Economics

Moving Forward with Practical Reform - from Positive Money

Positive Money is a growing campaign for ‘Honest Money’, although I suspect that some readers on this blog may challenge our definition of honest money. I wanted to outline our position, and show why we’re taking a particular route towards reforming the money system.

We make a separation between the academic debate – which could go on indefinitely, with no chance of a consensus – and the politically feasible steps that could make a real improvement to the existing system. The academic debate is good, as it helps to refine our arguments and figure out how money should work in an ideal world. But if we wait to come to a consensus before moving forward with practical steps to reform the system, then we might find that Rome has already burnt to the ground while we’ve been locked in the debating chamber!

The economic situation is deteriorating, and we need to find the fastest way of stopping the entire system collapsing. While many proposals from the Austrian school would have been a better foundation for the economy over the last couple of centuries, some of them are politically impossible to reach from this starting point, so we have to look at what is politically possible and move towards that as quickly as possible. We’ve outlined our own proposals at the end of this article.

Nationalised vs Denationalised Currencies

The mindset of ‘managing’ the economy is so ingrained that quite simply, there is no possibility of any government in the next decade choosing to give up its power over the country’s currency. No chance, regardless of how strong an academic argument is put forward. Without a pretty advanced understanding of money, the proposal for denationalisation, when filtered through the press, will sound like “Let’s abolish pound sterling and give the banks that caused the crisis a license to print money”. You and I know that this is inaccurate, but it is the way that the proposal will be interpreted.

This means we’re looking at a state-issued currency for the foreseeable future.

Full Reserves versus Free Banking

The free banking argument suggests that we should allow banks to engage in fractional reserve banking, but let them live and die by the sword. This means that they could promise instant access to demand deposits (as they do now) even though they can only repay a fraction of those depositors at the same time. Deposit insurance would be removed, and any bank that was subject to a run and became insolvent would be allowed to fail.

In the context of a state-issued national currency, this proposal is an absolute non-starter. When the average bank can only repay £71 for every £1000 in a customer’s bank account, removing deposit insurance today would almost certainly trigger a run on the banks, with customers withdrawing as much physical cash (notes) as possible. With the risk of the UK returning to a cash-only economy in a matter of days, deposit insurance would be immediately re-instated.

Consequently, with a state-issued currency, fractional reserve banking can only exist with deposit insurance in place. In other words, there is no way of removing deposit insurance and keeping fractional reserve banking, as long as we have a state-issued currency.

This then means that full-reserve banking is the only realistic option with a state-issued currency. As denationalisation is a political impossibility – at least for the next decade or two – this means that if you want deposit insurance removing, full-reserve banking is the only option.

Return to a Gold Standard?

A gold standard with state-issued currencies creates problems of its own, and shifting back to a gold standard now is not considered as a credible solution to the crisis among the people who would make such a decision. One advantage of a gold standard was to limit the growth in the money supply, but there are legal and practical ways that we can limit that growth with a fiat currency system.

So let’s assume that there’s no political chance of returning to a gold standard.

Fixed Money Supply?

With full-reserve banking, it’s entirely possible to have a state-issued fiat currency, in the form of coins, paper notes and digital ‘tokens’ in computer systems, and fix the supply of money at a specific number (when looking at money that can be accessed on demand). A fixed money supply would remove inflationary pressures, and likely lead to deflation (assuming that our productivity grows). It would also make manipulation of money impossible – there would be a set quantity, and that would never change. In a sense, this would be a more secure currency than gold!

So at this point, do we start to argue the case that deflation is not always a bad thing? No. The inflation debate is another one that will never be resolved. The dominant position seems to be that ‘low and stable’ inflation is the ideal target. In addition, central banks and governments are attached to the idea of ‘managing’ the economy, and would be unwilling to give up their tools to do so.

So, let’s accept that we won’t have a fixed money supply, and that there will still be some manipulation of the money supply. In this case, let’s get that manipulation out in the open.

Our Proposals

Bearing all that in mind, I think the proposal put forward in Positive Money’s submission to the Independent Commission on Banking is the best politically possible ‘next step’. This is what it does:

  • Implement full-reserve banking so that deposit insurance and state guarantees can be withdrawn and banks can be allowed to fail
  • Ties investment to real savings again
  • Provides the economy with a stable money supply
  • Keep the power to create money away from both profit-seeking bankers AND vote-seeking politicians
  • Put the power to create money with an independent MPC, who are tasked with keeping inflation at zero (or whatever target they set, say 2%).
  • We tie the creation of money into inflation, so that if inflation starts rising (beyond the target) then no new money can be created
  • For the first time in history, there will be complete transparency and accountability over the creation of money, and we’ll be able to see exactly how much the money supply has been increased, and why. (There will of course need to be mechanisms to ensure the accountability of the Monetary Policy Committee).
  • Note that under this framework, if the actions of the MPC correlate to instability in the economy, then you know exactly where to point the finger of blame, and can start arguing towards a fixed money supply.

It’s not perfect, but at the moment we genuinely think it’s politically the best solution that has a chance of being implemented. The academic debate over the best money system for the long term can continue, but right now the system is collapsing around us, so we need to call for a reform that is politically feasible.

Our Campaign

If these proposals do start to get attention then the lobbyists will swing into action. The only way to get around that is to make it something that masses of ordinary people will campaign on.

Understanding the denationalisation of money requires a fair bit of an understanding of money and also a bit of a mindset shift, so it’s not something that can be used to start a mass movement. So, here’s the angle that we’ll be taking:

  • Everyone knows that only crooks and criminals print their own £5 or £10 notes
  • The laws that make it illegal to print your own money have never been updated to take account of the fact that almost all money now is digital
  • Because there’s no law against creating digital money, banks have been able to get away with creating up to ¬£200bn of this digital money each year
  • In fact, we’ve now reached the situation where very nearly every pound in the economy was created by the banks, for their own benefit
  • As a result, banks now have a complete monopoly on supplying money to the economy/society
  • If we want money in order to live or do business, then we have to borrow it from the banks
  • They benefit from this monopoly to the tune of tens of billions a year at our cost, and we all end up in ever-growing debt

People have an intuitive idea that counterfeiting is a criminal activity designed to somehow rip people off. I suspect they also have an intuitive sense that they’re being ripped off by the banks, particularly considering the bailouts, the tax rises, spending cuts and rising national debt. By tying the two together we can grow a massive public campaign to get control of the creation of pound sterling completely out of the hands of the banks and into a transparent process, where we know exactly who is creating money, and who to blame if things go wrong.
Getting to full reserve banking with a state-issued currency is a massive battle, but once we’ve got that far, the economy and the system generally should be stable enough to allow a more relaxed debate about how money should work.

Read the proposal at: [ http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf ]

58 comments to Moving Forward with Practical Reform – from Positive Money

  • Tim Lucas Tim Lucas

    Hello Ben. Under your proposals, the independent central bank would print a given amount of money in order to keep some measure of inflation at a given, low level.

    Could I ask to whom the new money would be given to? Would this just be added onto government revenues? I find it very hard to believe that the independent central bank you crave would remain independent for long, given the power that it wields.

    • Hi Tim.

      This is a delicate one. I would suggest that the money is either put into the economy via government spending (or by covering existing spending and reducing taxes accordingly), or distributed evenly to citizens.

      There’s always a danger of politicians leaning on the Monetary Policy Committee (or whichever body is tasked with creating a money), but we have to guard against that by making sure that the MPC is transparent and accountable. It may need a chinese wall between government ministers and members of the MPC.

      Bear in mind that the military also wields a lot of power, but that there are sufficient safeguards in most countries to keep them independent of politicians and avoid them being used to ‘encourage’ voters in elections.

  • waramess

    To agree on a solution pre-supposes there is a consensus on the problem. Employ full reserve banking and you remove the need to insure depositors against failure.

    This is true but there will have to be provision for those depositors who wish to be a part of the action and receive an interest reward.

    Can we have sound money without sound banks?

    Maybe we can, but if not that is a problem far from having been resolved.

    Banks activities must be limited by the amount of capital they have and if the politicians and their lap-dogs wish to continue to control capital adequacy through proscribed asset quality then we are certain to experience the same skulduggery that brought us sub-prime.

    Allowing banks to fail is just one part of the equation, the second is to free all banks from regulation and let them succeed or fail through their own competence.

    Sound money and sound banks; too much to consider in one lifetime.

    • – “there will have to be provision for those depositors who wish to be a part of the action and receive an interest reward.”

      Agreed. In the proposal, we outline how Investment Accounts could be used to provide funds for bank lending, and how the risk of that investment could be shared between the bank and the investor/saver.

      We probably wouldn’t need the capital adequacy measures under a full-reserve system. Banks could be free to make their own loss provisions, and live and die by the sword. If a full-reserve bank goes down, investment account holders would become creditors of the bank and receive their fair share of the proceeds from any liquidation. Taxpayers wouldn’t need to shell out a penny.

  • Jose

    Definitely a step forward in the right direction. This proposal provides a robust explanation about why we should care about 100% reserve banking that can be used in public debates. It would not be the perfect solution but it is better than current.

  • Simon Bennett

    Hello Ben. I think I understand your arguments, and I certainly agree that we need a more honest form of monetary system. What puzzles me, however, is how, in your proposed system, do interest rates get set? Since the level of interest rates is a key factor in determining house prices and affordability, it is a key question that needs addressing.

    • Jose

      Hi Simon. It is explained in the proposal text (see PDF). Interest rates are prices, and they will be set by the market, via competition for funds. Cheers.

      • Robert Sadler

        Hi Jose,

        Isn’t that a bit of a fallacy given that the new MPC will still be able to influence interest rates via inflation (printing money)?

        • Jose

          Well, I think if inflation is targeted to be low (2%) then that should not be a problem compared to current situation, where lots of money are created by banks (30x-50x) and interest rates are highly manipulated to place that money easier into markets.

  • Ben,

    “Getting to full reserve banking with a state-issued currency is a massive battle*, but once we’ve got that far, the economy and the system generally should be stable enough to allow a more relaxed debate about how money should work”

    *and in my opinion at least, a very unpleasant thought.

    In the first instance, do you really believe you have a realistic chance to even influence, let alone control, the political process using the existing structure? That would be the very same political structure that created the monetary rules and economic mess in the first place? Well, good luck with that one. Don’t hold your breath would be my advice!

    Secondly, and allowing for a few moments the intoxicating notion of campaign success, how does the placing of the money monopoly under new management actually solve the fundamental dysfunctions that are inherent within the existing monetary set up? Allowing the State alone to create money takes us out of the frying pan and places us squarely into the fire. Your solution does nothing to eliminate deficit spending and inflation, which are chiefly enabled by legal tender laws. The truth, in the words of the American campaigner Thomas Greco is that “so long as political currencies, however issued, are legally forced to circulate at face value, the abusive issuance of money, the debasement of national currencies, and the centralization of power will continue”.

    To suggest that it is possible to implement strict measures to separate a monopoly control of the money supply from any political influence is no more than a fairy tale. It is a notion that conveniently ignores all the lessons of history in respect of centralised government. To give the State ultimate control over the means of exchange is to both invite and encourage totalitarianism.

    Further, putting “the power to create money with an independent MPC” (peopled by whom exactly, I wonder?) to manage the money supply and create new money as and when the economy is judged to need it, goes only to present enhanced opportunity for manipulation, control and profit for the select few and their cronies in a position to take advantage. It also smacks of central planning – anathema to a free society.

    “Society” Frederic Bastiat commented, “means exchange,” and so it is that ‘real’ money can only come from people engaged in exchange. This being the case, the elephant in the room is that we do not, in fact, require any monopolistic power at all to control or issue it. Credit money need not be the offspring of State or banking privilege. Interest-free credit money can be created apart from any banking cartel, and the entire process can be democratized. Having described so carefully the corrupting effects that result from bankers centralizing the money power, it is curious that you then ask us to accept it when under the control of politicians and bureaucrats.

    The great monetary reformer E.C Riegel wrote that most monetary reformers “accept the false premise that government must issue, control and manage money and prices. Thus their efforts are innocently devoted to various schemes to improve upon perversion. Government should not issue or control money; and it is not the function of money to control prices. Money is a neutral agent whose sole function is facilitating exchange, and not influencing prices in any way.” (Private Enterprise Money) Riegel says further, “There has never been and can never be an issue of money except by a buyer in the act of purchase,” and goes on to clarify the meaning of “issue,” saying that “No actual issue can take place until there has been an exchange for value. In other words, issue is not effected until accepted by the seller who surrenders value therefor.” (Private Enterprise Money)

    What we so badly need is actually a choice of currencies and exchange mechanisms, a complete separation of money and State. I am personally hopeful that the onset of the digital age will usher in many an opportunity to go down just this path. Time, as ever, will tell!!

    Personally however, I can only consider the ‘Positive Money’ campaign to be an attempt to “improve upon perversion” and thus unsupportable. I have no particular desire to swap one master for another. I seek to abolished slavery altogether.

    • @Peter – this is where you need to make a distinction between your ideal end goal, and the next practical step that will get you closer to it. What you described may work well, but there is zero chance of it being implemented in the next few years. Meanwhile, the current system is collapsing with no hope of repair.

      The best chance of getting to your ultimate destination is to be able to recognise a step in the right direction…

  • Peter,

    When we currently experience an excessive level of inflation, we have a complex array of banking regulations to blame, and no particular “target” to focus on. When enacting this reform, the MPC would be solely responsible for any money supply expansion, and inflation produced as a consequence would be solely attributable to them, and the government that targeted that level of inflation.

    If a government applied pressure to said MPC and was successful, and the inflation target changed, it would trigger a massive debate amongst economists and the media as to the wisdom of the change. Governments could live and die by their inflation targeting, as inflation would be a totally different thing under the new system. Inflation would be directly attributable to the amount of money creation causing it. Citizens would have a choice between inflation and the government spending it allowed, or zero inflation and deflation with reduced government spending. As the middle classes and working classes tend to be the most affected by inflation (wealthier people tending to hold inflation-proof assets), no government would be likely to even try to abuse the money creation mechanism in fear of causing too much inflation (it would be far more sensible to raise taxes to increase revenue and avoid their wrath). Should you wish for zero monetary supply expansion, you could vote for a party that would do this.

