http://www.npr.org/blogs/money/2010/08/26/129451895/how-to-spend-1-25-trillion
Cranky money policy or real economics?
Is this the start of the decline of the American Imperial Empire we are observing?
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By kind permission of Paul Birch, we reproduce his essay setting out a proposal for honest money through bearer shares, previously published on this site in October 2009. Paul’s own site may be found here: www.paulbirch.net. 1. Introduction Nobody understands money, least of all economists. Too sweeping a statement? Perhaps. But every analysis of the workings of monetary systems that I have ever read has been seriously in error at one or more crucial points. This is true not only of the supposedly impartial opuses of academic economics, but also of the writings of Marxists, socialists, Keynesian dirigists, free-marketeers, anarcho-capitalists, libertarians and utopians of every flavour. On important issues of monetary policy, then, and whether a free market in money is either workable or desirable, the protestations of the experts must be considered unreliable. In particular, the claims of libertarian-leaning economists, such as Ludwig von Mises, that the operation of “free banking” would be both stable and superior to the system of government monopoly called “central banking” need to be treated with scepticism; they have not proved what they think they have proved. Here I intend to give a description of certain aspects of the creation and use of money free of major error; it is conceivable that I may not entirely succeed. I shall argue that free banking, as it is usually understood, may be liable to gross instabilities and inefficiencies, especially in a free-market environment, and that a centralised fiat currency has definite advantages. However, I shall then describe an alternative form of free-market banking that appears not to suffer from these deficiencies and into which the current system of state control could be metamorphosed. I shall argue that it is the innate honesty or dishonesty of the banking method that most distinguishes good money from bad; and that it is of the greatest importance to ensure that the laws under which banking takes place are able effectively to restrain all dishonest forms of banking, including those in which the dishonesty is most subtle. 2. What is Money? So what is money? A deceptively easy question, that. Answers from the past include “gold”, “silver and gold”, “a medium of exchange”, “a promise to pay”, “a store of value”, “a measure of demand”, “just another commodity”. Such answers hold a germ of truth, but only lead to controversy, because they miss the essential point. All along we’ve been asking the wrong question. Instead, let us ask a new one: What is the function of money? The function of money is to keep track of who owes what to whom. In a world in which there is division of labour and in which we obtain diverse satisfactions by the voluntary exchange of goods and services we have need of an accounting device to permit this exchange to take place at minimal cost and without undue coercion or confusion. This accounting device we call money. Simple barter is not enough, because the goods I want are seldom held by the person to whom I can render service. Imagine a central register, detailing every transaction entered into by each and every person, and containing a list of all the favours owed by each and every person to each and every other person. That would do it. It would be hideously complicated, but it would work. Fortunately, though, we needn’t go to such lengths, because in a market economy most of that data is redundant. All we really need to know is the current balance to the account of each person — how much the rest of the world owes him or how much he owes the rest of the world — and even that need not be centrally recorded. In a market economy, then, the function of money is to reduce the transaction costs of honest trade (including gifts and bequests other than those directly in kind) by reliably and efficiently registering the indebtedness resulting from previous transactions. The details of those previous transactions no longer matter; only the present net position counts (except for incomplete transactions, such as when you have bought an item but not yet paid for it). So, if the function of money is to keep track of honest trade, can we now answer the original question in a more enlightened and constructive way? I think we can. Continue reading “Honest Money through bearer shares, a proposal” Last night, yours truly, along with a number of other Cobden Centre supporters and assorted free marketeers, listened to Toby Baxendale talk about a radical proposal to sort out the UK national debt. He talked about a good many other things, but the centrepiece of his talk was how, as part of a key reform, we could slash the debt burden and save future generations from the crippling expense of the current debt. What interested me, beyond the core of Toby’s talk, was the reaction from the audience. A number of people I spoke to – their conversations are off-the-record so I will not name them – told me they were skeptical about Toby’s reasoning on the national debt point, although they accepted that, at face value, there may be a vital point they were missing. I must say that I am not entirely convinced myself but that may because I have not understood the point and need to do a bit more thinking and reading. In particular, there is a worry that the Cobden Centre might appear, unless we thrash these issues out clearly, to be pitching some sort of “magic bullet” solution. And