smarty_Pants wrote:
Sure it is, if the deposit is in a checking account, for instance.
Great idea. One $100 bill is in the vault, the other nine are in the hands of the borrower. Jim Myrtle
Lets say I deposit $1000 in cash. The bank's liabilities have now increased by $1000 and its reserves on the asset side have increased by $1000 in vault cash. Now the bank loans $900 to you.
It does that by creating another liability for $900 in your name in exchange for a $900 IOU. So:
Assets: Liabilities:
IOU from you for $900
Reserves
+$1000 vault cash +$1000 me
+$ 900 you
Total +$1900 +$1900
Now you and I go on a spending spree. I spend $600 and you spend $800. oops! Bank is short $400! What good is your IOU now? It is just a promise but you and I have spent real money. $900 of that money was created from nothing.
Sorry! The columns did not line up. I'll try again latter if I can figure out how to.
It does that by creating another liability for $900 in your name in exchange for a $900 IOU"
Almost. The bank doesn't create a liability, it gets a new asset, my IOU and it reduces an old asset, vault cash.
I have the liability.
"Now you and I go on a spending spree. I spend $600 and you spend $800. oops! Bank is short $400!"
It doesn't matter what I spend, I already have the cash. Now if you spend $600, your account is reduced to $400 and the bank needs to reserve $40. They had $100 so can give $60 of the old reserve to you and need to borrow the other $540 in the Fed Funds market.
Another alternative is for the bank to sell the IOU from me to another bank for $900.
On Dec 30 10:49 AM Jolly_Rancher wrote:
\
>Banks need to concern themselves
> with the profitability of the borrower's investment rather than just
> the interest rate return on loans. A mortgagor produces no profit
> and so a bank should not consider a mortgage to be a very desirable
> loan to make. On the other hand, a loan to a profitable oil driller
> would be a very desirable loan. Banks need some incentive to make
> very profitable loans.
That is the problem with fractional reserve banking. Investment capital is created from deposits. The bank then has 10-20 times the initial "capital" to lend and as a result allows more investment than should have occurred. The bank securitizes their investment, and if they function properly then they should assess risk and offer a lower interest rate to a stable/well capitalized company. Versus, the current paradigm, where most countries tried to manipulate their currencies by buying US based debt, creating more capital chasing after fewer good loans, fueling consumption and inflation.
The idea that a gold standard would fail and lower the standard of living is a farce. The gold can simply be stored, the problem largely resided in additional hard money being created, coupled with the fractional reserve system.
If is unfortunate that ill informed people think they can solve our problems. This is the main problem, in that our leaders think they can forge a better system, than simply letting people take care of themselves.
Peace
We want to be able to spend beyond our means.
We want to have politicians (mostly lawyers) handle our financial affairs.
We want the "smarter" of us to manipulate the system.
We want a socialist system when it suits are needs.
We want banks to be leveraged 40:1 when our households go broke at 4:1.
Do you think that we may be in trouble?
You are incorrect. This is exactly what happens with the exception of having both the gold and the warehouse receipts replaced by Federal Reserve Notes (or their digital equivalents).
"Fractional-reserve banking is the banking practice in which banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder, while maintaining the simultaneous obligation to redeem all deposits immediately upon demand. This practice is universal in modern banking" - Wikipedia
en.wikipedia.org/wiki/...
"I already have the cash. Now if you spend $600, your account is reduced to $400 and the bank needs to reserve $40. They had $100 so can give $60 of the old reserve to you and need to borrow the other $540 in the Fed Funds market." - Jim
Except this is presicely what happens in every bank in the entire country. So when ALL the banks have only $100 in cash in the vault and need to cover $400 of demands, who is left to lend them money or buy that IOU? All the other banks are short too.
Oh yeah, the FED, who prints all the extra money 'from nothing' in return for yet another layer of IOUs from the banks themselves.
The current system is built so that it can issue money backed by nothing more than IOUs while claiming that it actually has the physical cash to back it. When events transpire to expose the fraud the banks engage in a shell game to hide the fact that they are attempting to earn interest on money that doesn't really exist.
Moonbat, you have to substitute dashes - for spaces to generate tables and maintain spacing. All multiple space blocks are reduced to a single space.
As for the bank balance sheet, it has assets of $1900
1) a $1000 deposit from moonbat
2) a $900 IOU from Smarty_Pants
It has liabilities of $1900:
1) $1000 on deposit in moonbat's account
($100 in notes and $900 in 'nothing', but all $1000 "payable on demand")
2) $900 in notes issued to Smarty_Pants
The original $1000 of notes moonbat deposited has become $1900 of money supply. $900 of which is created from nothing but Smarty_Pants' promise to repay. The bank is simply gambling that moonbat won't spend it until Smarty_Pants repays.
When Smarty_Pants does repay a portion of the debt, the money supply and the IOU are both reduced by the amount of principle paid off.
This is exactly how fractional reserve banking is done every day.
"The creation and destruction of commercial bank money occurs through this process. Whether it is created or destroyed depends on what direction the process moves. When loans are given out, ... money is created. When loans are paid back, ... commercial bank money is canceled out, effectively erasing it from existence." - Wikipedia (same link as above)
"The money multiplier, m, is the inverse of the reserve requirement
For example, with the reserve ratio of 20 percent ... So then the money multiplier, m, will be calculated as:
m = 1 / (0.20) = 5 (some editing for form in this equation)
This number is multiplied by the initial deposit to show the maximum amount of money it can be expanded to." - Wikipedia (same link)
"The reserve requirements are intended to prevent banks from:
1) generating too much money by making too many loans against the narrow money deposit base;
2) having a shortage of cash when large deposits are withdrawn (although the reserve is a legal minimum, it is understood that in a crisis or bank run, reserves may be made available on a temporary basis)" - Wikipedia (same link)
Well said. I tried at least 3 times last night to post a reply but could not. It was not meant to be. Your reply is much better.
moonbat was held back and is glad.
Assets:_______________... Liabilities:
IOU from you for $900
Reserves
____________+$1000 vault cash ____+$1000 me
______________________... 900 you
Total_______ +$1900______________ +$1900
When a bank prints a warehouse recipt, that's new money. Banks don't get to print new Federal Reserve Notes, they can only loan the ones they receive as deposits.
"Except this is presicely what happens in every bank in the entire country. So when ALL the banks have only $100 in cash in the vault and need to cover $400 of demands, who is left to lend them money or buy that IOU? All the other banks are short too"
Because when you spend the money, the recipient puts in under his pillow? It doesn't get deposited into his bank? LOL! You're funny!
"The current system is built so that it can issue money backed by
nothing more than IOUs while claiming that it actually has the physical
cash to back it"
More money isn't issued, backed by IOUs, your IOU is considered as good as money. If you default, the money supply shrinks.
"When events transpire to expose the fraud the banks
engage in a shell game to hide the fact that they are attempting
to earn interest on money that doesn't really exist"
The money they loan you exists. They hold a percentage in reserve and loan out the rest. If they really could "create money out of thin air", there would be no need for reserves. Think about it.
"The original $1000 of notes moonbat deposited has become $1900 of
money supply. $900 of which is created from nothing but Smarty_Pants' promise to repay"
Excellent! You do understand.
On Jan 02 01:46 PM Smarty_Pants wrote:
“You might have a point, if bubbles and panics weren't more severe when we were on the gold standard.”
There is no consensus among economists supporting the assertion that bubble and panics were more severe on the gold standard. One study after another has gone either way. And no matter if there was a consensus, it would have to be qualified by noting that there has never been a pure gold standard or bimetallic standard in the U.S. The only true Federal Government Gold Standard n the U.S. was in effect at the same time as the fractional reserve banking system. Fractional reserve banking existed before, during, and after the Gold Standard Act of 1900-1933. So, it is not really possible to separate analysis of monetary systems in modern times into gold standard vs fractional reserve banking and fiat money. We have always had both in modern times.
GDP didn't fall further during those panics? How much did GDP shrink after the Panic of 1873? How long did that Depression last?
"And no matter if there was a consensus, it would have to be qualified by noting that there has never been a pure gold standard or bimetallic standard in the U.S. "
Don't tell the goldbugs. LOL!
On Jan 02 03:20 PM asleeper wrote:
“I refer to price deflation because that is all that people care about. The money supply could grow 1% while GDP grows 3%, causing prices to drop 2%.
You could be "technical" and say we were "suffering" 1% inflation, but all people care about is the impact that 1% "inflation" has on prices, in this case it causes them to fall 2% a year.
And you can pretend that there was no inflation or deflation (in prices)while we were on the gold standard, before the Federal Reserve was created, but you'd be wrong.”
You needn’t suppose what I might say or not say or try to imply that I “pretend” anything.. That is a false way of arguing. Not to go by the same tack, I’ll stick to what you have just written.
Price deflation is not all that people care about as is evident in this thread and in other blogs where people are discussing the economy. People also care about the possibility of high inflation and even hyperinflation, because the Fed has massively increased the base money supply. Just because we are suffering price deflation at the moment does not mean we will not suffer high inflation should the banks loosen credit again.
You implied (I think) that I am a “gold standard” advocate who “pretends” there was no inflation or deflation on the gold standard before the Fed was created. You are wrong on both supposed points. A little history on the “gold standard” is in order.
The U.S. has never been on a pure gold or even a pure bimetallic money system. The US was on a bimetallic “standard” during the 1800s, mainly gold and very little silver, but, banks could and did issue paper money on a fractional reserve system against metals on deposit at the same time.
A true Federal Government Gold Standard was only in effect from 1900-1933 with the Gold Standard Act, but this law did not prohibit fractional reserve banking which continued unabated. The Gold Standard Act came to an end in 1933 when President Roosevelt outlawed private gold ownership except for jewelry.
Bretton Woods, enacted by the US in 1946 created a system of fixed exchange rates that allowed governments to sell their gold to the US at $35/ounce. Nixon ended Bretton Woods in 1971.
From 1946 to 1971, US citizens could not redeem dollars in gold, only foreign Governments could, and no one could redeem dollars for silver. U.S. citizens could not legally own gold again until Jan.1, 1975.
So, as far as US citizens are concerned, gold has not been money and we have not been on a gold standard since 1946, at the latest, even earlier if you go by the right of citizens to own gold. Silver has not been money since 1900. No gold standard of any kind has been used in any major economy since 1971. And, still we have “business cycles”, financial panics, bank failures, recessions, and what now looks like a depression looming.
The gold standard in effect from 1900-1933 was not a stable money system and did not prevent over-expansion of the money supply due to fractional reserve banking during credit booms or over-contraction during credit busts, because banks could create too much credit-money by loosening credit or too little by tightening credit.
When banks and brokerages tightened credit in 1929 after a period of loose credit, the stock market crashed, the money supply began to contract, and the Great Depression was on. Gentle price deflation due to stable money and productivity increases was not the problem. Credit tightening by member banks of the Fed, most notably JP Morgan, was the problem. A dramatic drop in the money supply resulted, made possible by the fractional reserve banking, fiat money regime. The drop in the money supply caused the drop in prices which you claimed is all that people care about.
I do not advocate a “gold standard”; I advocate a near-stable money supply that can be expanded approximately 0-5% per year by the Government and cannot be deflated. That would mean no Fed, no fractional reserve banking, and a loan would actually be a loan, not credit. I leave it to the economists to design the system.
I gave you a thumbs up because you are sensible and understand deflation and FRB. And what you advocate is relatively quite good, in fact. We would have steady price inflation most likely since creating money for investments causes price inflation which may or may not be countered by increased productivity. But no boom/bust cycle. What you advocate would be a huge improvement, imo.
If you are interested, there is a better way, imo. In fact, it seems to be ideal. Many will not be able to understand but I reckon you could. Just click on "My Website" if interested.
“Thanks for the link. The only thing is, modern banks don't issue warehouse receipts for gold. I agree, that would be "money from thin air", but since that no longer occurs, I don't think it's relevent to our discussion.”
The difference between Rothbard’s warehouse receipts for gold and modern fractional reserve banking is that modern banks use deposits of paper assets such as Federal Reserve Notes, T-bonds, and T-bills as reserves instead of gold. Otherwise, modern banks make “money from thin air” the same way that medieval goldsmiths did, when they issued more warehouse receipts for gold than they had gold.
Going back to the $1,000 deposit idea. Suppose a person deposits one thousand dollars in the bank. The bank then does not “loan” any of the $1,000. Assuming a 10% reserve, it creates credit of $900 and calls it a “loan”. The “borrower” withdraws the $900 and spends it. The recipient of the $900 deposits it back into the bank, where it serves as a reserve for $810 of new bank credit. The new “borrower” spends it and the new recipient deposits it back into the bank, where it serves as a reserve for more credit to be issued by the bank. This process continues in a decreasing geometric series until the bank has issued $10,000 in credit. The original $1,000 may still be sitting in the bank, but the amount of dollars chasing goods in the economy was $10,000 in this example. More dollars implies monetary inflation and monetary inflation implies price inflation.
There are several problems inherent in this scheme. First, the bank put up no money of its own, but now collects interest on $10,000.
Second, the increased money supply causes inflation which penalizes savers and retired people on fixed incomes. That is why Americans traditionally have saved so little since the establishment of the Fed. In a use it or lose it situation, t doesn’t pay to save.
Third, “Borrowers” who have first access to new loans can buy goods before others, such as wage earners, have access to the new money and before inflation caused by the new money manifests in the general economy. That is why wage increases always lag inflation and that is where stealing from wage earners comes in.