    Should a government put into its manifesto an increase in money supply expansion, the people would know who to blame if this turned out to not be a wise decision. It would quite simply be self regulating. A slight increase in inflation that can only be dealt with at the next election would be a million times preferable to the myriad problems the current system causes.

    We don’t do anything to eliminate deficit spending or inflation, it has already been explained that putting this into legislation is unfeasible. The inflation debate is ongoing amongst economists, and eliminating deficit spending through legislation is just not going to happen. We want our reform to be passed and made law, not to remain a quaint, Utopian monetary and fiscal ideal.

    Concentrating money expansion power with a democratically elected entity who can be solely responsibly for any damaging effects, and who can be set yearly “targets” for money supply expansion to avoid a spout of printing close to election time, for instance, is the safest thing to do. Given that the majority of economists and politicians would instantly disregard any proposal that didn’t include any money creation for the reason of it not allowing any inflation, this is something that anti-inflation folk such as yourself would have to accept as a necessary evil after this reform, albeit if only for the time being.

    It would be politically unfeasible to get from where we are now to where you want to be without an intermediary reform such as this. Any claims you make such as “out of the frying pan, into the fire” do not take into account the sound logic in the separation of targeting and power-wielding, and the easily implementable nature of such a reform.

    As for the invitations to totalitarianism and central planning, you really are exaggerating here. This is no more equal to central planning than the concept of taxation and spending is (and if you consider this to be “central planning” then please use this as a frame of reference), and is in fact safeguarded from abuse (and totalitarianism) by the democratic system, as described above.

    • mrg mrg

      Personally I’d feel safer if a referendum were required whenever the government wants to

      – increase the money supply
      – raise taxes
      – borrow

      In theory, you’re right that fear of electoral defeat could keep politicians in check. In practice, our FPTP system forces voters to choose the lesser of two evils, and promises are regularly broken.

      Still, I’m inclined to agree that your proposed setup would be preferable to the status quo.

      • A referendum on these things would be great, and completely justifiable. Getting the government to vote to reduce their own operating freedom might be a bit tricky though, but worth aiming for in the future!

  • Robert Sadler

    Hi Ben,

    Great article.

    However, you make a lot of broad assumptions in your essay here that I would like to question.

    Firstly, you say that there is no possibility of any government in the next decade choosing to give up its power over the nation’s currency. What makes you think the government has a choice? Is it not conceivable that the Pound, Euro and Dollar could all collapse within the next the decade? I am sure the chance of this happening to at least one of these currencies is significantly higher than zero. And who cares what the press thinks?

    You say the removal of deposit insurance would almost certainly trigger a run on the banks. Has there been a run on the banks in the UK of deposits greater than £50K? Why would people withdrawal physical cash? I wouldn’t.

    How is full-reserve banking compatible with a fiat currency?

    How is your MPC any different from the current MPC (in terms of independence)? How did you determine the dominant position is that low and stable inflation is the ideal target? Inflation implies business cycles so how would your proposal solve any problems at all?

    I understand your point about political expediency but I don’t see how your proposals would be any more politic but even worse I don’t see how they would solve the fundamental problem of capital consumption (impoverishment) caused by business cycles. Surely, we should focus on achieving a full solution even if in the short term we only achieve parts of it, piece by piece. If we shoot for the stars then we will at least hit the sky!

    • Jose

      In the current system, banks create inflation via granting loans, that leads inexorably to business cycles where capital is wasted, and the imposibility to redeem is obvious, making banks go bankrupt, and people will cry out for their money.

      How much is in deposits in the UK depending if greather than
      £50K or lower than that, in order to compare?

      In that new system, I think all money would be backed by real savings and it would not be fiat currency anymore, becoming money-certificates. It would be equiparable to gold for instance, with the difference that it will be easier to be manipulated (I mean to create inflation by issuing more).

      The lower the inflation the lower the consecuences of business cycles. Please note that under a gold standard inflation still occurs as more gold is found, usually with more effort than printing paper.

      Perhaps return to a gold standard can be considered as a second step, as it will be equivalent in practice but impossible to be manipulated at will.

      • Robert Thorpe Current

        > Please note that under a gold standard inflation still occurs
        > as more gold is found, usually with more effort than printing paper.

        I could disagree with many things you said here, since I’m not a Rothbardian. But, I’ll keep it simple.

        Inflation due to gold discovery’s only happens when they’re very large and very large compared to the current existing stock. In general the dominant trend is deflation because that is what increases in productivity create.

        • Jose

          I am refering to monetary inflation, not to a rise in the general level of prices.

          • Robert Thorpe Current

            Monetary inflation per se is not necessarily a problem, if the rise occurs in concert with a rise in demand for money.

            Monetary inflation doesn’t cause the business cycle by itself. See the reply I gave to Recharge at the bottom of this thread.

          • mrg mrg

            @Current

            “Monetary inflation per se is not necessarily a problem”

            Doesn’t monetary inflation necessarily imply seigniorage?

            And whether that goes to the central bank or the commercial banks, it sounds like a problem to me.

            I’m probably missing something, but it seems to me that the only deflation we should fear is the catastrophic sort that is only possible under fractional reserve banking. Deflation due to rising productivity is a good thing, and deflation due to a rise in the demand for money is temporary and self-correcting. As other things become cheap relative to money, people will be tempted by the bargains. Even if there is an expectation of better bargains in the future, purchases will not be put off indefinitely. Alternatively, demand for money may fall as political circumstances change.

            These strike me as natural fluctuations reflecting real preferences, which should not be smoothed out by our monetary system.

            [If this is an unwelcome tangent, already answered, or just nonsense, please feel free to ignore :-) ]

          • Robert Thorpe Current

            mrg,

            If you read my other posts you’ll see that while I agree with the Austrian point-of-view generally I’m a Monetary disequilibrium Austrian or “Fractional Reserve Free Banker”. I don’t believe that 100% reserve banking is superior to fractional reserve banking, or that FRB is fraud or causes the business cycle.

            > Doesn’t monetary inflation necessarily imply seigniorage?

            No. Think about a gold miner extracting gold from the ground. Is that seigniorage? No because the gold has value. The same is true with fiduciary media which is based on a bank’s assets.

            Seigniorage occurs when money is debased and the power of law is used to force that money back into circulation.

            > And whether that goes to the central bank or the
            > commercial banks, it sounds like a problem to me.

            In a market where there is free competition between banks I don’t think that it is. In their books and articles George Selgin, Larry White and Steve Horwitz go into this view in much more detail and explain why.

            > I’m probably missing something, but it seems to me that
            > the only deflation we should fear is the catastrophic sort
            > that is only possible under fractional reserve banking.
            > Deflation due to rising productivity is a good thing, and
            > deflation due to a rise in the demand for money is
            > temporary and self-correcting. As other things become
            > cheap relative to money, people will be tempted by the
            > bargains. Even if there is an expectation of better
            > bargains in the future, purchases will not be put off
            > indefinitely. Alternatively, demand for money may fall as
            > political circumstances change.

            I agree that when deflation is brought about by a rise in demand for money that it’s “temporary and self-correcting”. The same is true when inflation is caused by a fall in demand for money. But, the period of the correction may be quite long and may lead to recession. Prices don’t move instantaneous, and in many cases not even quickly. Businesses would waste too much time changing prices if they did, less than perfect pricing is efficient overall. So, when a rise in money demand occurs without a rise in the quantity of money a recession will occur until prices have moved to accommodate the change. For this reason it would be much better if the quantity of money were to rise temporarily and fall again when demand for money shift back. Fractional-reserve free banking can provide this useful behaviour.

            > These strike me as natural fluctuations reflecting real
            > preferences, which should not be smoothed out by our
            > monetary system.

            The fluctuations do reflect real preferences. A rise in demand for money means that those demanding want to hold a larger real balance. They are prepared to pay for that by exchanging goods of services for the money. Fractional reserve banking permits that to occur.

            In fact, it is the Rothbardian 100% reserve view that doesn’t take into account the desires of the consumer. To Rothbarians every market should be free to operate on contracts drawn up between the buyers and sellers. The buyers and sellers should be freely permitted to produce goods for sale. Except for the money market. On that market Rothbardians claim that only 100% reserve money certificates are permissible, fiduciary media is not permissible. In this case they argue that contracts drawn up by buyers and sellers aren’t satisfactory. Furthermore, they claim that production of fiduciary media is undesirable, they say banks should not be able to meet a supply but should hold the supply of money effectively fixed. Fractional reserve free bankers on the other hand are consistent free market advocates, we believe that the same laws should apply to the market for money as apply to other markets.

        • mrg mrg

          Thanks for your response, Current.

          “Think about a gold miner extracting gold from the ground. Is that seigniorage? No because the gold has value”

          I did wonder about gold. It’s a funny case, because its value (as money) is in its scarcity. A gold miner doesn’t so much add value as confiscate it from existing gold owners (albeit at a much higher cost than printing special patterns on a few bits of paper).

          I confess that my thinking here is quite muddled. I really must find time to read some FRFB material from the authors you mention.

          • Robert Thorpe Current

            Gold mining is a difficult case. Many 100% reservists disagree with each other about it. So to do some Fractional reserve supporters.

            This is my opinion…. In the long-run any amount of commodity money can provide the service of money to the community. The issue for business cycle theory is that that isn’t true in the short-run. In the long-run if a gold miner finds gold and converts it to commodity money (coins for example) in perpetuity then he doesn’t create wealth. But, that’s not really what happens. Gold is valued for it’s industrial uses as well as it’s use in coinage. So it does have a value separate from it’s use as money.

            The problem really is the shorter run. If a large amount of gold is found and put onto the market then it will cause prices to rise. That happened when the Spanish plundered the Aztecs. That rise will cause account falsification and confuse economic calculation. Notice that account falsification can happen even though there is certainly “real” gold. In this scenario there is an unexpected injection of gold, in general this is unlikely to happen. Gold flows from production can’t generally change quickly. In a hypothetical 100% reserve system I think they would cause only slight and predictable price changes. The problem with a 100% reserve system are different, the demand for money isn’t stable, so even with a fixed amount of gold in circulation the price level would change. Recessions would not be prevented in general although some would compared to a central banking system, others may be worse.

            (In a 100% reserve system if there were a rise in overall demand for money some have argued that it would stimulate more gold mining. I agree in theory, but I doubt that in practice it would be significant. The rises in demand for money caused by recessions are not usually long in duration. Gold mining companies would not be able to respond quickly enough.)

            With FRFB similar things apply about the gold production side. But, in that system there would be economic forces helping to stabilise the price level against shocks. With FRFB as banks become better at understanding redemptions and serving them they can reduce their use of gold reserves. So, in an FRFB system much less of the world’s gold would be tied up in money than in a 100% reserve system. That would reduce the resources put into gold mining compared to a 100% system and allow them to be used in other areas. It would allow more gold to be used in jewellery and industrial uses.

            So, I’m not really that concerned about gold mining.

            Lastly, it’s important to realise what Roger Garrison said once. Although a gold standard of either sort may waste some resources in gold mining that is offset by it’s safety compared to fiat money. With fiat money we must put much more faith in political leaders and examine their actions much more closely to ensure they don’t cause economic chaos. That’s where the long-term cost of fiat money is. Just because something is a social issue doesn’t mean that a physical solution isn’t appropriate. As Garrison says, a gold standard is like putting a lock on your bike.

      • Robert Sadler

        Hi Jose,

        I agree with Current here. The trend is for deflation due to increases in productivity. Also, while the World gold supply increases about 2-3% per year the big differences between that fiat currency is that gold has an intrinsic value whereas fiat currency does not.

        I’m not sure that a gold standard would be practically speaking, difficult to do. Simply divide the number of notes by the volume of gold owned by the British Government.

        • Robert Thorpe Current

          > I’m not sure that a gold standard would be practically speaking,
          > difficult to do. Simply divide the number of notes by the volume
          > of gold owned by the British Government.

          That sort of system wouldn’t really be practical.

          Let’s suppose that the government do the division you mention. That means they must agree to convert each pound to a particular very small quantity of gold. Notice that for a proper gold standard the conversion must be in both directions, the government must agree to redeem notes and to issue notes against gold. Mises discusses why in his books.

          Currently gold is £892 per ounce. The Bank of England and the Government don’t have enough gold to provide 1/892 of an ounce for each pound in existence. They must provide less.

          Since two way conversion between gold and notes is needed for a proper gold standard that means that the value of notes will be much higher than gold. As a result gold owners from all around the world will send their gold to Britain in return for notes which they can use to by UK assets at extremely cheap prices.

          For example, suppose the UK government agree to convert gold at £ = 1/10000 of an ounce. In that case if I’m an American who owns 10 ounces of gold I will send them to Britain and receive £100000 in GBP which I can use to buy assets in Britain.

          Opponents of the Rothbardian and “Hard Money” movements sometimes allege that this is exactly what these groups wish to happen. They allege that the 100% reserve argument is a justification for a policy that would hugely raise gold prices and benefit gold owners. I don’t know about that.

          But, the problem still remains. The influx of gold would cause many more GBPs to be created, which would cause inflation. British people would be impoverished and gold owners would be able to buy their assets at low prices.

          I’m not saying a 100% reserve standard (or a FRB gold standard) couldn’t be implemented, I’m just saying it couldn’t be implemented like this.

          • Robert Sadler

            Current, I don’t quite follow.

            There’s going to be massive inflation anyway under a fiat system so a short sharp inflation under a reconversion to using gold as a money doesn’t seem like a worse situation to me.

            Why would the UK Govt agree to convert gold at £/10000 when the market price is £/892?

            What would be a practical way to re-implement the gold standard?

          • Robert Thorpe Current

            > There’s going to be massive inflation anyway under a fiat
            > system so a short sharp inflation under a reconversion to
            > using gold as a money doesn’t seem like a worse situation
            > to me.

            I think it would be, it would be like Weimar Germany.

            I agree that under a fiat system of the type we have now there will be constant low-level inflation. There also could be sharply rising inflation, that has happened many times before in fiat systems such as in ’73-74 in Britain. But, in the situation I’m discussing sharp inflation is a certainty.