I am sure that Toby does not regard there being anything magical about honest money. One simple issue that arises from any plan to wipe out a lot of debt is the law. In debt restructurings, for example, one point that bankers have to deal with is the seniority of debt holders. The UK’s national debt is held by a variety of different people, foreign and domestic; it is held by a variety of institutions. Any plan to adjust debt, or cut it, has to take into account the kind of people who hold it and any contractural issues that may arise. It may sound nick-picky but it is the sort of detail that is actually very important in resolving debt issues at the corporate level, for example. I was mightily impressed by the few words of Steven Baker in reference to his maiden speech on the issue in the House of Commons. It almost seems too good to be true that we have a sitting MP who actually understands, and wants to spread understanding of, these issues. (The fact that Steven has actually had a serious job as an engineer is also a refreshing change). For far too long, the free market position has suffered from a lack of articulate defenders in parliament (there have been honourable exceptions, such as the late Nicholas Budgen or Jock Bruce-Gardyne). Simply conveying the message that states make a mess of money is a key argument to make. It would be good for other MPs and commentators in the mainstream media to be more acquainted with the Austrian school. There are already signs that this might be stirring: consider this article on banking by Dominic Lawson, who seems to have inherited his father’s grasp of good economics. Advisory Board Member Steve Baker, MP for Wycombe, yesterday made his maiden speech in the House of Commons. The full text may be found here. The articles which most closely inspired the speech are here and here. The following section of the speech — which we have annotated with links to relevant articles — made some key points about honest money:
In recognition of soaring inflation, and the looming threat that our new government will resort to monetisation of the national debt, we are bringing forward this classic article, originally published in December 2009. Mr Smith works hard, plans carefully, and saves what he can, putting his money into a building society. He pays his credit card bills off each month, and tries to overpay his mortgage when he can. Mr Smith got a 3% pay rise last year – inflation was only 2% – so he felt good about that. But… he doesn’t feel any wealthier. Year after year, the government had said that the economy was growing strongly, but still, things seemed harder for his family and him. Train ticket prices up again. Heating bills rocketed when the price of oil went up, but never seemed to come down. He swears a loaf of bread and a pint of milk were much cheaper in years gone by. When he changes his cash for Euros, he realises that his holiday in France is now unbearably expensive. His tax rates didn’t go up, but still, after all his bills were paid, he seemed to have less and less spare cash than he remembers a few years ago. There are Mr Smiths everywhere. Careful folk, who plan, save for a rainy day and have a sense of personal responsibility. Smith is the target. It is Mr Smith who is going to pay for the banking crisis. His saved wealth will pay the national debt. His prudence will bail out Gordon Brown’s profligacy. His forgone holiday will pay the banker’s bonuses. His careful spending will pay for the vast number of quangos. His financial planning will bail out the failed NHS computer project, over-budget military programs and ID cards. His sense of responsibility will end up funding the destruction meted out in Iraq and Afghanistan. It won’t be the politicians or the bankers who pay for global warming – he will. He knows he pays tax… but what is hard for him to comprehend is that there is another pernicious process draining his wealth and subverting his hard work towards paying for the misjudgement of others. Whether he likes it or not, he naively pays for the decisions made by the political class. He has no choice. No option. He was never asked to vote for it. And for the most part, the act of theft is so subtle he doesn’t even know it is happening. Why does he feel poorer? Why is it that Mr Smith seemed to miss the ‘boom’, yet is hurting more in the bust? Why doesn’t life get easier for him? What is going on? Inflation. As technology produces things more cheaply, Mr Smith should have been able to reap the rewards – except that things don’t get cheaper for him. Society cheats him when the government opens the spigot of new money, washing this value away as the torrent of new money chases prices higher beyond his reach. The winners are always those close to the gusher – the banks, financiers and politicians. These are the ones who get to spend the new money first, thus chase prices up before Mr Smith gets any sniff of what is happening. To save or to invest?Think about your personal circumstances. Every time your payslip comes in, you have a choice of how much to spend and how much to save. Every rational person knows that there is a balance to be struck between current enjoyment (consumption) and future enjoyment (savings – or deferred consumption). This choice is exactly the same for society as a whole. As a country, we must decide how much to consume, and how much to defer consumption in order to allow our children and us to enjoy things in the future. The choice for us all is simple. Defer consumption and invest for the future, or consume and enjoy now. What is the process by which we save for the future? There are two ways.
