This article was published yesterday at stevebaker.info.
Today sees the return of the Financial Services (Banking Reform) Bill to Parliament. It does not do enough.
In the book Banking 2020: A vision for the future, my essay summarises the institutional problems with our monetary and banking orthodoxy:
The features of today’s banking system
As Governor of the Bank of England Sir Mervyn King told us in 2010: ‘Of all the many ways of organising banking, the worst is the one we have today.’
Notes and coins are irredeemable: the promise to pay the bearer on demand cannot be fulfilled, except with another note or coin with the same face value. Notes and coins are tokens worth less than their face value and are issued lawfully and exclusively by the state. This is fiat money.
When this money is deposited at the bank it becomes the bank’s property and a liability. The bank does not retain a full reserve on demand deposits. In the days of gold as money, fractional reserves on demand deposits explained how banks created credit. Today, credit expansion is not bounded by the redemption of notes, coins, and bank deposits in gold.
Because banks are funded by demand deposits but create credit on longer terms, they are risky investment vehicles subject to runs in a loss of confidence. States have come to provide taxpayer-funded deposit insurance. This subsidises commercial risk, producing more of it and creating moral hazard amongst depositors who need not concern themselves with the conduct of banks.
The state also provides a privileged lender of last resort: the central bank. It lends to illiquid but solvent banks getting them through moments of crisis. In a fiat money system, central banks have the power to create reserves and otherwise intervene openly in the money markets. Today this is most evident in the purchase of government bonds with new money, so-called quantitative easing.
The central banks also manipulate interest rates in the hope of maintaining a particular rate of price inflation through just the right rate of credit expansion to match economic growth. That otherwise free-market economists and commentators support such obvious economic central planning is one of the absurdities of contemporary life.
Compounding these flaws is the limited liability corporate form. Whereas limited liability was introduced to protect stockholders from rapacious directors, its consequence today is ensuring no one taking commercial risks within banks stands to share in the downside. This creates further moral hazard.
Regulatory decisions have been taken to encourage banks to make bad loans and dispose of them irresponsibly. Among these are the US Community Reinvestment Act and the present government’s various initiatives to promote the housing market and further credit expansion.
Having insisted banks make bad loans, the regulatory state imposed the counterproductive International Financial Reporting Standards (IFRS) which can over-value assets and over-state the capital position of banks. This drives the creation of financial products and deals which appear profitable but which are actually loss-making. Since these notoriously involve vast quantities of instruments tied to default, the system is booby-trapped.
Amongst the many practical consequences of these policies was the tripling of the money supply (M4) in the UK from £700 billion in 1997 to £2.2 trillion in 2010. Credit expansion at this rate has had predictable and profound consequences including asset bubbles, sectoral and geographic imbalances, unjust wealth inequality, erosion of physical capital, excess consumption over saving, and the redirection of scarce resources into unsustainable uses.
Moreover, credit cannot be expanded without limit. Eventually, the real world catches up with credit not backed by tangible assets: booms are followed by busts.
The essay provides some objectives for monetary reform and sets out proposals from Dowd et al and Huerta de Soto.
I was pleased that the Parliamentary Commission on Banking Standards highlighted problems with incentives and accounting – the conversation is going in the right direction. At some point, when it becomes apparent that Mervyn King was right and we do have the worst possible banking system, I hope decision makers will realise that banks and the product in which they deal, money, are inseparable and that meaningful banking reform demands monetary reform.
You can download the book here.
As Baker correctly points out, the central weakness of banks is that we allow them to create “run prone” liabilities (i.e. deposits) which are matched by assets that can fall significantly in value. And when they do, a run starts. And it was a run on the shadow banks in the US, not to mention Lehmans, that caused the crunch.
As Prof. John Cochrane explained in a recent Wall Street Journal article, the solution is forbid banks to match assets that can vary in value with liabilities that are fixed in value (in dollar or pound terms). I.e. if a depositor wants to earn interest, then their stake in the bank should vary with the performance of the underlying loans or investments. Cochrane’s article is here:
Cochrane’s proposals are very similar to those put by Laurence Kotlikoff and Positive Money.
I do not care if a money lender is an individual or a corporation (such as church, a club, a trading bank – or whatever) as long as they actually have the money they are lending out.
If a person saves one hundred Pounds there is a hundred Pounds available to be lent out (either directly by the saver or by an agent – such as a bank) and when the money is lent out the saver does NOT have the money anymore – until when and IF the money is paid back.
There is not one hundred and one Pounds and there is not one thousand Pounds – there is one hundred Pounds to be lent out (if one hundred Pounds had been really saved).
Calling credit expansion “savings” or “the same as savings” is false, and if “broad money” (bank credit) is bigger than the “monetary base” (the actual money) then there is a bubble.
It is as harsh as that.
Quite agree. That is very much what is advocated by the works I referred to in the last two lines of my above comment.
” and when the money is lent out the saver does NOT have the money anymore – until when and IF the money is paid back.”
That is the crux of the matter. And the sad thing is that gold based money does not preclude fractional reserve banking. Fractional reserve banking was built on the fractional lending of IOUs of gold by goldsmiths. What gold does do is through its price in the free market signal when too many claims are made against it by rising in price against those claims. That implies that the free market has to be allowed to function, and that is what we don’t have. IOW we have to be able to constantly mark the IOUs to gold. The central banks understand this and they know that if the rig the price of gold they can establish the illusion that the paper lending is currently benign.
It is an insidious game that has been going on since Jesus threw the money-changers out of the temple. Information is the key and the internet is exposing 2 millenia of lies. We live in hope.
Accept Mr Musgrave (and please correct me if I am mistaken) you want government to print money and either spend it or lend it out (either directly or indirectly).
Whereas I hold that lending should only be from real savings (genuine SACTIFICE of consumption).
The desires of the world are on your side – I admit that.
But the “Gods of the Copybook Headings” have the last word.
But wherever the money supply comes from, be it fiat, bank generated credit, gold/commodity backed; does the expansion of the money supply not have to at least try and match production? If only what exists is lent and no new money is created, then how will growth occur?
The money supply should be fixed in total and also be infinitely divisible. That is how the supply grows without inflation.
A unit of gold divided in half in an economy that double in value is now 2 sub-units each with the value of 1 unit prior to the division. The money supply(by value) has grown , the total amount of money (by weight) stays the same. No monetary inflation.
One dollar gets counterfeited and another dollar is added the total money supply has grown(by weight and value). If the economy grow by the same amount then there is no inflation, if it grows by less(ie . some loans don’t perform, as always) then there is monetary inflation(as there always will be under this system).
Mr Mathews that is Irving Fisher – expand the money supply to keep the “price level” stable and allow “economic growth”. It did not work out too well when Benjamin Strong (or Alan Greenspan) did exactly that.
Let prices fall (gradually NOT in a boom-bust way), as people find better ways of producing goods and services.
“GDP” may not rise (the amount of money may remain the same)but people will get better off.
But we are so far from a rational economy that it almost like writing about another universe.
GDP, or aggregate economic output, is a fraudulent measure of wealth concocted for the benefit of the usurers. Economic progress by the creative destruction process of getting rid of non-economic enterprises and replacing them with innovative ones, advances our quality of life but may not increase aggregate output one iota. Ie GDP stays static. But the money lenders make profits on the amount loaned and if they can keep existing loans performing, albeit on non-economic enterprises, and also add new loans on new enterprises, then their balance sheets expand. Hence the faux religion of GDP, ever increasing output.
Thanks Paul, still trying to get my head around the current economic situation. It is not that long ago that I found out that banks don’t lend out deposits so I’m currently trying to cram, Smith, Marx etc. However, as far as I can see the creation of money/credit has always outpaced production by miles. Is not just an exercise in restraint, i.e. removing bank’s ability to create credit and removing money/credit from government control?
Easy as peas?
Fisher advocated direct monetary authority issuance of what you call ‘base money’ that remained permanently in existence.
Strong and Greenspan carried out bank-credit growth that expands and contracts the economy along with the supply of credit.
The question becomes why ‘a little deflation’ is a superior monetary policy goal than price stability, using increases in base money to match the increased growth of the economy.
In Fisher’s model, banks WOULD only lend out savings of real money.
Exactly, the expansion of the money/credit supply by banks means that all of the money/credit issued is on loan (and at interest, but that’s another post) and always has to be repaid. Money spent into the economy by the state (not necessarily government for political gain) remains in the economy?