            This sort of inflation is more damaging than the low-level sort. Low-level inflation has come to be expected. For example, we all know that we must get a few percent pay rise every year in order to be paid the same in real terms. Debtors and Creditors build the assumption of some inflation into debt contracts. Higher rates of inflation are quite different, many would not be expecting them. Expectations would be dashed.

            The need to economise on money would sharply increase which would create costs in real terms. People would bring forward purchases in order to avoid owning depreciating money for too long. If the inflation rate were too high then people would resort to barter.

            And of course there would be huge redistribution of wealth from ordinary people towards owners of gold.

            > Why would the UK Govt agree to convert gold at £/10000
            > when the market price is £/892?

            Because they haven’t got very much gold.

            To be clear here, are you talking about a move to a full-reserve system or to a fractional-reserve system?

            > What would be a practical way to re-implement the gold
            > standard?

            A fractional-reserve system could probably be reimplemented quite simply by a process of gradual change. First, banks are required to hold some gold as reserves which central banks sell. Then over a period of perhaps a year restrictions on banking are reduced. See Anthony Evan’s article here “2 days, 2 weeks, 2 months”. I don’t think things could be done as quickly as Evans says but I think that sort of thing could be done.

    • Hi Robert,

      Firstly, good point – I have no considered a complete collapse of faith in a national currency here. That would change the situation significantly. Still, I don’t see any government opting to remove legal tender laws as a way of dealing with the current crisis.

      Regarding a run on deposits over £50k, I recall that in the middle of the crisis, the advice all over the money pages was to spread your money about and make sure there was no more than £50k in any one institution. People wouldn’t run for cash on the amount over £50k – they’d just move it to another guaranteed institution.

      Remember that people ran on their savings at Northern Rock even when they fully covered by deposit insurance. If the government removed deposit insurance now, the message to the public would be ‘If your bank goes bust, you’ve lost the money’. I’m fairly confident that would trigger a run to cash – maybe not completely draining the bank, but at least enough for people to keep a grand or two in a metal safe at home.

      “How is full-reserve banking compatible with a fiat currency?” – ‘full reserve’ is not the same thing as being backed by a commodity. Full reserve involves, very simply, being able to repay all on-demand liabilities (bank deposits) at any point in time. If these liabilities are fiat currencies, then full reserve banking is completely compatible with fiat currencies.

      I completely understand the desire to focus on the ‘perfect’ solution. Unfortunately groups that try to do that often have no impact. We have to recognise that any change needs to go through political channels, so offering ideal solutions that we can’t reach politically doesn’t do much to help us out of the mess we’re in now.

      • Robert Sadler

        Hi Ben,

        Good point RE spreading cash around. It is perfectly rational although I do wonder if people actually do this? Personally, I would (and have) actually spread my savings between 100% reserve institutions and bullion. I think this type of action will become more widespread. It is my view that the market will eventually remove fractional reserve banks.

        I realise that today “full-reserve” does not mean the same as being backed by a commodity but I think that view derives from a time when banknotes were backed by a commodity. “Reserves” referred to the reserves of gold and you could redeem your banknotes in specie. Today, obviously fiat currency is backed by people’s faith in the British Government. If that goes away however then all of the banknotes in the vault, electronic accounts and safes at home become worthless.

        For that reason, in my view, the only true reserves are a real, tangible and marketable asset – i.e. gold.

        That said, I understand your position. Anything your organisation can do to improve the current situation is a good step forward.

  • Peter Wraith claims that “allowing the state alone to create money” “does nothing to eliminate deficit spending and inflation, which are chiefly enabled by legal tender laws.”

    My answer to that is that it is widely accepted that the optimum rate of inflation is around 2%, rather than 0% or any other percentage, thus I have no desire to “eliminate inflation”.

    As to deficits, most economists are perfectly happy with deficits as such: excessively large deficits are another matter. It is widely accepted that deficits are a good idea during recessions. Moreover, deficits are unavoidable assuming one accepts a 2% rate of inflation and for the simple reason that a 2% rate of inflation implies that the monetary base shrinks in real terms at 2% a year. Deficits are required simply to keep the base constant in real terms.

    Peter then claims that “To suggest that it is possible to implement strict measures to separate a monopoly control of the money supply from any political influence is no more than a fairy tale.” Well of course central banks will always be subject to some political influence. The US, the UK, Switzerland and a dozen other countries have had to deal with this problem for about the last century. The problem has never been solved to perfection and never will be. On the other hand in a large majority of countries a large majority of the time, civilisation has not collapsed as a result of total failure to find a perfect solution to this problem. The exceptions are obvious: Zimbabwe, Weimar, etc.

    In his third last paragraph, Peter advocates that money be created only by the private sector and at the instant that a purchase is made, as advocated by E.C.Riegel. In effect, this is a return to Tally Sticks and Bills of Exchange: the devices which were largely responsible for lubricating the economic system prior to about 1900. Tally sticks go back several thousand years. That system works, but it is inefficient.

    That system was reincarnated during the Irish Bank strike in 1978: it involved cheques passing from hand to hand, as Bills of Exchange used to. Imagine the inefficiency!

    I agree with Peter that “state only money” is hopeless under the Mugabwes of this world. But they are very much the exception, I think. As far as responsible countries go, I’m happy with “only the state creates money”.

    • Hi Ralph,

      I have been pondering whether or not to respond to your comments as I am conscious of an immediate return to the indefinite debate “with no chance of a consensus” that Ben’s article seeks, at least within the context of this listing, to circumvent. I am however, too weak to resist…

      In respect of optimum rates of inflation I plant myself firmly in Tim Lucas’s camp.

      With regard to “..most economists are perfectly happy with deficits as such” and “It is widely accepted that deficits are a good idea during recessions”, forgive me, but so what? Most astronomers once believed the earth to be the centre of our solar system. It turned out they were wrong. Indeed, I don’t think it’s too far wide of the mark to suggest that had humankind through the ages done nothing but accept the prevailing consensus we’d likely all still be living in caves, whilst perhaps burning the odd witch on a cold night for a bit of additional warmth.
      Also, it might have been more accurate to have inserted the word “mainstream” (Keynesian?) between ‘most’ and ‘economists’. This is because not a single one of these “most economists”, that I am aware of at any rate, actually saw the current crisis coming – whilst ‘minority’ others certainly did. This surely suggests “most economists” frame of reference to be in some way flawed and thus in need of further impartial study and possible revision? But no, a couple of rather convenient ‘Black Swan’ sightings later and the “most economists” continue undaunted, pontificating almost daily once again, citing the same exhausted theories containing everything but evidence in respect of their efficacy, on the best way out of the crisis.

      “On the other hand in a large majority of countries a large majority of the time, civilisation has not collapsed……” – Not yet they haven’t, but the road to collapse tends to be a very long one. Would you disagree though that with (especially Western) economic and political systems going the way they are, that we are at the very least on the ‘on’ ramp.

      To equate Riegel’s theories with ‘Tally Sticks’ & ‘Bills of Exchange’ and from that (wholly inaccurate) proposal to swiftly deduce that ‘it’s been tried, tested, it’s inefficient – let’s move on to State monopoly issue’ is akin to suggesting that a modern naval ‘destroyer’ is, in effect, the same thing as a Viking ‘longship’. Well, in as much as both craft float, both require(d) crews and both are / were deemed warships, the statement is true, but that’s pretty much where the similarity ends.

      I can only re-iterate that for me, the nuts and bolts of the issue surround the fact that I believe there to be no economic advantages, and very considerable disadvantages, to any kind of monopoly control over money and banking. I find it very, very difficult to comprehend the claimed advantages of a full State monopoly in respect of the issue of money over the current set up – which in any case requires the permission and acquiescence / connivance of the State to operate.

      Maybe it’s simply down to the fact I do not have the faith / trust in the State that the supporters of ‘Positive Money’ appear to possess. I do not regard the State as in way neutral, philanthropic or voluntary – to name but three of the most common political illusions. With all attempts at controlling the growth of this behemoth and the reining in of its activities having so far failed, what better way for the populace to gain complete mastery of their alleged ‘servants’ than to completely separate money & State and thus deny to politicians their everlasting, gift of deficit spending? For a start, the waging of war would become well nigh impossible without the consent of almost the entire population – alone a huge step forward. State monopoly of issue is quite simply the polar opposite to this vision.

      Finally, as for Ben’s view that there is ‘zero chance of it (the separation of money and State) being implemented over the next few years’ I can only agree, at least on the ‘macro’ level. On the ‘micro’ level, however, there is plentiful and ever increasing experimental and development room for ‘Private Enterprise Money’. Given the rapidly advancing digital age, there is no reason at all why businesses and communities the world over cannot create, issue and control their own private currencies and credit clearing systems. If the future is a choice between traditional State issued or regulated money and a variety of non-political cybercash options determined by market forces – which I personally think is a distinct possibility, I certainly know where I’m headed, and to which camp I will devote my energies!!

      • Hi Peter,

        Just to clarify, we’re not relying on a believe in an benevolent, competent state. We’re pretty clear that it was the failures of legislators, regulators and the central bank that propped up and enable the commercial banks to do so much harm through this system.

        At the moment there is zero accountability over the control of the money supply. It has been outsourced to commercial banks, who in normal times have completely asymmetric incentives – a big reward for increasing the money supply (lending), and no rewards, plus the risk of losing a job, if they don’t increase the money supply.

        Our proposals are designed to get this control over the money supply out into the open, so that we can exactly who is responsible, and hold them accountable. If it is still a shambles with state monopoly control over money creation, then denationalisation would be the only logical next step. However, I do believe there will be significant benefits from implementing the proposals that we’ve outlined, over the current system, even if they are not perfect.

    • Robert Thorpe Current

      Ralph,

      I could argue with you about all sorts of points, but I’m most interested in this one:

      > Moreover, deficits are unavoidable assuming one accepts a 2% rate of
      > inflation and for the simple reason that a 2% rate of inflation
      > implies that the monetary base shrinks in real terms at 2% a year.

      Reading your post I get the feeling you’ve been reading those post-Keynesians from Texas A&M University.

      Can you explain the justification for this? What assumption are you making about velocity?

      > Deficits are required simply to keep the base constant in real
      > terms.

      Why do deficits help in this way?

  • Tim Lucas Tim Lucas

    Hello Ralph,

    I met you briefly at the JHDS lecture. Given that you attended and that you heard De Soto as he ran through the logic showing that the injection of credit into the loan market results in an alteration of the production structure, misallocating capital and causing boom and bust through the well-trodden mechanism of the Austrian Business Cycle Theory, I am at a loss as to how on earth you can assert that

    ‘it is widely accepted that the optimum rate of inflation is around 2%, rather than 0% or any other percentage, thus I have no desire to “eliminate inflation”.’ Perhaps you weren’t listening.

    In the case of a fully-reserved system in which additional money is injected into the system via a central bank as explained by the Positive Money team, as represented by the two Bens above however, this wouldn’t result in ABCT but would -in my view end up in a subsidy being given to the government at the expense of the private sector.

    However, it is even more ludicrous to assert that under this system being proposed by the Bens, that ‘it is widely accepted that the optimum rate of inflation is around 2%’ since this system has NEVER OPERATED IN THE HISTORY OF THE WORLD.

    Hence, any comments with respect to inflation that economists make must refer exclusively to the current system in which we operate. A 2% rate of inflation under our current system would over any reasonably long time period require a 5% growth in broad money (assuming 3% productivity growth). As was explained in the lecture that you attended, this is distortionary, re-distributive and leads to lower aggregate standards of living as well as wild swings in business confidence. It is anti-freedom since it has led to a massive increase in the size of the state, immoral and unjust since it robs hard working people of their purchasing power. I am aghast that this has passed you by.

  • Ben,

    Although I generally approve of your efforts to promote the Bank of England Act, still my most basic disagreement with it is that you ignore the problem of sovereign debt all together in this essay. How can you possibly hope to control the national money supply if you continue to give Parliament the ability to fund their pet spending projects above the national income — in other words by deficit — by borrowing by selling bonds, mostly to big banks? I do believe in attempting the politically practical if when successful it will lead to a demonstrable improvement in the situation.

    That major question aside, I have a few other questions:

    1. You mention that “there is no possibility of any government in the next decade choosing to give up its power over” their national currency.” Perhaps I am unaware of the complete situation in Britain, but I can say with certainty that the U.S. government has NO power whatsoever over its national currency at present. Our proposal here is for the U.S. government to take back the money power from the banks. How is the setup different in Britain?

    2. You are correct in saying that: “One advantage of a gold standard was to limit the growth in the money supply….” However the pertinent question as my film “The Secret of Oz” points out is, yes, but for whose advantage? The ultimate goal in the creation of a national money supply is to do so in the public interest. Gold has never at any time in history — in any nation — created money in the public interest — in the interest of freedom from serfdom for the general population.

    3. You also continue to pay homage to the goldbugs by saying: “In a sense a [fixed, state-issued currency] would be a more secure currency than gold!” There is absolutely nothing secure — that is non-manipulatable — about a gold-only money system. All the owners of gold need do to sway politicians to support whatever legislation they favor is to threaten to call in their gold-backed loans en masse and thereby cause deflation or depression. I think the rest of your proposal for a flexible money supply — as long as it is not debt-based — is excellent.

    4. In the bullet points under “Our Proposals” I was shocked to see you diverge from British monetary reform expert James Robinson’s proposal when you say, “Put the power to create money with an independent MPC, who are tasked with keeping inflation at zero (or whatever target THEY set, say 2%). Robertson’s proposal is that the Parliament sets the target and the MPC implements changes in the money supply to hit that target. This, I think, would separate power nicely. Does this represent a change in Mr. Robertson’s thinking?

    5. I’m just completely confused by your use of the term “denationalization of money” under the heading “Our Campaign”. Don’t you mean to take the money power back away from the banks and put it somehow closer to being in control of the public interest?