Fourth, if all loans are to be repaid, some borrowers must necessarily go bankrupt because the bank created the principle when it issued the credit, but it did not increase the money supply by an amount equal to the interest. So, if most of the loans are paid back with interest, not enough money remains to pay interest on the others. That is why our Government cannot pay off the national debt. If it did, the money supply would shrink dramatically causing terrible deflation. When money = debt, you cannot extinguish debt without extinguishing the money supply too. This problem is ameliorated to some extent by spending of bank profits back into the general economy, but for the most part, compensation is accomplished by the issuance of new loans and the accompanying incessant inflation.
Fifth, in a centralized system, such as the Fed, leaders of the member banks can profit from what is essentially insider trading, from the knowledge of future credit terms. That is why the bailout money authorized by Congress did not go to buy toxic assets as Paulson said it would, but is being used to shore up balance sheets and buy out competitors for pennies on the dollar, because the Fed member banks knew full well that credit would not loosen up anytime soon.
Here is a good link to a video on how banking evolved: video.google.com/video...
I recommend skipping the first 1:50 - it is mostly well-known quotes about the banking industry – and skipping the part about an alternate money system at the end. The middle is a very explanation of how fractional reserve banking actually works.
First off more often than not the "money" that gets spent isn't even notes. Ever hear of those new-fangled things called a checkbook or a debit card? I did note that digital equivalents count as money. It's still money when one bank writes down "$1000" in a ledger for my account balance.
Call your bank and ask them how much 'money' is in your checking account. They will tell you the 'number' that represents your balance whether there are bills there or not. Same for every other depositor. What they don't tell you "Well, there's a balance of $1000 but we are only backing $100 of that with cash and the other $900 with some other guy's IOU".
I recently moved a large sum of money into a new brokerage account via an electronic ECH transaction. For a few days I had over $50,000 in my checking account. If I had called they would have told me that's how much 'money' was in my account, but if I had showed up unexpectedly and demanded it all in cash they couldn't have given it to me. You can be certain of that.
The money's not really there, it's just a number in a ledger that they will let me spend electronically (via debit card for instance) and which they will 'honor' by moving the number from my ledger account to the retailer's ledger account in another bank. Even though it's not banknotes, it still functions as 'money'.
So how is it you can claim that the money supply hasn't increased? When a loan is issued and backed by only an IOU, the 'number' representing the loan balance in the bank becomes money and can be spent electronically, even if there aren't any banknotes in the bank at all.
In the above example both moonbat and I could 'spend' that money without ever touching the notes. What does the bank do when two other banks (one for each retailer) each demand the $1000 we both spent with two checks? They give those other banks 'numbers' from their ledger sheet. It's not really there, and part of it was really only an IOU from the borrower, but it's still 'money' and is used as such.
"Excellent! You do understand." - Jim
Yes I do. Although it is becoming clear that you have your own set of facts and interpretations and choose not to consider any evidence to the contrary. That's fine. It's a free country where a person may hold their opinion as they wish, regardless of any counter argument.
If nothing else moonbat and I have put links to our facts and our interpretations of them in print where others can read them, look at the information supplied on the links we provided, contrast them with your unbacked opinion, and decide for themselves.
Best Wishes for the new year.
You must be a sleep learner! I'm impressed. Please comment more often.
So expanding the number of claims on wealth was the source of prosperity? Wow - I had no idea!
This is one of the worst S.A. articles I've read. The author made so many logic errors I lost count of them all. Such poor judgement is why we so desperately need the gold standard. I trust the market to regulate our money more than I trust the judgements of policymakers.
“GDP didn't fall further during those panics? How much did GDP shrink after the Panic of 1873? How long did that Depression last?”
Are you an economist? Can you cite enough sources on both sides of the issue to prove a consensus? Have you compared the metrics of 1873 with the metrics of the Depression. Because there are scholarly papers taking both sides of the issue. You made the assertion. Now prove it, if you can.
asleeper wrote, "And no matter if there was a consensus, it would have to be qualified by noting that there has never been a pure gold standard or bimetallic standard in the U.S. "
Jim Myrtle wrote, “Don't tell the goldbugs. LOL!”
LOL all you want, and tell them yourself. If all you intend is to play cat and mouse with supposed “goldbugs”, then by all means keep fooling around. The larger issue addressed by the article is the monetary system.
Although I do not advocate a return to any of the past "gold standards", I did begin reading several websites published by those I suppose you would call goldbugs after the Nasdaq crash. As a result, learned enough about the monetary system to earn a lot of money back that was lost and to know that the Fed and private fractional reserve banking is a very bad system for most of society.
True.
"Otherwise, modern banks make “money
from thin air” the same way that medieval goldsmiths did, when they issued more warehouse receipts for gold than they had gold"
False.
"Going back to the $1,000 deposit idea. Suppose a person deposits one thousand dollars in the bank. The bank then does not “loan” any
of the $1,000. Assuming a 10% reserve, it creates credit of $900
and calls it a “loan”."
Why wouldn't you call a loan a loan?
" The “borrower” withdraws the $900 and spends
it. The recipient of the $900 deposits it back into the bank, where
it serves as a reserve for $810 of new bank credit"
Excellent! You have 2 deposits, one for $1000 and one for $900. Total $1900. This supports 2 loans, one for $900 and one for $810. And no one counterfeited or created anything out of thin air. You'll notice that each loan is smaller than the deposit it comes from.
"There are several problems inherent in this scheme. First, the bank
put up no money of its own, but now collects interest on $10,000"
If the bank is collecting interest on $9,000 in loans and holds $1000 in reserves,it must be paying interest on $10,000 on deposits.
On Jan 02 04:15 PM asleeper wrote:
Doesn't change anything.
"So how is it you can claim that the money supply hasn't increased?
When a loan is issued and backed by only an IOU, the 'number' representing the loan balance in the bank becomes money and can be spent electronically, even if there aren't any banknotes in the bank at all"
Not sure what comment of mine you think you're referring to. When you borrow money, the money supply increases. If you think I denied that, please show me where.
" In the above example both moonbat and I could 'spend' that money
without ever touching the notes. What does the bank do when two other
banks (one for each retailer) each demand the $1000 we both spent with two checks?"
You absolutely could both spend $1000. In that case the bank has to borrow Fed Funds to cover the withdrawals until it could raise other deposits or sell the IOU.
"Yes I do."
Great. Then why are you still claiming banks create money out of thin air?
" Although it is becoming clear that you have your own set of facts and interpretations and choose not to consider any evidence to the contrary"
My facts are clearly shown by my mathematical examples. That you sound like you agreed with. Until you didn't. Don't confuse yourself by using "credit" or "debit cards". Use hard cash in all your examples and you'll see that banks lend out less than their deposits. If they do that, they aren't creating anything.
On Jan 02 04:21 PM Smarty_Pants wrote:
asleeper, it is apparent that Jim does not wish to present or link to facts, only to continue to assert that "crushing deflation" is bad and to deny that fractional reserve banking is what brings the economy to the point where 'crushing deflation' is possible.
Apparently Jim does not have issues with congnitive dissonance on this topic as others might given the contradiction involved.
Anyone else who wishes to comment on or question my analysis, I would be glad to hear it. I'm always open to different interpretations. It's possible I have overlooked something, but it doesn't appear that Jim will provide anything that I cannot counter to my satisfaction with the facts supplied by a reasonable search and a bit of thought.
They were both serious Depressions that occurred while we were on the (however imperfect) Gold Standard. If you think we've had more serious drops in GDP since then, I'm all ears.
"As a result, learned
enough about the monetary system to earn a lot of money back that
was lost and to know that the Fed and private fractional reserve
banking is a very bad system for most of society"
Excellent job earning back that money. If you ever come across a system that can prevent fractional reserve lending without causing a new Dark Ages, be sure to spread the word. It's sure to be interesting.
On Jan 02 04:29 PM asleeper wrote:
To my way of thinking this is an unsupportable contradiction. If the money supply is increased, then the 'extra' money was created out of nothing.
Saying it's backed by an IOU (ie. a promise) is akin to trying to buy a car and telling the salesman "It's OK. My buddy told me he'd give me the money later.", then show him your buddy's IOU on a cocktail napkin, and expecting the car sales manager to approve the deal.
Yet insert a bank as middle man in the transaction and suddenly your buddy's "promise" becomes actual money because it's written on the banks version of a cocktail napkin instead of an actual cocktail napkin ... as I see it that's money from nothing. No different that using an actual cocktail napkin without the bank, except on one case it becomes money and in the other it the salesman calls the cops to drag you out of the showroom after having a good laugh.
If you disagree on that issue, then we have reached a point where we will have to agree to disagree. Your definitions and conclusions do not support those I have reached and probably never will.
Your borrowing increased the money supply. Your IOU is now money.
"Saying it's backed by an IOU (ie. a promise) is akin to trying to
buy a car and telling the salesman "It's OK. My buddy told me he'd
give me the money later.", then show him your buddy's IOU on a cocktail
napkin, and expecting the car sales manager to approve the deal"
If you can get that to work, good for you.
When you sign the IOU or loan papers at the dealership, you increased the money supply.
"Yet insert a bank as middle man in the transaction and suddenly your
buddy's "promise" becomes actual money because it's written on the
banks version of a cocktail napkin instead of an actual cocktail
napkin ..."
Yes. The bank can now sell your loan for real money. Because it is.
"as I see it that's money from nothing"
Why did Hamilton agree to back all the Revolutionary War debts at 100 cents on the dollar? He knew it would increase the money supply. An increase that was badly needed, because deflation is bad. Seems like a high price to pay to stop deflation. He must have thought it was a price we needed to pay.
I think he was right. You can disagree if you'd like.
"If you disagree on that issue, then we have reached a point where
we will have to agree to disagree"
Maybe we have.
"Your definitions and conclusions
do not support those I have reached and probably never will"
As long as you don't claim that banks can loan out 10 times (or more) their deposits, I really hate that claim. It's the worst of the misunderstandings about the Federal Reserve, banking and money supply that I hear repeated all the time.
I'm on vacation, have a nice weekend.
On Jan 02 05:10 PM Smarty_Pants wrote:
> "When you borrow money, the money supply increases. ... Then why
> are you still claiming banks create money out of thin air?" - Jim
>
>
> To my way of thinking this is an unsupportable contradiction. If
> the money supply is increased, then the 'extra' money was created
> out of nothing.
>
> >
>
> No different that
> using an actual cocktail napkin without the bank, except on one case
> it becomes money and in the other it the salesman calls the cops
> to drag you out of the showroom after having a good laugh.
>
>
Here's an excellent Milton Friedman video that explains a few interesting points much clearer than I could. Enjoy!
1. Create money from nothing in exchange for an IOU as collateral. Purchasing power comes from the public at large. Theft, in other words. The money is not backed by the collateral since not any money holder can redeem his money for partial or full ownership of the collateral. Only the borrower can do so. There is no backing.
2. Money goes back to nothing as loan is repaid. This maintains the scarcity of and hence the value of fiat. The interest does NOT go to nothing however. The Bank keeps that. The collateral is released to the borrower.
1. It supports high growth rates. Really? What about the boom/bust cycle? What about malinvestments?
2. It provides more and cheaper goods due to manufacturing investment. Yes, and who is buying those goods now when people are concerned about losing their jobs?
3. It decreases unemployment. So, it's OK to steal people's money to build a factory if they can get a job there and earn it back?
4. It allows the government to tax via inflation. This sounds like a condemnation to me.
If it is to be meaningful, a gold standard requires that the quantity of money issued by a monetary authority is tied in some way to the quantity of gold it holds.
If it isn't, then the so-called gold standard is meaningless - smoke and mirrors. If it is, then the distribution of gold and changes to the total quantity of gold available for monetary purposes largely determine the quantity of money.
But MV=PQ. So price levels and industrial production become tied to ownership of gold. Either a permanent deflation - that is fall in price levels - is forced or gold must continually inflate in value so that more money can be issued on the basis of gold holdings whose net growth will be slower than the growth in world production. Either way, basically productive investment is hobbled in favour of gold.
Better to have competing currencies and let the US $ fall off its throne as the reserve currency of the world.
First, I agree about competing currencies. It is the ideal solution.
However, price deflation is a good thing if brought about by productivity increases. Everyone benefits. Wages need not drop. OTOH, monetary deflation is an actual decrease in the money supply and is harmful. The two should not be confused.
Yes. If fractional reserve banking is eliminated with gold backed money there will be a gradual decline in price levels over time as there was during the 19th century here in the US (excepting the periods of war).
I would replace the word 'hobbled' however. Since banks would not be able to lend out money that depositors didn't want to lend the smaller amount of available money to lend would wind up diverting money to the most sought after use.
Think about it. If you were the only one who had money to lend (ie. banks couldn't just 'create it') and several businesses desired a loan, you could have them bid for it. Highest interest rate wins. The business with the highest profit margins (ie. greatest consumer demand met efficiently) would be the one most able to outbid the other borrowers. A business that couldn't turn a profit (think Big 3) wouldn't be able to bid and would either have to restructure or go under.
Loans for 'survival' would rarely be supplied. Businesses that rely on debt today wouldn't survive either. While this would slow business expansion to the rate of personal savings (or savings of internal profits), there would be very few cases of loan defaults. Liquidation would be a very rare thing because great care would be taken when making the loan.
Part of the reason we have bubbles today is because it's easy for banks to create money for any situation. There isn't any sort of market competition to see whether business A or B should have the loan, they both get one. Then C and D get one too. Then everyone discovers that the market can only support three businesses and one of them goes under, liquidating their inventory and capital equipment at firesale prices, crushing everyone with 'deflation'.