Exactly, the expansion of the money/credit supply by banks means that all of the money/credit issued is on loan (and at interest, but that’s another post) and always has to be repaid. Money spent into the economy by the state (not necessarily government for political gain) remains in the economy?
If I understand your question, then, yes, you are correct. As an aside, many defend the banks’ expansion of the money supply through fractional reserve lending because as the loan is repaid, the added money is “extinguished”. But the inflationary damage is done at the moment the borrowed funds are spent.
It is money created from nothing which competes in the market with the money we and businesses had to earn. That it is later paid back, doesn’t change that.
To Craig Howard
Not to be in disagreement here, but I believe it is a simple truism of endogenous debt-based money systems that ALL money must be ‘created from nothing’, especially including all that we and businesses had to earn to invest.
Creating money ‘from nothing’ is somewhat axiomatic of all money, as ‘money’ is merely a legalized social construct.
On validating fractional-reserve banking because the money gets extinguished when the loan is repaid, …..yes, but absent a new loan to replace that money being extinguished by the loan repayment, the money supply would contract, causing deflation.
So, there is a built-in imperative to maintain that private, debt-based money mechanism.
And, for some of us, that is a problem.
Banks are no more than glorified business accountants, that is, they receive moneys in and credit the account of the depositor and they lend the money out at their own risk, and debit the account of the borrower. So far so good.
They can also see that given the vibrant and irregular behaviour of their current accounts there is always a core level of deposits that they can lend out as term moneys. This is not conjuring credit from thin air.
If they get this wrong then the Bank of England will step in and provide liquidity.
The problem starts with Free Banking where the BofE holds ten percent of deposits to ensure that up to ten percent of depositors who might want their money back are protected. This is the old idea of “four lifts in a hotel of 25o” theory.
All this is plausible, if not quite regular except it presupposes that the bank assets are regular.
Where a bank like RBS fails is that its assets were far from regular and ten percent is not enough when everyone is heading for the lifts, including the Bof E itself.
Another classic error is where the banks are in receipt of extraordinary large deposits, such as in the rise in oil prices from $2,50 their estimates on the core deposits is wrong and they are at great pressure to lend them all out. This results in significant risk taking both with regard to liquidity and solvency.
So all in all, would zero reserve banking be a constraint on growth? Would the private depositor be unwilling to see his deposit lent out to risky borrowers and would private depositors be willing to lend their money to junk bond borrowers.
Well, there you have your answer and, as a big benefit, the government would not need to rescue the banks nor would they be inclined to rescue the private depositor
“the money that is loaned” – most of this “money” DOES NOT EXIST.
People fundamentally misunderstand “fractional reserve banking” – it is not a matter of lending out 90% (nine tenths) of the money one has as a bank.
It is more like lending out 900% (90 tenths) of the money one has as a bank.
For “ANY” bank, lending is basically limited to the equivalent of +/- 100 Percent of its deposit ‘balances’.
It is the banking system as a whole that multiplies the base amount by 9 times.
Not that that’s a big deal.
Irving Fisher’s “keep the price level stable” policy was discredited in 1921, 1929 – and has now (with the Alan Greenspan mess) been discredited again.
Lending must be from REAL SAVINGS – the real SACRIFICE OF CONSUMPTION by real savers.
Not from banking credit bubbles – and not from the government printing press either.
Interesting that in attacking Fisher’s work, it is easily done for 1921 and 1929 as Fisher only took to its writing in 1935.
Fisher only developed his 100 Percent Money proposals in recognition of Simons’ work in recommending the Chicago Plan for Monetary Reform to FDR.
It is his 100 Percent Money proposal and his ‘Debt-deflation Theory of Great Depressions’ that mark his full-reserve and monetary authority school of thought, which is relevant to any discussion of monetary reform..
Not that he didn’t write plenty in the 20s and was indeed criticized for not recognizing the financial bubble of that time, but he made up for this with his greatest works that followed.
WARAMESS, Paul is right on this issue. 97% of all issued money/credit is created out of thin air by private banking. In fact this is the very essence of banking. A borrower asks for a loan and promises to repay. The bank then lends on this promise of repayment. The ‘loan’ or the ‘egg’ always comes before the ‘deposit’ or the ‘chicken’ The reserve limits in the US at 10% and China at 18% have not existed in the UK for many years.
My understanding is that 10 percent reserve has to be deposited with the BofE but when the deposit is repaid the 10 percent is returned. Surely in this way the reserve posted with the BofE will always amount to 10 percent of deposits and the bank will be able to lend out 90 percent of deposits.
The idea that the baker makes a deposit and the bank makes a loan to the butcher who places it on deposit before using it to buy machinery and that allows the bank to relend it in the maeantime will be negated by the unwinding of the reserve asset by the butcher withdrawing the deposit to spend on machinery.
Should the machinery manufacturer decide to place the sale proceeds with the bank as a deposit, then that is an entirely new transaction, isn’t it?
“Paul is right on this issue. 97% of all issued money/credit is created out of thin air by private banking. In fact this is the very essence of banking. A borrower asks for a loan and promises to repay. The bank then lends on this promise of repayment. The ‘loan’ or the ‘egg’ always comes before the ‘deposit’ or the ‘chicken’”
If this was true the accounting equation Assets = Liabilities + Capital would not balance.
The deposit always comes before the loan.
Yes, this was my thinking also, but alas not the case. If there is any way I can post a PDF I have the Q3 Invesco Perpetual Intellegence Seminar 2012 which explains a lot about broad money creation by private banks. Even shows how the money markets do exactly the same thing through off balance sheet ‘special purpose vehicles’.
These bankers must do some lobbying!
PS Paul, love Gods of the Copy Book Headings
Sorry Allan but I just don’t buy the idea that private banks create money.
Banks create credit for sure by borrowing short and lending long. This is a real destabiliser of the economy.
Fractional reserve banking will allow banks to ratchet up their lending irresponsibly where they can persuade the Central Bank that their asset base is stronger than it really is i.e. by having junk bonds and mortgages incorrectly classified as AAA status but every penny they lend out is matched by a borrowing or a deposit.
As Ralph says the asset base may be lower than the liability but this is a matter of valuation and so long as the asset is left on the books at an inflated value then there is notionally a match beetween assets and liabilities.
The real problem with FRB is that it is a one size fits all solution which does not actually fit in all circumstances, particularly when a bubble is building.
The real problem with banking is that it is over-regulated with the wrong sort of regulation imposed by the wrong sort of people. No commission earning banker will these days not spend an inordinate amount of time contriving ways of upgrading the quality of his asset in order to circumvent the Capital Adequecy Requirements.
So maybe disbanding the entire system and allowing the markets to determine how much a bank can borrow and a move to 100 percent FRB would be an excellent idea which would solve a huge range of problems with the banks.
“by having junk bonds and mortgages incorrectly classified as AAA status ”
That is just wrong if its junk you are unlikley to be paid and if its AAA you are highly likely to be repaid. The problem is that to many people assumed a AAA rating definded not just the probability of repayment but its value between inception and maturity.
No one prediced a AAA morgagate backed FRN would trade at 60/70. This did not mean it did not deserve its AAA status because the probability of repayment was unchanged. What it reflects is that there where no buyers.
For a proper understanding of the actual way that money works today, may I recommend the book “Modernizing Money” by Ben Dyson and Andrew Jackson of Positive Money UK.
All of the questionable mechanics of modern money are examined in this recent work.
The problem with the book is it repeats the assertion that banks create money. This is just fundamentally wrong. Banks can only lend the money they have borrowed or received from shareholders. If you choose to ignore something as basic as the accounting equation it’s difficult to take you seriously.
It’s actually easy to understand. When a bank lends £10 (ignoring capital) it must have borrowed £10. The £10 it borrows comes from a lender who already has the £10 somewhere. So the lender withdraws £10 from a bank, which by definition can only pay it by reducing its assets by £10. The lender then lends the £10 to the other bank who lends it to a borrower. You may notice in this cycle no money is created or destroyed.
I also laugh when they suggest repaying a loan destroys money. That does not happen when a loan is repaid to a bank the bank repays its depositor. The depositor now needs to lend the £10 to someone else.
Not sure where you learned that banks can only lend money they have in their accounts, but it is not correct.
That’s how it should be, not how it is.
As for the magic of double-entry accounting, banker-style, the banks books balance just before you walk in the door and borrow $10K. (Haven’t found the Pound symbol).