The evil of Forced SavingThe natural state of affairs in a free market, with a more consistent supply of money, is that general prices fall as technology advances. The prudent are rewarded, and borrowers have to carefully evaluate and moderate their flights of fancy, only investing borrowed funds carefully in sound projects. When the value of money declines, savers find that their money buys less, whilst borrowers are happy to find that they can repay their debts with money of a decreased value. It’s like borrowing five books from the library and finding that you are only required to give four back! By setting a target for rising prices and then pulling levers to increase the supply of money in the economy to achieve it, the government prevents the natural response of general prices to competition, increased efficiency and innovation: they stop prices from falling. Entrepreneurs, innovators, inventors and new businesses exist because they believe that they can satisfy society’s wants better than they have been served before. They have ideas, innovations and take risks in order to provide goods that are cheaper than they otherwise would be. Businesses operating in a competitive environment always seek to reduce costs, be that one step more efficient and produce a cheaper or better widget. As group of people, entrepreneurs bring efficiency and innovation, and they make stuff cheaper. The benefit to Mr Smith should be that his income goes further. As time progresses, technological innovation should mean he can buy more with the same cash. But that’s not what happens, as any pensioner knows. Saved money buys far less now than it did at the time it was saved. Governments achieve rising prices by encouraging the supply of new money. This new money comes from the central bank via its control of the banking system. The first users of this new money are invariably politicians, finance capitalism and big business. These guys get to use the newly minted money first, and thus spend it first. This process bids up prices, leaving everyone else chasing behind, and poor old Mr Smith last in the queue. What an evil system it is then, when government can control money in such a way as to give it a first user advantage that penalises all those in the general population whose wealth is being rapidly diluted. A process that systematically violates and loots pensions, savings, fixed incomes and the actions of prudent, and rewards the profligate, the speculative borrowers and above all, rewards the biggest borrower of all: Government. Let’s be clear. The current system is a process that diverts the benefits of innovation and technological advancement that should accrue to the general population, and thrusts it towards the desired spending of the well connected and the political class. We need to stop this continual violation of the little man. Mr Smith has to start realising what is happening to him. That’s why I’m proud to support the efforts of the Cobden Centre. There are many possible routes to sound money. On the 18th of May, I outlined my plan to reform the banking system. Yesterday we published an alternative proposal from our Founding Fellow Dr. Anthony J. Evans. Today I’d like to highlight some pure Austrian thinking from Philipp Bagus, Assistant Professor at Universidad Rey Juan Carlos, Madrid. His paper is entitled Monetary Reform – The Case for Button-Pushing. The abstract lays out his approach:
Bagus concludes
Please read the whole paper. Bagus also has some very valuable insights to offer on the subject of maturity mismatching, which featured heavily in the debate over my Emperor’s New Clothes proposal. There’s two ways to view the financial meltdown that occurred in 2008. The first is that it was a rare and unfortunate blip that can be remedied with calm and enlightened improvements in the regulatory framework. The second is that it exposed a serious flaw in the entire monetary system, and is likely to be repeated unless a radical transition takes place. It’s no surprise that politicians, bankers and regulators – the architects of the banking industry – favour the first idea. This is why their response has skirted around the edges instead of dealing with the core. Even supposedly extreme measures such as nationalising banks are in fact attempts to preserve the status quo.