If the amount of money was limited, there never would have been that many businesses making enough profit to afford to borrow all that money. Only the most profitable firms in that line of business would need the money to expand and only then if they knew they were going to be more productive as a result.
Substitute "focused" investment for "hobbled" investment. "Slow and steady growth" instead of "excessive growth and future collapse".
If the path of progress is a steady climb then the fall in price level will be a slow one as well, instead of a wholesale, economy wide liquidation plunge.
Amen to that. The reserve dollar has been the biggest con game ever put over on the people of the world. I am amazed at how long it continues myself.
I=====================...
I------------------ I O U -------------------I
I-------------------- A ---------------------I
I------------------Ban... -----------------I
I=====================...
moonbat: I think if you print that coupon out you can add some ice cream and make a banana split with it. ;-)
Let's see if we can extrapolate the properties of competing monies from history:
1. Gold directly used as money honest/stable/relative... slowest growth
2. 100% Reserve gold Banking honest/stable/next slowest
3. FRB gold banking dishonest/unstable/ real growth rate?
4. FRB fiat banking dishonest/most unstable/real growth rate?
First let's decide on honesty so FRB is out. Next we notice that gold is stable but relatively slow. Is there something better than "stable" we might use instead? How about "appreciating"? OK.
So:
5. 100% Reserve ? honest/appreciating/at least faster than 100% gold.
So what should ? be? The key to this is to know that the instability in the stock market is caused by the underlying FRB money and banking system it is built on. And the solution is recursive: A stock market based on stable monies backed by the stock market. I do not claim to have invented this since the properties of it amazes me. It lines up with the Bible in numerous ways with regard to who to charge interest to, the evil of monetary deflation, putting money to work, hoarding, etc.
I wish the idea to be in the public domain for free. Little interest so far though Smarty has been kind. Maybe if I charged $.25 a copy and a self-addressed envelope? Anyway,
click on "My Website" if interested. It is not very long.
I am very impressed with the way you handle people even when heavily (if unintentionally) provoked. You have what is desired in a man according to the Bible, kindness. I almost blew it today and I need mercy the most. Luckily, it is no sin to vent on FRB.
But I should be careful anyway.
> "Otherwise, modern banks make “money
> from thin air” the same way that medieval goldsmiths did, when they
> issued more warehouse receipts for gold than they had gold"
>
> False.
Really? In the goldsmith's day, you could distinguish between gold and paper warehouse receipts. Gold was money and paper a representation of money, easier to handle, but money only by virture of representing gold. If a bank issued more paper as "credit" than it had corresponding gold on deposit, it not only inflated the money supply and caused inflation, it risked a bank run. With no way to distinguish between the original receipts of actual gold depositors and the receipts created as "credit" by the bank, depositors who had actually put gold into the bank could be cheated out of their gold in the event of a bank run by debtors rushing to obtain gold for their receipts.
Fast forward to modern banking and consider that each of the original $1,000 deposited at the bank is analogous to gold. Say, you sign each bill with a metallic gold flake pen to emphasize the idea. By the time the bank finishes issuing credit, there is 10,000 dollars circulating in the economy, going to and from the bank as people make payments and deposits by check or electronically, even if the gold pen marked bills never move. The modern bank inflates the money supply by issuing credit not all of which is backed by the original $1,000, just as the goldsmith did with paper receipts and gold.
The modern day equivalent of the medieval goldsmith's bank run on the depositor's gold would be the news that the bank intends to shut its doors. As people rush to the bank to withdraw their money in cash before the doors close, the only cash available is the gold pen marked $1,000. Yet depositors demand to withdraw $10,000. The original depositor of the marked $1,000 is just as much at risk of losing his money to debtors as the gold depositor was in the first example.
If everyone demanded cash for their deposits at every bank, the Treasury could print bills for 100 years and probably still not be able to produce the cash reserves for depositors. At a typical branch bank, I know from personal experience that you would be lucky to be able to withdraw $5,000 on any given day without advance notice.
So, conceptually they are the same racket. $10,000 worth of IOUs backed by $1,000 cash is not the same thing as $1,000 cash. Just as $10,000 worth of warehouse receipts for gold backed by $1,000 worth of gold is not the same thing as $1,000 worth of gold.
> "Going back to the $1,000 deposit idea. Suppose a person deposits
> one thousand dollars in the bank. The bank then does not “loan” any
> of the $1,000. Assuming a 10% reserve, it creates credit of $900
> and calls it a “loan”."
>
> Why wouldn't you call a loan a loan?
Why wouldn't you call a left hook and a right cross both punches? Because they are not the same and left hook and right cross are more accurate. "Credit" is a more accurate term than loan that does not obscure the money creation aspect of circulating bank created IOUs as legal tender. "Monetized debt" would be be an even better term, but then everyone would know that the only thing backing it was an IOU.
If I want to lend you $10 to buy lunch, I must give you $10 from my wallet. You have ten more, I have ten less, and no new money has been created. That's a traditional loan, like loaning a lawnmower. If you choose not to borrow from me and manage to convince the restaurant to accept an IOU from you, that is credit. You can call it a loan if you want, but most people call it credit. It is not bank credit though, because it cannot be circulated or spent like legal tender, so just like a real loan, it does not increase the money supply or cause inflation.
Bank credit is even stranger. It ought to have its own special name, but it doesn't. Bankers prefer that people believe they are actually lending depositor's money, which they most certainly are not. Banks are allowed to "lend" to a borrower the borrower's very own promise to repay and once the bank has done that, the borrower can spend his promise to repay. In effect, the bank waves a magic wand over the borrower's promise to repay and converts it into legal tender. Banks are given the legal franchise to do this, create credit that is legal tender backed only by the borrower's promise to repay. The debt instrument is very much like the restaurant IOU, except the bank is allowed to convert it into legal tender. It becomes money by fiat, that is by law.
If the restaurant had the same legal rights as the bank, it could print out little dollar bills and "lend" them to you. You could pay your $10 bill with it, but that would be a transaction separate from the loan. After paying your bill, you would still owe the restaurant $10, plus interest. Meanwhile the restaurant could spend the $10 you paid for your meal and wait to collect your repayment of the loan principal, plus interest.
Of course restaurants cannot do this, only banks can. If a restaurant did this, it would be prosecuted for counterfeiting. Banks do it legally. But no matter who does it, when credit circulates as money, it inflates the money supply, the amount of legal tender chasing goods and services.
> " The “borrower” withdraws the $900 and spends
> it. The recipient of the $900 deposits it back into the bank, where
> it serves as a reserve for $810 of new bank credit"
>
> Excellent! You have 2 deposits, one for $1000 and one for $900. Total
> $1900. This supports 2 loans, one for $900 and one for $810. And
> no one counterfeited or created anything out of thin air. You'll
> notice that each loan is smaller than the deposit it comes from.
Critics of this process refer to it as counterfeiting for two reasons:
1) A promise to repay is not equivalent to payment, and
2) It is legally not considered counterfeiting by legal fiat.
Anyone who tries to do what a bank does without legal charter as a bank is guilty of counterfeiting, and legal protection does not alter the effect of the practice on the economy.
> "There are several problems inherent in this scheme. First, the bank
> put up no money of its own, but now collects interest on $10,000"
>
> If the bank is collecting interest on $9,000 in loans and holds $1000
> in reserves,it must be paying interest on $10,000 on deposits.
Have you checked that recently? Interest paid on deposits is almost zero and interest collected on bank "loans" probably averages 5% or better. Let's say the bankers put up the original $1,000 dollars themselves. Their return on the $1,000 then is the interest on $9,000, or $450 per year. Forty five percent per year is not bad. And, that is assuming the bankers put up the entire reserve. Not bad at all. If depositors put up all the reserves, the returns are infinite.
I have an idea. If you have money you don't want lent out, don't deposit it in the bank.
"Part of the reason we have bubbles today is because it's easy for banks to create money for any situation"
Those darn banks, lending out less than their deposits.
On Jan 02 08:38 PM Smarty_Pants wrote:
issued more warehouse receipts for gold than they had gold"
False.
"Really?"
Since banks don't print FRNs, they are not like goldsmiths.
On Jan 02 10:07 PM asleeper wrote:
You math is wrong. With a 10% reserve requirement, a $1000 deposit does not allow a bank to issue $10,000 in credit
"If the restaurant had the same legal rights as the bank, it could print out little dollar bills and "lend" them to you"
Banks don't print dollar bills to lend to you.
On Jan 02 10:07 PM asleeper wrote:
Asleeper covered this but I think I see your problem. Yes, an individual bank lends out less than deposits but you fail to realize that the deposits are themselves subject to withdrawal at any time. That is why they are called "demand deposits". If the deposits were instead 6-month CDs then they could be lent out for 6 months at most. The depositors would have RELINQUISHED the use of their money for 6-months. They have LOANED their money to the bank for 6-months which in turn can loan that amount or less for 6-months or less to a borrower.
Retailers can sell their accounts receivable.
Just as credit card companies can.
Excellent! That's what I've been saying.
"but you fail to realize that the
> deposits are themselves subject to withdrawal at any time. That is
> why they are called "demand deposits"."
I understand they can be withdrawn tomorrow. I understand banks borrow from each other overnite (Fed Funds) all the time when reserves drop below required levels or excess reserves are held.
"If the deposits were instead
> 6-month CDs then they could be lent out for 6 months at most. The
> depositors would have RELINQUISHED the use of their money for 6-months"
Technically, you can still get your CD money early, if you forfeit some interest. Reserve requirements are lower on CDs, by the way.
On Jan 02 10:53 PM moonbat1775 wrote:
in reserves,it must be paying interest on $10,000 on deposits.
"Have you checked that recently? Interest paid on deposits is almost zero and interest collected on bank "loans" probably averages 5% or better"
My point was not to discuss interest rates, but to show, again, that banks cannot lend out multiples of their deposits. Yes, it's terrible that banks can pay you less than 1% while charging 5% and more. The solution is to become a bank or buy their stock. Their debt now yields in the double digits.
On Jan 02 10:07 PM asleeper wrote:
What you fail to see is that the need to borrow is an indication of the creation of money and hence theft by inflation. Why should a bank have to borrow money to meet its normal liabilities?
Deposits and withdrawals are made on a daily basis. Reserves are needed by some banks, some banks have an excess. That's how the business works. It doesn't mean they loaned out more than their deposits. It doesn't indicate anything about inflation.
" Why should a bank have to borrow money to meet its normal liabilities?"
If a bank tried to finance every day obligations with Fed Funds, that could be a troublesome sign. Most banks that borrow Fed Funds also lend Fed Funds soon after.
On Jan 02 11:39 PM moonbat1775 wrote:
I wouldn't be surprised to see Jim:
mowing his lawn with an IOU for a lawnmower.
brushing his teeth with an IOU for a toothbrush
taking his IOU for a dog out on a walk
driving to work with an IOU for a car
or watching the playoffs on an IOU for a TV
Because as we all know, an IOU is exactly the same as the thing it loaned out in Jim's world.
For the rest of the us, An IOU is an acknowledgment or commitment to pay a certain sum of money:
IOU - noun -
1) a paper that has on it the letters IOU, a stated sum, and a signature and that is given as an acknowledgment of debt
2) an obligation
debt - noun - something owed
obligation - noun -
1) a commitment to pay a particular sum of money
2) also an amount owed under such a commitment
An IOU is most certainly NOT money itself, except to Jim.
Tomorrow (if the Lord wills and I live) the First (and only) Aggregate Bank of America will be formed from every US bank in the world.
Not perfect, but I try my best.
Prov. 19:11
Smartypants to Ricard:
"Something tells me the Fed is choosing between the lesser of two evils, and future inflation seems less toxic than rioting in the streets"
- "Rioting could only serve to bring out the swat teams and push us toward a 'national emergency' which "requires" a dictatorship (only for a while naturally) to resolve."
The ease with which you wrote this gave me pause. Rioting in the streets to me is an unthinkable situation, and would be a huge degradation to our personal security, and would easily fit under my definition of "disaster", to a degree orders of magnitude greater than what we are currently experiencing. Your comment has further convinced me that the Fed is making the right choice in choosing future inflation.
There is no guarantee that a dictator would ever give up power (think of the illustrious Julius Caesar) and it would bring us that much closer to the Armageddon that Mr. Hui and others like him (me included) reference, not as a rhetorical device, but an actual reality. I find it unthinkable to profit off of this state of affairs (i.e., this is not why I joined Seeking Alpha).
Smartypants to Jim:
"If nothing else moonbat and I have put links to our facts and our interpretations of them in print where others can read them, look at the information supplied on the links we provided, contrast them with your unbacked opinion, and decide for themselves."
All Jim is doing is quoting out of an Econ 101 textbook, something that is widely available, and backed by nearly all of the esteemed economists in the world. The burden of proof is on people like you, Smartypants and Moonbat, to convince people like Jim and me that an alternate system is preferable. In order to do so, people like you and Moonbat need to demonstrate not only your vaunted golden solution, but more importantly a keen understanding of what the public at large knows as fact, and then be able to debunk it. Comments like the one below (and there are very, very many)...:
Jim to asleeper:
“There are several problems inherent in this scheme. First, the bank put up no money of its own, but now collects interest on $10,000"
- "If the bank is collecting interest on $9,000 in loans and holds $1000 in reserves,it must be paying interest on $10,000 on deposits."
...demonstrate that the gold bugs advocating their point of view do not have an adequate grasp of our current economic system, or at the very least are giving an incomplete and inadequate picture to further their own ends. The former renders further advocating a gold standard less credible, and the latter makes it completely and utterly pointless.