As the bank books the loan as an asset, and the deposit as a liability, the banks books also balance at the end of the day, except at a $10K higher level, as is the increase in the money supply. Banks increase the money supply by lending.
Assets still equal liabilities, including, or plus, equity, depending on your preferred expression of the balance sheet.
I suggest a read of the Fed’s publication “Modern Money Mechanics”, available free online.
The UK never had an equivalent explanation until Positive Money authored its book, which is completely accurate in its details, being highly vetted by BoE and Treasury before publication.
Again, in the cycle that you describe you are totally correct that no money is created or destroyed.
But that is the way it should be.
A permanent money system.
But that is not the system that we have.
And that is why we NEED to change this system.
Joe – it makes no difference whether you use the word “system” or not. If more “money” is being lent out than actually exists – then there is a bubble.
Bankers tend to deny that – for example I talked to one banker who insisted that “the money is there – but then the deflation destroys it”.
I see so there is a pile of notes and coins in his vault but then the evil “deflation” elves come along and destroy these physical notes and coins. Of course not.
The money never existed in the first place – the banker is making the mistake of treating credit-expansion as if it was money.
As for your claim that boom-and-bust (which is caused by credit-money expansion) is “no big deal” – this shows, yet again, that my low opinion of you is correct.
Lastly – your implied claim that because Irving Fisher only started a write a particular work in 1935 means he was not a well known person in the 1920s…..
Joe – your position is so absurd (and so dishonest) that it is impossible to believe you are not a troll.
Irving Fisher was well known for his doctrine that the “price level” should be kept stable – for his view that “inflation” was not a rise in the money supply (what it actually is) but a rise in the “price level”.
This doctrine of Fisher is both false – and highly damaging.
I wish we could confer in person so that I didn’t have to play the mole to your whack-a every time I post on this fine blog.
Being neither troll(??) nor a liar, I must again clarify our disagreements, with nary a discouraging word on your views of my character.
You react to my correction about who creates the 9X multiple, with ….
“”If more “money” is being lent out than actually exists – then there is a bubble.””
Not sure what you mean by that but….. in today’s system, bank credit is “money” creation. Every bank-credit loan that creates a deposit account increases the money supply. So, it is never possible for more money to be lent out than exists….. by definition bank-credit money lent out is money in existence.
On this basis, I should ask that you take up this second claim….
””the banker is making the mistake of treating credit-expansion as if it was money.””
with your banker friend.
That’s what I would do.
Actually, the money systems of the whole world are making that mistake, and as a result, bank-credit, today, IS money.
Next you justify your ‘low-opinion’ of me by refuting a claim I never made …..
“that boom-and-bust (which is caused by credit-money expansion) is “no big deal”
I would never make that claim because you and I and everyone else here at TCC agree that booms and busts are a symptom of our money problems, and one that needs solving.
Next comes an “implied claim” ….. this that Fisher was not well known in the 1920s.
Implied, by whom? Seems another of those ‘eye of the beholder’ implications.
Many of Fisher’s truly great works that transformed political economics included those from before 1900. His epic writings on interest theory and the nature of money’s ‘purchasing power’ were begun before the 20s.
But this post is about monetary reform.
And until the crash of the banking and financial system, it’s hard to think of the few non-Austrians – notably Frederick Soddy – who were calling for a systemic repair to the institution of money.
So, again, it was to the mid-30s, and in response to Simons’ Chicago Plan proposal, that Fisher began his work on debt-deflation theory and monetary authority issuance of the money supply, incorporating full-reserve banking as its cornerstone.
Sorry, but the works I am referring to are Fisher’s monetary reform works, and again they all came after the crash.
On your last point, I find as much support among Austrian economists for those aspects of money that you ascribe to Fisher as I do in the mainstream.
Money creation is not inflation by any traditional definition, notably Von Mises.
Price stability is what maintains the purchasing power of a national currency.
Neither of those tenets are false, nor economically damaging.
Joe, I agree Positive Money are doing an excellent job in highlighting this.
I really find the Jackson-Dyson book to be the most important publication written in many years for providing a proper footing to understanding both the operation of the present money system, and for informing on the potential societal benefits that come from a switch to an equity-based, real-money system in the future.
It should be required reading for not only every economics student, but anyone who takes out nomination papers for public office.
And I see Adair Turner’s proposal for Overt Permanent Money Finance as embracing the bulk of the work of Positive Money, though he falls short of a total switch to full-reserve banking. So far.
From past experience – anything that Joe (a Keynesian type) suggests reading, is not worth reading.
However, the works of the late Murray Rothbard, are worth reading on this matter.
As for private banks creating money…..
The can create “broad money” (credit) but only for a limited amount of time.
The credit expansion is the phony “boom” – which must, sooner or later, come crashing down in the “bust”, then the “broad money” (which never really existed in the first place – no the “deflation elves” did not “take the money” because there was no extra money and there are no deflation elves) goes pop, as the bank credit goes back down towards the monetary base.
Only if government steps in (perhaps by Central Bank activity) can the phony credit money bubble of the banks, be turned into real money.
This is not a good thing.
And as the then Governor of the Bank of England tried to explain to Walter Bagehot in the 19th century (Bagehot did not understand him) even the possibility that a Central Bank might step in to save them, makes commercial banks (and other such) more reckless than they otherwise would be.
Now,this is making much more sense
Wow! Don’t think I’ve ever been called a Keynesian-“type” before.
Don’t worry, Dad, consider the source.
Actually I admit to reading Keynes, preferring his minor “Tract on Monetary Reform” to his General Theory work.
Totally agree that the works of Murray Rothbard are well worth reading – as my Dad urged me to be sure to do …… after Frederick Soddy and Irving Fisher.
For a more modern perspective, read both Huerta de Soto and the Jackson-Dyson work at Positive Money UK. It is of vital importance to have a clear understanding of the contrasts within monetary thought, and thus eliminate much of the fog around the money system so as to act effectively for change.
Again, if Paul pays any attention through his gold-colored glasses to what I write, I totally agree with him about the problems of fractional-reserve banking and (im)moral hazard. My disagreements are to consort with Soddy, Simons, Fisher and Friedman on who should create and issue the nation’s money.
“who should create and issue the nation’s money”
What do you mean create money?
The only people who can create money are the central banks since they are the only entities who have decided they can ignore the accounting equation.
Even more interesting what do you mean by money?
In the interest of promoting understanding of money, I try to never separate the “creation”-of-money issue from the “issuance”-of-money.
In the US, the government creates coins and currency, and issues the coins.
My understanding, based on “Modernizing Money”, is that in the UK the government creates and issues both the coins and currency.
Which is why in the UK it is said that the banks issue 97 percent of what serves as money, and in the US it is more than 99 percent.
In the UK, the central bank IS part of government, in the US, not.
While any central bank can be empowered by a sovereign government to create that nation’s money, virtually near zero money creation takes place by central banks.
Please explain what you mean by “the accounting equation”.
In general conversation, what I mean by ‘money’ is as defined in H.A. Mann’s “The Legal Aspect of Money”.
In shorthand, it is that which LEGALLY serves as the universal medium of exchange in the nation of issue.
The fact that governments empower private bankers to create bank-credit (in replacement of private BankNotes) and to recognize those bank-credits as legally satisfying debts owed to anyone agreeable, including government, is what gives those bank-credits the quality of money.
But, in reality, they are not money.
The are unit-of-account-denominated private ‘credits’ that serve the function of money as exchange media.
That should be stopped.
Am I going mad, or is someone censoring and removing posts here, from this Libertarian site ? 3 of mine gone from this morning. I hope not on both counts.
I am a bit back to basics here. The money supply has to match production right? This is not rocket science. Money is just a means of exchange, and only that. It can be created by anyone (although only for the purpose of exchange and not for profit) and can be anything. Surely the problem is always with printing/making too much therfore outstripping production and causing inflation? Hence the £0.90p double decker at M&S?
I think it is a mistaken view that money supply needs to match production.
A stable money supply would simply increase or decrease in relative value to the items being exchanged.
For example, should the supply of wheat increase then the price against other goods might decrease so making the other goods more valuable in money terms.
Should the population increase so that more stuff is consumed then the value of money relative to all other goods will increase (deflation).
Production worldwide does however seek to match demand and consumption on an annual basis and here is the root of all inflation when the money supply is increased.