    Bill Still

  • Recharge

    You are absolutely correct Bill – these proposals represent a nationalization of the money supply. The vast majority of money that exists today in the UK is created by private banks as debt to serve their own commercial interests. I always find it puzzling that people talk about the Government ‘printing money’ when the talk about quantitative easing (QE). Insofar as this does result in new money being created (rather than being held as reserves on bank balance sheets), the money is created by private banks as loans. Similarly, the MPC independently determines the rate of money creation to meet the Government target for inflation, so the Government really has very little to do with the whole process – it is outsourced to the private sector. Indeed, it is the private banks (allegedly defenders of the free market) who benefit from this system: not only do they appropriate the value of seignorage (equivalent to 12p income tax according to Robertson), they also get to use the new money before its inflationary effects have cascaded through the economy. The current system is a genuine scandal and I am all for nationalizing the money creation process to reclaim this value for the Government in line with Robertson’s proposals. Have a look at the following site to see Robertson’s full argument.

    http://www.jamesrobertson.com/book/creatingnewmoney.pdf

    • Robert Thorpe Current

      > Government really has very little to do with the whole process
      > – it is outsourced to the private sector.

      But, by setting up the institutions as it does the government has a great deal to do with the process. The government created the central bank, central banks are not market created, it created fiat money, it created deposit insurance and it created the MPC.

      In this respect it’s like many government interventions. Privateering for example. Though I don’t believe banks are morally equivalent to privateers.

      > Government ‘printing money’ when the talk about quantitative
      > easing (QE). Insofar as this does result in new money being
      > created (rather than being held as reserves on bank balance
      > sheets), the money is created by private banks as loans.

      The point is that the government is creating large amount of new base money.

      Economists often divide money into two broad categories. “Inside money” is money which is someone’s debt. Bank accounts and notes issued are “inside money”. “Outside money” is money which is nobodies debt, gold would count in a gold standard. In our system government fiat money is “outside money”.

      Rothbardians unfortunately don’t seem to understand this distinction, but it is very important. When a commercial bank wants to issue inside money it must own a corresponding amount of assets. A commercial bank cannot engage in seignourage in normal circumstances because it must buy the ability to create money with assets. But, when a government issues fiat money it need not obtain any new assets. A government really does create money ex nihilo.

      When a bank creates a banknote it’s making something that is an asset to others, but a liability to the bank itself. But, when a government is creating a note it’s making something that an asset to it and to others. The cost of doing this is later inflation.

      • Recharge

        “But, by setting up the institutions as it does the government has a great deal to do with the process. The government created the central bank, central banks are not market created, it created fiat money, it created deposit insurance and it created the MPC.”

        Yes, the framework was created by the Government, but that is about it. The point is they have little to do with the day to day running of it.

        “The point is that the government is creating large amount of new base money.”

        It is the independent Bank of England that creates new base money not the Government itself. The Government has no say in whether this base money is created as that is the job of the MPC. Furthermore, because of the fractional reserve system the private sector pyramids far more money on top of this base money, so the vast majority of money is created by, and in the commercial interest of, the private sector and not by the Bank of England.

        “When a commercial bank wants to issue inside money it must own a corresponding amount of assets. A commercial bank cannot engage in seignourage in normal circumstances because it must buy the ability to create money with assets.”
        The asset is created at the same time as the liability – it is a loan or an IOU on the asset side of the balance sheet. So it doesn’t need to buy anything, it just needs to lend money to someone and bingo an asset (an IOU) and a liability (a demand deposit) appear simultaneously on the bank’s balance sheet.

        “When a bank creates a banknote it’s making something that is an asset to others, but a liability to the bank itself.”

        But, in a fractional reserve system, as long as the money supply grows exponentially (to reach a 2% inflation target for example), the aggregate quantity of assets (IOUs) and liabilities (demand deposits) grows exponentially, and the liability in aggregate will never be claimed back (unless there is a bank run). So the banks in aggregate collect the value of seignourage because their liabilities in aggregate cannot and will not be claimed back. Ever. So their liabilities (along with their assets) will in aggregate just keep on growing.

        “But, when a government is creating a note it’s making something that an asset to it and to others.”

        All fiat money is a liability to society as a whole, whether it is created by Government or by private banks. It is a claim on wealth, not wealth in itself, and it is a claim against the aggregate wealth of society. The value of this claim is appropriated by the person creating the money. In a zero inflation world this is appropriated exclusively as seignourage (ie. they capture all the value of productivity gains); and in an inflationary world, partly as seignourage and partly in the ability to use the new money before its inflationary effects have cascaded through the economy (ie. they capture all of the productivity gains and then appropriate some of the pre-existing value as well). In our system private banks appropriate most of this value not the Government and I think that it is high time that we nationalized this value appropriation.

    • Robert Sadler

      Recharge,

      To say something is “outsourced” means you have a lot to do with it. If my company outsources its IT department that just means instead of me hiring and firing each individual IT employee I hire and pay another company to do it for me. I still have control over whether or not they continue to work for me and what they do for me.

      Secondly, it is naive to assume the Government has little to the money creation process. Bankers and Governments have been intertwined in this process for centuries. Look up “What Has Government Done to Our Money” for details.

  • Robert Thorpe Current

    Ben Dyson,

    In many ways this proposal is very similar to Toby Baxendales. I explained my problems with Toby’s proposal in an article here:
    http://www.cobdencentre.org/2010/06/a-problem-with-the-baxendale-plan/

    In short, once bank accounts no longer pay interest and no longer offer free services, then holding money will be much less attractive than it is today. A 100% reserve fiat standard would be inflationary because people would attempt to economise on holding money much more than they do today. For that reason it’s very likely that the government would have to destroy money to meet an inflation target rather than creating it. This problem could be helped if the government paid interest on money using newly created money. But if they did that then the interest rate wouldn’t really be a market price.

    Another major problem with this approach is that the principle benefit of creating money would go to government. As it stands the government make a small amount of base. Because of the required reserve ratio this injection permits the commercial banks to create more money by creating bank account money against assets. If the government did this directly they would have much, much more new money to spend. There would therefore be a much greater temptation for abuse.

    I don’t agree with the claims you intend to use to sell this idea to the public. A counterfeiter creates certificates that appear to be something they are not. When a counterfeiter forges a banknote he puts someone else’s name on it and doesn’t agree to redeem the amount shown, when a banker creates a banknote he puts his own name on it and agrees to redeem the amount shown. A bank doesn’t forge, a bank account is a completely legal an moral form of contract. Like you I have reasonably low opinions of the modern media but any half-decent columnist could write a column pointing this out.

    • Robert Sadler

      Current,

      Why do people currently hold money at the bank when they are actually paying to do so? Interest rates < Inflation.

      If they would pay to do so while incurring insolvency risk why would they not pay for security?

      Also, if they really are keen to earn a return rather than have security they can buy bonds or equity instead. At least that way they should be aware that they have a risky asset.

      • Robert Thorpe Current

        > Why do people currently hold money at the bank when they are
        > actually paying to do so? Interest rates < Inflation.

        Come on Rob! I've had long discussions with you, you know the answer :)

        Investments such as bonds and shares are not acceptable for indirect exchange. Government money and bank account transfers are. Granted in some situations one or the other of those sometimes isn't acceptable. But, it's useful to keep a stock of both, which is something nearly everyone in the developed world does.

        Things like transfers and cheque handling are normally provided for free by banks today. What do you think would happen if suddenly charges were introduced for those and interest payments ceased? People would still hold money and money-substitutes, but they would economise on them to prevent losses from foregone interest and from charges for making too many transfers.

        • Robert Sadler

          Yeah sorry I’ve lost track of our earlier discussion which is now buried deep in the archives…

          I don’t think that cheque handling and transfers are really free in the UK, they just appear that way. Banks cover that in two ways: a)the spread between the rate they pay the customer and what they receive from loans and b)penalties (i.e. for overdrafts and bouncing cheques) and other fees. This is similar to the way Forex providers claim to charge no commission on Forex services when really it is buried in the spread.

          Of course today, bank customers are paying to keep their money in the bank because they are earning negative interest. And in the US they get charged to keep their money at the bank. Remember returns must be calculated net of fees.

          The fact is today, you can keep your savings in a 100% gold backed institution, with full security and earn a greater net return than you can earn in a savings account.

          • Robert Thorpe Current

            > I don’t think that cheque handling and transfers are really
            > free in the UK, they just appear that way. Banks cover that
            > in two ways: a)the spread between the rate they pay the
            > customer and what they receive from loans and b)penalties
            > (i.e. for overdrafts and bouncing cheques) and other fees.

            I don’t see how you’re really disagreeing with me here. Banks lend to borrowers and charge them an interest rate. Banks borrow from account holders and pay them in various ways, in interest and in free services. You say those services are paid for by “the spread between the rate they pay the customer”. Yes, exactly! And as you point out other charges associated with borrowing such as fees are important too.

            If banks were 100% reserved then they couldn’t do that. The income which gives banks the ability to fund these services would be cut off. Banks wouldn’t give account holders free services because account holders would not be lending to them.

            > Of course today, bank customers are paying to keep their
            > money in the bank because they are earning negative
            > interest. And in the US they get charged to keep their
            > money at the bank. Remember returns must be calculated
            > net of fees.

            Yes, but as I mentioned before doing this is quite rational because of the payment services that banks provide.

            I’m sure you keep a small quantity in a bank to make payments with. Or do you convert from gold for every payment?

            > The fact is today, you can keep your savings in a 100%
            > gold backed institution, with full security and earn a
            > greater net return than you can earn in a savings account.

            Today the price of gold is rising. Because of the actions of central banks, as we know.

            But, that would not happen if we had a gold standard. In that situation gold would be money. So, there would be a cost for warehousing. In a gold standard the cost of a 100% reserved account would always be greater than that of a fractional reserved account.

            The situation now is quite different because gold is a normal good now. This is one of the main reasons that central banks got rid of gold standards.

            > In my view, if the average person understood the true
            > risk of fractional reserve banking they would quickly
            > switch to 100% reserve institutions, as I have done.

            That hasn’t happened in previous free banking situations.

            The Bank of Amsterdam may have used full reserves for a part of it’s life, but it was a government institution. It was owned by the elders of the bank of Amsterdam.

        • Robert Sadler

          Also, fees for cheque handling and transfers can be bundled (like with your mobile phone bill), so it wouldn’t seem like you were paying a fee for every bill payment.

          In my view, if the average person understood the true risk of fractional reserve banking they would quickly switch to 100% reserve institutions, as I have done.

  • Robert Thorpe Current

    Recharge,

    >> But, by setting up the institutions as it does the government has a
    >> great deal to do with the process. The government created the
    >> central bank, central banks are not market created, it created fiat
    >> money, it created deposit insurance and it created the MPC.
    >
    > Yes, the framework was created by the Government, but that is about
    > it. The point is they have little to do with the day to day running
    > of it.

    Yes, but that doesn’t mean that they “really have very little to do with the whole process” as you claimed earlier. They are essential to the whole process.

    It is “outsourced to the private sector” just like many things have been in times past, including privateering and imperialism. That outsourcing doesn’t mean the government isn’t critical.

    I think you are trying to underplay the government’s role in other to portray the private sector is a negative light.

    >> The point is that the government is creating large amount of new
    >> base money.
    >
    > It is the independent Bank of England that creates new base money
    > not the Government itself. The Government has no say in whether this
    > base money is created as that is the job of the MPC.

    The MPC control the near term creation of money. But, the government control the policy targets and to a large degree who is a member of the MPC.

    In the longer run it is governments who are responsible for money creation even if they do it through arms-length institutions.

    > Furthermore, because of the fractional reserve system the private
    > sector pyramids far more money on top of this base money, so the
    > vast majority of money is created by, and in the commercial interest
    > of, the private sector and not by the Bank of England.

    Yes. But only the Bank of England creates money truly from nothing.

    >> When a commercial bank wants to issue inside money it must own a
    >> corresponding amount of assets. A commercial bank cannot engage in
    >> seignourage in normal circumstances because it must buy the ability
    >> to create money with assets.
    >
    > The asset is created at the same time as the liability – it is a
    > loan or an IOU on the asset side of the balance sheet. So it doesn’t
    > need to buy anything, it just needs to lend money to someone and
    > bingo an asset (an IOU) and a liability (a demand deposit) appear
    > simultaneously on the bank’s balance sheet.

    As I just said in another thread, I think you take a too concrete view of economics.

    You say that a bank “just needs to lend money to someone and bingo an
    asset (an IOU)”. This is true *always* it applies to any lending of money. If I lend a £10 note to you then I have an asset – your debt. Banks are not doing anything special or privileged here, anyone with capital to lend can do it.

    Lending money to someone can be described as “buying a debt”. That is how it’s thought of in bond dealing. A lender sells capital now in exchange for a promise of income later. The future income is bought with the capital.

    Just because a debt is intangible doesn’t mean it’s meaningless, it’s a form of contract. In many ways ownership of physical property is very similar.

    >> When a bank creates a banknote it’s making something that is an
    >> asset to others, but a liability to the bank itself.
    >
    > But, in a fractional reserve system, as long as the money supply
    > grows exponentially (to reach a 2% inflation target for example),
    > the aggregate quantity of assets (IOUs) and liabilities (demand
    > deposits) grows exponentially, and the liability in aggregate will
    > never be claimed back (unless there is a bank run). So the banks in
    > aggregate collect the value of seignourage because their liabilities
    > in aggregate cannot and will not be claimed back. Ever. So their
    > liabilities (along with their assets) will in aggregate just keep on
    > growing.

    Er, yes, exactly. Both bank assets and liabilities grow in nominal terms with inflation, and are expected to do so. So, how are banks supposed to make seigniorage then?

    Note I said earlier that commercial banks don’t make seigniorage in normal situations. In situations of unexpected expansions by central banks the commercial banks can make seigniorage-like incomes.

    >> But, when a government is creating a note it’s making something
    >> that an asset to it and to others.
    >
    > All fiat money is a liability to society as a whole, whether it is
    > created by Government or by private banks.

    No, or at least, not without government bailouts. Money substitutes created by commercial banks are a liability of those banks. The government only has a responsibility to bail them out if it promises to do so.

    > It is a claim on wealth, not wealth in itself, and it is a claim
    > against the aggregate wealth of society.