Asleeper’s next comment is even less encouraging:
“Second, the increased money supply causes inflation which penalizes savers and retired people on fixed incomes. That is why Americans traditionally have saved so little since the establishment of the Fed. In a use it or lose it situation, it doesn’t pay to save. “
You have just redefined capitalism there. Capitalistic systems are built off savings, which are then properly invested in projects that increase a nation’s wealth and productivity. Banks allow these “savers and retired people on fixed incomes” the chance to capitalize their accumulated wealth that one must assume they couldn’t do on their own…because they have many options today to take matters into their own hands. Given that they are retired or what not, perhaps they can acquaint themselves to our economic system and capitalize on their own wealth as they see fit. If they can’t, banks are more than willing to assume the risks involved in investing for a small return through interest on CDs, deposits, etc. IF these savers and retired people on fixed incomes have no other option than to accept 0.25% rates on their savings, I’d have to fault their own stupidity for not participating in our capitalistic society, rather than faulting capitalism itself. Myself, I save wads, and invest most of it myself. I have come out ahead of inflation. That is good enough to debunk your point, but I’d rather come out ahead of certain benchmarks as well. That is why I joined Seeking Alpha.
As far as inflation adding a penalty, a deflationary system would inflict the same penalty. Let me illustrate. If money supply were fixed, and Mr. Entrepreneur was able to increase productivity twofold on his shoemaking factory, 1) everyone else is better off, Mr. Entrepreneur more than anybody, 2) the price of shoes would readjust for deflation, but more importantly, it would readjust to allow Mr. Entrepreneur more profit for his efforts. Where does this profit come from? In a deflationary monetary system, he cannot be rewarded with more currency, unless it comes at a cost to someone else. Eventually, the ones who would have to burden this cost are the ones who are the least productive, or contribute the least to the system. More than likely, labor will be seen as the ones to get cut (that will not change in any system). Instead of a government mandated minimum wage, more than likely there will be some sort of maximum deflationary rate set to protect those at the bottom of this deflated totem pole, or to keep them minimally productive. This would equate to the government forcibly deflating future earning power of others to offset for the inability of the inflexible money supply to reward entrepreneurialism with adequate currency. What would make someone angrier than “phantom taxes” through inflation? You got it, a lower paycheck.
Smartypants to NZEconomist:
“Either a permanent deflation - that is fall in price levels - is forced or gold must continually inflate in value so that more money can be issued on the basis of gold holdings whose net growth will be slower than the growth in world production. Either way, basically productive investment is hobbled in favour of gold" - NZ economist
- “Yes. If fractional reserve banking is eliminated with gold backed money there will be a gradual decline in price levels over time as there was during the 19th century here in the US (excepting the periods of war).”
- “I would replace the word 'hobbled' however. Since banks would not be able to lend out money that depositors didn't want to lend the smaller amount of available money to lend would wind up diverting money to the most sought after use. “
Stop right there. You are advocating banning the fractional reserve system. If a bank accepts $1000 in deposits, how much can it lend out? 0 – not $1000 – the depositor can do that himself without the bank. Banks would cease to exist. Do you understand why I keep asking you what banks in your world would look like?? I was only half joking about my reference to the Temple of Jupiter. I am really shocked that this is the premise of an intelligent discussion. I would replace the word “hobbled” with “a noose tied around its neck, and the chair kicked out from under it.” Jim made yet another great point:
Jim to Smartypants:
“Since banks would not be able to lend out money that depositors didn't want to lend…"
- “I have an idea. If you have money you don't want lent out, don't deposit it in the bank”
I now have the same idea. In fact, in your world, Smartypants, banks wouldn’t exist in the first place. Who would do the lending? You? It certainly won’t be me…I would have traded that gold a long time ago for food, water, and guns…lots of guns. That would be the ultimate investment in the dystopia painted by most gold bugs, IMHO. I would then become part of that mob-centric entity I mentioned at the beginning that would confiscate your gold.
One part of me would like to continue this discussion, but my time is up. Unfortunately, I have to invest my time in other pursuits, in search of greater reward than a stimulating discussion with gold bugs: returns on my capital in inflated fiat currency.
It gets exhausting repeating the same, basic, facts and have them bounce off their brick wall.
On Jan 03 02:23 AM Ricard wrote:
> BTW, great work Jim. Thanks for the Econ 101 refresher.
>Since banks don't print FRNs, they are not like goldsmiths.
A borrower from a goldsmith would have signed something akin to a “loan document” just like a modern borrower. The borrower would have received a gold receipt of some kind and promised to repay it with interest just like a modern borrower. The gold receipt credited to the medieval borrower in exchange for his promise to repay is analogous to the dollars credited to a modern borrowers account, because the borrower may withdraw it at any time from the bank in the form of FRNs. Who printed the FRNs that the bank hands to the borrower is irrelevant. The money credited to the borrowers account by the bank by virtue of “dollarizing” the borrower’s promise to repay is legally equivalent to the creation of FRNs.
What exactly do you object to in the analogy? If it was exactly the same, I wouldn't have said "like".
Jan 02 10:52 PM Jim Myrtle wrote:
>You math is wrong. With a 10% reserve requirement, a $1000 deposit does not allow a >bank to issue $10,000 in credit
Correct. One point to you. I didn’t bother doing looking up the formula and doing the math precisely. $900/(1-0.9) = $9,000. Doesn’t change the argument.
asleeper also wrote,
>"If the restaurant had the same legal rights as the bank, it could print out little dollar >bills and "lend" them to you"
Jim Myrtle wrote:
>Banks don't print dollar bills to lend to you.
Let me revise what I wrote, so you can deal with the concept. “If the restaurant had the same legal rights as a bank, it could take your signed IOU, file it, create an account for you, and credit the account for the same amount as the principle noted on the IOU. The restaurant, at least in theory functioning as a bank, could obtain FRNs ultimately from the Fed which asks the Treasury to print them. To make an unnecessarily long and complex tale short, the restaurant could ultimately hand you fresh crisp new FRNs printed up by the Treasury at the request of the Fed just to handle your account, which you could then use to pay your meal. After which you would continue to owe the restaurant for the meal, because the FRNs were a "loan". Meanwhile the FRNs would begin circulating in the economy, increasing the money supply, until you pay off the loan.
The point which you avoided dealing with is that whole process is conceptually no different than if the restaurant had printed the bills itself as I said, or no different than if a bank had printed the bills itself, even though we both know the Treasury prints FRNs. The effect on the money supply would be the same. The salient point is that securitization of IOUs as legal tender increases the money supply..
Jan 02 11:05 PM Jim Myrtle wrote:
>Retailers can sell their accounts receivable.
>Just as credit card companies can.
Yes, they both can sell their accounts receivable if someone is willing to buy them. If the accounts receivable consist of dollar equivalents such as credit card payments in process or checks, they can certainly sell them. Use of a credit card is bank credit, legally the same as if you took a loan from the bank.
When the restaurant receives a credit card payment the bank securitizes the credit card holders promise to repay the bank and issues it as bank credit to the restaurant. The restaurant doesn’t care if credit card holder repays the bank or not. They have already been paid once the credit card payment clears processing. Repayment of the bank credit is then between the cardholder and the bank that issued the card.
But the example I gave was that you gave the restaurant an IOU. Restaurants cannot sell an IOU because the IOU hasn’t been securitized by a bank into the legal equivalent of an FRN. You would only get away with paying for a meal with an IOU if you were a regular customer and were trusted to make good on it by the restaurant itself. The restaurant would expect you to come back and pay in cash, by check, or credit card at a later date.
The IOU does not increase the money supply. Use of a credit card does, at least temporarily until you pay off the monthly balance..
Jan 02 11:24 PM Jim Myrtle wrote:
>My point was not to discuss interest rates, but to show, again, that banks >cannot lend out multiples of their deposits. Yes, it's terrible that banks can >pay you less than 1% while charging 5% and more. The solution is to >become a bank or buy their stock. Their debt now yields in the double digits.
I don’t think anyone has missed you point about banks not lending out multiple of their deposits. I’m certainly haven’t been disputing that. And your solution is the one my brother took. He is now V.P. of a large commercial bank. Funny, he doesn't dispute that banks create money (FRNs) by lending or cause inflation by loosening credit or cause deflation by tightening credit.
I’ve been saying that a bank can turn a promise to pay into legal tender, such ability creates monetary inflation, price inflation, and leads to an unstable money supply capable of collapse, monetary deflation, and price deflation. Do you dispute that?
Do you dispute the assertions that:
1) there is a real difference between $1,000 in FRNs and a signed loan document on which a debtor promises to pay $1,000 FRN’s plus interest?
2) that a bank is able to turn a promise to pay $1,000 FRNs into the legal equivalent of $1,000 in FRNs?
3) that creation of FRNs by the Fed and banks by securitizing promises to repay is the source of inflation that caused the FRN to lose approximately 95% of its value since 1913? (For the purpose of discussion, I define “creation of FRNs” to mean that the Treasury prints FRNs at the request of the Fed, which the Fed then lends to the U.S. government and others in exchange for T-Bonds, T-Bills and other collateral, and banks create FRN equivalents in checking accounts by fractional reserve banking and securitization of “loans documents”.)?
If you would rather quibble with the way I framed the questions rather than respond to the concepts expressed, I'll give this up at this point. Otherwise, I'm still interested in your reply.
The most important difference being the goldsmith was printing receipts for multiples of his gold deposits. Modern banks can only loan their deposits less their reserve balance. Because they don't print FRNs.
"Correct. One point to you. I didn’t bother doing looking up the formula and doing the math precisely. $900/(1-0.9) = $9,000. Doesn’t change the argument"
Your math is still wrong. A $1000 deposit with a 10% reserve allows the bank to create exactly $900 in loans, not $9000.
"The restaurant, at least in theory functioning as a bank, could obtain FRNs ultimately from the Fed which asks the Treasury to print them"
If the restaurant wanted to wire money to the Fed, they could get FRNs. Not sure what that has to do with your story.
"After which you would continue to owe the restaurant for the meal, because the FRNs were a "loan". Meanwhile the FRNs would begin circulating in the economy, increasing the money supply, until you pay off the loan"
Now you owe the restaurant and the Fed, still not clear where you're going with this.
"The salient point is that securitization of IOUs as legal tender increases the money supply.."
Borrowing increases the money supply. Are you proving what I've said all along?
" If the accounts receivable consist of dollar equivalents such as credit card payments in process or checks, they can certainly sell the"
They wouldn't sell credit card payments, they'd sell IOUs.
"Restaurants cannot sell an IOU because the IOU hasn’t been securitized by a bank"
You can sell an IOU that a bank hasn't touched. Suppliers that need cash can sell an IOU from WalMart (just an example) if they need the money now, instead of in 60 days (just an example).
" Funny, he doesn't dispute that banks create money (FRNs) by lending"
Don't confuse the money supply with FRNs. MZM, which includes FRNs, is narrow money. M1 is broader money. He can lend all day long and increase M1. He can't increase FRNs.
"I’ve been saying that a bank can turn a promise to pay into legal tender"
Legal tender? Like FRNs? A bank can sell your promise to someone else, for legal tender but can't turn on the printer in the vault to turn it into FRNs.
"there is a real difference between $1,000 in FRNs and a signed loan document on which a debtor promises to pay $1,000 FRN’s plus interest? "
Of course there is a difference. One is very liquid, one is less liquid.
One pays interest, one doesn't. One has risk of default, one doesn't.
"that a bank is able to turn a promise to pay $1,000 FRNs into the legal equivalent of $1,000 in FRNs?"
I don't know your definition of "legal equivalent".
"that creation of FRNs by the Fed and banks by securitizing promises to repay is the source of inflation that caused the FRN to lose approximately 95% of its value since 1913? "
I don't dispute that the growth of high powered money and subsequent growth of M1, M2, M3 etc over and above the growth of GDP causes inflation.
On Jan 03 03:29 AM asleeper wrote:
What real is backing behind the money is the real economy. If GDP were an effective measure of actual economic activity you might say GDP is what backs the currency. The Gold Standard was created through a very primitive and naive understanding of the nature of money, and eventually failed when it no longer met the needs of the Modern World.
Of course if we did go back to Gold Standard those holding the Gold would be rich beyond their wildest dreams, but I am afraid they are just going to have to get by on their fantasies, because the rest of us aren't quite so naive.
On Dec 30 08:56 AM archman82011 wrote:
> Return to the gold standard would mean one thing:
>
> Accountability.
>
> We can't have that now can we? That means if we have accountability
> in our finance system, we have to have accountability in government.
> If we have accountability in government, that means our citizens
> have to be more accountable, and return to an ethical and moral country.
>
>
> We can't have that though. That means minimal corruption, less graft
> and greed. Our country would have to do what is best for the majority
> instead of what is best for the select few.
>
> Good golly we can't have that now can we????
>
>
The best performing asset class the last year was physical gold. But, similar to what Jim Myrtle said about banks, if you don’t want to invest in gold, don’t do it. I’m not trying to convert you or Jim but simply trying to share what I’ve learned since 2000 investing in precious metals and studying the monetary system.
Take it or leave it as you prefer, but you decide to take some of it and use it as a springboard for further study, one thing you will quickly learn is that prior to the establishment of the Fed, the monetary system and central banking was one of the hottest topics in American history dating all the way back to and before the Revolutionary War.