Exactly my point. Banks continue to create credit/money even though we have no growth. The choice of where this credit/money goes is also chosen by the private banks so there is always a bubble not just in liquidity but also in the areas the bankers feel safest like property. As for the previous idea that this credit/money is destroyed once repaid is just not true. This credit/money is also lent out again many times. £375 billion from BOE adds to the supply of cheap money hence the FTSE gains in the last year after QE.
Please read Mervyn Kings explanation of the banks creation of credit/money, there is a lot of information on Positive Money.
Joe – I also read Keynes, but I also read refutations of Keynes, such as Henry Hazlitt’s “The Failure of the New Economics”, the book of essays (by various people) “The Critics of Keynes”, Hayek’s work refuting Keynes (some of which is published in his “New Studies” of 1978 – the section of the book on economics), and more recent work such as that of Hunter Lewis’s “Where Keynes Went Wrong”.
I doubt you have read any of the above – or have any interest in doing so.
You are simply here to be a troll.
I do not go on collectivist sites and you should not be on a free market site.
And do not do your tap dance about how the editors of the site have not asked you to leave – because if you had an moral decency at all you would leave without being asked.
Whack-O! on you, Mr. mole, repeats Mr. Marks.
Every time I write a comment that corrects your WANs about who I am or what I think or what I’ve read, I get in reply another these 404(nobody-home) error messages.
On these pages I’ve already said that we’ve both read Keynes, Hazlitt, Hayek, VonMises, Rothbard and Huerta de Soto. Also Menger and Boem-Bawerk, and a couple of others who you pointed me to. So, please stop trying to find an un-read Austrian author to prove my ignorance about money systems. I’m still learning.
I find minor truths in all of them, more with Hayek perhaps, and I painstakingly try to avoid criticism of the body of their works out of respect for the TCC. Most importantly, though, I am always participating with a positive view of what might lie ahead. That’s why I’m here.
I’ll repeat once more, I’m not a Keynesian, nor Neo Keynesian and not a Post-Keynesian. Though, again, I find all of them with positive contributions to the money-system ideas of the day, but they all fall short also from the need for radical reform to the system of money.
Please tell me where the collectivist money sites are. As I’ve said, as my Dad told me, Milton Friedman was more of a radical on money than any of the socialists searching for that collective good.
I am me.
No part troll.
(Very)Minor part post-Keynesian.
Of the Soddy-school of monetary science.
And obviously not of the Paul Marks school of moral decency.
For the record Milton Friedman thought that Benjamin Strong was a good head of the New York Federal Reserve – i.e. Benjamin Strong the credit bubble man. And Milton Friedman believed that Irving Fisher (who was astonished by the bust of 1921 and that of 1929 – and who made the fundamental mistake of trying to redefine the word “inflation” to mean a rise in the “price level” rather than the inflation of the money supply was the “greatest American of the 20th century”.
Milton Friedman should be followed on many things (for example his opposition to Occupational Licensing – and other white collar union scams), but not on monetary policy.
As for the term “the nation’s money” Joe is being deliberately offensive by using this collectivist term. He is being a troll.
As Joe knows perfectly well – money is created by private buyers and sellers choosing something to act as a store of value and medium of exchange. It is not “the nation’s money” it is the money of private buyer and sellers.
To use terms such as “the nation’s money” in an American context brings back the history of 1933 and the Fascist actions of the “FDR” Administration in stealing all private money (in this case gold – although money may be any commodity) and tearing up private contracts (both contracts with the government and contracts between private parties).
The fact that other Fascist actions of the Administration of Franklin Roosevelt, such as the National Recovery Administration (General Johnson jackbooted “Blue Eagle” thugs – who went around enforcing “laws” that they simply made up) were struck down by the Supreme Court in 1935 (and the Roosevelt Administration decided to DRAW BACK from Fascism, for example the praise for Mussolini’s Italy starts to come to an end at this time) should not blind us to the fact that the confiscation of privately owned money in 1933 and the voiding of private contracts in 1933 – were Fascist Acts done by people who (at that time – NOT later) were open in their admiration for Fascist Italy.
No more of this “the nation’s money”.
It is offensive (deliberately so in this context) – and it must stop now.
Paul, my opinion of Benny Strong is more important than Friedman’s, as such, his grade would be a ‘D’, and not what I would call ‘good’. But that’s just me, and has nothing to do with banking or money reform.
I had thought Friedman’s praise of Fisher was limited to that of the greatest American monetary economist(or perhaps just economist) of the last century – BUT I COULD BE WRONG about what Friedman said. I would agree as to a greatest monetary economist accolade.
Friedman said and did many things, but why would we talk in this blogpost about anything except his views on money and banking reform? Those views transcend his wide-ranging prescription of free-market economics – in everything except money. This should give one pause to consider his rationale.
On money, while one might call Friedman a collectivist, I see him more as rule-of-law pragmatist on national money issuance.
Dr. Ronnie Phillips in his book on “The Chicago Plan and New Deal Banking Reforms” (M.E. Sharpe Press – 1995) quotes Friedman in Ch. 12, pg 166 as saying : “”The production of fiat currency is, as it were, a natural monopoly…. Henry Simons held this view – which I share – that the creation of a fiat currency should be a government monopoly”.
This is why Adair Turner is pushing Friedman and Fisher’s views for issuance of permanent, debt-free public money (my words) as a solution to our present debt-based money crisis.
Is it not possible to believe in a national money system – that would be a sovereign, fiat national money system – which system ALL of the world’s modern monetary economies presently use for national currency purposes, without being branded a collectivist-troll? I hope so.
Having read Del-Mar’s History of Monetary Systems about 40 years ago, I am a firm believer in the ‘fact’ that a nation’s currency and money system belong to any nation’s sovereign people, and they can thus operate that system in any manner they choose.
Discussions of ‘public money’ should bring back thoughts of 1933, as that began the previous time of major reform to the nation’s system of money and banking – not that any of it went far enough to achieve the true economic stability that was required. (Emphasis on ‘should’).
Every sovereign nation has, as its method for achieving its social and economic goals, a national money system. That fact and the universal existence of national money systems should neither offend anyone nor render silent a vibrant discussion of national money and banking reform. Any change to any new money system, say private bank issuance and commodity backing for instance, must show its superiority over the present private monopoly, fiat money system, issued as debt.
I come here to discuss the options, trying always to use somewhat intelligent and civil discourse. I will surely leave if invited to do so by TCC.
“As Joe knows perfectly well – money is created by private buyers and sellers choosing something to act as a store of value and medium of exchange. It is not “the nation’s money” it is the money of private buyer and sellers.”
Must disagree money is neither a store of value or a medium of exchange. Money is no more than an accounting measure of value. You cannot hold money. For example if I have a fish which is worth £10. I can sell it to someone and he will pay me £10 but to do that all he does is move £10 he has lent to a bank if he pays me via a bank, or he has lent to the Government if he pays me in cash.
s much as we find it hard to imagine money is not an asset in its self. Money is just a debt held with someone. Only when we pass that debt on to someone in exchange for a real assets do we have a store of value.
Money’s “unit-of-account” function in the national system of money neither trumps nor displaces its “medium of exchange” function.
While that accounting function is necessary as a measuring unit of national economic activity, it has much less import to that same real economic activity, which is what users of the money system care about.
We earn ‘media-of-exchange- money’ and we spend same. That exchange in national commerce is what the economy is all about.
Not sure of the significance of ‘holding’ real money.
I have a fiver in my pocket.
Am I holding it?
And what difference does it make whether I am or not?
We can not turn back to other matters.
I repeat that private banks, on their own, can not increase the long term money supply – they can (and do) engage in credit expansion (which they call “broad money”) but their “boom” must lead to a “bust” in which the credit shrinks back down to towards the monetary base.
It the government obsession with “cheap money” (“low interest rates”) that leads to the long term inflation (i.e. the long term inflation of the money supply – leaving aside Fisherite nonsense about the “price level”).
Money “based on” gold (or “based on” any commodity) – yes, I agree, this is a terrible confusion.
Either the commodity (which need not be gold) is the money – or it is not.
Talk of the having the money “based on” X commodity opens the door to fraud.
“Mr Banker you are lending people money?”
“Yes I am”.
“But the people leaving your bank do not seem to be carrying bags of gold”.
“Oh that is because they might be mugged in the street, but the gold is safe in my vault……”.
It is a lie – and no tap dance about “it is the system not the individual banker” fundamentally alters that.
Even back in the days of Mr Morgan (he of the unfortunate nose condition) it was a lie – and a lie backed by THE GOVERNMENT (for example “discounting” the debt paper of the big New York banks was illegal under the National Banking Acts).