    As I have probably said before I don’t like the word “claim”. In English it doesn’t distinguish between a debt relationship and an ownership relationship.

    Anyway, regardless of that, as I mentioned above a note from a commercial bank is not a “claim on the aggregate wealth of society”, it is a debt of the commercial banks and it’s owners.

    Government created fiat money is different. If any asset backs it then that is the ability of the government to tax and enforce laws. Through these powers they can create money and shift the liability it represents onto the rest of society.

    > The value of this claim is appropriated by the person creating the
    > money.

    It depends entirely on what must be given up to create money. Banks need assets in order to produce liabilities, there is no free lunch for them.

    It could be argued that in the long run there is little free lunch for government either. Because, if they drive the rate of inflation too high then the electoral consequences are serious. But, they can get away with quite a lot of abuse since the electorate have so little knowledge about the issues.

    > In a zero inflation world this is appropriated exclusively as
    > seignourage (ie. they capture all the value of productivity gains);
    > and in an inflationary world, partly as seignourage and partly in
    > the ability to use the new money before its inflationary effects
    > have cascaded through the economy (ie. they capture all of the
    > productivity gains and then appropriate some of the pre-existing
    > value as well). In our system private banks appropriate most of this
    > value not the Government and I think that it is high time that we
    > nationalized this value appropriation.

    In some ways I like your posts on the Cobden centre site. I may not agree with you, but you’re always a good debating partner.

    And, I like the way that you have made 100% reservist thought into a left-wing idea. I thought about presenting Rothbard’s idea as a plan for interventionism, but I could never have done it as well as you have. I think you may have helped the cause of us supporters of fractional-reserve free-banking no end :)

  • Recharge

    “I think you are trying to underplay the government’s role in other to portray the private sector is a negative light.”

    Maybe it came across like that, but I was not trying to be negative about the private sector (I work in the private sector myself), I was just trying to emphasize that the Government plays a very limited role in the day to day operation of the monetary system, especially since Gordon Brown made the Bank of England responsible for achieving the targeted inflation rate. So when I hear people talk about inflation as a stealth tax it is simply not true, because the Government does not generate inflation and doesn’t capture the vast majority of seigniorage. Yes, it could change the framework (and in line with the above proposals I think it should) so that it takes direct responsibility for creating new money and it does collect the siegnorage. But as a matter of fact it does not under the current framework.

    “You say that a bank “just needs to lend money to someone and bingo an asset (an IOU)”.

    This is true *always* it applies to any lending of money. If I lend a £10 note to you then I have an asset – your debt. Banks are not doing anything special or privileged here, anyone with capital to lend can do it.”

    But, as I have said to you before Current, there is an absolutely critical difference here: the banks create the ten pound note before they lend it (or to be precise they create electronic digits in a demand deposit). If they were lending their own equity (like I would be in your example) that would be fine. But they are not: they are lending deposited money which already has a claim on it (I know it is legally not a bailment (Carr v Carr 1811) but that does not, in my view, affect the underlying position). This means that depositor and lender both act as if they had title to ten pounds and the bank has therefore doubled the money supply. I have no problem with private banks lending their own equity or genuinely acting as brokers between savers and borrowers (ie. 100% reserve banking), but that is not what they currently do and which is why your analogy is not right. In reality the banks are doing something special and privileged – they are increasing the money supply.

    “Er, yes, exactly. Both bank assets and liabilities grow in nominal terms with inflation, and are expected to do so. So, how are banks supposed to make seigniorage then?”

    They make seigniorage because they increase the money supply and they get to use the money first (by lending it out at an interest rate that anticipates the future inflation that they cause). As I said in my last post, this enables them to capture the value of productivity gains in seignorage and, if inflation is above zero, to appropriate pre-existing value by devaluing the existing stock of money. I agree that if bank loans in aggregate were to be paid back and liabilities in aggregate reduced, then the money supply would contract and the banks would give the value they have appropriated back to whoever holds the remaining money (ie. the currency would deflate back to the pre-inflationary higher value but they would be paid back at the post-inflationary lower currency value before they had collected their perpetuity interest). But under the inflation targeting monetary system we currently have, loans in aggregate cannot and will not be repaid so the banks get to keep the value appropriated in perpetuity (or more accurately until the entire system collapses under the weight of exponential growth). If you still doubt that the banks appropriate this value Current, my question to you would be: if the banks do not capture this value, where does it go, because somebody benefits from diluting the power of money?

    “In some ways I like your posts on the Cobden centre site. I may not agree with you, but you’re always a good debating partner.”

    Thanks – I enjoy these exchanges as well and your posts have sharpened up some of my thinking. I came across this site by chance last month and I’ve been a regular visitor since (I like reading things I disagree with!).

    “And, I like the way that you have made 100% reservist thought into a left-wing idea. I thought about presenting Rothbard’s idea as a plan for interventionism, but I could never have done it as well as you have. I think you may have helped the cause of us supporters of fractional-reserve free-banking no end :)”

    I have to say, when I read Rothbard’s book I did sense a lot of the thinking was left leaning in his critique of the modern banking system.

    • Robert Thorpe Current

      > “I think you are trying to underplay the government’s role in other
      > to portray the private sector is a negative light.”
      >
      > Maybe it came across like that, but I was not trying to be negative
      > about the private sector (I work in the private sector myself), I
      > was just trying to emphasize that the Government plays a very
      > limited role in the day to day operation of the monetary system,
      > especially since Gordon Brown made the Bank of England responsible
      > for achieving the targeted inflation rate. So when I hear people
      > talk about inflation as a stealth tax it is simply not true, because
      > the Government does not generate inflation and doesn’t capture the
      > vast majority of seigniorage.

      You’re confusing two different issues here. Yes, the government doesn’t control the day-to-day running of the Bank of England. That doesn’t mean that it the government doesn’t gain funds from seigiourage, it certainly does. There is no direct connection between day-to-day control and seigniourage.

      > Yes, it could change the framework
      > (and in line with the above proposals I think it should) so that it
      > takes direct responsibility for creating new money and it does
      > collect the siegnorage. But as a matter of fact it does not under
      > the current framework.

      As I explained earlier, what siegniourage exists is collected by the government through the Bank of England. Private banks cannot collect siegniourage income because although they can create money they cannot create unbacked money.

      > “You say that a bank ‘just needs to lend money to someone and bingo
      > an asset (an IOU)’. This is true *always* it applies to any lending
      > of money. If I lend a £10 note to you then I have an asset – your
      > debt. Banks are not doing anything special or privileged here,
      > anyone with capital to lend can do it.”
      >
      > But, as I have said to you before Current, there is an absolutely
      > critical difference here: the banks create the ten pound note before
      > they lend it (or to be precise they create electronic digits in a
      > demand deposit).

      I don’t agree that that is a critical difference. Again, this is something that normal citizens can do too. Let’s suppose I own a pub, I can say to you: “You have £10 credit” and write £10 credit on a slate next to your name. This is not creation of money because an account with a pub could not become a money substitute. But, it is the same sort of transaction.

      > If they were lending their own equity (like I would be in your
      > example) that would be fine. But they are not: they are lending
      > deposited money which already has a claim on it (I know it is
      > legally not a bailment (Carr v Carr 1811) but that does not, in my
      > view, affect the underlying position).

      But, why should people only be able to lend their own equity. The normal law is that money that is lent can be lent in turn, so long as none of the contracts forbid it.

      > This means that depositor and lender both act as if they had title
      > to ten pounds and the bank has therefore doubled the money supply.

      I agree that in this example the money supply increases. However, both parties do not act as though they have title to ten pounds of cash. The current account holder does not have title to ten pounds, he has a debt which is worth ten pounds. Since the bank has shown by it’s past actions that this debt is very good the certificate for it circulates as a money-substitute.

      The current account has a value of £10 only in a small part because of the reserves the bank keeps. The rest is accounted for by the assets the bank owns.

      > I have no problem with private banks lending their own equity or
      > genuinely acting as brokers between savers and borrowers (ie. 100%
      > reserve banking), but that is not what they currently do and which
      > is why your analogy is not right. In reality the banks are doing
      > something special and privileged – they are increasing the money
      > supply.

      In the example you give the money supply increases. The ability to increase it isn’t really a privilege supplied by government as Rothbard claims. In Free banking situations banks were able to do exactly the same thing despite having no protection from central banks or deposit insurance.

      The banks ability to produce money substitutes rests upon it’s ability to ensure that those substitutes are sound. Despite Rothbardian assertions to the contrary banks have been able to do this for long periods of time and gain the trust of their customers.

      As Selgin and White have pointed out, over a long period of time banks have discovered how to operate with small amounts of reserves and large amounts of assets such as loans. In Scotland banks began by using large quantities of reserves and gradually reduced them. This certainly increased the amount of money-substitutes, but it did so only slowly. As Selgin, White & Horwitz have explained, a free banking system only changes the amount of money-substitutes quickly in response to an increase in holding.

      The concerns that Rothbardians have that free-banks would increase the money-supply enormously are unfounded. They are constrained by the amount of reserves available and the amount of assets available. Under the current system the only reason that sharp increases in money-supply and inflation occur is because governments and central banks have the ability to alter the amount of reserves by creating fiat money.

      > “Er, yes, exactly. Both bank assets and liabilities grow in nominal
      > terms with inflation, and are expected to do so. So, how are banks
      > supposed to make seigniorage then?”
      >
      > They make seigniorage because they increase the money supply and
      > they get to use the money first (by lending it out at an interest
      > rate that anticipates the future inflation that they cause). As I
      > said in my last post, this enables them to capture the value of
      > productivity gains in seignorage and, if inflation is above zero, to
      > appropriate pre-existing value by devaluing the existing stock of
      > money.

      When reading economists from the 19th and early 20th century, such as Mises and sometimes Hayek & Keynes it’s always worth remembering that the gold standard was still in use. The public expected that there would not be overall trends in prices, they would not rise and would not fall much overall. That is what happened in the 19th century during the period of the international gold standard. Year-by-year or month-by-month there was quite significant inflation and deflation, but over a period of several years the trend was small. Unlike today where a few percent of constant inflation can be expected. So, expectations of inflation are quite different now to what they were then.

      Mises original ABCT thinking doesn’t really apply to the world today. Let’s suppose I know there will be ~3% of price inflation in the future. Can I benefit from that by buying assets cheaply before they rise in value? No, I can’t, not really because everyone else’s inflation expectations are similar, that ~3% future inflation is already factored into asset prices.

      What matter now is deviations from the expected rate of inflation, especially deviations that occur through asset price inflation since that isn’t incorporated in the CPI or RPI indexes. Banks certainly can profit from those by buying assets cheaply from people expecting only the past trend rate of inflation. (Of-course banks can screw this up by holding assets into the bust, which is what they actually did this last cycle).

      Higher than expected inflation can only be created by the creation of more base money for reserves by the central bank.

      > If you still doubt that the banks appropriate this value Current, my
      > question to you would be: if the banks do not capture this value,
      > where does it go, because somebody benefits from diluting the power
      > of money?

      Let’s deal with the normal situation where the price inflation rate is at it’s historical trend first. From what you’ve said earlier I’d guess that your view is that a certain percentage inflation rate always means that someone somewhere is gaining by seigniourage. A hypothetical example is useful here.

      Let’s suppose we have an isolated economy where the unit of currency is the brick. There are no fractional reserve banks. People use certificates for bricks which are 100% reserved. Over time the technology for making bricks and mining minerals becomes more advanced and bricks fall in cost. As such the brick makers can produce more of them every year, if required. In this case the price of other goods measured in bricks will rise, there will be price inflation. Let’s suppose that manifests itself as persistant price inflation that everyone expects, does that mean that anyone gains a seigniourage income? No, even though prices are rising it doesn’t. The brickmakers are not “watering down” the bricks as kings once mixed gold with base metals. Technology permits them to supply bricks more cheaply. In this case there may be inflation without any seigniourage.

      The normal steady price inflation we have seen in developed countries in the past 50 years is similar. Banks must hold assets against their liabilities as I mentioned earlier. Owners of assets will not be fooled into thinking that there will be no inflation in the future. Any current asset price factors in expected inflation, as Fisher pointed out a hundred years ago. Governments are the only exception because they don’t really base their issue of currency off assets. The assets they use are bonds which they can create at will through their power to tax. The asset that underpins a fiat currency is the wealth of taxpayer that the government can take from them.

      > “In some ways I like your posts on the Cobden centre site. I may not
      > agree with you, but you’re always a good debating partner.”
      >
      > Thanks – I enjoy these exchanges as well and your posts have
      > sharpened up some of my thinking. I came across this site by chance
      > last month and I’ve been a regular visitor since (I like reading
      > things I disagree with!).

      Thanks.

      > “And, I like the way that you have made 100% reservist thought into
      > a left-wing idea. I thought about presenting Rothbard’s idea as a
      > plan for interventionism, but I could never have done it as well as
      > you have. I think you may have helped the cause of us supporters of
      > fractional-reserve free-banking no end :)”
      >
      > I have to say, when I read Rothbard’s book I did sense a lot of the
      > thinking was left leaning in his critique of the modern banking
      > system.

      Yes, Rothbard reserves his suspicion of free enterprise and free contracts mostly for discussions about banking. His short book “The Case Against the Fed” is even more paranoid.

      In several ways Rothbard’s system is like Marx’s, and like pop-music. All three of them have a “hook”, something to bring in the public. In Marx it’s the theory of exploitation which can be quite simply explained and is superficially plausible. In Rothbard it’s the theory that fractional reserve banking is fraud and causes the business cycle, which is similarly simple to explain and superficially plausible. I’m pretty sure that Rothbard decided to use FRB as Marx used exploitation because he studied Marx and Lenin and their political strategies. (Others have pointed this similarity out before, I didn’t think of it).

      • Recharge

        Current,

        We seem to be going round in circles here. There is a technically correct answer to this (it is not just a matter of opinion or judgement as so many questions in economics are) but we do not seem to be able to converge on it. Naturally, I think I am correct and I will try to answer your points below without too much repetition of what I have said before. But if you still disagree then I can see no way of reconciling our positions and one of us must be wrong but cannot see it.