Sure there are “goldbugs” around who talk blithely about civic unrest, stockpiling food and guns and other unpleasant topics, but I don’t buy into the Armageddon scenario either. Surprisingly, my brother who is VP of a large commercial bank is more inclined to buy into that whole mega-disaster scenario than most “goldbugs”.
I’m not a goldbug (I’m pretty sure), I don’t represent goldbugs (I’m sure), I’m not sure what you think I don’t grasp, and I don’t know what ends you think I advocate, so I’ll continue to try to explain my views better.
I think you believe I don’t understood what Jim’s been saying. BTW, I said the bank may have put up all or none of the original $1,000, and Jim was right about the total loan amount being $9,000, not $10,000.
Of course the bank pays interest on the $10,000 on deposit in the example, but do you understand that if you try to explain to 100 people that the bank need only put up at most, $1,000 of its own money to generate $9,000 in “loans” and then earn $450 per year on their $1,000 investment, a 45% return per year, that 99 of them will think you have gone crazy? Because everyone “knows” that banks lend out their depositors money and how can they generate more than $1,000 in “loans” if they only had $1,000 to begin with?
Jim certainly understands the mechanics of banking and I do too, but most people do not understand where the $9,000 in loans comes from. The first $900 they understand, but after that, most people see it as smoke and mirrors and think that you are lying when you try to explain how a promise to repay $900 can be turned into dollars on deposit, which can be spent, re-deposited in the bank and serve as new reserves for the issuance of more more credit. Economists know it causes monetary inflation, and if the monetary inflation exceeds economic growth, it creates price inflation too.
Were you aware that I already wrote in this thread that I do not advocate a gold standard? The author stated that a return to a gold standard would be disasterous, which cannot really be discussed without discussing our current monetary system. I’ve been trying to get across how our monetary system works, its weaknesses, its unfairness, not extol its virtues obviously. Anyone can read the purpose of the Fed on its own website or out of an Econ 101 book. But they do not advertise its drawbacks.
I know all the same pro-Fed explanations and arguments you do. Do you understand what I’ve been writing or do you just consider it bunk because you do not recall the Econ 101 book saying there were any drawbacks to the current monetary system? There are alternatives to the existing system that are not gold standards, but why even consider them if you do not know how the existing system works or what it might be doing wrong? My goodness, most people do not even believe the Fed represents a cartel of private banks. They think it is a Government Agency.
Econ 101 does say that “Capitalistic systems are built off savings, which are then properly invested in projects that increase a nation’s wealth and productivity.”
But, wait one minute. If I put the $1,000 in the bank, my savings, to kick off the great capitalistic enterprise, why does the bank get $450 per year on $9,000 worth of loans and I get about $5 for my 0.5% interest per year on the capital that started it all? Why does everyone have to start their own bank to get a fair share of the “capitalist” system. Seems like the banks who have the least capital of all but have a corporate franchise to turn debt into money make out like bandits.
And, why are American renowned and reviled worldwide for not saving if saving is such a great part of the capitalistic enterprise? The Government exhorts people to spend, not save. Economists say that if people save instead of spending, the consumer sector of the economy will collapse. If people save instead of borrowing, the money supply will collapse and we will have disastrously high deflation, because debt = money.
Are Americans stupid? I say they are smart or at least they do the best they can with little or no understanding of the monetary system, and the monetary system is stupid. The Fed wants steady inflation and inflation that exceeds what middle and low income people can earn on investments. So, they don’t save and they borrow instead. Economists say that, too. I’m not out on a limb there. Instead of saving, they borrow and leverage the biggest hard asset they own, their house, expecting it to appreciate fast enough due to inflation to make a profit as the money supply expands. It works until banks tighten credit and inflation slows or reverses as just happened recently. People don't understand that what goes by the moniker "business cycle" is really just bank credit expanding and contracting.
Regarding seniors, financial advisors typically advise seniors not to seek aggressive returns but to put savings into “safe, conservative” investments to preserve savings rather than gamble with it. The kinds of investments they recommend, such as fixed income annuities and permanent life insurance typically do not beat inflation.
Middle class and low income people typically keep money in banks, bonds, or CDs. It’s really upper middle class who have any real money to invest in stocks, businesses, commercial real estate and the like, high return investments. Bank savings, bonds, and CDs typically don’t beat inflation over time. Social Security certainly doesn’t keep up with inflation. It’s indexed to the CPI, which consistently understates inflation.
You may be smarter than most seniors, most investors even, but you need not disrespect those less fortunate than you in order to toot your own horn. Would you feel disadvantaged by a monetary system that leveled the playing field a bit?
If you don’t mind, what is your background socioeconomically and education-wise? What has been your average compound rate of return per year of all your liquid assets, after taxes. For most people, even you probably, it is much less than you would estimate off the top of your head. Most people are not fully invested all the time, and they do not take into account funds that are idle. Very likely you haven’t beaten inflation or if you have, you haven’t beaten it by much. Most professional money managers don’t beat it by much. Some years like 2008 are gauged by how little is lost, not how much is gained.
I’m not sure I fully understood your shoe example, but if “everyone else is better off, Mr. Entrepreneur more than anybody”, what is the problem? If Mr. Entrepreneur lowers his prices a little he could lower his prices a little, sell even more shoes, take market share from another shoemaker, and make a bigger profit.
That kind of thing, productivity increases, happens far more rapidly in the semiconductor industry than changes occur in the overall money supply. One of my two brothers works for a semiconductor manufacturer that has almost no debt. They finance capital improvements almost entirely out of profits, and they design or customize much of their production equipment. Productivity increases and price reductions do not result in lower wages at their company, but market share does. People who work for companies that fail must go to work for another or move into a new industry that is starting up. That is capitalist “creative destruction”.
The only other thing I can think of to say is that the state budget crisis in my state might mean a substantial but in my pay before long. However, if deflation continues like it has in recent months, my expenses will drop even faster, except for my mortgage. Debt is the real problem in a deflation. Debt in high deflation = bad, debt in high inflation = good. Unemployment is always bad.
Enough arguing. May all your investments in the New Year beat inflation!
> "A borrower from a goldsmith would have signed something akin to
> a “loan document” just like a modern borrower. The borrower would
> have received a gold receipt of some kind and promised to repay it
> with interest just like a modern borrower"
>
> The most important difference being the goldsmith was printing receipts
> for multiples of his gold deposits. Modern banks can only loan their
> deposits less their reserve balance. Because they don't print FRNs.
If the money the bank "loans" is redeposited in the bank, cannot the bank continue to lend until the total loans are a multiple of the original deposit, the original deposit being the "base" the multiples are built on, the same way that multiples of gold receipts are built on the original gold deposit in the goldsmith's bank? And, both multiplying effects cause inflation?
> "Correct. One point to you. I didn’t bother doing looking up the
> formula and doing the math precisely. $900/(1-0.9) = $9,000. Doesn’t
> change the argument"
>
> Your math is still wrong. A $1000 deposit with a 10% reserve allows
> the bank to create exactly $900 in loans, not $9000.
We went over this before. If the $900 is redeposited in the bank, the bank can lend $810 more, and so on, until it can lend a total of $9000 with $10,000 on deposit, including the original $1,000. You agreed to that, even corrected my math on the total credit being $9,000 instead of $10,000.
> "The restaurant, at least in theory functioning as a bank, could
> obtain FRNs ultimately from the Fed which asks the Treasury to print
> them"
>
> If the restaurant wanted to wire money to the Fed, they could get
> FRNs. Not sure what that has to do with your story.
I felt you were quibbling about banks not being able to print FRNs, forcing me to revise my story to stay on point, which was that a handwritten IOU does not increase the money supply because it isn't equivalent to legal tender, and a bank loan does increase the money supply because it is equivalent to legal tender..
> "After which you would continue to owe the restaurant for the meal,
> because the FRNs were a "loan". Meanwhile the FRNs would begin circulating
> in the economy, increasing the money supply, until you pay off the
> loan"
>
> Now you owe the restaurant and the Fed, still not clear where you're
> going with this.
>
> "The salient point is that securitization of IOUs as legal tender
> increases the money supply.."
>
> Borrowing increases the money supply. Are you proving what I've said
> all along?
I've been saying all along that banks create money and increase the money supplying by the process of securitizing loan documents. That the act of securitizing the lenders promise to repay by the bank is the point of money creation by banks, referring to that act as issuing credit. And, I've been under the impression you been denying that. Apparently, there has been a "failure to communicate" all along arising over different assumptions about who meant what kind of money and what-not. And, maybe I've not been using banking industry-consistent jargon.
Sorry, but that cracks me up. One of my favorite sayings is that the strangest thing about communication is the illusion it has been accomplished.
> " If the accounts receivable consist of dollar equivalents such as
> credit card payments in process or checks, they can certainly sell
> the"
>
> They wouldn't sell credit card payments, they'd sell IOUs.
>
> "Restaurants cannot sell an IOU because the IOU hasn’t been securitized
> by a bank"
>
> You can sell an IOU that a bank hasn't touched. Suppliers that need
> cash can sell an IOU from WalMart (just an example) if they need
> the money now, instead of in 60 days (just an example).
Can your local corner restaurant really sell your handwritten IOU? Now, I'm not sure. Can he take it to the bank and use it to borrow money or exchange for FRNs as he could a check? if not, then I would say the IOU cannot increase the money supply.
> Don't confuse the money supply with FRNs. MZM, which includes FRNs,
> is narrow money. M1 is broader money. He can lend all day long and
> increase M1. He can't increase FRNs.
Yes retail banks can increase M1 but not FRNs. Modern money is rather slippery and has several definitions. But I've been referring to broader money measures than just FRNs, measures that banks can increase..
> "I’ve been saying that a bank can turn a promise to pay into legal
> tender"
>
> Legal tender? Like FRNs? A bank can sell your promise to someone
> else, for legal tender but can't turn on the printer in the vault
> to turn it into FRNs.
What I mean by "turn into" is that a bank can take my signed promise and physically hand me FRNs. Since my promise is not legal tender but my bank has given me legal tender for it, as far as I'm concerned, the bank has turned my promise into legal tender.
> "there is a real difference between $1,000 in FRNs and a signed loan
> document on which a debtor promises to pay $1,000 FRN’s plus interest?
>
> Of course there is a difference. One is very liquid, one is less
> liquid.
> One pays interest, one doesn't. One has risk of default, one doesn't.
Also, one is legal tender and the other is not. So, which one is money, the loan document on file at the bank or the credits in the borrowers account?
> "that a bank is able to turn a promise to pay $1,000 FRNs into the
> legal equivalent of $1,000 in FRNs?"
>
> I don't know your definition of "legal equivalent".
Dollar credits in the borrower's account. I say they are legally equivalent to FRNs because I can ask the bank to give me FRNs based on bank account credits and they must do it unless they don't actually have any FRNs on hand that day.
> "that creation of FRNs by the Fed and banks by securitizing promises
> to repay is the source of inflation that caused the FRN to lose approximately
> 95% of its value since 1913? "
>
> I don't dispute that the growth of high powered money and subsequent
> growth of M1, M2, M3 etc over and above the growth of GDP causes
> inflation.
Thank you. We agree on that and probably more if not for the communication gap. I'm curious, are you a banker, a teacher or neither? I'm a math teacher and ex-engineer.
Yes, people would likely not be fleeing to treasuries rignt now, but all the over-valued CDS, stock, bonds, etc. that were sold to the rest of the world would have already been paid for in gold ;)
On Dec 30 09:21 AM Ricard wrote:
> This argument is not valid.
>
> If we were on the gold standard during this crisis, gold itself wouldn't
> have prevented the majority of Americans from borrowing to the hilt.
> Gold may bring your much-sought-after accountability, but it wouldn't
> have prevented the leverage that destroyed so much wealth.
>
> In this case, your accountability would have dire consequences.
> America would have been stripped of its gold by foreigners as they
> redeem their dollars for gold instead of Treasuries, and we would
> only have one way to regain it back: war. If we do not wage war,
> our economy would have been so crippled from this bout of euphoria
> that we would have not only lost our pre-eminence, but quite possibly
> our nationhood due to the subsequent lowering of our per capita consumption.
> Remember, we don't really produce as much anymore, and without large
> gold stocks, it would cost us dearly as a percentage of gold stocks
> remaing to purchase what others produce.
>
> This doesn't sound like a reasonable solution for fiat to me. Your
> "accountability&am... only comes as the consequence of inane choice.
> It does not counsel or deter stupidity.
>
>
>
> On Dec 30 08:56 AM archman82011 wrote:
To summarize, despite any intricacies regarding legal tender status:
1) Jim agrees that bank lending increases the money supply.
2) Jim believes that deflation in any large measure is bad
I am going to guess that Jim believes run away inflation is bad, though that point has not been discussed.
So that leaves Jim with just one option, what I would call "Goldilocks Inflation", or just the "right" amount of inflation, whatever that means.
The Chicago School of thought is that inflation should match GDP growth so the value of money in goods remain constant. I have referenced Rothbard and made the comment that any attempt at implementing that policy would eventually wind up being a race to issue credit based money (thereby growing the money supply) by individual banks so *they* got the extra business before another bank got it.
Perhaps Jim or Ricard or Dave W could enlighten us dense engineers and tell us how exactly they would restrict money creation by banks to the growth rate of GDP without just blowing right past it.
Seems to me that as soon as a bank increases the money supply by issuing a debt backed loan that the borrower can go out and spend that money, thereby increasing the GDP and enabling even more money creation, which can be spent, enabling even more money creation, etc. etc.
We engineers would call that a positive feedback loop. The more money you create, the more GDP increases and so in the extreme you can create an infinite amount of money under that system.