However, back in the days of the first Mr Morgan the lie had limits – it was only with the creation of the Federal Reserve system in 1913 that all real limits on the lie were removed (the monetary order became a “reality free zone” – but reality has a nasty way of hitting back).
A money lender should do just that – lend money, REAL SAVINGS (SACRIFICE OF CONSUMPTION). Not credit bubbles – and not government printing press games either.
Sorry, I cannot figure if Paul Marks’ comment is a reply to anything I wrote. Trying not to ignore, if it were –
PM : “”I repeat that private banks, on their own, can not increase the long term money supply – they can (and do) engage in credit expansion (which they call “broad money”) but their “boom” must lead to a “bust” in which the credit shrinks back down to towards the monetary base.””
The reason banks cannot increase a ‘long-term’ money supply is because they create short-term, temporary, debt-based, bank-credit money – ‘broad’ as it may be indeed.
It is the failed pro-cyclical mathematics and architecture of debt-based money that causes the booms and busts.
PM – “”It (is) the government obsession with “cheap money” (“low interest rates”) that leads to the long term inflation (i.e. the long term inflation of the money supply – leaving aside…….).
If you really think that cheap money leads to inflation, then try expensive money. But again, increases in the supply of money that accommodate economic growth do not cause ‘inflation’ in any accepted meaning of the term. (Ludwig Von Mises – The Theory of Money and Credit, pg 126).
PM – “”A money lender should do just that – lend money, REAL SAVINGS (SACRIFICE OF CONSUMPTION). Not credit bubbles – and not government printing press games either.””
It was Fisher and Friedman’s design that banks would lend real (sacrifice-of-consumption, savings-type) money, and thus eliminate credit bubbles. So, except for that last part, which equates public money management with ‘government printing press games’, certainly I agree.
Joe – I repeat what I have already said.
As for the central point.
Lending should be from real savings – and “real savings” means a sacrifice of consumption by private people.
“”Lending should be from real savings – and “real savings” means a sacrifice of consumption by private people.””
Thanks. I think we’re all good on that part.
No matter who creates the money, it MUST be fully-reserved, and be brought ONLY through financial intermediation (based on what a depositor is willing to accept for the bank to use his or her monies to lend for what a borrower is willing to pay) to credit markets.
We all do that.
Soddy, Fisher, Simons, Friedman, Kucinich,,,)
So, for those of who do not harbor a bit of hate for the fire-rescue team extricating us from a bad car wreck, or the teacher trying to educate my sixth-grader(when I had one) – just because they ARE the government – the pertinent operating question here becomes, who should issue the supply of money? And how?
Austrians avoid the question by saying we just use the existing money supply and deflate prices (just a little).
Reformers say the government should introduce that money into the bottom of the economy, where it will percolate UP to savings and investment, while preserving the purchasing power of the currency.
How to do that while elimination political corruption is the debate that needs having.
“Reformers say the government should introduce that money [the money the government produces from nothing] into the bottom of the economy, where it will percolate UP to savings and investment while preserving the purchasing power of the currency”.
That does not sound like a sacrifice of consumption – it does not sound like a sacrifice of consumption because it is not a sacrifice of consumption. It is free lunch economics – literally a free lunch, with the poor (“the bottom of the economy” being given money they (we – because I am poor) have not earned.
Still I must thank you for so openly stating your position – i.e. where you stand. I must confess that I did not expect such honesty – and so I must apologise for my unjustly low expectations. I now do apologise to you for this.
As for “debate” – there is nothing to debate. On fundamental matters – there never is anything to debate.
People state their position (what side of the war they are on) then stand ready for battle. And battle means what it says – (on both sides).
In fundamental matters (as opposed to tactical matters) discussion (debate) serves no purpose.
For example, when “Socrates” (really Plato) denies that justice is to each their own – one should simply walk away (because the disagreement is not over a tactical matter – it is over a fundamental matter, a matter of principle). Just as if someone denies that investment should be financed by a voluntary sacrifice of consumption – there is nothing further to discuss (because the disagreement is fundamental – not tactical).
And that is all.
“And that is all”.
My sincere thanks and my acceptance of your apology.
I must agree that on things monetary, discussion is debate. This is mostly because money is our least understood of socio-economic necessities, which also explains the need to discuss, so as to inform. And so I can not agree that there is nothing to discuss on either fundamental or tactical matters.
For instance, your absolute certainty that what I described above does not represent “sacrifice of consumption”, apparently because that money was issued at the bottom of the economic ladder in order to provide the national monetary policy objective of increased exchange media needed to protect the purchasing power of the currency.
I am certainly just as poor as yourself, in terms of income. I am the luckiest and richest man alive in many other terms.
So, if in creating the $400 Billion that the economy needs to achieve its 2.6 percent potential economic growth next year, the government replaces that amount of either taxation or debt-issuance revenues to fund my pension or Medicare, then “I” will not save and invest, and sacrifice consumption because I cannot afford to.
Rather I will spend virtually all of my income – being a preferred, high velocity contributor to money exchange – and the stuff I will buy will contribute to the profits of the business with which I do commerce.
It is “they” who must decide to save (being the sacrifice of consumption) and invest (being the economic means for increasing production), so that adequate credit flows also feed the potential for economic growth.
There can be no doubt that this investment is financed by the saver’s sacrifice of consumption – as well as the desire to increase profits. Again, all reform proposals for well over 100 years have been in favor of full-reserved, or non-reserved, banking, where no privilege of creating purchasing power exists for anyone. All reform proposals require the sacrifice of consumption by some player in the economy in order to capitalize savings and investment.
It is simply not true that the government, in providing the means of exchange needed for common socio-economic progress, represents any kind of free lunch to anyone. I earned my pension and healthcare benefits. The economy needs +/- $400 Billion in order to achieve its potential. That is an example of why the essence of the money system, the fundamentals as you call them, should be always open for discussion, and thus debate.
Again, thanks Paul for being here on this. I do not feel it either possible or good that our paths do not again cross. And I admit to enjoyment of the discourse.
Superb dicourse Joe and Paul. I have a lot to learn.
I am however still totally against money being issued by private banks as debt. It is immoral and leads to the inevitable conclusion that money creates money. Fine if you already have some, a nightmare (literally) if you don’t.
I agree that fiat currency is far from perfect but at least it give those at the bottom a chance. Sacrafice of consunption is fine provided you are in a position to consume in the first place. At what rates of interest will banks lend when only lending real money? Once again those wanting to borrow will lose.
With thanks back to you and Paul, and also to TCC for accommodating, I hope its OK to respond to your perhaps-hypotheticals on things money and banking.
On being in opposition to money being issued by private banks as debt, I always thought that both Austrian school and Soddy school proponents also agreed this was a bad idea.
While that issue is the true essence of the Soddy school, Austrians have ever promoted that credit, as it were, must always come from savings. This is one reason why Austrians are more comfortable with the ‘slightly-deflating’ system of money.
While both Austrians and Free-bankers have a minor wing in the fractional-reserve banking camp, most see the principle of the lending only of savings as most fundamental and moral.
Reformers say that banks can only lend real money. Period.
So there should be a lot of agreement about ending the private monopoly on debt-based money.
Those who sacrifice consumption have consumptive power to spare and it is fine to reward that sacrifice as the market sees fit.
Most important is your question about the effect on the cost of money when banks lend only real money. It depends.
Cost being related to supply and demand, the cost will mainly depend on the supply of money in the system.
Soddy’s view is that the essence of national money is in being the means of exchanging the national economy. The supply of money, being issued by the state, will always be adequate to meet the demand. In other words, there must be enough money to accommodate natural production and consumption. That is important for financial and economic stability.
Enough money means no inflation and no deflation of the purchasing power of the currency.
What the interest rate is when there is enough money in existence should be a market determination. In theory, we control interest rates to control the supply of money to control inflation.
Control of the supply of money obviates the need to control interest rates.
Money is more than the commodity that it is.
That’s why the real monetary issue between reformers and Austrians comes down to who, if anyone, should issue the national currency.
Read “The Denationalization of Money”.
A couple of typing mistakes (more important than my normal legion of typing mistakes) in the above.
Milton Friedman said (absurdly) that Irving Fisher was the greatest American ECONOMIST of the 20th century (in my word-blind way I did not type the word “economist”).
Also I meant to type “now we can turn to other matters” not “we can not turn to other matters”.