        “You’re confusing two different issues here. Yes, the government doesn’t control the day-to-day running of the Bank of England. That doesn’t mean that it the government doesn’t gain funds from seigiourage, it certainly does. There is no direct connection between day-to-day control and seigniourage.”

        I agree, my point was twofold: (i) they don’t control the day to day operations and (ii) even if they did they don’t get the (vast majority) of the valueseignorage anyway. So to call inflation a stealth tax makes no sense.

        “As I explained earlier, what siegniourage exists is collected by the government through the Bank of England. Private banks cannot collect siegniourage income because although they can create money they cannot create unbacked money.”

        But they only produce a small percentage of the total money supply, so their ability to collect seigniorage is very limited.

        “I don’t agree that that is a critical difference. Again, this is something that normal citizens can do too. Let’s suppose I own a pub, I can say to you: “You have £10 credit” and write £10 credit on a slate next to your name. This is not creation of money because an account with a pub could not become a money substitute. But, it is the same sort of transaction.”

        No it isn’t, because in this example you would not be creating a simultaneous claim on the same asset as you would be lending me an asset that is yours, namely your beer (ie. your equity). If you had stored some beer for someone else for safe keeping in exchange for a beer certificate, and the owner had a right to claim his beer back at any time, and you then gave it to me in exchange for an IOU, this would be the same sort of transaction. It is fundamentally different in character because you create a new asset (an IOU) at the same time as you create the new liability (the beer certificate) and thereby double the quantity of beer certificates in circulation.

        “But, why should people only be able to lend their own equity. The normal law is that money that is lent can be lent in turn, so long as none of the contracts forbid it.”

        Again, this is fine, provided that there is no increase in the money supply and that the banks genuinely act as brokers between borrowers and savers (ie. 100% reserve banking). I don’t think that the creation of new money should be the by-product of the commercial lending activities of private banks. If new money does have to be created (and I’m open minded about whether this is desirable or not), then it should be spent into existence by a public authority not lent into existence by a private bank.

        “I agree that in this example the money supply increases. However, both parties do not act as though they have title to ten pounds of cash. The current account holder does not have title to ten pounds, he has a debt which is worth ten pounds. Since the bank has shown by it’s past actions that this debt is very good the certificate for it circulates as a money-substitute.”

        I doubt that if you did a survey of bank customers that you will find many who regard the contents of their current account as a debt to the bank – I certainly do not. Psychologically, I regard it as the bank keeping my money safe until I want to use it and I very much act as if I had title to that money.

        “Let’s suppose we have an isolated economy where the unit of currency is the brick. There are no fractional reserve banks. People use certificates for bricks which are 100% reserved. Over time the technology for making bricks and mining minerals becomes more advanced and bricks fall in cost. As such the brick makers can produce more of them every year, if required. In this case the price of other goods measured in bricks will rise, there will be price inflation. Let’s suppose that manifests itself as persistant price inflation that everyone expects, does that mean that anyone gains a seigniourage income? No, even though prices are rising it doesn’t. The brickmakers are not “watering down” the bricks as kings once mixed gold with base metals. Technology permits them to supply bricks more cheaply. In this case there may be inflation without any seigniourage. The normal steady price inflation we have seen in developed countries in the past 50 years is similar.”

        In this example there is no seigniourage because the cost of producing the brick is the same as its value, and inflation occurs because the cost of producing bricks, and hence the value of bricks against other commodities reduces over time. With fiat money, the situation is completely different, because there is a big difference between the cost of producing money (practically nothing for an electronic demand deposit) and its value. This is exactly what I meant in a previous post when I said all fiat money is a liability against society as a whole, because unlike a brick it has no inherent value.

        In a fractional reserve banking system banks do not create more fiat money because the cost of producing said money is falling over time: they do it because the Central Bank increases their reserves through open market operations and they can then pyramid new loans on top of their new reserves to increase the money supply in aggregate. They lend this money out at interest and hence collect the difference between the cost of producing the new money (virtually nothing) and the value of the new money. On the other side of the balance sheet, they do not pay me any interest on my current account (the newly created demand deposit) because they do not have to – I put my money there for safe keeping and not as an investment.

  • Conrad Jones (Cheam)

    “Put the power to create money with an independent MPC, who are tasked with keeping inflation at zero (or whatever target they set, say 2%).”

    We already have a 2% Target – that Target is symetrical – if it’s below 2% then the Money Supply must be inflated to increase inflation. This isn’t going to make a lot of difference to the current problem. We already have an Independent MPC.

    “We tie the creation of money into inflation, so that if inflation starts rising (beyond the target) then no new money can be created”

    If the money supply has inflated – then why not deflate it? This will restore value in peoples savings. It will also make the Pound a hedge against inflation in the World Currency Markets – a bit like the Swiss Franc. It will still be open to abuse by clever Central Bankers who manipulate the statistics like they do now with Inflation Rates (RPI replaced with CPI, and the very definition of Inlfation changed to Price Rises rather than Increasing the Money Supply)

  • Conrad Jones (Cheam)

    One of the problems that we face is that many people do not realise there is a problem with the current system. This may be just a lack of interest or a belief that they are “doing OK”. Many people have seen there Houses rise drammatically in “price” (not value).

    The News media constantly shows Stock Market reaching another “Record Price”. There is a deafening silence when it comes to the Price of Gold and Silver – which strangely are only occasionally mentioned when they pass through a particular threashold value – but the FTSE is reported several times a day, every day.

    This provides the illusion that the economy is doing well and so allows people to relax into a false sense of security. This reported separately from the Tax Rises, the constantly high Inflation (even when using the fiddled CPI figure).

    When dividing; House Prices, DOW Jones or FTSE Price by the cost of an ounce of Gold, the picture suddenly looks very different. House Prices began falling in Value well before the “crash”. The DOW Jones has been falling in value for years, possibly decades due to the debasement of fiat currency.

    • mrg mrg

      “When dividing; House Prices, DOW Jones or FTSE Price by the cost of an ounce of Gold, the picture suddenly looks very different”

      I remember a good article by James Tyler about this:

      http://www.cobdencentre.org/2010/03/some-people-doodle-pictures/

      I’ve always found it ridiculous that stock market charts don’t account for inflation, and that people celebrate the Dow Jones going back above 10,000 as if it means as much the second time around.

      One of the things that always frustrates me is a failure to separate facts from theories. I would love to see economists first agree on the truth of a graph like the one James has produced, then argue about the reasons for it, and the policy implications. No doubt there will be subtleties, like the dividend question James accounted for, but even with different assumptions about returns, how different would the graphs be?

      • Robert Thorpe Current

        There’s another paper on that called “Point Blindness” you can find it by searching for that phrase.

        There can be asset price inflation too. People seem to think that asset price inflation must be at the same rate as inflation for output. I think in some case it isn’t.

  • Conrad Jones (Cheam)

    One of the biggest problems is the Boom-Bust cycle.

    Created by Expansion in Credit, then a deflation in credit.

    The Private Banks are blamed but they are nothing more than Businesses who are taking advantage of a system which is not available to any other Private Business – the safety net provided by the Bank of England.

    We are often told that with the Bank of England guaranteeing our savings – we could lose them.

    The Bank of England is providing this fantastic service of guaranteeing our Savings. This is a lie.

    The Bank of England is tasked with providing Politicians with as much money as they need to action wild socialist schemes – whatever the cost. But it is also the provider of unlimited funds to pay for War – it’s original purpose back in 1694.

  • Robert Thorpe Current

    Recharge,

    > We seem to be going round in circles here. There is a technically
    > correct answer to this (it is not just a matter of opinion or
    > judgement as so many questions in economics are) but we do not seem
    > to be able to converge on it.

    I agree with you there.

    > Naturally, I think I am correct and I will try to answer your points
    > below without too much repetition of what I have said before. But if
    > you still disagree then I can see no way of reconciling our
    > positions and one of us must be wrong but cannot see it.

    Fair enough.

    > “You’re confusing two different issues here. Yes, the government
    > doesn’t control the day-to-day running of the Bank of England. That
    > doesn’t mean that it the government doesn’t gain funds from
    > seigiourage, it certainly does. There is no direct connection
    > between day-to-day control and seigniourage.”
    >
    > I agree, my point was twofold: (i) they don’t control the day to day
    > operations

    Agreed.

    > and (ii) even if they did they don’t get the (vast
    > majority) of the value seignorage anyway. So to call inflation a
    > stealth tax makes no sense.

    I’ll come onto that later.

    > “As I explained earlier, what siegniourage exists is collected by
    > the government through the Bank of England. Private banks cannot
    > collect siegniourage income because although they can create money
    > they cannot create unbacked money.”
    >
    > But they only produce a small percentage of the total money supply,
    > so their ability to collect seigniorage is very limited.

    Yes, that’s right, so there only is a very small amount of seigniourage overall. I’m not claiming here that anyone collects a large amount of seigniorage in any normal situation. Seigniourage is far down my list of complaints about central banking.

    In my view the important problem with central banking is that the central bankers are poor economic guardians. They allow the creation of too much money at some times and too little at others.

    > “I don’t agree that that is a critical difference. Again, this is
    > something that normal citizens can do too. Let’s suppose I own a
    > pub, I can say to you: ‘You have £10 credit’ and write £10 credit on
    > a slate next to your name. This is not creation of money because an
    > account with a pub could not become a money substitute. But, it is
    > the same sort of transaction.”
    >
    > No it isn’t, because in this example you would not be creating a
    > simultaneous claim on the same asset as you would be lending me an
    > asset that is yours, namely your beer (ie. your equity).

    I’m not lending you any specific asset. I’m promising that when you ask I will supply something to you. The credit I give you doesn’t give you ownership of any of my beer or my other assets. You don’t own a share, you own a debt.

    I could have £1000 of beer and I could have given away £2000 of credit. In that case I must have £1000 of other assets to avoid being bankrupt.

    > If you had stored some beer for someone else for safe keeping in
    > exchange for a beer certificate, and the owner had a right to claim
    > his beer back at any time, and you then gave it to me in exchange
    > for an IOU, this would be the same sort of transaction.

    In my example nobody has been promised a bailment. Banks don’t promise anyone bailments, they deal with debts.

    I agree entirely that it’s wrong for someone who has promised to store something to do otherwise. But banks don’t store things except in safe-deposit boxes.

    > It is fundamentally different in character because you create a new
    > asset (an IOU) at the same time as you create the new liability (the
    > beer certificate) and thereby double the quantity of beer
    > certificates in circulation.

    What I was intending to show with my example above is that it’s easy to create a new asset and a new liability. Ordinary people do it all the time.

    Perhaps I wasn’t clear in my pub example. Suppose Jim owns a shop. He says to a customer that she can have £20 free credit for a month. If he likes Jim could write £20 in the asset column of his account because the customer owes him that much. But if he does that he must also write £20 in the liabilities column too because he owes the customer that much.

    As with the pub example, the only difference between these debts is that other people don’t accept them instead of money.

    > “But, why should people only be able to lend their own equity. The
    > normal law is that money that is lent can be lent in turn, so long
    > as none of the contracts forbid it.”
    >
    > Again, this is fine, provided that there is no increase in the money supply

    Why? What legal or moral imperative is there not to increase the money supply? If the transaction that creates money is legal then why can’t banks create it?

    You can argue that fractional-reserve banking causes the business cycle and that it should be banned for that reason. I would disagree with that too, I think it’s an incorrect interpretation of Austrian Business Cycle Theory.

    My point here though is that banks don’t need to dupe anyone to create money, nor do they engage in seigniourage. Granted, someone could be duped, and in circumstances of unexpected changes in the demand for money banks could earn seigniourage.

    Rothbard’s adherence to 100% reserve banking isn’t really consistent with his general free-market beliefs. He may have believed that it’s consistent, but really it’s an interventionist exception. He doesn’t want simply to remove priveleges that banks enjoy, he also wants to make banks shoulder extra responsibilities that other agents and businesses don’t have to shoulder.

    I’m not saying that because it’s interventionist it must necessarily be wrong, I’m not a natural-rights libertarian.

    > and that the banks genuinely act as brokers between borrowers and
    > savers (ie. 100% reserve banking).

    Why do you think that fractional reserve banking is a bank “genuinely acting as a broker”? I think that it is.

    I don’t think that there is necessarily anything more honest about timed-debts than on-demand debts.

    > I don’t think that the creation of new money should be the
    > by-product of the commercial lending activities of private banks. If
    > new money does have to be created (and I’m open minded about whether
    > this is desirable or not), then it should be spent into existence by
    > a public authority not lent into existence by a private bank.

    But, why do you think it’s better that way?

    There are two different questions in this debate. The first is whether on-demand banking disobeys any principles of law that are local to those the bank deals with. My aim here has been to show that there need not be.

    The second question is whether the existence of on-demand banking creates macroeconomic instabilities. I don’t think it does. I’ve been into this argument much more on other threads here.

    See this one for example:
    http://www.cobdencentre.org/2010/09/dangerous-defeatism/comment-page-1/#comment-7724

    > “I agree that in this example the money supply increases. However,
    > both parties do not act as though they have title to ten pounds of
    > cash. The current account holder does not have title to ten pounds,
    > he has a debt which is worth ten pounds. Since the bank has shown by
    > it’s past actions that this debt is very good the certificate for it
    > circulates as a money-substitute.”
    >
    > I doubt that if you did a survey of bank customers that you will
    > find many who regard the contents of their current account as a debt
    > to the bank – I certainly do not. Psychologically, I regard it as
    > the bank keeping my money safe until I want to use it and I very
    > much act as if I had title to that money.

    The Cobden centre did a survey, and you’re right people are quite confused about it. However, there are two reasons for this…

    Firstly, generally debts to banks really are very good, they really are very safe. Current account holders have a right to the bank’s assets that takes priority over shareholders, so they have a very good chance of been paid even in the rare occurence of a failure. Secondly, government provided deposit insurance has made people forget the remaining problem. Because depositors will be paid in the worst case by the state that means that people have less incentive to become well informed about banking.

    Neither of these things mean that the banks are committing fraud or that without government intervention banking would be 100% reserve. When banking has been mostly free of government intervention people have chosen FRB even knowing that there are risks.