For those of us who favour the second idea, 2008 provided a golden opportunity to join the public debate and present a credible alternative. Perhaps we missed it. But if indeed another crisis is coming, this article attempts to outline a 14-point plan that could be implemented quickly and genuinely reform the institutions that create financial instability. The key aspects of this proposal have been made previously, notably by economists Kevin Dowd and Richard Salsman. It could be implemented in three phases: Over 2 days the aim is to ensure that all operating banks are solvent
Over 2 weeks the aim is to monitor the emergence of free banking
Over 2 months the aim is the end of central banking
You can download a copy of the plan in pamphlet form here. This post originally appeared on stevebaker.info. Via The Telegraph.
But this begs the question, “Why is the money supply dependent on interest rates and government spending?” It turns out the great economist Irving Fisher told us back in the 1930s: banks create and destroy credit money by granting and calling loans. As Fisher wrote:
He went on (emphasis mine):
Fisher set out the problem in the 1930s and a solution, one which offered the possibility of paying off the national debt and largely ending economic cycles: 100% reserves on demand deposits. We face the same problem today and we have the same tantalising possibilities. There are politicians who understand: see for example the speech by the Earl of Caithness in the Banking Bill Debate 2009:
This is why colleagues and I established The Cobden Centre: we need honest money now to end the crisis and set us on a firm foundation for a sustainable and healthy future economy.
This article was originally published in October 2009. Many people know the Bank of England is creating new money through quantitative easing but if the quantity of money is being increased, how is that quantity being measured? What is counted as money? As the Bank of England explains:
But when I consider quantitative easing, I am concerned with the following problems:
As my colleagues point out in their working paper, the fact that the monetary authorities have turned to increasing the quantity of money will focus attention on how that quantity is measured. This article provides some background information and indicates Baxendale and Evans’ key findings. Continue reading “What is money?”
This article was originally published on 20 January 2010. It is a speech by James Tyler to the Adam Smith Institute Next Generation Group on 6 October 2009. This speech is also available on hedgehedge.com. I have spent the best part of the last two decades pitting my wits against the market. It’s an unforgiving game: I’ve seen ups and downs, and many of my rivals buried under an avalanche of hubris, passion, illogical thought and unchecked emotion. I have witnessed the sheer folly of the ERM crisis, the Asian crisis, the failure of the Gods at Long Term Capital Management and the insanity of the tech boom. I have enjoyed the ‘NICE’ decade (Non-Inflationary Constant Expansion), and scared myself silly during the credit crisis. I am a trader. I risk my own money and live or die by my decisions, and face the threat of personal bankruptcy every time I switch my screens on. I get no salary – indeed I turn up at the start of the month with a large office overhead – a ‘negative’ salary. I have no fancy company pension scheme, no lucrative monopoly or franchise. I eat what I kill. Mistakes cost me my livelihood, so, above all, my decisions have to be rooted in practical and logical decision making. Some have called my kind parasitic, but I would have said that I bring order, efficiency, predictability, stability and deep liquidity to a crucial process: a process that makes the whole world keep ticking. I make money work. I make the market in interest rate derivatives: a market born out of the neo classical revolution in finance fostered in Chicago during the 1970s. I am a child of Friedman, Fisher Black, Myron Scholes and the modern international financial system. My analysis was steeped in the neo-classical, efficient markets paradigm. Friedman’s ideal was working. Enlightened central bankers guided the free market with gentle nudges and short term liquidity infusions, free floating currencies gently adjusted themselves to the constant flow of new information and efficient and rational markets took all in their stride. Credit flowed, people got wealthier, economies developed and all was well. And then the crisis struck. |
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In their working paper