As for banks.
Formally speaking they do not (and never have) issue “money as debt” – they (in various complex ways) expand CREDIT (not money). The trouble (or one trouble – perhaps not the only trouble) is that many people (including the bankers themselves) treat their credit as if it was money.
One even gets supposedly “free market” supporting people talking about “private money” when they mean bank credit.
Money (as Carl Menger shows) starts off as a commodity (it need not be gold – it can be any commodity that buyers and sellers value, for money must be a store-of-value not just a medium of exchange) – only later do governments come in with their legal tender laws and tax demands.
Commercial Banks can not produce a valued commodity from nothing (their book keeping tricks are just that – book keeping tricks NOT magic). And banks do not have the power to impose legal tender laws or make tax demands (insisting that the taxes be paid in their paper). Commercial banks do NOT produce money – they (in various complex interactions between them) expand CREDIT.
Is this credit expansion by banks “fraud” (as the late Murray Rothbard claimed). Well a modern lawyer would say “no” – and a traditional Roman lawyer would have said “yes” (Roman law held it as a basic principle that a money lender must actually have the money he was de facto claiming to have – otherwise no loan could be made). A modern lawyer would say that a banker does not have to have physical CASH in order to (legally) “make loans” – others people would denounce this as a example of banker influence on the legal system (pointing at biased court judgements in the 19th century).
However, from the point of view of economics it does not matter if banker “credit expansion” is “fraud” or not (and it should be noted that some bankers could produce an insanity defence anyway – such as the banker who insisted to me that “the money was there, but then the deflation destroyed it”, he honestly seemed to believe that evil “deflation” elves had broken into the vaults of his bank and …..he honestly did not understand that THE MONEY NEVER EXISTED IN THE FIRST PLACE, the “bust” just exposed the truth), what matters, from the point of view of economics, is the EFFECTS the credit expansion (the boom-bust) has – and these effects are, in the end, HARMFUL (they hurt more people than they help).
This “credit boom” inevitably leads to a BUST – as the banks do not have the money (the cash) to support their credit.
Then governments face a choice – either they let this credit bubble collapse (“a massive contraction in the broad money supply” – “broad money” being BANK CREDIT) or they produce money (from nothing) to back the banks.
Actually governments love credit expansion (“low interest rates” – “cheap money”)and actively back bank credit expansions (without government backing, via the Central Bank, commercial banks would be less extreme in their credit bubble activity).
It must be kept in mind that neither bank credit expansion (boom-bust) or the government printing press increases real wealth – not in the long term.
On the contrary – the economy would be better if neither private bankers or the government indulged in such antics.
Loans should be 100% for REAL SAVINGS – and real savings are THE VOLUNTARY SACRIFICE OF CONSUMPTION.
Both private bank credit bubbles (“credit expansion”) and the government printing press are an effort to get “something for nothing” – “free lunch economics”.
In the long term both practices make things WORSE (not better) than they otherwise would be.
Sorry people – but there is no real alternative to thrift, hard work and self denial (the voluntary sacrifice of consumption in order to finance investment).
Neither private banker credit expansion or the government printing press do long term good (they do long term HARM).
The promise that “monetary economics” (either by credit expanding banks – or by the government printing press) can produce a quicker or less difficult road to economic progress is an illusion – it is just magic pixie dust and a castle in the air supported by nothing but moon beams.
Paul, thanks, as usual.
The reason we all ‘refer’ to bank-credit AS money is because ALL national monetary authorities, which authorize the creation of bank credit to serve as money, compile monetary ‘aggregates’ to track the quantity of “money” (exchange media) in circulation, and the basis for all of those aggregate measures are currency and bank-deposit balances that are created by bank-credit issuance.
Also because the courts have found the tender of bank-credit as satisfying any debt that is not otherwise agreed by the borrower.
Having said that, I totally agree that bank-credit is not money. It merely serves the exchange function of money, as real money does not otherwise exist.
I do agree with Rothbard and I believe most people would, having read Adams’ “The Legalized Crime of Banking” as a much younger man. (Another of my Dad’s insistence, being a conservative Christian businessman) Google up The Credit River Decision (Minneapolis) for a country lawyer-Judge view of fractional reserve banking.
“The bank failed to bring “consideration” to the transaction.” More or less.
On the balance of the equal immorality and wickedness of bank-credit and “printing-press” public money expansion, I think you still have not thought this through.
WHY is the government (not Fed reserve-credits, but real money) expansion of the exchange media in concurrence with ACTUAL economic growth – dollar for dollar – bad in any way? The money created goes to pay for real stuff being exchanged, thus allowing banks to expand their balance sheets, accumulating depositor savings for investment. Why is that bad, or a problem for anyone?
The Austrian notion that scarcity of money ( a little deflation) produces some imaginable “better-good” is flawed on this point. I have already pointed out that Von Mises agrees that such money increases can not be inflationary.
If public money creation is not inflationary and yet accommodates economic growth, please explain, what is the problem?
The point that money must be a store-of-value (not just a “medium of exchange”) is an important one – and it is not in any way undermined by economic value being subjective (or by Hayek, sometimes, forgetting the point in his old age).
Government fiat money is not a true store-of-value – its value is based on government THREATS (hence “fiat” – edict, order) tax demands and legal tender laws.
And banker credit?
Even in the old days this was just debt paper (even if the government forbad people “discounting” the debt paper of favoured banks – such as the big New York banks favoured by the National Banking Acts of the late 19th century). Mr Morgan (him of the nose problem) did not lay awake at night in a cold sweat (and on and on) because he was operating a “private money system” – he was engaged in a desperate scam (although a very limited one by modern standards) and he knew it. And the other bankers in the system were worse (not better) which is why he “had to” engage in such stunts as locking up fellow bankers in his house at a conference and……
The system (the various banks) did not really have the money (the cash – the gold) that their “loans” (their credit expansion) said they had.
They did not “loan money” (people did not leave their banks carrying bags of gold as their loans) – they “credited to the account” and engaged in various other boom-bust activity.
Benjamin Anderson (the interwar period banker and writer on the economic history of the period) is a good example of the better sort of banker of the period (the sort like Mr Morgan before the First World War) still awful – but someone who had limits.
Unlike Milton Friedman, Benjamin Anderson (like all his kind – the better sort of credit bubble banker) was sincerely horrified by the “Bank of the United States” (an utter scam – that Friedman could not see the problem with) it even treated mortgage paper as ….. (says the horrified Anderson – oh yes that particular game does not need computers and higher mathematics, bubble people have been playing the “let us tern mortgages into tradeable paper and …. with …” for a very long time indeed, and it always ends in a collapse). But Benjamin Anderson’s rules (the rules of the Thieves Guild – as opposed to the bad thieves outside the guild, such the Bank of the United States) do not include such things as bankers actually honouring their contracts – not when they “can not”.
Benjamin Anderson (again the good face of banking)just assumes that cash payments must be “suspended” in a “crises” (i.e. when a banker bubble is bursting – which they must eventually do), he does not even do the legal tap dance of saying “it is not really contract breaking because….” (as someone like George Selgin might), Benjamin Anderson just (politely) mocks people with an “old fashioned” view of morality – people who think there is a “moral law in the sky” and do not understand that morality is really what is the advantage of the progress of mankind.
How banker boom-and-bust is for the long term advantage of the progress of humanity Mr Anderson does not explain – he just assumes it. And if morality (such as keeping one’s word on cash payments) is just “law in the sky” stuff to be (politely) mocked – how did Mr Anderson possibly believe that the Constitution of the United States (or anything else) could withstand the winds of collectivism?
In short even the “conservative” part of the WASP elite were (at least by the 1920s) undermined – by their own relativist philosophy (if they could break their word, because good and bad, right and wrong, were just calculations of advantage, so could other people…..).
How could such people make a real principled stand against the New Deal when they accepted its philosophical underpinning (that the rules of right and wrong did not apply to the educated elite – the “wise”)? Of course they could not really make a stand of PRINCIPLE against the New Deal – they were hollow (although often charming and well meaning) men (whose “education” had replaced their manhood) and their enemies knew it.
An honest money lender (and a money lender can be honest) never has to “suspend cash payments” and break his word in all the other ways either.
An honest money lender did just that – he (or she) lent out MONEY (CASH). Did not pretend to borrowers that he was lending them money (when he was NOT) and did not pretend to savers that their cash was in the bank (when it was NOT).