    > “Let’s suppose we have an isolated economy where the unit of
    > currency is the brick. There are no fractional reserve banks. People
    > use certificates for bricks which are 100% reserved. Over time the
    > technology for making bricks and mining minerals becomes more
    > advanced and bricks fall in cost. As such the brick makers can
    > produce more of them every year, if required. In this case the price
    > of other goods measured in bricks will rise, there will be price
    > inflation. Let’s suppose that manifests itself as persistant price
    > inflation that everyone expects, does that mean that anyone gains a
    > seigniourage income? No, even though prices are rising it
    > doesn’t. The brickmakers are not ‘watering down’ the bricks as kings
    > once mixed gold with base metals. Technology permits them to supply
    > bricks more cheaply. In this case there may be inflation without any
    > seigniourage. The normal steady price inflation we have seen in
    > developed countries in the past 50 years is similar.”
    >
    > In this example there is no seigniourage because the cost of
    > producing the brick is the same as its value,

    No, not necessarily. Brick makers could be making a profit from producing bricks and there would still be no seigniourage.

    > and inflation occurs
    > because the cost of producing bricks, and hence the value of bricks
    > against other commodities reduces over time. With fiat money, the
    > situation is completely different, because there is a big difference
    > between the cost of producing money (practically nothing for an
    > electronic demand deposit) and its value.

    What we’re talking about here is fractional reserve banking, not fiat money. What the government produce is fiat money. What banks produce is an on-demand money substitute.

    The cost to a bank of producing money isn’t “practically nothing” in any meaningful sense. If a bank wants to lend me £1000 then it must acquire £1000 in fiat money first so that it can hand that over to me when I ask. I’m not disagreeing here that money is created, my point is that the cost of doing so isn’t nothing.

    The bank must pay for the debt it buys from me by supplying me with funds. The cost of money creation is the cost to the bank of buying the debt, the profit is the income stream from the debt. Banks only create money when the profit outweighs the cost. They are like the brick-makers.

    > This is exactly what I meant in a previous post when I said all fiat
    > money is a liability against society as a whole, because unlike a
    > brick it has no inherent value.

    In your view does a loan-contract such as my mortgage have any “inherent value”? If not is it a “liability against society as a whole”?

    Just because a bank’s assets aren’t necessarily physical things doesn’t mean that they are liabilities of others. “Abstract assets” like debts still have owners.

    But, debt is more physical than people tend to think, in most debt relationships a debt has an associated physical collateral and the lender has the right to sieze it if payments aren’t made.

    > In a fractional reserve banking system banks do not create more fiat
    > money because the cost of producing said money is falling over time:
    > they do it because the Central Bank increases their reserves through
    > open market operations

    Yes, that’s right. My example was only hypothetical.

    > and they can then pyramid new loans on top of their new reserves to
    > increase the money supply in aggregate. They lend this money out at
    > interest and hence collect the difference between the cost of
    > producing the new money (virtually nothing) and the value of the new
    > money.

    If the cost of producing new money were zero then surely this profit would be very great. A bank could create £1000 at no cost and lend it out at interest thereby making a little over £1000 in clear profit. Have a look at a bank’s P&L account and see if you can find that huge profit :)

    > On the other side of the balance sheet, they do not pay me any
    > interest on my current account (the newly created demand deposit)
    > because they do not have to – I put my money there for safe keeping
    > and not as an investment.

    No, but they have to provide you with some banking services. I’m sure if they didn’t then you could keep paper money in a safe.

    • Recharge

      Current,

      Let me try going around in one more circle.

      “In my view the important problem with central banking is that the central bankers are poor economic guardians. They allow the creation of too much money at some times and too little at others.”

      Agreed, and in my view the problem is the complete lack of transparency and complexity of this system. How many (even well educated) people really understand how new money is created and how the monetary system works? This is why the proposals outlined above are so attractive: in this system it would be very clear how the new money is created, when it is created, and who has created it. Similarly, and even more importantly, money creation would cease to be the by-product of the lending activities of private banks and new money would not be lent into existence as debt. This is turn would cease the exponential growth in aggregate debt that is necessary to make the current monetary system work.

      “I’m not lending you any specific asset. I’m promising that when you ask I will supply something to you. The credit I give you doesn’t give you ownership of any of my beer or my other assets. You don’t own a share, you own a debt. I could have £1000 of beer and I could have given away £2000 of credit. In that case I must have £1000 of other assets to avoid being bankrupt.”

      Let’s forget the legal relationships for a minute to try and understand the fundamentals of this transaction. My point is that you have created an obligation to supply me some beer on demand and, if someone has entrusted you with this same beer for safe keeping, you already have an obligation to supply this same beer to him on demand. This is (to me at least) a fundamentally different sort of transaction from agreeing to supply someone credit up to the value of beer that you already own. Now, in the case of beer it is not so important, because if both parties demand their beer at the same time then one of them will be disappointed and will have to come back another day when I have procured more beer with the other assets I own. In the case of money however, the situation is very different, because (as you know) the loan I give to one customer (ie. the IOU asset on my balance sheet), becomes a deposit (a liability) at another bank, which in turn is used to create new assets (loans) by that bank, which in turn becomes a deposit at another bank… and so on until the money multiplier has worked its magic. This means that the failure to meet my demand for money means that you will have to use your assets (IOUs) to procure more money to meet my demand, so you duly call in your loans, which in turn leads to other banks having to call in their loans which in turn will cause a cascading collapse of the banking system as everybody tries to call in their loans simultaneously. In the end the legal relationships are irrelevant: the problem is the opaque, unstable underlying debt-based structure of the monetary system.

      “Why? What legal or moral imperative is there not to increase the money supply? If the transaction that creates money is legal then why can’t banks create it?”
      That is my point – it should be illegal – for all of the reasons given above: it is opaque, unstable and provides a subsidy to the banks in the form of seignorage (see below for further comments on this point).

      “My point here though is that banks don’t need to dupe anyone to create money, nor do they engage in seigniourage. Granted, someone could be duped, and in circumstances of unexpected changes in the demand for money banks could earn seigniourage.”

      Let’s try and clarify this point and go back to the original Goldsmiths. When they (originally) charged people to deposit gold with them for safe keeping, they soon realized that they could lend a large proportion of this gold out at interest. In this case they were charging both depositor and lender and increasing the money supply. Do you agree that they were collecting seignorage? If not, what would you call the value they appropriated? (I would call it seigniourage as they were appropriating the difference between the value of a gold certificate and the cost of printing it whilst paying no interest to the hapless depositor – he was in fact paying them). Over time, the Goldsmiths realized that they could make more money by attracting more people to deposit gold with them by paying (a small amount) of interest to depositors and pyramiding loans on their deposits. In other words, they were prepared to give away some of the seigniourage to depositors to allow them to increase the volume of their loans up to some profit maximizing level (ie. the seigniourage was now shared between the banks and depositors). In my view, this situation has not fundamentally changed up to the present time. The banks give away some of the value to demand depositors in the form of banking services and very low interest (and by the way it is not that long ago that banking services were not free and current accounts did not earn any interest at all). So the cost of producing money has increased from the banks perspective (not reduced as in your brick example) but it is still retaining a large amount of the seigniourage value for its shareholders (and its senior staff who appropriate a huge amount of the revenue of banks).

      “Why do you think that fractional reserve banking is a bank “genuinely acting as a broker”? I think that it is.”

      Banks do not genuinely act as brokers between borrowers and savers because the interest rate is not set by brokers in the market place to balance the supply and demand for loans. Rather, it is set by the central bank (and achieved through open market operations) to achieve a completely different objective, namely a targeted rate of inflation (and hence a certain rate of growth in the supply of money).

      “No, not necessarily. Brick makers could be making a profit from producing bricks and there would still be no seigniourage.”

      Sorry, I meant the full cost of producing the bricks, including an appropriate return on capital (ie. “normal profit”). This is why there is no seigniourage, because the full cost of marginal brick produced = value (assuming all bricks cost the same to produce). Gold is a bit different because the value of gold is not set by the long run marginal cost of the last unit of gold produced (as is the case with bricks), because there is always a shortage of gold so gold miners always earn super normal profits (this is a sort of seigniourage). With fiat money, the situation is even more extreme, there is a very low cost of production but a huge value, so the producer of the money always makes a super normal profit (aka economic rent): this is called seigniourage in the case of fiat money . I agree that the banks give some of this away to their depositors, but they still collect the lions share and earn super normal profit.

      “If the cost of producing new money were zero then surely this profit would be very great. A bank could create £1000 at no cost and lend it out at interest thereby making a little over £1000 in clear profit. Have a look at a bank’s P&L account and see if you can find that huge profit :)”

      If you take a look at the growth in the money supply (M4) since the early 1970s when it exploded and then you then take a look at the cumulative excess returns to finance (as reported in Haldine (2009) Chart 1, http://www.bis.org/review/r090710e.pdf?frames=0), you will see that it also explodes exponentially in the early 70s, such that £100 invested in 1900 would have been worth £10000 in 2006 (16% CAGR over the whole 106 year period). Similarly, their median return on equity (in the decade pre-financial crisis http://www.bankofengland.co.uk/publications/fsr/…/FSR07Oct3.ppt) was around 25%. Now I don’t know which industry you work in, but by the standards of the (mature, like banking) industry that I work in that looks pretty super normal to me.

      It is true that much of this excess return to equity was wiped out in the subsequent banking crisis, but that only goes to underline my point about instability and the un-sustainability of the debt based money creation system. It also does not alter the fact that for a period of almost four decades (which happened to co-inside with a period of enormous bank money creation), the banks earned huge super normal profits(and many of their current and former executives are still living off this – notoriously Fred the Shred for example). It might just be co-incidence of course.

  • Robert Thorpe Current

    Recharge,

    > Let me try going around in one more circle.

    Just one more time :)

    > “In my view the important problem with central banking is that the
    > central bankers are poor economic guardians. They allow the creation
    > of too much money at some times and too little at others.”
    >
    > Agreed, and in my view the problem is the complete lack of
    > transparency and complexity of this system. How many (even well
    > educated) people really understand how new money is created and how
    > the monetary system works?

    I agree that the system is complex and not transparent, and I agree
    that that doesn’t help.

    > This is why the proposals outlined above are so attractive: in this
    > system it would be very clear how the new money is created, when it
    > is created, and who has created it.

    Yes, that aspect of it is better than the current system.

    > Similarly, and even more importantly, money creation would cease to
    > be the by-product of the lending activities of private banks and new
    > money would not be lent into existence as debt. This is turn would
    > cease the exponential growth in aggregate debt that is necessary to
    > make the current monetary system work.

    But, what you’re describing is really a non-problem. As I mentioned earlier, the “exponential growth” is in nominal debt not real debt. The growth of the debt is a product of the guidance of the central bank which is in the direction of gradual price inflation.

    There is nothing wrong with money creation occurring through private banks in my opinion.

    > “I’m not lending you any specific asset. I’m promising that when you
    > ask I will supply something to you. The credit I give you doesn’t
    > give you ownership of any of my beer or my other assets. You don’t
    > own a share, you own a debt. I could have £1000 of beer and I could
    > have given away £2000 of credit. In that case I must have £1000 of
    > other assets to avoid being bankrupt.”
    >
    > Let’s forget the legal relationships for a minute to try and
    > understand the fundamentals of this transaction. My point is that
    > you have created an obligation to supply me some beer on demand

    In the original example I didn’t say that I promised specifically beer. But still, we can use that example if you like.

    > and, if someone has entrusted you with this same beer for safe
    > keeping, you already have an obligation to supply this same beer to
    > him on demand.

    Yes.

    > This is (to me at least) a fundamentally different sort of
    > transaction from agreeing to supply someone credit up to the value
    > of beer that you already own.

    Yes, I agree it is. Legally it is too, if someone agrees to store something for another then that is called a bailment. If someone agrees to supply something on-demand to repay a debt then that’s a debt contract.

    > Now, in the case of beer it is not so important, because if both
    > parties demand their beer at the same time then one of them will be
    > disappointed and will have to come back another day when I have
    > procured more beer with the other assets I own.

    Yes, but in similar cases can be important.

    Notice also that what you say about beer is also quite true of gold reserves if the bank uses an option clause.

    In Scotland in the period of free-banking banks generally didn’t gaurantee to pay on demand. They gauranteed to do one of two things:
    1) Pay on demand.
    2) Pay a higher amount later.

    They gauranteed to pay a penalty interest rate to the note holder. So, if it happened that a note holder came to the counter when there was no gold then the bank could invoke the option clause and pay later. It could pay later by selling assets for gold.

    However, the option clause was almost never used like that. In reality the banks could quite easily tell how much gold they needed, so they never ran short of reserves. The clause ended up being used mainly to irritate competing banks.

    > In the case of money however, the situation is very different,
    > because (as you know) the loan I give to one customer (ie. the IOU
    > asset on my balance sheet), becomes a deposit (a liability) at
    > another bank, which in turn is used to create new assets (loans) by
    > that bank, which in turn becomes a deposit at another bank… and so
    > on until the money multiplier has worked its magic.

    If you think about this some more it isn’t that different from the example I gave. A brewer (for example) can list within his assets sums that are owed to him by those who he supplies. The reinsurance industry does essentially the same thing on a very large scale, not as large as banking, but similar.

    I think it’s very important to understand exactly what’s going on with the money multiplier here. Let’s suppose I have 100 gold coins and I deposit them in a bank. The bank must increase it’s reserve slightly, but it can lend the rest of the coins out. It can only lend those coins out if it has a good loan that it can make. Remember, the bank must part with the actual gold coins if it lends them out. The loan accounting entry at one bank doesn’t create a deposit accounting entry at another without anything else happening. When it occurs the sum of gold involved is exchanged.

    > This means that the failure to meet my demand for money means that
    > you will have to use your assets (IOUs) to procure more money to
    > meet my demand, so you duly call in your loans, which in turn leads
    > to other banks having to call in their loans which in turn will
    > cause a cascading collapse of the banking system as everybody tries
    > to call in their loans simultaneously.