It also seems to me that this is pretty much how our current economy got to the point it's at right now. Banks created bucket loads of money to buy housing, which increased GDP and so the bubble was under way, continuing on until it got out of hand and it suddenly became clear that all those promises to repay the IOUs the banks were holding weren't going to be repaid.
Net result: crushing deflation as the IOUs are written off, lending stops and GDP growth stops and likely reverses.
Which Jim also thinks is bad.
My main point in the whole discussion is that if you want to minimize the threat of crushing deflation then you have to give up money creation via fraction reserve banking. It doesn't matter what you claim backs the money as long as the supply of that backing is stable and not capable of growing recklessly as fiat money tends to do.
Historically, the backing that has proven most suitable is gold, but I'd be happy to use peanut butter sandwiches if I knew that banks weren't going to increase the supply via fractional reserve banking (and assuming people couldn't create their own).
So Jim, Ricard, Dave W, what system do you propose to replace our current fiat backed, fractional reserve system? This one has been shown to be sorely lacking by current events. At this point our economy is facing two options, either Jim's horridly crushing deflation with bankruptcies galore in the financial sector or it's opposite, hyperinflation, because the only way to make all the bad loans meaningless is to inflate the currency to the point where you can pay them off.
What do you propose to replace it that will avoid hyperinflation while also avoiding crushing deflation?
For a glimpse at the effects of hyperinflation research Weimar Germany or Zimbabwe, because the odds of that happening here are rising with the FED's enormous increase in base money. If the economy does recover you can expect that base money to muliply like rabbits and inflation will return on steroids.
"During the first half of 1922 the mark stabilized at about 320 Marks per Dollar ... in June ... the inflation changed to hyperinflation and the Mark fell to 8000 Marks per Dollar by December 1922. The cost of living index was 41 in June 1922 and 685 in December" - Wikipedia
"Many of the dramatic and unusual economic behaviors now associated with hyperinflation were first documented systematically in Germany: order-of-magnitude increases in prices and interest rates, redenomination of the currency, consumer flight from cash to hard assets, and the rapid expansion of industries that produced those assets." - Wikipedia
"The inflation reached its peak by November 1923, but ended when a new currency (the Rentenmark) was introduced." - Wikipedia
"The Rentenmark replaced the Papiermark. Due to the economic crises in Germany after the Great War there was no gold available to back the currency. Therefore the Rentenbank, which issued the Rentenmark, mortgaged land and industrial goods worth 3.2 billion Rentenmark to back the new currency. The Rentenmark was introduced at a rate 1 Rentenmark = 1:1,000,000,000,000 Papiermark."
"The Rentenmark was only an intermediate currency and was not legal tender. It was, however, accepted by the population and effectively stopped the inflation. The Reichsmark became the new legal tender on 30 August 1924, equal in value to the Rentenmark"
"The Rentenbank continued to exist after 1924 and the notes and coins continued to circulate. The last Rentenmark notes were valid until 1948."
OK Jim, while we slept 1/2 of the US banks merged into the 1st Aggregate Bank of America and the other 1/2 merged into the 2nd Aggregate Bank of America. All of the assets, equity, and liabilities have been added up and are now on two balance sheets. There are now just two US banks. We'll talk about the Fed later maybe. Here they are:
1st Aggregate Bank of America (1st ABA)
Assets:
---IOU's:
-----$9T
Reserves:
----$11T
Total:
----$20T
Liabilities + Equity:
---Equity:
------$1T
---Liabilities
-----$10T Checking Acct. Deposits
------$9T Checking Acct. Loans
Total
---- $20T
So we see that the 1st ABA has lent out 90% of its deposits (9T). The leverage is thus 19/11 = 1.727/1 . This is less than the legal maximum of 1.9/1.
Now the balance sheet for the 2nd Aggregate Bank of America:
2nd Aggregate Bank of America (2nd ABA)
Assets:
---IOU's:
------$4.5T
Reserves
------$6.0T
Total:
----$10.5T
Liabilities + Equity:
---Equity:
---$1.0T
Liabilities:
---$5.0T Checking Acct. Deposits
---$4.5T Checking Acct. Loans
Total:
--$10.5T
The 2nd AGA has lent out 90% of its deposits (4.5T). Its leverage is 9.5/6.0 = 1.58/1. This is less than the legal maximum of 1.9/1.
Now for whatever reason (they are demand accounts, aren't they?) the customers at the 1st AGA decide to withdraw 14T and deposit it with the 2nd AGA. oops! 1st AGA is 3T short. Who is it going to borrow from now Jim? There are no other banks besides the 1st AGA and the 2nd AGA. The money doesn't exist. The 1st AGA created 9T of money from nothing and without another bank to borrow from is exposed as a counterfeiter. What good are the IOUs 1st AGA has? The 2nd AGA wants money not IOUs.
What about the Fed? Sure it can create some money from nothing and lend it to 1st AGA. That's its job, to back up the legalized counterfeiting cartel know as our banking system.
Money from nothing which steals its purchasing power from the public at large.
You nailed that right, my friend.
But clever theft is still just theft
and to honesty will bend.
Here is the problem with FRB business loans. Using MV = PY
where:
M = total money supply
V = dollar transactions per year
P = the price level
Y = aggregate output
When the loan is first made, the business will spend it on investment. It will thus filter down into wages. What will happen to the money next? There are two choices save or spend. Since the money is unbacked, it has no stable value. As Ludvig Von Mises pointed out, there is no reason to believe that the new wages will be saved at a higher rate than the old wages. So let's assume the wages are saved at a 10% rate as usual. The other 90% is spent.
So, using MV = PY. If M increases by deltaM and 10% of that M is saved then PY must increase by 90% of deltaM. Since Y has much more inertia than P, we can assume that all the increase occurs in P. The other 10% of deltaM ends up in savings where it will be recycled into investment loans and then to wages where 10% of 10% = 1% will be saved and so forth. This will increase V by the factor of about (M + .11 deltaM) /M. Since these are real savings and there is no other place to put them, we will allocate them to increased output. So we have:
(M + deltaM)*(M + .11 deltaM)*V/M = (P+.90deltaM)*(M + .11 deltaM)*Y.
So, 90% of the "investment" has just raised prices! Which
leaves 11% (include recycling of real savings) for productivity increases! Which, in a huge irony of honesty, is the exact amount the savers were willing to save in the first place, 10% recycled.
Also, even with FRB, savings should be encouraged to cause real productivity increases.
The economy would be in shambles before a year had passed as it was in Weimar Germany.
Such is the problem with those who think that it's OK to print create "just a little" money to match GDP growth. Nice theory, but no practical means of avoiding the eventual avalanche of money creation that results in our current system.
Sooner or later you wind up where we are now with a choice between the two options of unimaginably bad and horrendous for 'solutions'.
and Freedman too.
Mises was right.
Rothbard too.
It turns out honesty
is the key.
Who'd of thought
that'd be true?
Perhaps engineers,
who learned to see
that beauty is not truth
but truth has beauty.
Why not mathematicians then?
Why have they failed?
Because they wearied of nature
and on their own paths did sail.
So the humble engineers
who reality can't deny,
turn out in the end
to be wiser than the "wise".
It would serve the discussion better by purging it of emotional bias, pro or con, if in place of 'gold' we were instead to substitute a term such as 'fixed-supply store of value' which stands for what is argued by most on all sides to be the essence of a gold standard without all the historical and emotional baggage associated with the word gold.
The assertion most closely approximating an argument is that a FSSOV standard would be chronically deflationary because a presumably increasing supply of goods and services would be tied to the limited pool of FSSOV. Having prices in terms of units of FSSOV that continually drop, and presumably wages that decline over time as the economy grows, is seen as psychologically unacceptable. It doesn't 'feel' right that one's pay packet should appear to shrink or rise at a tiny rate as one progresses in one's life and career, even if the value represented by that pay packet grows tidily, and overall price levels fall in parallel. It doesn't 'feel' right that the price of one's home and other assets declines or remains flat over time, even if the value represented by that price grows in parallel with the expanding economy.
But that comes down to a matter of what one is used to. It also doesn't feel 'right' (even if it feels 'normal' because that is what we all experience in our era), that the store of value leaks out at a rapid rate such that the dollar, for example, has lost 95% of its purchasing power in 90 years, all of which value has effectively been disposed of by government policy makers and stakeholders in an inflationary system.
It also doesn't feel right because the only experience anyone has with deflation in an environment where inflation is the anticipated norm, coincides exactly with periods of economic contraction where people and institutions are all hurting. We tend to associate 'absolute deflation' with periods of economic stress when the norm is for there to be relative price inflation. So we associate pain with it. But there is nothing inherently painful about price deflation when the economy is turning over and moving ahead nicely.
Also there is the suggestion in the article that having a FSSOV would provide a constraint that would be dysfunctional during economic turns in that there would be no obvious way to use some kind of central monetary policy to modulate them.
Presuming that fractional reserve banking and associated leverage, with certificates of deposit/banknotes denominated in the FSSOV, is here to stay, adjusting the reserve requirements either centrally or transparently by institution, could address such credit adjustment concerns without undermining the tether of the economy to the FSSOV. What's more it would finally abolish the ability of the central government entity to divert value to politically favored projects at the expense of the economy.
The problem with the traditional arguments marshalled against a FSSOV is in part that they are blindered by an understandable inability of ordinary people to imagine how a system they never have experienced would function. If the 18th, 19th and early 20th centuries had the benefit of enhanced knowledge since then about the operations of markets and credit, the more-or-less constant FSSOVs of the day could have weathered periodic business fluctuations far more readily than they did. Why it is that advocates of any FSSOV are expected to operate with the tools and rules of a pre-horse and buggy era in a side-by-side comparison, while advocates of the current centrally adminsitered no-standard-of-value de facto 'wildcat central banking' era are allowed to shore up their system with all the tools and knowledge of the modern day, is puzzling only if one ignores the stake the existing order has in preserving the centrally-controlled order and the inability of even expert economists, much less the man on the street, to envision any context other than a chronically inflationary centrally-organized one under which everyone on earth has lived his entire life.
To achieve a gold standard, there would have to be MASSIVE deflation, as well as a huge transfer of economic wealth from those who do not hold gold to those who do. Maybe that's why the goldbugs are so for it.
This is the tyranny of humble arithmetic.
My comments below are strong medication but as expected I'm afraid it would be highly unpopular. However I sincerely hope that you would appreciate my goodwill.
A deep recession and perhaps a depression would be sobering, awakening and even cleansing for all of us. The past two decades of the markets being knee-jerking and schizophrenic with the Fed nudging interest rates on a 6-week has got to end.
For so long equities had bee held hostage by those sharp pencils in Wall Street on a quarterly basis. This obsession had sacrificed long-term investment R&D over short-term gains. T
The present crisis also calls into question our fundamental core of true leadership in business and government. The light at the end of the tunnel will not appear until such time that we all wake up from our self-hypnotization.
On Dec 30 09:03 AM PrudentMan, CFA wrote:
> We were on the gold standard in 1929 until the middle 30s. On or
> off, we still had a 12 year recession which ended with our supplying
> the Allies with war munitions.
>
> So on or off, now and then we got over-extended both publicly and
> privately on credit encouraged by a consumer driven Non-Term-Limited
> Congress who will never want the punch bowl taken away
>
> A hangover is to remind you that you overindulged. A recession reminds
> you that you are overextended. Both are good for you in the longer
> run if you pay attention the their message, which is another problem.
Thanks for your reply. I’ll be as brief as I can here as I’m noticing that this particular blog is becoming endless.
“Richard,
The best performing asset class the last year was physical gold. But, similar to what Jim Myrtle said about banks, if you don’t want to invest in gold, don’t do it. I’m not trying to convert you or Jim but simply trying to share what I’ve learned since 2000 investing in precious metals and studying the monetary system.
“Take it or leave it as you prefer, but you decide to take some of it and use it as a springboard for further study, one thing you will quickly learn is that prior to the establishment of the Fed, the monetary system and central banking was one of the hottest topics in American history dating all the way back to and before the Revolutionary War. “
- Fair enough, take it or leave it, but my point is that gold is not an investment, according to not only myself, but most advocates of gold. It is a store of value, one that is supposed to remain constant, and neither increase nor decrease in the same manner as actual investments, which are based on productivity and management shrewdness. It rises and falls in today’s world due to supply constraints, and demand expectations. Most of this demand is non-utilitarian…meanin... that it is pure speculation, or a wish to turn gold into the new fiat. Definition of fiat: an authoritative or arbitrary order. It does not equate to an inflationary or deflationary currency. It merely means that we choose to believe it has value, and so it does.
“Sure there are “goldbugs” around who talk blithely about civic unrest, stockpiling food and guns and other unpleasant topics, but I don’t buy into the Armageddon scenario either. Surprisingly, my brother who is VP of a large commercial bank is more inclined to buy into that whole mega-disaster scenario than most “goldbugs”.
“I’m not a goldbug (I’m pretty sure), I don’t represent goldbugs (I’m sure), I’m not sure what you think I don’t grasp, and I don’t know what ends you think I advocate, so I’ll continue to try to explain my views better.
“I think you believe I don’t understood what Jim’s been saying. BTW, I said the bank may have put up all or none of the original $1,000, and Jim was right about the total loan amount being $9,000, not $10,000.
- I think you do, but I do believe that Jim has demonstrated an uncanny level of proficiency at this subject. Basically, all I’m saying is that if I were to trust in someone’s judgment, I’d trust in someone who is the most correct, and right now, Jim is the most correct (in my mind) compared to any one of you, to say nothing about all of you put together, in manners regarding our current system.