Reality has a way of hitting back – and reality includes those silly “rules of morality in the sky” that “educated” people such as Benjamin Anderson no longer believed in. And the “progress of humanity” actually depends on keeping those rules – not on (politely) mocking them as one breaks them.
A credit bubble banker (unlike a real money lender) is a bit like a juggler – accept that he is throwing glass vials of nitro about, sooner or later one of these glass vials will hit the ground – then the “credit expansion” (whether it is called “fraud” or not) ends in lots of blood and gore. Something like the “Bank of the United States” is just a DRUNK version of the credit bubble banker juggling with vials of nitro (yet Milton Friedman still could not see a problem with it) – but even if the juggler is someone as sober as Benjamin Anderson, the SYSTEM still will not work over time – because it is a SYSTEM based upon lies and absurdities.
As for a modern banker?
The “credit expansion” is now not even bits of paper (which at least might have attractive designs upon them) – now it is just numbers on a computer screen (nothing more).
To treat this as “money” (as the system does) really is the world of magic pixie dust, and fairy castles in the air.
It is not a store-of-value.
Here I do not agree with the importance of the issue.
The “store” of value function of money is way overblown as to its importance toward monetary policy.
Properly issued real money need have no ‘storage’ capacity to value. As ‘exchange media’ it is already conveying the market ‘value’ of the transaction. That is , in the words of Soddy, the real “role” of money.
That anyone wants to “store” the currency for future-value purposes, then they should be subject to market machinations that determine the value of all money. All money properly issued preserves the purchasing power, and therefore the ‘value’ in commerce, of all money.
Monetary policy ought not favor either spenders or savers, neither should it penalize either. Monetary policy should equitably serve the needs of all of the users of the monetary system. This is best done simply by controlling the inflation and deflation of the price for goods an services, thus preserving the purchasing power of the currency.
Having said that, again, I agree with the body of postulations here against bank-credit money and fractional reserve banking.
In the end, as long as banks lend real money, which you prefer to label a sacrifice of consumption, or simply deferred consumption, the store of the value OF MONEY is axiomatic, again reflected in long-term stable purchasing power.
Joe – if something is not a true store of value it is NOT good as money.
It is either a con (as with banker credit bubbles) or an exercise in terror – as with government fiat money schemes (“use these bits of power to pay your taxes in and as payment for X, Y, Z, private dealings or we throw you in prison”).
Also the free lunch point remains.
Investment should be financed 100% by real savings – i.e. the voluntary sacrifice of consumption.
If investment is being financed either by banker credit bubbles, or by the government printing press – then there is a problem.
A very serious problem indeed.
We can, and do, disagree on this point.
I say that the role of money is to provide for the exchange of real goods and services, and if properly issued as to quantity, money can, and should, only store its own value as to the stable purchasing power of the currency.
We all accept that Austrians prefer that no new money be created, causing scarcity in money, an increasing value to the holder of the money(the cost of money appreciates) and general price deflation.
What is also true, however, is that investment can be, and should be, funded by savings, regardless of which system is in effect.
By the way the idea that economic development requires more money is false.
There is nothing wrong with the prices of goods and services falling gradually over time (not collapsing in a boom-bust)as people find better ways to produce goods and services.
Using the government printing press to try and “maintain a stable price level” is a problem – actually it is a nightmare.
I accept that Austrians prefer a little deflation, rather than stable prices. (Who wouldn’t want prices to go down – for anything?)
Reformers prefer neither deflation nor inflation, but stable prices.
The question that comes to the fore, and ought not get swept away by ideology on either side, is why one system is preferable over the other – not to us, but to the users of the money system.
I always grant the Austrians their claim that we have never had truly free markets.
I ask that Austrians recognize the essential truth that we have never had government-issued money, Greenbacks excepted, since we were no longer Colonies – and the UK has never had real government printing press money. Interesting that Lord Adair Turner is now proposing just such a solution.
“Stable prices” refers to the fallacy of the “price level” (the sort of price index thinking that Irving Fisher made fashionable).
A “stable price level” can hide very real inflation (i.e. increase in the money supply).
Also what matters is relative prices – and who decides what is invested in.
If people voluntarily sacrifice some of their consumption in order to finance investment – that is a different sort of thing (a wildly different thing) from financing “investment” via the government printing press. Even if the two sums of money are the same in size – the results will be utterly different (especially over the longer term).
Also I do not see why state power is considered “reform” and its supporters “reformers”.
Unless one considers Louis XIV or the Emperor Diocletian “reforms” which I do not.
By the way the United Kingdom certainly does have government issued money – the Bank of England has been 100% government owned since 1946 and its notes are entirely fiat.
No gold (or other commodity) has been issued in return for these notes by the Bank of England since 1931 (really since 1914 – as the “return to gold” in 1925 was at such an false exchange rate that it was a farce).
These are GOVERNMENT notes – and they 100% fiat.
Everything after “By the way…”. Totally agree.
I said that the UK had more government-issued money BECAUSE the BoE is part of the government, in agreement with what you wrote here – thus making private money(?) creation at the 97 percent level in the UK, versus 99 percent-plus in the US.
No disagreement there.
“A “stable price level” can hide very real inflation (i.e. increase in the money supply).”
Paul, is there an enigma within that riddle?
A stable general-price level can not hide any general price inflation, as, ipso-facto, a stable price level is non-inflationary. That’s the definition of a stable price level – there is no inflation, nor deflation, regardless of the amount of money in circulation.
“Also what matters is relative prices – and who decides what is invested in.”
1. Relative, as to what?
2. Under the Fisher, Friedman, Turner and Kucinich proposals, the government only issues the money into circulation; it is the private sector that determines what is saved and where all investment is made.
So, no problem there.
“Also I do not see why state power is considered “reform” and its supporters “reformers””.
Well, under the present system, the bankers issue 97 to 99 percent of the national money stock as temporary, private, debt-based monetary assets that the Restofus rent in perpetuity, and under the proposed reforms, the state would issue 100 percent of all of the stock of permanent money, without debt, and the bankers would borrow it from the people to lend.
Thus, a permanent reversal of the status-quo in money creation and issuance, which, again by definition, is reform.
I should have pointed out (and did not) that even Milton Friedman (the arch defender of Irving Fisher – i.e. the tradition of increasing the money supply “in line with economic growth” in order to “maintain a stable price level”) eventually came to the conclusion that the monetary base (i.e., in our system, government fiat money) should be FROZEN – i.e. NOT increased “in line with economic growth” in order to “maintain a stable price level”.
Milton Friedman changed his position because of bitter experience with governments (around the world) over decades.
Governments simply COULD NOT BE TRUSTED with such a rule (this was the final position of the arch defender of fiat money). Whereas “STOP PRINTING MONEY – JUST STOP” was so simple even governments would find it hard to twist it.
However, unlike the Old Chicago School of the 1930s, the new Chicago School (of Milton Friedman and co) largely ignored the danger of bank credit – i.e. of boom-bust events.
Indeed Milton Friedman’s final position concerning government (stop printing money) is in contradiction with his standard advice as to what to do in a great “bust” – i.e. that the government (via the Central Bank, or if there is no Central Bank in existence – then directly) should create money to bail out the banks.
A system whose arch defender (Milton Friedman) admitted needed de facto government bailouts during a bust – is plainly not a good system.
Milton Friedman did not invent this terrible idea (the idea that banks are special – that they must be bailed out) that goes back to Walter Bagehot (the man who ruined the Economist magazine- and wrote a much praised, but quite dreadful, book on British politics “The English Constitution” – we should “concede whatever it is safe to concede” to the collectivists, which means Bagehot you j*** that everything ends up getting conceded. whether it is “safe” or not) and so on – but it remains a terrible idea.
Surely throughout his life, Milton Friedman was many things to many people.
But I am not sure why you say Friedman changed his mind about money supply increases by government, and by rule, and that his ‘final position’ was the opposite.
While his initial “Fiscal and Monetary Framework” piece was written in 1948, two of his major books, “Freedom to Choose” and “A Program for Monetary Stability”, were both initially printed in the 60s and later reprinted in the 90s and in both cases he specifically re-iterated his money-rule preference.
I have never seen that Friedman abandoned his ‘money-by-rule’ proposals in favor of a “STOP PRINTING MONEY” position.
To be clear, ABSENT a ‘money-by-rule’ construct, the central bank(Private) could, and has, readily print excess money that threatens inflation in general prices, so that a “STOP” sign would be appropriate.