    The type of collapse you mention has never really happened. That’s not to say there have been no banking crises, but rather those that have occurred have been quite different in nature. As I’ve said before, generally banking collapses are caused by the market realising that the assets of the bank are worth less than was previously thought.

    Something I still think you’re missing is that the banks assets are the most important thing, not it’s reserves. A bank must keep enough reserves to pay out those redemptions that occur, that’s one of the things it must do. But, far more importantly it must maintain good assets. Let’s suppose that on some particular day a bank has no gold for some reason (suppose it’s robbed). But, it has plenty of assets, much more than the value of it’s liabilities. In that case it can enter the gold market and buy enough gold to replenish the reserve it needs for regular transactions. The sum of assets and gold reserves a bank has must be more than 100% of the value of its liabilities, it’s not only the gold reserves that count. The bank’s capital, it’s margin of assets beyond liabilities is the real measure of it’s soundness, not it’s reserve ratio.

    You suppose that when there is a rise in redemption at a bank it will call in loans. Why would it do that? Why not sell assets, or pay less dividend? The bank doesn’t have to call in it’s loans and probably wouldn’t. If a bank did then that indicates that it was probably bankrupt anyway.

    > In the end the legal
    > relationships are irrelevant: the problem is the opaque, unstable
    > underlying debt-based structure of the monetary system.

    I agree that if there were a good argument that FRB be banned then the law should be changed no matter what it says now. I just don’t think there is.

    When you describe it as “opaque” what you mean is that it’s private people conducting private business. Certainly it is, and that is often opaque in other circumstances, but it’s opacity doesn’t cause problems. Why do you think it causes problems here?

    I work in the semiconductor industry. Have you any idea how the chips in your PC work? I do but I only have a vague understanding of most of them. That doesn’t matter, the industry works anyway because it delivers products the consumer wants. The same is true of banking, bank customers don’t have to have a perfect understanding of the legal status of their accounts to be able to use them.

    > “Why? What legal or moral imperative is there not to increase the
    > money supply? If the transaction that creates money is legal then
    > why can’t banks create it?”
    >
    > That is my point – it should be illegal – for all of the reasons
    > given above: it is opaque, unstable and provides a subsidy to the
    > banks in the form of seignorage (see below for further comments on
    > this point).

    At the beginning of this thread you were discussing things from a quite Rothbardian point of view. That is, you were discussing the local rights-and-wrongs of FRB. Now you’ve moved into a wider argument.

    I’m a utilitarian (a rule utilitarian). I believe that the law should be shaped by what produces the best long-run outcomes. I don’t believe in natural law. My point is arguing about the local situation with FRB was to show that FRB isn’t anything particularly special or unique. All that’s really special about it is the creation of money-substitutes, apart from that it’s quite like other debt relationships.

    So, I’d agree with you that FRB should be prevented by law if I thought it was bad for the long-term health of society. But, I don’t. If you read the books by Steve Horwitz, Larry White and George Selgin they show that most of these supposed disadvantages of FRB are really either myths or disadvantages of Central Banking.

    > “My point here though is that banks don’t need to dupe anyone to
    > create money, nor do they engage in seigniourage. Granted, someone
    > could be duped, and in circumstances of unexpected changes in the
    > demand for money banks could earn seigniourage.”
    >
    > Let’s try and clarify this point and go back to the original
    > Goldsmiths. When they (originally) charged people to deposit gold
    > with them for safe keeping, they soon realized that they could lend
    > a large proportion of this gold out at interest. In this case they
    > were charging both depositor and lender and increasing the money
    > supply.

    No, even the early Goldsmiths paid interest to depositors. Samuel Pepys lent to a goldsmith, he recorded that he was paid interest (of ~7% per annum I think).

    > Do you agree that they were collecting seignorage? If not, what
    > would you call the value they appropriated? (I would call it
    > seigniourage as they were appropriating the difference between the
    > value of a gold certificate and the cost of printing it whilst
    > paying no interest to the hapless depositor – he was in fact paying
    > them).

    There is no evidence that the early Goldsmiths ever claimed to supply “gold certificates”, which in Austrian terms are bailments for gold. Like modern fractional reserve bankers they dealt in debt. They stored gold only if specifically requested.

    The income they collect is profit and completely legitimate.

    > Over time, the Goldsmiths realized that they could make more money
    > by attracting more people to deposit gold with them by paying (a
    > small amount) of interest to depositors and pyramiding loans on
    > their deposits. In other words, they were prepared to give away some
    > of the seigniourage to depositors to allow them to increase the
    > volume of their loans up to some profit maximizing level (ie. the
    > seigniourage was now shared between the banks and depositors).

    I don’t see how you can call this seigniourage. In my view, if the word “seigniourage” is to be meaningful it must mean that someone is debasing money and issuing something in place of it that is not worth what others believe it’s worth. Exactly where in the process you describe does this happen?

    As George Selgin has pointed out even the books that were written to demonize Goldsmiths in their time did not accuse them of lending out money they had promised to store.

    > In my view, this situation has not fundamentally changed up to the
    > present time. The banks give away some of the value to demand
    > depositors in the form of banking services and very low interest
    > (and by the way it is not that long ago that banking services were
    > not free and current accounts did not earn any interest at all).

    In the past banks provided services at subsidised prices. Also, they provided security that’s difficult to achieve by storing money at home.

    I don’t understand why supplying current account holders with banking services and interest is somehow “splitting” seigniourage with them. Isn’t seigniourage taking something away from money holders not giving them something?

    > So the cost of producing money has increased from the banks
    > perspective (not reduced as in your brick example) but it is still
    > retaining a large amount of the seigniourage value for its
    > shareholders (and its senior staff who appropriate a huge amount of
    > the revenue of banks).

    Certainly, banking makes money, I disagree that this is seigniourage though.

    Think about this, suppose that the central bank didn’t create new money and commercial banks didn’t either. Suppose that everyone became used to that new situation, so they factored it into debt contracts. In that case wouldn’t FRB banks still exist and pay similar amounts to senior staff and shareholders?

    Remember a point I made earlier I don’t think you’ve answered…. A fractional reserve bank must always support it’s liabilities with assets. It must lend to people, people who calculate in real terms and work out as well as they can the real value of their repayments. In a world of steady inflation that means everyone has steady inflation factored in.

    So, how does a bank earn from seigniourage? If the central produce £X of new money then if the bank wants to lend that money out it must buy it by offering competitive loans. This is exactly why the amount of nominal debt outstanding must always be rising if there is steady inflation. It doesn’t get it for free, only the government gets it for free.

    > “Why do you think that fractional reserve banking is a bank “genuinely acting as a broker”? I think that it is.”
    >
    > Banks do not genuinely act as brokers between borrowers and savers
    > because the interest rate is not set by brokers in the market place
    > to balance the supply and demand for loans. Rather, it is set by the
    > central bank (and achieved through open market operations) to
    > achieve a completely different objective, namely a targeted rate of
    > inflation (and hence a certain rate of growth in the supply of
    > money).

    Well, I agree that the price which banks buy and sell their debts for isn’t a free-market price, it’s a price set by the central bank. But, that doesn’t mean they aren’t brokers, rather it means that the market they work in is rigged.

    Farmers are still farmers and sell cows even though the market they work in is subsidised.

    To be clear, I’m not defending Central Banking here. I think that in the long-run the BoE should be abolished and we should have free banking. I’m defending fractional-reserve banking here.

    As I said earlier I agree that if the Central bank make an unexpected expansion of the money supply then the commercial banks *do* make an unjust profit.

    > “No, not necessarily. Brick makers could be making a profit from
    > producing bricks and there would still be no seigniourage.”
    >
    > Sorry, I meant the full cost of producing the bricks, including an
    > appropriate return on capital (ie. “normal profit”).

    I don’t really agree with your theory of profit, but that’s something for another time.

    > This is why there is no seigniourage, because the full cost of
    > marginal brick produced = value (assuming all bricks cost the same
    > to produce). Gold is a bit different because the value of gold is
    > not set by the long run marginal cost of the last unit of gold
    > produced (as is the case with bricks), because there is always a
    > shortage of gold so gold miners always earn super normal profits
    > (this is a sort of seigniourage).

    In my example bricks were money. So, surely in my example bricks also earn “super normal” profits?

    Notice that in the long-run there is always a shortage of *anything*. Bohm-Bawerk discusses this in his books.

    I don’t understand why you think “super normal” profits occur. If the existing brick makers are making very high profits then why don’t more companies move into making bricks? Similarly, if gold mining makes very high profits then why don’t other companies move into that?

    Just as importantly, why is it a bad thing that people compete to make a commodity. If I make a box of tea bags that are the same as other tea bags, but more cheaply priced then have I diddled anyone? No, I’ve competed with them legitimately. Similarly, if a brick is money and I sell bricks more cheaply than others sell bricks, or if I offer extra services, then I’m competing legitimately. Nothing about this changes just because money is the subject of the discussion.

    > With fiat money, the situation is even more extreme, there is a very
    > low cost of production but a huge value, so the producer of the
    > money always makes a super normal profit (aka economic rent): this
    > is called seigniourage in the case of fiat money . I agree that the
    > banks give some of this away to their depositors, but they still
    > collect the lions share and earn super normal profit.

    Well, why don’t more people start up banks then and capture some of that profit? :)

    > “If the cost of producing new money were zero then surely this
    > profit would be very great. A bank could create £1000 at no cost and
    > lend it out at interest thereby making a little over £1000 in clear
    > profit. Have a look at a bank’s P&L account and see if you can find
    > that huge profit :)”
    >
    > If you take a look at the growth in the money supply (M4) since the
    > early 1970s when it exploded and then you then take a look at the
    > cumulative excess returns to finance (as reported in Haldine (2009)
    > Chart 1, http://www.bis.org/review/r090710e.pdf?frames=0), you will
    > see that it also explodes exponentially in the early 70s, such that
    > £100 invested in 1900 would have been worth £10000 in 2006 (16% CAGR
    > over the whole 106 year period). Similarly, their median return on
    > equity (in the decade pre-financial crisis
    > http://www.bankofengland.co.uk/publications/fsr/…/FSR07Oct3.ppt) was
    > around 25%. Now I don’t know which industry you work in, but by the
    > standards of the (mature, like banking) industry that I work in that
    > looks pretty super normal to me.

    I agree that banking is very profitable. In my view much of those profits you mention came about because of expansions of the money supply by the central bank. In the inflationary episodes of the 70s and 80s and the subsequent busts, for example.

    My point above was this:
    > A bank could create £1000 at no cost and
    > lend it out at interest thereby making a little over £1000 in clear
    > profit.

    You implied earlier that a bank can create money costlessly. That’s not true, money to a bank is a liability.
    In fact you said the same thing again here:

    > With fiat money, the situation is even more extreme, there is a very
    > low cost of production but a huge value, so the producer of the
    > money always makes a super normal profit (aka economic rent)

    I assume what you mean here is the cost of production of the paper, but, that has little to do with it. A bank needs a note for 500 ounces of gold to issue a note for 500 ounces of gold. Far more importantly it needs an asset worth 500 ounces of gold. How can it obtain that without paying something close to the same amount?

    My point here is that banks make no peculiar sort of steady-state profit. In normal circumstances when the Central bank is neither contracting or expanding unusually they make profit in the same way that other industries do.

  • On reading the Moving Forward With Practical Reform statements 14 Dec 10 I assume that “state issued currency” means the issue of coin and notes which is a tiny fraction of the money supply or it means the issue of treasury bonds to private banks for capital raising for government , however the private banks then expand the money supply by the fractional reserve process,upon the bonds it is this process that I have issue with as the central or reserve bank is separate to government and can decide the SRD or the prime assett ratio for credit creation not the government.
    I agree with the statement that a failed bank should not be bailed out as it has just applied too much risk in debt management upon the privilage of credit creation, and deposit insurance should be paid by the banks themselves not the taxpayer, and I suggest that a nationalised bank owned by the government would be a full reserve or full assett backed bank due to all backing comming from the national productivity of the public as is the case for private bank loans public and private today.
    Gold backing is still in use in some countries, however in those countries there seems to be no better result in the outcomes we are discussing such as unpayable debt causing failure on the speculation of multiples in loans.
    The Australian experience in years 1911 to 1923 was a grand experiment in the use of full government banks, where the government bank was used in compitition with private banks, it was able to keep interest rates down by this compitition, it also funded the Indian Pacific Railroad with no debt at the completion of this 2500 mile long project, also the first world war was funded by this bank with no debt at the end of hostilities.
    Today Australia has no Government Bank or State Government Banks, thy sold them all of in “deregulation”in the 70’s
    In contrast the Sydney Harbour Bridge was funded by the Bank Of England in 1920-30 and we finished paying for it in 1982
    My input for your study if you wish could elaborate on this Australian experience, plus my own understanding of the Banking systems around the world is that they are mostly all private banks with a central or reserve bank, all not directly responsible to the government yet managed by the relationship between the treasury of the government and the central or reserve bank looking like a government bank.
    In my opinion this arrangement could be managed by the government and treasury working directly with government banks all open and accountable to the public.
    And if this type of bank system would charge no more on fee or interest than the actual cost of running the banking system which means a no profit bank or a very small return if and when required by the government the reasons being open also to the public, however an upper limit of interest or fee charge placed in the bank acts, somthing like 3% and no more.
    This limit would drive all shylocks out of wanting to be in the bank system, and begin a system where all things physical can be made finiancially possible.
    This arrangement allows the cost of providing a suitable means of exchange using a monetary unit that works like a postage stamp without speculation bubbles, making the money supply a service rather than a commodity that has value in itself, rather the value is in the ease of exchange without the cost speculation applied at present.
    If you study say H. G. Mclowd the creator of the early English bills of exchange acts and ours you will see that he is in two thoughts about this subject saying on one hand private banks boosted early trade, however he also states that the excessive use of high ratios in credit creation caused many failures in Scotland and England in the past.
    Lastly I feel we will not be able to change anything untill all the people see the result of a final collapse of the present banking systems and demand change everywhere in the world, I hope over time we can arrive at an understandable remedy before and after this happening that sems not far off.
    Thank you for the chance to discuss this with you and all the best Allan Jones Lithgow NSW Australia.