- I would still like to see an explanation as to how a bank would work without FRB, for example. In my mind, a bank exists solely to take advantage of FRB – the reserve requirements set by the Fed simply ensure that the bank doesn’t get carried away with it…it is not meant to encourage them. Think of it this way…if you though that Mr. Brainiac was really good at spotting good businesses, you’d probably want to give him a chance with your money. If you gave Mr. Brainiac $1000…he’d probably use all $1000 to get the best return, which is probably what you want him to do. However, this will result in 100% FRB, if other people also begin to put their money with Mr. Brainiac. The Fed steps in and says wait…you need to hold some of that money back, lest you get carried away. Hence the Reserve requirement.
“Of course the bank pays interest on the $10,000 on deposit in the example, but do you understand that if you try to explain to 100 people that the bank need only put up at most, $1,000 of its own money to generate $9,000 in “loans” and then earn $450 per year on their $1,000 investment, a 45% return per year, that 99 of them will think you have gone crazy? Because everyone “knows” that banks lend out their depositors money and how can they generate more than $1,000 in “loans” if they only had $1,000 to begin with?
“Jim certainly understands the mechanics of banking and I do too, but most people do not understand where the $9,000 in loans comes from. The first $900 they understand, but after that, most people see it as smoke and mirrors and think that you are lying when you try to explain how a promise to repay $900 can be turned into dollars on deposit, which can be spent, re-deposited in the bank and serve as new reserves for the issuance of more more credit. Economists know it causes monetary inflation, and if the monetary inflation exceeds economic growth, it creates price inflation too.
“Were you aware that I already wrote in this thread that I do not advocate a gold standard?
- Admittedly I have been rather brief in reading these comments…there are simply way too many, and I have other things to do. I have noticed that Jim’s comments are uncannily accurate. Most posters that are arguing with him have had to correct themselves or adjust their position, whereas Jim’s has remained constant…all he is doing is quoting econ 101.
“The author stated that a return to a gold standard would be disasterous, which cannot really be discussed without discussing our current monetary system. I’ve been trying to get across how our monetary system works, its weaknesses, its unfairness, not extol its virtues obviously. Anyone can read the purpose of the Fed on its own website or out of an Econ 101 book. But they do not advertise its drawbacks.
“I know all the same pro-Fed explanations and arguments you do. Do you understand what I’ve been writing or do you just consider it bunk because you do not recall the Econ 101 book saying there were any drawbacks to the current monetary system? There are alternatives to the existing system that are not gold standards, but why even consider them if you do not know how the existing system works or what it might be doing wrong? My goodness, most people do not even believe the Fed represents a cartel of private banks. They think it is a Government Agency.
- You can go even further, and say that the government itself is a cartel of the wealthy and powerful, especially in a capitalistic democracy. It takes people with capital to know how to allocate it in a capitalistic system. Successful capitalism rewards everyone with enhanced productivity. The public only understands that they are better off under certain leaders, not whether or not these leaders are enlightened capitalists. I’m simplifying it, but this line of reasoning is valid to a good degree, that I am sure. After all, capitalism is what made us better than the Commies, not democracy.
- Another example – India is growing far slower than China, yet India is more democratic than we are, and China is usually associated with a one-party dictatorship. The reason China is doing better economically is because they are incredibly adept at allocating capital to enhance production…even if that means forcibly relocating millions of starving peasants. Regarding Indian democracy, I read a WSJ article about squatters who inhabited an airport runway. They were allowed to stay despite the fact that they made large portions of that airport unusable because they voted, and politicians catered to their demands. This illustrates (at least in my mind) the difference between capitalism and democracy.
“Econ 101 does say that “Capitalistic systems are built off savings, which are then properly invested in projects that increase a nation’s wealth and productivity.”
“But, wait one minute. If I put the $1,000 in the bank, my savings, to kick off the great capitalistic enterprise, why does the bank get $450 per year on $9,000 worth of loans and I get about $5 for my 0.5% interest per year on the capital that started it all? Why does everyone have to start their own bank to get a fair share of the “capitalist” system. Seems like the banks who have the least capital of all but have a corporate franchise to turn debt into money make out like bandits.
- 1) You have just demonstrated the effects of leverage. Banks are rather complicated machines, with many, many people who dedicate themselves to analyzing risk. The pool of this knowledge is used to get extraordinary returns. Admittedly a good number of these people failed miserably the past 5 years, if not longer.
- 2) You would get more like 1.0-2.5% interest if you put your money in a 1-2 year CD today. This is not only beating treasuries, but this is earning you money in a deflationary environment...CDs just 3 months ago were yielding 3.5-4.0% for 1-2 years, which easily beat inflation at that time. If you think you’ll need the money during that time, it won’t really matter if it deflates or inflates, wouldn’t it? You’d spend it no matter what.
- 3) People do not need to start their own bank to earn good returns. Banking and lending concentrate on one kind of capital allocation – debt. You are more than welcome to directly participate in enterprises through equity, either of banks or other firms. Why “must” people do this? They don’t, unless they want to participate in capitalism. We are not “communist” – we do not cater to solely labor. We cater to capital in all forms. Labor is one form of capital, but it is generally the most unorganized and the least informed of the capitalistic system. Furthermore, most productivity improvements marginalize labor…just look at GM. They protected labor (think “Job banks”) at the expense of their own survival in this globally capitalistic environment. I think GM has done the right and noble thing throughout (at least in car-making), and it would make quite a Greek tragedy if its history were ever made into a play…especially Rick Wagoner’s history at GM. It’s very hard to place blame though…if starving Japanese in the 60s or starving Koreans in the 80s didn’t win against GM, starving Chinese would be doing it now, or starving Iraqis later…you get my drift.
- 4) Banks don’t have capital outside of what customers give them, yes…they act as agents on our behalf to capitalize on what would otherwise be non-performing assets (cash in a mattress). Stick your money in 1 year CDs, and you are almost guaranteed to beat inflation by a good margin – this has been true of the past 20-30 years if I recall correctly (not sure about the mid-70’s).
“And, why are American renowned and reviled worldwide for not saving if saving is such a great part of the capitalistic enterprise? The Government exhorts people to spend, not save. Economists say that if people save instead of spending, the consumer sector of the economy will collapse. If people save instead of borrowing, the money supply will collapse and we will have disastrously high deflation, because debt = money.
- Americans, and the developed world in general, are failing at capitalism as we speak. That is why most respected analysts are favoring emerging economies over the developed world. The government exhorts people to spend, because the government caters to the public, not to the ideals of capitalism – the public feels good when they spend. Capitalistic virtues do not earn you votes unless you are a conservative Republican in a conservative district. That eliminates nearly 50% of the electoral population, who live in California and New England, where consumer oriented spending was pornographic. I’m not a Republican or a Democrat, and I realize I am making a gross generalization, but much of this is true.
- If the consumer sector of the economy collapses as you say, perhaps people will instead invest in capitalistic objectives, like an education (human capital), instead of that double mocha latte at Starbucks.
- If people save instead of borrowing, and those savings are invested in capitalistic objectives that improve our productivity, it would result in our becoming a more export-oriented economy, instead of the cesspool that we are lamenting about right now. We would be export oriented because whatever production processes we would discover due to capital investments would exceed the cheap labor advantages of developing countries (in theory). This would require that our country become more austere with their spending, and invest more in their own education. It does not require that we adopt a gold standard and the crippling deflation that comes with it.
“Are Americans stupid? I say they are smart or at least they do the best they can with little or no understanding of the monetary system, and the monetary system is stupid. The Fed wants steady inflation and inflation that exceeds what middle and low income people can earn on investments. So, they don’t save and they borrow instead. Economists say that, too. I’m not out on a limb there. Instead of saving, they borrow and leverage the biggest hard asset they own, their house, expecting it to appreciate fast enough due to inflation to make a profit as the money supply expands. It works until banks tighten credit and inflation slows or reverses as just happened recently. People don't understand that what goes by the moniker "business cycle" is really just bank credit expanding and contracting.
- I agree that Americans are smart, but Americans generally receive next to no education in the financial system unless it is their major in undergrad or they get an MBA in finance. They consequently make abysmally poor financial decisions, like getting Botox instead of paying their mortgage.
online.wsj.com/article...
“Keeping Up Appearances In a Downturn”
This article was dated right around Christmas. Again, this article focuses on California and Florida, where consumer-oriented spending was prolific.
- The Fed does not want inflation that exceeds what middle and low income people can earn on their investments. The Fed wants steady prices so that they can control the money supply to account for productivity improvements, and not have to worry about crises like this. Again, a man that saves $1000 a year will beat inflation with a 1 year CD at most banks.
- People do not understand why their house is appreciating. If people do not understand why their house (which is real estate, a form of business) just earned them $150,000, and instead just take advantage of it without knowing the consequences, they should go out of business. What happens when businesses go out of business? They either liquidate or file for bankruptcy. This brings up the oft-quoted scenario: What happens when the man who owes $100 can’t repay? It’s his problem. What happens when the man who owes $100 million can’t repay? It’s someone else’s problem. Right now, the Fed has a very big problem – on a personal level, the second half of the quote is true – on a geo-political level, the first half is true (we owe China “$100”, if you get my drift). They’re screwed on both ends.
- What I am simply saying is that people who buy a house should know what they are getting into. Most Americans equate it with things like raising a family, settling down with the hubby or wifey, and getting old and pruny while the rug-rats grow up and succeed. What they don’t realize is that their house is part of a business called real estate, one that accounts for an enormous amount of our nation’s wealth and productivity, and the price they pay for this business is incredibly important to how our nation functions. This lack of realization is now costing us, and making people think that gold is the solution to their problems. I thought it might have been too, until I read more and more of the arguments of supposed gold-bugs. I do have a lot of respect for some of their arguments, which is why I can speak intelligibly about some of them (like the point of view that gold is not an investment – it is a store of value, and nothing more). I just think it requires acknowledging much more failure than is realistic or required for this situation.
“Regarding seniors, financial advisors typically advise seniors not to seek aggressive returns but to put savings into “safe, conservative” investments to preserve savings rather than gamble with it. The kinds of investments they recommend, such as fixed income annuities and permanent life insurance typically do not beat inflation.
- Yes they do. Again, 1 year CDs…if they have more than $100,000, there are plenty of variable immediate annuities that guarantee an income for life, regardless of what the principle does. If the principle appreciates, these annuities are usually tiered to accommodate.
“Middle class and low income people typically keep money in banks, bonds, or CDs. It’s really upper middle class who have any real money to invest in stocks, businesses, commercial real estate and the like, high return investments. Bank savings, bonds, and CDs typically don’t beat inflation over time. Social Security certainly doesn’t keep up with inflation. It’s indexed to the CPI, which consistently understates inflation.
- You probably know what I am going to say…1 year CD…Most people that know me know that I spend an inordinate amount of time looking at this stuff. Sometimes, I get comments like ‘I just put my money in the bank and get 4-5% on it.’ They’re surprised when I say, ‘that’s a great decision, keep doing it, and I’m serious.’ Most people should stay out of stocks, bonds, real estate (including their own house), etc, unless they’re willing to put in enough time to understand it, and it takes a lot of time and experimenting. Plenty of rich bourgeois middle class folks lose hundreds of thousands, if not millions of dollars, because they think their mastery of their specialty makes them magically able to master the market…they are usually humbled in quick order. I’ve met my fair share of this type of “investor”. Luckily, anyone with $1000 can beat inflation through…a one year CD.
- If all a senior citizen has is Social Security, maybe he needs to re-read that fable about the ant and the grasshopper. Slightly harsh, but you reap what you sow. I’m sure that person lived quite a life spending away his or her future retirement. I for one have little pity for him or her.
“You may be smarter than most seniors, most investors even, but you need not disrespect those less fortunate than you in order to toot your own horn. Would you feel disadvantaged by a monetary system that leveled the playing field a bit?
- First of all, thanks for the compliment. I really mean no disrespect, although I’d rather toot my horn about gold if it isn’t all that it’s cracked up to be.
- Gold wouldn’t level the playing field. I really believe that if we went to a deflationary monetary system like gold, future earnings would also be deflated, if not by market forces, then by government mandate. We currently have minimum wages to account for inflation. If we adopted the gold standard with no FRB, I’d expect us to have a maximum wage deflation rate to protect laborers at the bottom of the rung. Lastly, people who would rely on fixed income would also see their incomes deflate, because the more productive of our society would be rewarded more than those that are not. In our current system, fixed income loses some purchasing power through inflation. In this supposed gold standard, fixed income would lose purchasing power through deflation – lower paychecks. The constant remains in both system – productivity is rewarded at the expense of the less productive.
“If you don’t mind, what is your background socioeconomically and education-wise? What has been your average compound rate of return per year of all your liquid assets, after taxes. For most people, even you probably, it is much less than you would estimate off the top of your head. Most people are not fully invested all the time, and they do not take into account funds that are idle. Very likely you haven’t beaten inflation or if you have, you haven’t beaten it by much. Most professional money managers don’t beat it by much. Some years like 2008 are gauged by how little is lost, not how much is gained.
- I respect your curiosity – I’ll keep it at that. I have no personal website and I’m not selling anything. All I’ll say is that I’ve been investing for my own account for about 10 years, and it’s been quite a learning experience. The most important book by far I’ve read that has shaped my views is “Security Analysis” by Ben Graham - all it takes to understand that book is a good deal of patience and knowledge of Accounting 101. The more I learn, the more I am convinced that average Americans treat spending money as consumption, no matter if it’s buying a six pack of longnecks, a car, a house, or stocks even. This point of view is unfortunately wrong, even though I respect most of the people I know who think this way – they’re usually great a parties. People like this made poor decisions the past 5-10 years, and here we are.