But that is far different from abandoning the money-rule, again as he specifically updated in his 1992 version of his Program for Monetary Stability in support of ‘money-by-rule’, even proposing a Constitutional Amendment for that Rule.
Especially, as his original 1948 Proposal was taken for the purpose of eliminating the boom-bust cycle to the degree possible, so that we could end the pro-cyclical “creation and destruction of capital” that could cause bank failures and raise the need for bank bailouts, I have never seen any proof of a reversal of his 1948 Proposal.
I repeat that commercial banks do NOT create money – but they do expand credit, which they (and everyone else) treats as if it was money – till the bust comes, then this “broad money” turns out not to exist (because it never really existed).
However, a lot of self deception is involved – I refer again to the banker who insisted to me (with passionate, if utterly wrongheaded, sincerity) that “the money DID exist – the deflation destroyed it!”
Oh those pesky deflation elves – breaking into his vault and destroying the money that really “did exist”
First of all, many good banker friends have no idea that they create money when they make loans. So, your banker-friend comment comes as no surprise.
While I do wholeheartedly agree that what bankers create is NOT money, per se, that which they do create serves the exchange function of money in the economy, and counts towards the nation’s money supply, that is, the money supply goes up and down with each bank loan and each bank loan repayment.
What should happen is the reverse.
Banks should NOT create exchange media – the government should do that and it should remain permanently in existence, and thus the total amount of that media in circulation would never change when a bank makes a loan and issues credit.
Joe – commercial bankers create money, they create CREDIT (which they, and most others, treat AS IF it was money – till the inevitable bust comes).
When someone says “debt is money” or “money is debt” or “all money is debt to someone” the are confusing CREDIT with money (hence the term “broad money” for what is actually BANK CREDIT).
This is why (for example) a banker may (with total, if utterly wrongheaded, sincerity) claim “the money existed, it really did Paul, but the deflation destroyed it…..”
To confuse money and credit is a deadly error – but a very common one.
As for money itself….
It can be of two types.
It can either be a commodity – a store of value, something that buyers or sellers choose to value.
It can be based on force (the threat of aggressive violence) – as with government FIAT (order – edict) money. Which is only a “store of value” in the sense of government tax demands and legal tender laws.
I favour the first form of money (commodity money – with the commodity being something freely valued by buyers and sellers) and you favour the second form of money – government fiat money.
I favour investment being financed by the voluntary sacrifice of consumption – with what the investment is in being decided by the real savers (those who make the voluntary sacrifice of consumption).
You favour investment being financed by the government printing press. Even if this does not have a en effect on the “price level” (a concept I reject anyway) it certainly has an effect on RELATIVE prices (hence MALinvestment).
I hold that the two types of investment are fundamentally different (leading to wildly different long term results) – you do not agree.
We are both against treating bank credit (credit bubbles) as money.
Bank credit is NOT money.
For example a lot what bankers think are “deposits” DO NOT EXIST.
Go to the vaults of your bank.
You will not find much physical gold there – but leave that aside for the moment.
You will not find nearly enough physical fiat notes and coins there (these silly bits of paper and token coins – you do not even have enough of them) – not nearly enough to cover the “deposits” you think you have.
The evil deflation elves did not steal the money in your vaults.
Because these elves DO NOT EXIST – and neither does a lot of the money you think you have.
It never did exist.
Nuff said about it all, except, please explain what you mean by ‘relative’ prices.
Dear Joe – Milton Friedman did indeed move to a “freeze the monetary base” position.
This was not some great change in his economic philosophy.
It was just that DECADES of experience with governments (of all political parties and all round the world) had convinced him that, whatever was true in economic theory, trusting governments to keep to his (really to Irving Fisher’s) rule about only increasing the money supply “in line with economic growth” in order to keep a “stable price level” was trusting government far too much IN PRACTICE.
Give them the power to increase the money supply and they would abuse this power.
Of course to a modern student of the Austrian School there is no conflict between theory and practice.
Even if government is made up of saints and angels – the honest application of the Friedman-Fisher rule will have HARFUL (not beneficial) effects. At least compared with the government not being involved.
By the way – I reject the idea that Federal Reserve notes are not government money (the government backs them with its legal tender laws and tax demands).
However, even if they are NOT government money – the Dollar notes in such countries as Canada and the currencies of such countries as Britain are government money (as the Central Banks in these countries are 100% government owned and have no link with any commodity).
The last major nation to have a currency that was not totally government money was Switzerland – where the old Constitution kept some link (some limitation) with gold.
However, the new Swiss Constitution ripped up that link (that limitation).
These days the Swiss Franc is a fiat currency – just as the Dollar and Pound are.
By the way – to gold and silver fans.
Do not tell people you have gold (gold is less hard to hide than silver – one of its advantages).
And remember the other vital metal (more important than gold or silver).
French peasant farmers find it very useful in dealing with informers and other such (and have done for centuries).
The bodies of the “enlightened active citizens” do not present difficult problems of disposal – as a farmer has ways of dealing with such things.
Sorry, that explanation is insufficient. I cited two of Friedman’s RE-writings from the 90’s that both included his “money by rule”.
It is not enough to quote – ‘freeze the monetary base’.
That really means nothing without a context, so, being topical to…..’what’?
Freeze the currency issuance?
Freeze the non-currency(non-money) reserve issuance?
Some context is in order there.
And he never proposed to give “them” the power of how much money to create – always insisting they could not be trusted. Rather he promoted enshrining (indexing) money creation to some metric – by law, even proposing to amend the Constitution as late as the 90s.
I have often heard it claimed, and never seen it proven, that Friedman changed his mind on ‘money by rule”.
As for FRNs, they are created by the government and, though issued into circulation by the private banks remain government money. The government can, and has, made whatever it likes be legal for tendering a payment to government, as it does with bank credit right now.
Again totally agree that any country with a public, currency-issuing central bank is issuing government money as currency. Thus only 97 percent of UK money is privately issued.
But, please don’t be fooled into thinking that government-issued money that is tied to a fixed exchange commodity is not also government money. Of course it is. ONLY as such could it be in existence, and any eventual change by the government to abandon the exchange value would do nothing to change its governmental status.
So, going long on lead, that’s your investment advice?
We need not go into the whole Austrian thing about “not overinvestment – MALinvestment” (investing in the wrong areas – misallocating resources and time), let us stick to just the term “relative prices”.
The same thing you would mean by “relative prices” Joe – the price of something in relation to other things.
For example, the present British government has a policy of propping up the housing bubble (indeed, if possible, inflating the bubble still further) – the British government does NOT have a policy of increasing “the price level” in general, but it does like high house prices (and so subsidises the buying of houses – subsidising the buying of something being the standard way of increasing the price, the price of medical care and student loans, since the government started subsidising the buying of these things, being relevant American examples).
This (subsidising something increases the price over what it otherwise would have been) has been known since at least the time of David Ricardo – subsidise farming and the price of farm land will be higher than it otherwise would be and (if there is no general inflation) less resources will go into other areas of the economy. The CAPITAL STRUCTURE of the economy is thereby distorted (with more resources going into the favoured area of the economy than should go there – more resources and more human TIME).
If you asked me WHY the British government wishes to maintain a high price of housing (in relation to other things) I might have more trouble in replying – but then I am not a mental health specialist.
Your guess is as good as mine – and there may actually be no rational answer as to why the British government is acting the way it is (hence my mention of mental health – I do not mean this as an insult, on the contrary it is quite possible and a rather scary possibility).
This is why I would actually be relieved if it turned out there was some ordinary reason – such as bribes from house building companies. Better to be ruled by corrupt people — than by people who are mentally ill (and, I repeat, I intend no insult to people who are mentally ill).
Joe – repeat what I have already said.
Milton Friedman had (alas!) no theoretical change of heart – just a practical one.
He continued to believe that a government controlled by saints and angels should increase the money supply “in line with economic growth” he just, eventually, noticed that governments are not made up of saints and angels and thus can not be trusted with the power to increase the money supply.
Of course an Austrian School person would hold that even if government were made up of saints and angels they should NOT do this.
As for bank credit…..
Mises and Hayek (at least Hayek before old age) understood that that the “Currency School” were correct and the “Banking School” were wrong.
The Currency School were correct about the problem (bank credit – loans that were not really from REAL savings), but wrong about the solution – limiting “bank notes” (as with Peel’s Act of 1844) solves nothing, as bankers have many ways of inflating credit.
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