- Regarding solutions to beating inflation, the S&P 500 Index has handily beat inflation in most, but not all, 10, 20, 30, 40, etc year periods. Index funds require little intelligence to purchase – they merely require that you control your emotions and the urge to sell during times like this, and throw away all that garbage that most mutual fund salesmen throw at you. Dollar cost averaging goes very far in exerting adequate self-control. Anyone in Treasuries would have had spectacular returns this year, and would have beaten inflation for most of their life if they stuck to shorter terms. Again…1 year CDs almost always beat inflation…
- Agreed about your comment regarding 2008, there are many years like that. The key is self control. In times like this, as things get worse and worse, the more likely things will get better and better in the not too distant future…or at least that is what I believe. Just as long as things don’t break. Reverting to the gold standard would be acknowledging that what we have right now is broken.
I’m not sure I fully understood your shoe example, but if “everyone else is better off, Mr. Entrepreneur more than anybody”, what is the problem? If Mr. Entrepreneur lowers his prices a little he could lower his prices a little, sell even more shoes, take market share from another shoemaker, and make a bigger profit.
- There is no problem. The key is to understand that Mr. Entrepreneur would earn more money than the average joe, which means that someone below average, who may have been average before Mr. Entrepreneur came along, would suddenly earn less. His wages would have to be deflated to reward Mr. Entrepreneur for his success, since the money supply cannot be inflated to compensate. The government would have to intervene by setting a maximum deflation rate, so that the wages of this below average person (who is probably a citizen of the utmost integrity) are fair and not unduly deflated. In our current system, most people do not see this deflation…it is actually adjusted through inflation, as you are keenly aware. That’s what I meant when I said that the only thing that would anger someone more than seeing inflation eat away at his paycheck, is to see a lower paycheck. People are beginning to see lower paychecks today through unpaid leave, etc, in today’s deflationary environment. Instead of being angry, they’re scared…really scared.
I hope we understand each other better now. I don’t mean to be insulting, but life is tough. Risk taking is tough. Losing money and going through bankruptcy if necessary is tough. I believe that no one has really lost money unless the firms (including real estate, i.e. their own house) they were investing in went bankrupt, or they sold in this environment (which most personal finance columnists that I’ve read have expressly counseled people not to do).
Lastly, despite all of my gold-bashing, I still can’t shake out one fact – that the US’s foreign currency reserves are almost all in gold. That keeps me interested in blogs like this.
Happy New year.
Regardless, my main point was that gold or no gold, if people want to spend like it's 1999...nothing's gonna stop them.
On Jan 03 07:56 AM Against Aphobus wrote:
> Ricard, Your argument is thought provoking, but isn't it just as
> possible that the U.S. would have benefited monetarily in this crisis
> if we were on the gold standard?
>
> Yes, people would likely not be fleeing to treasuries rignt now,
> but all the over-valued CDS, stock, bonds, etc. that were sold to
> the rest of the world would have already been paid for in gold ;)
>
BTW, here's a link to that WSJ article about Indian squatters:
www.mindfully.org/WTO/...
In India, the Path To Growth Hits Roadblock:
Slums
Huge Squatter Settlements Hem In Development Sites;
A Potent Political Force Mrs. Pawar's Runway View
JOHN LARKIN and ERIC BELLMAN / Wall Street Journal 17mar2006
I couldn't believe it when I first read it - it's rather entertaining, and enlightening about the difference between capitalism and democracy. Enjoy.
One has to do with reserve requirements for banking and credit under a FSSOV (fixed-supply store of value). Together with loan portfolio quality and performance, the reserves held by a bank are the best measures of the likelihood that the bank can withstand adverse financial conditions.
Spinning off my comment on flexible reserve requirements, my preference would be for no central entity to arbitrarily fix reserve requirements and compel private institutions to abide by that percentage, although getting away from that politically might well prove difficult. Rather I think having each institution define its own reserve requirement in a totally transparent way would serve better.
One mechanism for doing so would be for the bank to publish its self-chosen reserve requirement in a crisp and unambiguous way and tie a representation of that requirement to all the bank's dealings, such that customers, would-be customers, creditors and commercial trade partners would have a simple actionable measure of risk/leverage/gearing for each bank's time and demand deposits, debt, etc.
One such crisp measure could be a published and regularly-updated number corresponding to the reserve requirement itself, or a series of letter symbols for various ranges. A bank that held full reserves for 100% of its demand deposits could be designated as 100 or, say, A-level, on an letter scale where the risk increases as the reserve ratio drops. (Some critics of fractional reserve banking have argued that it is fraudulent to promise immediate availability of all demand deposited funds when that would be impossible with reserves below 100%, but that argument, while formally logical, does not reflect real-world commercial practicalities, and assumes unqualified rigid terms for the deposit agreement, although this is never really the case.)
In practical terms, a bank such as this example, one that merely warehoused deposits might be less than competitive and profitable. There is, after all, a compelling logic to fractional reserve banking with increasing risk to depositors the more leveraged the deposits are, traded off against the increasing profitability of greater lending capacity.
So of course most banks, even conservative and highly responsible ones, would opt for some reserve less than 100% because even in a full-blown bank run panic, not 100% of depositors are going to simultaneously demand immediate withdrawal of all their deposits.
So there could be all manner of ratios down to suicidally dangerous reserve coverage of a percent or two, where in the course of ordinary business on a statistical basis of inflows and outflows it would be nearly certain that such an institution couldn't always cover the daily fluctuation of balances without recourse to and dependence upon borrowing from the outside.
Similarly, time deposits would have stated reserve ratios of their own.
So customers could select a risk/reward level for a banking relationship that was deemed prudent for its own foreseeable and even unforeseeable situation. Banks could select a level of risk/reward that suited individual and local economic conditions without being forced into lockstep.
Had there been near-instant communication and financial transparency available during the 19th century American "wildcat" banking era, the outright frauds and high-risk insolvency failures behind excessive, un- or under-backed banknote emissions would have been mitigated. Even without banks issuing their own notes, having this measure of deposit security risk today would alleviate dangers which we all have seen.
Obviously the bank deposit insurance pool, whether governmental such as FDIC, or purely private, could set deposit guarantee premium rates rationally, based in large part upon the reserve ratios that individual financial institutions adopt, as well as loan performance and other measures as at present. Since for retail customers FDIC insurance (or some secure private equivalent) is an absolute requirement, there would be a strong financial incentive for even the loosest banks to act more responsibly and thus hold down their deposit insurance rates.
Institutions once again could compete for deposits based on their own deliberate policy decisions, merits and risk profiles, rather than having an artificial equality among banks that incentivizes the best to bring their level of risk as high as possible so as to compete effectively with those who are the most irresponsible or least risk-averse. Dealing with a "double-A" 100/25 bank would be more secure than with a "double-Z" 5/3 bank, and the world would know it.
While best under a FSSOV, this transparent flexible reserve-ratio mechanism could work perfectly well even under the "central wildcat bank" no-standard-of-value system now in place.
On Jan 04 10:25 AM Adamantane wrote:
> I don't see an actual argument for or against a 'fixed-supply store
> of value' standard in the article, merely a raft of assertions.
>
>
> It would serve the discussion better by purging it of emotional bias,
> pro or con, if in place of 'gold' we were instead to substitute a
> term such as 'fixed-supply store of value' which stands for what
> is argued by most on all sides to be the essence of a gold standard
> without all the historical and emotional baggage associated with
> the word gold.
>
> The assertion most closely approximating an argument is that a FSSOV
> standard would be chronically deflationary because a presumably increasing
> supply of goods and services would be tied to the limited pool of
> FSSOV. Having prices in terms of units of FSSOV that continually
> drop, and presumably wages that decline over time as the economy
> grows, is seen as psychologically unacceptable. It doesn't 'feel'
> right that one's pay packet should appear to shrink or rise at a
> tiny rate as one progresses in one's life and career, even if the
> value represented by that pay packet grows tidily, and overall price
> levels fall in parallel. It doesn't 'feel' right that the price of
> one's home and other assets declines or remains flat over time, even
> if the value represented by that price grows in parallel with the
> expanding economy.
>
> But that comes down to a matter of what one is used to. It also doesn't
> feel 'right' (even if it feels 'normal' because that is what we all
> experience in our era), that the store of value leaks out at a rapid
> rate such that the dollar, for example, has lost 95% of its purchasing
> power in 90 years, all of which value has effectively been disposed
> of by government policy makers and stakeholders in an inflationary
> system.
>
> It also doesn't feel right because the only experience anyone has
> with deflation in an environment where inflation is the anticipated
> norm, coincides exactly with periods of economic contraction where
> people and institutions are all hurting. We tend to associate 'absolute
> deflation' with periods of economic stress when the norm is for there
> to be relative price inflation. So we associate pain with it. But
> there is nothing inherently painful about price deflation when the
> economy is turning over and moving ahead nicely.
>
> Also there is the suggestion in the article that having a FSSOV would
> provide a constraint that would be dysfunctional during economic
> turns in that there would be no obvious way to use some kind of central
> monetary policy to modulate them.
>
> Presuming that fractional reserve banking and associated leverage,
> with certificates of deposit/banknotes denominated in the FSSOV,
> is here to stay, adjusting the reserve requirements either centrally
> or transparently by institution, could address such credit adjustment
> concerns without undermining the tether of the economy to the FSSOV.
> What's more it would finally abolish the ability of the central government
> entity to divert value to politically favored projects at the expense
> of the economy.
>
> The problem with the traditional arguments marshalled against a FSSOV
> is in part that they are blindered by an understandable inability
> of ordinary people to imagine how a system they never have experienced
> would function. If the 18th, 19th and early 20th centuries had the
> benefit of enhanced knowledge since then about the operations of
> markets and credit, the more-or-less constant FSSOVs of the day could
> have weathered periodic business fluctuations far more readily than
> they did. Why it is that advocates of any FSSOV are expected to operate
> with the tools and rules of a pre-horse and buggy era in a side-by-side
> comparison, while advocates of the current centrally adminsitered
> no-standard-of-value de facto 'wildcat central banking' era are allowed
> to shore up their system with all the tools and knowledge of the
> modern day, is puzzling only if one ignores the stake the existing
> order has in preserving the centrally-controlled order and the inability
> of even expert economists, much less the man on the street, to envision
> any context other than a chronically inflationary centrally-organized
> one under which everyone on earth has lived his entire life.
>
If you're talking about "redeposits", you'll see the total loans can't exceed 90% of total deposits. So $10,000 in deposits allows $9,000 in loans.
"We went over this before. If the $900 is redeposited in the bank, the bank can lend $810 more, and so on, until it can lend a total of $9000 with $10,000 on deposit, including the original $1,000. You agreed to that, even corrected my math on the total credit being $9,000 instead of $10,000"
$1000 in deposits allows $900 in loans, $10,000 in deposits allows $9000 in loans.
"What I mean by "turn into" is that a bank can take my signed promise and physically hand me FRNs"
Yes, you can walk into your bank, sign loan documents and walk out with cash. Or buy a car. Or a house.
" We agree on that and probably more if not for the communication gap. I'm curious, are you a banker, a teacher or neither? I'm a math teacher and ex-engineer"
Ex-engineer, ex-finance guy, science teacher.
On Jan 03 07:52 AM asleeper wrote:
Yeah, don't believe me. Go to FDRS.com. I don't like the little effer that runs the place but his web site will explain it.
On Jan 11 11:23 PM Jim Myrtle wrote:
> "If the money the bank "loans" is redeposited in the bank, cannot
> the bank continue to lend until the total loans are a multiple of
> the original deposit"
>
> If you're talking about "redeposits"... you'll see the total loans
> can't exceed 90% of total deposits. So $10,000 in deposits allows
> $9,000 in loans.
>
> "We went over this before. If the $900 is redeposited in the bank,
> the bank can lend $810 more, and so on, until it can lend a total
> of $9000 with $10,000 on deposit, including the original $1,000.
> You agreed to that, even corrected my math on the total credit being
> $9,000 instead of $10,000"
>
> $1000 in deposits allows $900 in loans, $10,000 in deposits allows
> $9000 in loans.
>
> "What I mean by "turn into" is that a bank can take my signed promise
> and physically hand me FRNs"
>
> Yes, you can walk into your bank, sign loan documents and walk out
> with cash. Or buy a car. Or a house.
>
> " We agree on that and probably more if not for the communication
> gap. I'm curious, are you a banker, a teacher or neither? I'm a math
> teacher and ex-engineer"
>
> Ex-engineer, ex-finance guy, science teacher.
>
>
>
>
> On Jan 03 07:52 AM asleeper wrote:
>
Wrong. They lend less than your deposit, not more.
On Jan 13 12:52 PM bosun.j wrote:
> With your $1000 the Banksters can "loan" $9000! Nice part about it
> is if you get a lawyer who will sue them for not being able to prove
> the lost ANYTHING, and they won't because they CREATED it, no court
> in the land will make you pay it back
>
> Yeah, don't believe me. Go to FDRS.com. I don't like the little effer
> that runs the place but his web site will explain it.
On Jan 13 01:26 PM Jim Myrtle wrote:
> "With your $1000 the Banksters can "loan" $9000!"
>
> Wrong. They lend less than your deposit, not more.
>
>
> On Jan 13 12:52 PM bosun.j wrote: