THE ISSUE
Under the current system of banking it is possible to expand the supply of money in a nation. This causes the value of money to decrease for everyone and thus represents a loss to everyone of an amount of money which is a gain to someone else. This is what we normally call inflation. This is involuntary and hence a theft of the resources of some for the aggrandizement of others. This is not acceptable ethically or economically and so we must discover how to insure that it is not possible , or at least punishable in the usual way (restitution). This is a complicated issue with far reaching consequences for a lot of areas of economic life.
While "inflation" in the sense of rising prices can occur without money supply growth such inflation represents genuine differences in demand and supply. We would not wish to stop this (comparatively minor and infrequent ) kind of inflation. But it is unarguable that the main type of inflation in this century has been caused by increases in money supply through the banking system and the relationship has been clearly traced by many economists such as Friedman in his history of money supply movements (5) and in the (non monetarist) history of inflation : "The Great Wave"(2) . Despite the clarity of the former's understanding of the problem, we will be proposing some different solutions to the ones he would propose.
BANKS AND RESERVES
We have in most countries of the world what's known as a fractional reserve banking system. This means that if everyone that had accounts with a bank decided to withdraw their money on a given day then there wouldn't be enough to go round since most of the deposits would have been lent out in long term mortgages. However, in a given day only a few people will withdraw all their money and others will deposit so the banks only keep that percentage they think they will need and lend out the rest . The amount of "cover" a bank has is what a bank keeps in reserve to meet current liabilities i.e. that it doesn't loan out . This amount does not in itself increase or decrease the money supply, contrary to the impression one sometimes gets when reading the literature. On the contrary its the CHANGE in reserves that causes the increase. The process by which this happens is explained in any introductory economics textbook , namely , that once a loan is supplied by one bank it is usually deposited again in the same (or a different ) bank and then the same money lent out again. The system is such that a bank can't increase its loans until it receives a deposit from somewhere else in the system. But as each bank can only lend a certain % of its deposits then the effect gets less and less with each transaction until finally we reach a point when all the banks are lending up to their reserves and there is then no further effect on the money supply from this unless the % banks keep in reserve changes.
This only happens with loans from a bank (intermediated lending), it doesn't happen when an individuals loans money to another since unlike in the banking system only one person at a time has access to this money. The banking loan on the other hand has the effect, in practice, of increasing the money supply but ONLY if the banks are in the process of increasing the % of their deposits that they lend out. Once the level of reserves (what the bank doesn't lend out) reaches a level below which the banks don't want to go, then the money supply stops increasing and new loans are made only when old ones are repaid..
But the problem is that this actually hasn't happened much recently. For the last few decades reserve ratios have been falling gradually- partly due the removal of certain credit controls. In the UK , M4 ( which is one of the best measure since its one of the broadest) has been rising by between 8 and 18% a year in the 80s.. Not unrelated was the fact that the reserve ratio was decreasing form 2 to 1% (i.e. halving) gradually and monotonically (i.e. never coming close to decreasing) .In fact , from 1966 -80 ,M4 never decreased ( though bank lending did decreased one year, though by an amount less than 5% of the increase of the previous year).. This decrease in reserve ratio wholly explains the rise in the money stock.
THE ISSUE IS STOPPING DECREASING RESERVES NOT 100% BANKING.
In order to stop the increase of the money supply it is thus only necessary to stop the DECREASE in reserves , it is not necessary to insist that banks much keep 100% in reserve. The latter system ( suggested by the Chicago school at one point) would mean banks could basically only match deposits and mortgages of a similar term- so depositors would have to deposit for a longer time (say 10 years) and mortgage borrowers would have to borrow for a shorter time (say 10 years). Each liability would be the same term as the asset.
This is a system that effectively doesn't lend for house purchase.
However this is not necessary (because its only the change in the reserves that needs to be zeroed not the absolute level). Furthermore it is not desirable, if there are other ways to create zero MS growth, as it would mean great difficulties in matching lenders and borrowers. Most importantly, the transition to this system would involve the money supply contracting by about 50 times (i.e. 98% drop) . Major depressions are about 20% ! 100% reserve banking would lead to the recall of most of the mortgages in circulation, the inability to buy property until you'd saved up for it, thus a huge drop in property prices. A contraction of the money supply by a factor of 50. Most banks would go out of business
We don't want them to be unable to lend out deposits placed with them at interest because how then would they be able to fulfill their legitimate function of matching borrowers and lenders, yet this is what 100% reserve banking basically means. .
Even in the banking system I propose with constant money supply banks would still take short deposits( instant access or 3 month notice) and lend long (mortgages) because that's the nature of the supply of bank deposits( customers want access) and the demand for credit which is still dominated by long term mortgage lending since even now consumer credit is a small proportion of total bank lending.
100% reserve banking then isn't the issue, banks will always have to lend long and borrow short. They will always have to lend a certain % short in order to cover possible short term liabilities, they will always be vulnerable to runs to some degree ( although they could possible insure against them). The point is not 100% reserve but the fact that they should not be able to decrease reserves below a given level
FRACTIONAL RESERVES ARE NOT NECESSARILY FRAUDULENT.
The point could be conceded that its possible to ensure constant money supply without 100% reserve banking but that there is a further problem. It could be argued that banks take deposits promising to redeem all notes ( or deposits ) on demand but in fact may not be able to in the event of a run. This is fraud is it not? To that charge I would argue that I agree that banks should make clear in their terms and conditions contract that notes and deposits are usually redeemable on demand but may in exceptional circumstance not be payable but would then be paid later and bear a rate of interest for the customers inconvenience. But , this is a point of contract law and is not fundamental to the control of the money supply and hence inflation. I agree banks should be able to be sued for fraud if they promise something and are unable to do it. But given that threat, it is a fairly simple matter for banks to amend their contracts to reflect this and then they are doing no wrong !
More practically in recent years a practice has developed whereby a mortgage book can be securitised and sold . So in other words a bank can liquidate its ( formerly most illiquid) assets very quickly nowadays making it much less vulnerable to runs, and much closer to the ideal, with respect to the prudential concern (that it is undesirable for banks to be going bankrupt frequently)
THE GOLD KEEPER ANALOGY
Fractional Reserve Banking is often described in terms of the man who gives out many receipts for gold and becomes indebted to multiples of his assets. (Tools of Dominion p742). This is not a particularly good analogy because it gives the impression that banks in a fractional reserve system NECESSARILY lend on assets they don't have .Modern banks do take deposits and lend them in 25 year mortgages which means that they don't always have on hand the reserves to pay back depositors "on demand" but they do have the money ultimately if they need it. There is nothing intrinsically wrong with this, as long as the contracts express this reality which they could easily do..
It may be better to tell people up front that their deposits are redeemable on demand up to a point and after that they will have to wait for the banks to recall mortgages but that is a point of contract rather than principle and it is enough to note that this isn't the primary cause of the problem. Most banks, most years could redeem their deposits given enough time, even if they couldn't redeem them on demand.
Historically ,notes were contractually able to be redeemed in gold which caused problems when the bank could not produce it. However if the bank could sell its mortgage book and thus pay off notes in gold there wouldn't be a problem. And there's nothing intrinsically better about contracting to redeem in gold rather than other assets.
The same principle applies to bank notes in previous centuries (insignificant in modern economies) as bank accounts now- they lead to money supply expansion when they first appear but reach an equilibrium money supply at the level which is expressed by the needed reserves. After that the system is not in itself inflationary.
Nor is there a problem using promises to pay instead of commodities to pay for goods and services. Token money is not a problem. The problem only arises if it is allowed for the money supply to increase as a result.
MORE ON BANKING
Furthermore if loans are repaid and not loaned out then the system works in reverse. The loan is repaid out of income for example so an employer draws on a deposit decreasing the reserves of the bank, since they must hold a fixed percentage of a sum that has decreased. Next they don't lend out money they've just got in from people being paid by cheques drawn on company deposits and so on.
Additionally it should be pointed out that even if reserve ratios are constant, if extra deposits arrive in the system this has the same dramatic effect on the money supply ( if lent out to the same degree as previous deposits) as decreasing the reserves. So reserve control does not in itself totally control the supply of money.
A SOLUTION
Inflation (i.e. the growth in the money supply) in a sense can be viewed as a form of externality, like pollution. And like pollution the problem is that costs are borne by everyone and there is no effective way (at the moment) for those who bear the costs to recover them from those that get the benefits and like pollution the problem is inadequate property rights- like the commons in the middle ages and public areas in government housing projects-what nobody owns, everybody spoils.
Banks at present have every incentive to continue profitable lending but everyone looses if the money supply increases. What we need is to freeze bank lending at the current level and convert that level into a system of property rights where to lend would legally require the possession of the property right to lend that amount of money. These rights would be tradable ( and divisible)- so banks that could expand their lending most profitably would be able to buy these rights to lend but because one banks loss would be another banks gain there would be no money supply increase here ( the reason to make the right based on an amount of money lent rather than the amount of reserves allowed is that rises in the amounts of deposits also would increase the money supply in a reserve controlled system whereas amounts of money that you are able to lend encapsulates both these factors.
As society became richer, other things being equal, the amount of deposits in the system would rise but not be able to be lent, so the reserve ratio would effectively be constantly increasing. These extra deposits would have to be invested in other kinds of assets In other word if there are currently £1 billion in deposits and banks currently lend out 99% of that then if you froze the system at this point then as people grew richer and the volume of deposits increased to £1.5 billion the banking system can still only lend out 99% of £1 billion which is now an effective ratio of just under 66%. This means the banking system would have lots of deposits that it is not allowed to lend. In time this would mean that less and less of societies wealth would be bank deposits and more and more in other assets. In other words the effect of any effective moves to zero money supply growth would ultimately be the end of the present banking system, other things being equal, for matching deposits and loans made necessary by the almost co-incidental effects of the effects of ratios on the money supply. But other things are not equal as we will see below.
WHAT WOULD BE THE EFFECT OF THIS ?
One of the first effects would be the securitisation of loans . Having sufficient deposits the rate on savings payable by banks would fall and people would be more tempted to put their money direct with companies rather than deposit with banks for them to loan out. But this is not a problems - in some ways it may be desirable that people borrow this way as it doesn't increase the money supply. In fact the authors of Competition or Credit Controls (3) themselves point out that the removal of the "Corset" in the UK in 81 removed the need for these evasions and thus increased the money supply by 10% in two months as the money returned to the balance sheets of banks (that equivalent to 60% a year inflation although of course the 10% was a once off and not a monthly event !). Another effect would be the higher levels of trade credit, another effect of the credit controls in the past, again this presents no problem as this kind of credit doesn't expand the money supply.
THE DECLINE OF THE BANKS ?
Another effect would be the cutting out the middle man , lenders and savers would deal with each other direct more often with companies intermediating, i.e. savers might lend direct to the borrower (securisation of loans is a subset of this). If savers were prepared to lend to borrowers directly and tie up the money for 25 years ( or possibly less e.g. .if the market cleared at say 10 years ) then this would be one additional way of gaining mortgage finance once the banks stopped being the major source.(like with 100% banking above ) If lending was fixed at a given (though privately tradable ) amount, which is the only once-for-all way to stop money supply growth, then as the price of houses went up, the amount available from banks to finance them would be proportionately less since it would be fixed in value.
If other organisations intervened and offered to lend long and borrow short i.e. basically to be banks then they would have to be subject to the same terms that banks would be, in other words to buy the right to lend from existing institutions.
THE EFFECT ON THE BANKS OF ZERO MONEY SUPPLY GROWTH
However this kind of analysis, in one sense, forgets the object of our discussion- to create a system of zero money supply growth. If this was the system then the "general level of prices" would be constantly falling and if wages were going up by a bit more than "inflation" then they may well be falling too in nominal terms ( although they would be going up in terms of purchasing power, this may mean the prices of houses would be falling (like any other commodity) and that the banks would have ever increasing purchasing power for their constant supply of loans and thus their continued existence. Interestingly this gives banks a vested interest in constant money supply and falling prices.
Rates of interest on savings might be zero or even negative as deposits would increase in terms of purchasing power even if no interest was given. As a result nominal interest rates on loans might be very low, 2%or 3% or less even if they were high in real terms as a result of the new permanent tight money environment . This is important politically as borrowers wouldn't feel worse off even if they were (the feel good factor would not depart quickly !)
The effect above is possible but not automatic in a system of zero MS growth. Its quite possible since on average over the last 30 years if you take away money supply inflation, prices fall at 4% a year, wages go up at 6% a year (2% nominal) and house prices go up at 7% a year (3% nominal). This would create a falling role for the banks in the mortgage market anyway as houses became more valuable with respect to a fixed amount of bank lending.
WHAT KIND OF LENDING
We must also consider what exactly we define as being the lending that we are restricting to those with the relevant property rights. We do not want to exclude, for example, businesses issuing bonds, which is a form of lending because this does not increase the money supply. Similarly any other form of direct lending from one person to another does not affect the money supply as when the loan is made it comes out of one persons bank and into another and so there is no increase.
The reason banks increase the money supply is that when the deposit in loaned out, it is quickly deposited somewhere else and becomes the basis for a loan by somebody else. This happens relatively quickly , probably for someone to deposit the money loaned and for this to be transferred to other bank accounts takes about 4 or 5 days If the banks are dropping their reserve ratios from average 2% to average 1.9% (5% increase in the money supply) this takes around 50 iterations in the model to start to be close to the ultimate value so we can probably expect that kind of change to take about 9 months to translate from reserve ratio change to money supply growth. The question is- is there other organisations in society that might have the same effect once we restrict the obvious institutions? Would the lending out of other people's money be a suitable definition? If we made this our starting point then it would exclude the banks, building societies, insurance companies, and so on loaning without the relevant property rights. It would also prevent people raising money by issuing bonds in order to lend the money out ( unless they had the relevant property right to so) without stopping them issuing the bonds for other purposes. It wouldn't however stop new entrants into the market loaning out their own money. Even if they withdrew it from their deposits this wouldn't necessarily contact the money supply because there might well be a surplus of deposits over loans anyway. When this money was deposited in a bank however there would be no multiplier effect as the increase would not effect the amount of money banks would be able to lend. Note issues would be similar ( banks could not loan by giving people promises to pay anymore than it could loan by giving people electronic entries in a computer, without the appropriate right)
. If non-banks (say IBM or Ford) issued notes (that is promises to pay on the assets of the issuer ) and people were able to use them to buy things ( because of the Ford name ) then they would be returned to Ford to pay and the system would cancel. If they weren't returned but became a form of currency then this behaviour would be an increase in the money supply. Ford would only want to do this if it was effectively a loan from someone - i.e. they were paying their obligations in promises to pay (possibly bearing an interest rate). So this is really equivalent to the issue of company bonds, and these bonds becoming acceptable currency. Not impossible, but not a problem to our system.
We are not restraining the growth of lending per sce but lending through intermediaries of other people's money which has the multiplier effect.
POSSIBLE PROBLEMS AND THEIR SOLUTION
One major problem to credit control of any kind is seen to be the Euro Sterling deposits market (3) . This is where national or foreign banks have sterling denominated deposits in offshore accounts. That is they accept deposits from UK residents and loan out these deposits to UK residents but are not in a UK jurisdiction. The problems with this is that banks could lend far more than they had in assets in these jurisdictions into the UK to make up for the fact that they are lending far less than they would like to lend of the deposits they have in the UK. The effects of this are the same as if they were lending a higher % of their reserves in the UK, so in other words its a way to get round the rules. However as L & H point out later in their book (3) in a different context, there is an easy way to stop this and that is simply by law to make loans and mortgages unenforceable in the courts if the lending institution didn't own the right to lend that amount of money. This is pretty effective constraint especially if borrowers knew about it. Furthermore other lenders ( or perhaps anyone) would be able to sue lenders in the courts who lent more than their right to do so. Possibly the loan documents would arrive with the number of the property right printed on it ( and borrowers would want to check this ( after they had the loan) to find out if they could legally not pay it back !)
OTHER IMPLICATIONS
Equity Finance
With this kind of system banks might invest a proportion of the rest of their deposits in equities including new issues which would mean banks funding the private sector through equity rather than through loans. This is better as it doesn't have money supply increasing effects.
No need for a central bank
It is worthwhile to note that we are not talking about reserves with a central bank but the legal ability for banks or more exactly any institution that takes deposits , to lend a fixed amount of money conditionally on it owning the right to do so. Central banks would no longer be necessary except to manage the national debt. Open market operations, changes in interest rates or various ratios, actions to restrain the banks balance sheet, provision of liquidity in last resort, legislation of credit terms, would all be things of the past. Greatly simplifying the financial system and making it more predictable.
There would however be no disintermediation. This occurs when business switches away from companies with reserve ratios to ones that don't (as in the 60s and 70s) . Clearly in the system we are proposing all organisations that wished to lend would have to purchase the property right to lend and specified percentages of a specified amount ( which in practice amounts to a right to lend a specific sum of money ) which would have to be sold by existing institutions and probably be fairly expensive.
EFFECTS OF ZERO MONEY SUPPLY GROWTH
This is an important subject to look at since about a third of the responses I got on the Internet about this subject claimed that zero money supply growth was undesirable . From a moral point of view we have ethical reasons for seeing it as desirable but there are also clear economic reasons why it is worthwhile. Firstly, there would be higher real rate of interest on borrowing - a fixed amount of borrowing for ever. But with falling prices the fixed amount of borrowing would be able to buy more and more. ( the nominal interest rate might not be much higher as in a system of falling prices there is a deduction for inflation in the interest rate rather than an addition)
Secondly , no inflation means no distortion of prices which means higher rates of economic growth as less business projects fail due to distorted price information.(see Hayek, Denationalisation of Money et al). This is especially true in the case of asset price inflation where money supply growth is often expressed in higher share or property prices leading people to think there is a genuine shortages of houses or Canary Warfs when this in reality isn't the case as people discover when the bubble bursts. In the long term these booms are far from good for growth. Similarly if a sharp rise in share price reduces the cost of capital then firms will be tempted to overinvest. .This can also seriously harm anyone who has lent on the basis of these values. In Japan this situation in the 80s led to much overinvestment in bad projects and hence no growth in the first half of the 90s. Zero money supply growth eliminates these massive misallocations.
Competition may bring down bank margins as they cut costs, but larger numbers of unloanable deposits would bring down rates of return on savings causing some of them to be invested in other assets rather than bank deposits, alternatively the banking system would possibly try to get rid of the deposits by encouraging its depositors to invest in unit trusts and the like, possibly offering guaranteed rates . Additionally saving rates may go up if banks restrict their lending by insisting on higher deposits( as those in most countries other than Britain do), people then have to save for their deposits which is a major part of the where the incomes of the young go in Spain.
Above all allocation of resources would be efficient because the situation would be the same forever rather than constantly changing as governments changed interest rates and reserve requirements and other credit laws. Today people loose lots of money every year because good decisions in one environment later become bad decisions as the government changes all the rules. Having a constant and predicable situation would be a major boon for any country.
Central banks are government agencies like any other and they make many mistakes especially since its impossible for any central institution to have all the information it really needs for decision making since its in the heads of millions of people. As a result they are often responsible for major crises and problems- Friedman blamed the gross incompetence of the Bank of England for the monetary problems of Britain in the 80s (shadowing the Deutchmark was certainly a bad idea !) , Mexico's problems in 94 stemmed in part from the Central bank pursuing lower interest rates on government debt instead of stable monetary policy or parity with the dollar. The government prevaricated. The freedom that can be created if banks are restricted from increasing the amount they lend, leads to major free market efficiency improvements in every other area of banking as the government stops having an active role to play. Most importantly there would be no booms and busts, no stop go , ever again.
Other costs reduced are menu costs (updating your catalogs/menus for new values of good/services), shoe leather costs (cost of going to the bank/broker a lot because you don't like to hold on the cash since it's losing value), and uncertainty (no one wants to lend/borrow money if they cannot be sure of the future value of money). (6)
It would mean there would be no rational for currency control and hence no crises. No need for capital markets and stock markets to allow for the uncertainties (a) of inflation itself and (b) of government policy changing in response to it. Less uncertainty mean more business decisions turning out to be good ones and hence more economic growth.
In fact in Getting it right , Baro p 65 , the author relates that in studies of over 100 countries from 1960 to 1990 that 10% drop in the inflation rate means a 0.25% increase in growth. This means that from an average 5% inflation and 2.5% growth country we would go to one with zero MS growth, hence -4% inflation and hence 4.75% growth. This difference over the last twenty year would have raised the average income in Britain by 54%. So your income and that of the poorest people of this country would have been fully 50% higher today than it is if we had implemented this policy sooner. From 1960 to 1982 Britain went from being the 6th to 17th richest country in the world , with this policy it would have become the richest.
Furthermore Baro concluded that there is no support for the idea that inflation has to be tolerated to ensure output and employment (Getting it right : Baro )
The effect of high interest rates on investment decisions is slight as there are usually many other factors involved in the project that effect its costs and benefits.
It could be charged that restricting the number of loans we are restricting the growth of the economy. With any system, including the current, the number of loans are restricted. If maximising the number of loans was always desirable then we would have no reserve requirement at all. Furthermore the loans that would be stopped by our system would be the ones that were of lowest quality. So while some economic growth may be stopped by not making loans that would have ended up successful, other growth would result from the non making of loans which would go wrong. But the overwhelming factors discussed above including the growth enhancing effects of prices that reflect real supply and demand situations, would by far outweigh any growth affects lost by lending decreasing at the low quality end of the market. Its also worthwhile to note that we are only talking about intermediated lending, direct lending from one company to another would doubtless fill the gap created by our ceiling on bank type lending situations. There is a big difference, between falling prices after a boom (such as the 6.8pa falls in prices in 1930-33 in the US great depression) and falling prices generally. The former negative effects represent the price and thus growth distorting effects of the initial boom. As von Mises said when asked about the Great Depression - "the government should have done nothing , sooner !" The great depression money supply shock was caused by bank failures not all money supply decreases would have had the same effect. Since our system makes bank failures less likely (less lending) our system doesn't create risks of the great depression as some have argued. Note also that even if less loans are made ( and it is likely that this would be the case). It would be the worst risk loans that would go first. Now lets look at the recent banking crises in Thailand and South East Asia, in Mexico and Latin America and also the Savings and Loans crisis in the United States and the banking crisis in Japan. Clearly in the developed and the developing world the problem is not that we have too few loans but that we have far too many, especially at the high risk end. Zero money growth would stop these crises arising in the banking system to a large degree. The world saving from the reduction of banking crises is huge . The Japanese crisis cost $400 billion, the US crises £180 billion ( $1800 per household.). In terms of GDP the Argentine crises of 80/82 cost 55% of GDP (more than the whole of government spending for a year), Chiles crises was 40% and Israel and Uruguay's crises were over 30% of GDP. Another 100 countries have had banking crises in the last 20 years with huge costs, (23 over 3% of GDP- more than a years growth in most places), both in the developed ( Spain, Sweden,Norway) and the developing world ( Brazil, Malaysia, Cote D'Ivoire, Hungary). It happens to all kinds of economies and the costs (if there are any) of reducing the volume of loans at the less desirable end is surely outweighed by the benefits in avoiding such crashes. More Competition With the implementation of the one control we have discussed above , it would then become possible to abolish all the other controls on banks ,thus allowing the banks to compete more effectively , and for new entrants to eat away at the high charges of incumbents. We might even see the emergence of independent clearing systems. Up till now money supply concerns have limited the competition of the banking sector somewhat, once we have dealt with that issue the competition can be as strong as any other industry and the banking sector needs this particularly since its arguably more hated by its customers than any other organisation except the Inland Revenue!
People would adjust to price levels like that of the computer market now, constantly falling prices. This isn't necessarily a utopia in itself but we must understand what is happening here- the productivity gains of society usually absorbed by the banks, the government and other first port of call users of the increase in money supply is now being spread throughout society in constantly falling prices. If this happened before tax rates were cut then it would have the additional virtuous effects of moving people out of higher tax brackets. For third world countries it would have the highly desirable effect of making foreign debt denominated in dollars (or other foreign currency) worth far less in local currency over time ( if they just pay the (declining) interest payments for 20 years the capital will be worth virtually nothing in local currency).
TRANSITION TO THE NEW SYSTEM
The main transaction would be the auctioning-off of the rights to lend. I am not in favour of automatically giving them to banks as that would create a barrier to entry for new institutions that might want to compete in the new regime If the level of debt that the total was being frozen at was set at a projected level a few months higher than the time it was taking place (i.e. money would be allowed to continue to grow for a few short months more) there should be little shock to the system in changing to the new regime. After it is set up it needs no government supervision, only the courts if there are violations.
(1) Denationalisation of Money : Hayek ( Institute of Economic Affairs: 76, 78,90)
(2) The Great Wave - history of inflation- see index
(3) Competition or Credit Controls Llewellyn and Holmes IEA
(4) Kaldor- various
(5) Friedman- various
(6) Internet comments : this one from Charle9216@aol.com
Appendix 1 CURRENCY CRISES
The easy way to avoid the crises of Mexico and Thailand ( or even of countries in the ERM ) is to have a freely floating exchange rate and not try to pretend your currency is worth more or less than it is ( which is what fixed currencies basically are). Imagine, we had a fixed price of Chicken . Then we had a shortage of chickens one year due to natural factors , normally the market would have adjusted and the price of chicken would go up. In a fixed system, the speculators know that the chicken price is unrealistically low so they buy up as many chickens as they can get their hands on , on the assumption the government will have to increase the price at some point. This causes the shortage to become more acute still and the market price (which its of course illegal to sell at since you have to sell at the fixed price) to get even higher puting more pressure on the government. If the goverment then "devalues/revalues the chicken" at a higher price then the speculators sell the chickens and make a profit.
This is essentially what happens in a financial crisis like those in Mexico and Thailand and is easily averted by floating the currency and allowing it to reflect the real price of the currency against others. The loss of confidnece that tiggers the crisis can be changes in the cabinet and assasination attempts of key politicians ( Mexico) or many othe factors. Floating rates take these transient factors out of the value of the currency.. The policy of the central bank in Mexico sterilised the exchange rate effects on money supply anyway so there was little point in the policy in the first place.
Fixed and then devalued currencies have totally unneccessary negative effects on people since many people (in Mex and Thail) borrowed in foreign currencies which looked cheaper at the time , and then had to pay back in the really much higher rate. This led to many bankruptcies and knock on effects. This doesn't happen with floating rates which accurately reflect all the information available ( prices are an amazingly efficient way of transmitting information)
The argument that floating currencies lead to instabilities in trade is not an economic problem for business because if it was they would hedge against it by using options ( and they don't) in countries with floating exchange rates.
The argument that fixed rates lead to lower inflation is statistically true because the countries peg to a country with good monetary policies. But it is of course far better to have good monetary policies yourself as explained elsewhere in this article.
The IMF has found no evidence that fixed exchange rates lead to higher growth (Economist 20th sep 97) If people started lending with bonds would that not then be a good thing as the money loaned then requires people (non-banks private sector) to withdraw deposits to pay for the bonds which contracts the MS by the same amount that the MS expands when the company deposits its loan in its bank.
Similarly when a person wants to start a bank then he sells assets to convert into loans which people have to withdraw money from accounts to buy. Alternatively he starts taking deposits which means a loss of deposits to other banks.
However clearly when people grow richer they have more money to put in deposits. What if there is an increase in the savings rate. I.E people get paid more, direct into their bank accounts, to its automatically more deposits and then keep in there more than they did before. The problem can be higher wages or a higher savings rate, both create more deposits.
Appendix2 THE DEBATE
The following are comments I got on the paper on the Internet, my comments are in bold.
<< P.S. I would also disagree with Dougieie's view of an increase in the money supply, ipso facto, causing inflation. All the money supply reflects is the amount of supply there is for money for the law of supply and demand, indicating that money is a commodity as is every other type of tangible property. The amount of demand when juxtaposed against the money supply sets the interest rate. >>
I wasn't aware this was an issue in need of defense. It is certainly true empirically that over the last (X) years a doubling of the money supply results in a halfing on the purchasing power of money. For example in the west about 20 times since 1947. i.e. money supply 20 times as much and prices 20 times dearer. Although an increase in the supply of another good say coffee may affect the demand in most cases money supply increases through the supply of loans and so the demand is there at the same time as the supply, so its price that is primarily affected. Other time periods are shown in A Monetary History of the United States by Friedman et all.
(Prices of individual commodities can of course increase because of scarcity rather than inflation but a rise in the money supply always results in an increase in the price level (unless the velocity of money changes permanently which is unlikely), it cannot do otherwise .
Inflation comes in when the government interferes with the market by artificially setting an interest rate or messing with the reserve ratio, which indirectly affects the interest rate, since it will make the supply or money more or less available, or by printing money. If the government stays out of the equation, any increase in the money supply will be offset by another element of the economy suffering deflation, counteracting the effect of a reduction in interest rates. If you have no government interference in the market, you have no market inflation or deflation (though you do have local inflation/deflation. >>
I am myself argueing that the government should stay out of the equation but its got to get out in such a way that the banks can't continue to increase the money supply (unless you are suggesting they need the government to be able to do this, they don't ) . Its how we do this that I'm suggesting in my article.
It is quite possible for banks if they continue to decrease their chosen reseves in the the absense of the government (via the banking multiplier effect ) to create increases in the supply of money that are not reflected by withdrawals elsewhere. What is the mechanism you suggest for withdrawals in the mechanism elsewhere, where and why would banks decrease the supply of money, remember that if banks are able to expand the supply of money then interest rates become lower expanding the demand for money also.
(2) << There is no doubt that there is room for improvement in all monetary systems. The caution that I suggest is due to some knowledge of what a monetary system with the limited supply can do.
Prior to the Depression of 1929, the United States had a system which had resemblance to the system you propose. Gold and Silver backed currency with limited supply caused banks and businesses to issue their own currency or script.
I've thought a bit about other currencies in another paper inspired by Hayek's denationalisation of money. Other currencies in themselves wouldn't defeat the system as long as they had to convert rights to lend in pounds into rights to lend in the new currency. There would still be no change in the supply of money if loans in one currency were simply replaced by loans in another. ( I am envious of the time you have to commit to research but perhaps in our conversations I will learn much from you.)(The theory hear seams to be sound. If I were looking for problems, who determines conversion rates and whether or not these conversion rates could change through time would be important things to know. The real potential for disaster in such a process would likely come from speculators in the resource markets. The level and value of information that these people can gather today is almost unbelievable. No one individual would be able to compete with the multi-billion dollar firms ability to collect and analyze information for profit. One mistake in design or implementation of such a system would likely cause a loss of faith by the average participant.-Start a panic-)
My grandfather thought that the problems began when the ordinary working people noticed that the value of U.S. gold and silver currency was increasing.
This would be an effect, prices falling relative to money Do you know whether the money supply was constant, shrinking or rising slowly at this point. (I'm not certain. There should be books on this subject - Milton Freidman-)(However, the older I get, an awareness of the fact that bias affects the writing of most historical events makes it difficult to separate truth from fiction. But to answer your question, the available money supply appears to have been shrinking. With interest rates somewhere below 1% & 3%, bank stability in question, people felt more secure hold wealth in cash making currency less and less available. )
People with money or access to money only had grab it and hold on to it to be more wealthy the next day. In my country at that time, it was virtually impossible to remove wealth once it was accumulated. (It really was interesting. There have always been stories of people literally starving or freezing to death rather than spend their money for needed resources.)
There are families that I know in my community that made a fortune at that time. The ability and power to manipulate people came with these fortunes. Gaining control of local and regional political systems, carried with it, a legacy, that exits today. Many of the social problems in this country can be traced to this period. Economic classes developed and were/are fortified by the use of wealth in politics. Only in the last 10 to 15 years has the power been eroded enough, by gradual inflation, to break the choke hold of many of these families.
Consider that people that hold the money supply gain by being able to slow the development of resources. The old saying, "You are only rich so long as everyone else has less than you.", does not provides a reason for some types of people to promote social change.
As I understand you , you are saying that in a system of constant money supply it is easier to hold onto money once attained and that this is necessarily a bad thing , is that correct? I would have thought there might be some benefits in that if the people were productive enought to gain it in the first place they might be able to use it more effectively in the future, no? (This is not a question of good or bad, rather, human nature. If you or I were in the market for a resource, believing that the resource was about to get cheaper, we would likely wait to purchase. If a large enough group of economic participants adopted this attitude, money value could continue to climb relative to the value of resources.)(The Federal Reserve today changes it's mind frequently but often states a healthy inflation rate of somewhere between 3 & 5%. This level appears to keep the FED's control over the supply of money near absolute and sensitive to the level of growth in the economy.)
Secondly, one of the main groups that would gain would be poor pensioners on fixed incomes. (The problem for this group would be the ability of the pension funds to continue to support the pensioners. These types of funds usually depend on the health of the economy. Most in this country commit a large portion of investment activities to the companies of the employees. ) You know more about international issues and communities than I. Could you see a similar perversion of the system that you propose? Keep in mind that when it is possible to increase wealth by simply doing nothing. That is exactly what many of the wealthy will do. Interesting idea that it might create a disincentive effect not to work.(These people will work at manipulating rather than producing. )
P. S. The script and bank currency of the 20's was not unlike the credit cards of today. -Challenging isn't it!-
Casey
What appears to have been one large problems of this era will make providing information today difficult. People were so busy making money that taking time to consider anything else was not that important. The "Roaring 20's" as they have been often called busily recorded successes rather than problems. There are a wide range of views of what may have caused the "Great Depression" by many economist with the truth probably having more to do with a lack of good reliable financial information than anything else. But one thing is for certain, many of the people in power today made their fortunes during and right after this period by gaining control of resources suggesting that some had better information than others. This is something that your plan needs to be careful to prevent.
One of my worries about the 1990's in the U.S. is the number of parallels which can be made with the 20's. The FED will likely prevent a calamity like the Great Depression in this country. However, today economies are linked world wide and to some degree the monetary systems linked as well. The UK did not fair well during the late 20's & 30's either. Can any parallels be drawn with the UK? )
(3) I skimmed your paper... I have heard most of this before.
First of all, not everyone loses from inflation... borrowers gain when inflation is unanticipated. Second, you can't freeze bank-lending, which is only at a short-run equilibrium at any moment in time.... short run equilibriums constantly change, day to day. What is the equilibrium today is not necessarily the equilibrium tomorrow. I would simply become a non-bank bank and start accepting deposts from others and making loans. There are plenty of those in the US. The bank deposit expansion multiplier works even if there is just one bank in the whole system, and that bank does not have to take on all the characteristics of what we legally define as a bank. Freezing lending in a growing economy makes no sense. My system would apply to all deposit takers whether or not they are currently defined as banks. Freezing intermediated lending does make sense for economic growth as it stops the growth of the money supply. Other types of direct lending like issuing bonds may well take up some of the slack but that's OK because that type doesn't increase the money supply
Third, you can't control deposits or withdrawals of cash, which impacts on excess reserves and therefore on lending.... unless you are willing to tell people where they can deposit their money and how much... which makes you an anti-capitalist. Agreed , this isnt part of the plan Fourth, zero money supply growth accomplishes nothing. The money supply should grow at least at the same rate as the nominal GDP. See above , the negative effects of money supply growth Fifth, falling prices are not good. Falling prices are just as bad, if not worse, than rising prices. See the Great Depression.
Sixth, I have no idea how you deduced that prices will fall 4% per year while housing prices will rise 7% per year. Are you trying to exprapolate some past trend???? If you are, or even if you aren't, that is just nonsense. Again, see the effects of the Great Depression.The figures are historical A much simpler solution is just make the Fed or the Bank of England or whomever follow Friedman's monetary rule and be done with it. This would only make the money supply rise with GDP which would still result in the value of some peoples money falling at the expense of others. Its also not once for all, it needs to be continually managed by central banks which creates mistakes and uncertainties (although certainly better than the current system)
(4) In a message dated 10/15/97 7:43:43 PM PST, you write:
<< Haven't heard from you in a while. Still curious about how the UK monetary system works. In particular several points:
How are interest rates controled ?
Do British banks have a reserve system ? If so, how does it work? In structure its similar to the US but reserve ratios aren't much used now (as in America) as the authorities try to control monetary growth using the Demand for money (rather than affecting the supply). Interest rates are decided upon by the Bof E like the Fed and the banks have to toe the line.
I still have your original letter. However, my ability to understand some of it depends on a little more information about the UK system.
My position is applicable to any monetary system including US situation, the systems is different from a reserve system or any central bank system so it doesn't really matter where you start it would be a big change.
A little side track. I am an Agricultural Economist. Droughts in Asia and a loss of much of the anchovie harvest in South America has me a little worried about stabiltiy in the commodities markets. This may affect monetary system stability as trouble of this type has an effect on consumer disposable income and inflation.
>> Yes, its strange some people (like Hayek) wanted to base monetary policy on a basket of commodities isn't it !
However in a system of constant money supply , this wouldn't have an effect on the general level of prices but only on the prices of the various commodities. If prices of anchovies went up then people would have less to spend on other things but it wouldn't cause inflation if it was impossible to increase the money supply to compensate (after OPEC in 71, governments inflated to ease the pain, thereby creating far greater pain in the later 70s , which is what always happens when governments inflate)
(5) Note: when RJ quotes me he puts my text in quotes, my reponse is in bold. Thank you for responding to my post RJ, glad to other people keen to think through the issues ! (I've replace Doug with Dougie since that is my prefered name !) (1) How to you propose handling the transition from 2% to 100% banking which involves a contraction of the money supply by a factor of 50 ! i.e. mega depression
(2) By 100% banking, is the primary issue for you that if everyone in a given day came into the bank that they could receive their money back, on demand. Because as I note in my article because mortgage books can be sold on the capital markets we are not too far away from that at the moment.
(3) There are 2 quite separate ethical issues here: the first is growth of the money supply which is theft from one person to another and which my system would stop.
The other is banks promising to do what they cannot do, i.e. redeem deposits on demand. I agree that this is fraud and should be illegal. BUT if it was made illegal it would be a simple matter for banks simply to contract differently to do what they reasonably could do, i.e. to pay deposits on demand or pay punitive interest at 8 over base (or whatever) on them until they do redeem them, which could be in a maximum of a year or whatever (historically this HAS happened in history (Scotland C18), although not along with the other things I recommend) . Banks could realistically promise to do this and would thus NOT be fraudulent since unlike today they would be promising to do what they absolutely COULD do. To complete the circle they would have to stipulate in mortgage contracts that they could recall them at will, in fact most mortgage contracts already have such a clause or one very close (check it out !)
IF BANKS WERE CONTRACTING TO DO WHAT THEY ABSOLUTELY CAN DO THEN, HOW CAN THAT BE CONSIDERED FRAUDULENT.
Further Dougie said:
"I would appreciate comments on (his thinking on) money and ways to
control it."
My reply:
Since I routinely disagree with Barry's economic opinions this post is
routine on that account. However, Barry is quick with the disclaimer
that he is not an economist.
On the other hand Dougie Shaw's L-O-N-G post on money and banking
gives evidence that he has been reading the standard texts on the
subject. Guilty as charged to both accounts, of perpetuating long documents ( and Im afraid this isn't the only one) and of reading the standard texts, what's the punishment?
And, rather than promoting a radical Christian Reconstruction on the contrary I firmly believe my solution is that of Biblical Chrstian Reconstruction of the basic principles of current banking fractional reserve practice (a laNorth) yes this is a point of departure from Gary but I think a necesary one it seems that brother Shaw wants to join a long list of those who also wish to be the head "tinkerer" and "monetary control lever puller" of our present world-wide fiat monetary system.
Definitely not, my solution is a once for all solution and requires no tinkering or manipulation by the government which as my site makes clear, to me is only a judiciary anyway, no executive agencies !
.. A precariously tottering
system that the Y2K bug is quite likely to topple. lets not get sidetracked now !
Just to bring up a few quotes for comment:
"THE ISSUE IS STOPPING DECREASING RESERVES NOT 100% (reserve)
BANKING."
Let me interpret this phrase. Once apon a time people (like bankers or
gold smiths) would only issue receipts for coins that they took in as a
deposit for safe keeping. That was called 100% reserves. Money was
deposited with the "goldsmith"/banker for safe keeping.
Then the "goldsmith/banker" decided to make loans with the OPM (other
people's money) that was collecting dust in his vault. That is called
FRACTIONAL reserve banking.
As I have noted in the article this is an illigitimate analogy because modern banks loan out money that people deposit in the knowledge that it will be loaned out. As long as the money supply isn't expanded and the banks don't contract to do what they cannot, there is no ethical problem.
First there were 90% reserves... and nothing bad happened.
Then there were 40% reserves... and nothing too bad happened as long
(as long as the President would declare a bank holiday when people
wanted their gold back upon demand as they were promised)
Now this is roughly 12 to 15% reserves... and nothing too bad has
happened since people only hold fiat money that can not be redeemed in
any scarce tangible substance.
So then Dougie is simply saying ENOUGH.. Let's not overdo this fractional
reserve thing. Let's just keep the banking reserves at a steady 12% or
so and the monetary system will be just peachy!
A little sarcastic but essentially true
================
Here's the practical problem for you Dougie.
To maintain that level of fractional reserves, banks MUST continue to
keep a constant volume of loans on the books. If they allow the loans to
be paid off, (without finding new loan customers) then the reserves will
grow, and the commercial loan created fiat money will SHRINK. That's
called recession/depression time Dougieie.
I would expect banks to continue to loan out what they have at the moment, wouldn't you. My system simply doesn't allow them to increase the amount . Anyway you have a bit of a cheek talking about recession when you want a 50 fold decrease in the money supply !
In other words, because fractional reserve banking FRAUDULENTLY
expands the money supply by deception (to the depositors) the curse of
an automatic collapse of the new bank credit "funny money" is like a
stretched rubber band just waiting for an economic "weakness" to
contract the money supply back to the original 100% reserve amount.
It is true money supply is being fraudulently expanded at the moment, but it is not true that to avoid fraudulent expansion you require 100% reserves
The fact that the banking system (with the aid of Big Brother) has been
able to keep Keynes' "elastic money" in a state of constant expansion
for so long does NOT mean that this state of fraudulent money and
banking affairs can last indefinitely.
Agreed
and,
"100% reserve banking isn't the issue, banks will always have to lend
long and borrow short."
====
Rather Dougie, 100% reserves IS the issue.
Yes, banks can lend long AS LONG AS their depositors know that THEIR
money is out on loan like a Certificate of Deposit and is NOT a demand
deposit which is 100% available for their use.
agreed, but it doesn't take 100% reserves to do that
If banks "borrow long" term (like a CD) , then they can lend "long term."
However if they make 20 years loans with money that is supposed to be
available for depositors on a moments notice then there is always the
potential of a "run" on the bank and it is AT THAT POINT that bank is
bankrupt (no matter how much is owed to the bank at the end of the 20
year loan).
see above about selling mortgage books and contracting possibly not to redeem deposits on demand, 100% reserves still not necessary
and,
"FRACTIONAL RESERVES ARE NOT NECESSARILY FRAUDULENT."
OK, Dougie, here is my challenge.
Try the "fractional reserve game" with any other institution than the
PROTECTED MONOPOLY of a government controlled banking industry
and then write back and tell us what the judge tells you!!!!!
Go ahead. Make my day.Start a parking lot service.
You know. People "deposit" their car with you while they work.Rather than let this "idle resource" be "underutilitzed" you start up a taxiservice using "other people's cars."If some "depositor" comes by at noon rather than at 5 o'clock simply saythat their car is out for a wash and wax job and here use someone
else's car as a "loaner" in-the-short-run. Then them not-to-worry. Everyone will get their car back in-the-long-run.Dougieie, even if cars were "fungible" what would the judge say if you tried such an operation?
Like it :) . But as above, its only a matter of contracting differently, to use your example above if the car parking company contracted with the owners to using their cars as taxis then it would be OK. Similarly if the banks contract to do something they CAN reasonably do, redeem within 6 months and pay interest in the meantime, and contract with mortgagees to take back their loans within 3months if necessary, then there is no fraud problem here.
and,
regarding the "gold keeper analogy," Dougie Shaw says that "there is
nothing intriniscally wrong with a gold smith issuing more (demand
deposit) receipts (as loans) than he actually has.
To me that sounds kind of like saying there is nothing wrong with writing
bad checks, as long the checks keep circulating and do not come back to
the bank in order to be cashed!
Not actually, as long as the banks have not got more loans than deposits (as opposed to reserves), which even todays banks don't do, then the situation is not analogous to the bad check one
There is more than an element of truth in that analogy. Economists can
often be heard saying that our economy is primarily as strong as the
people BELIEVE that it is.
When the economy is built solely or primarily upon "self-fufilling
prophesy" the writing is upon the wall.
Dougie, my suggestion is that you read more banking history and less
Fabian money and banking theory. my banking history is mostly C17+ byzantine, I find your stuff below absolutely fascinating
In 1361, the Venetian Senate forbid banking in their jurisdiction because
of the financial hardship that BOOM-BUST cycle which the fractional
banking system created.
good for the Venetians, but the boom bust cycle is caused by MS growth which my system stops rather than fractional reserves per sce , you seem to confuse the two (as I did for a long time, since North doesn't explain the distinction in the literature and he was my main source at the time)
In 1584 the largest bank at its time (house of Pisano and Tiepolo) closed
it's doors because of lending against fractional reserves.
At its liquidation it outlawed all fractional reserve banking.
No profit could be allowed from the issue of bank credit.
The result? The banks were required to sustain themselves solely form fees for coin
storage, exchanging currencies, handling the transfer of payments
between customers and legal notary services.
That 100% reserve formula of HONEST banking not only created a stable
and prosperous bank but it became the foundation of Venetian
commerce. In time their 100% reserve bank notes carried a premium
over coin.
Non 100% banking is not necessarily dishonest as I explain above although I'd be the first to admit the current application is ( because banks contract to do what they cannot
Throughout the 15th and 16th century banks sprang up all over Europe.
Virtually without exception they practiced fractional reserves. Also
virtually without exception they failed when some natural force incited a
"run" and that bank was history.
interested in your sources for this , please also note I dont agree with banks contracting to do what they cannot as in latter ages would have been less than now
The old phrase is that "short bankers hang on long trees."
The best example of HONEST BANKING occured in Germany with the
Bank of Hamburg. It was a profitable 100% reserve bank that was in
existence for over 200 years. When Napoleon nationalized the bank in
1813 that bank had much more than 100% reserves in comparison to all
the outstanding bank notes.
interesting, did it compete with other non 100% banks
The idea that fractional reserves are essential for a bank to exist is just
so much anti-Christian propaganda. It is opposed to the 8th
commandment as well as the witness of history.
I'm not claiming that it is nessessary for banks to exist, but as above is theres no fraud and the money supply doesn't grow then the 8th commandment has been kept which is of course the whole point of my paper
and, Dougie says:
"nor is there a problem using promises to pay instead of commodities to pay for goods and services. Token money is not a problem... (so long asit is not) allowed to increase (the money supply) as a result."
========
Dougie, there is a very great difference between "financial assets" and
"real assets."
Commodity money is a real asset of some tangible nature. It does not
represent anything. It is useful in an of itself.
Cars, houses, roads, lumber, gardens, tools etc. are real assets.
However ALL financial assets are IOUs.
All financial assets are DEBT instruments.
Today's money is at best a "financial asset."
Bonds, T-bills, stocks (an IOU of future dividends), mortages, Sallie
Mae's, etc.
THOSE financial assets are only as good as the debtor's ability to repay.
If there is a disruption in the very high tech production ability of this
country (or the world) this kind of asset can literally DISAPPEAR.
Gary North's basic appeal to his Christian brothers in regard to this Y2K
issue is for us to GET OUT of financial assets and get into real assets.
[What % of YOUR wealth is in financial assets?]
That means that you will not get to ride the crest of the coming/continuing
(?) BOOM market in the securities (financial asset) market.
However, you will not be exposed to the BUST either.
Getting out the the financial asset markets for many of us means getting
out of DEBT. If that means a radically lower standard of living, then DO IT
NOW.
Contrary to Dougie Shaw's opinion, "token money" IS a problem if it is a
legal tender fiat token . A "financial asset" token in which the
international exchange value is supported primarily by the CURRENTLY
efficient technology and division of labor, and domestically is supported
by the government's police power and BLIND faith of the people.
this last bit is no longer on the subject of control of the money supply really, but let me just say that if there was a catastophy coming I agree you are better off with things that will last in a non division of labour world, like carpentry skills, food growing equipment,etc.. BUT I don't think there is a catastrophy coming, but that's another subject ( did you read the last train out in 82 ,theres been quite a few trains since then , sorry to be sarcastic :))
Once again thanks for your comments and I await your reply. Oh - and I'll let you know about the car park deal -but I'll be contracting properly with my customers. However will there be gas after the crash......
submissions to Theonomy-L@dlh.com miscellaneous requests to dlh@dlh.com
Can someone explain to me why, after Roosevelt's work in the '30's,
a bank run is a danger?
If everyone goes to their bank and asks for cash,
that might be a strain on the printing presses.
But how is the economy going to suffer?
>>> Because the bank has lent out the money mostly for mortgages, and depending on how quickly it can get the money back, it may be unable to pay in the short term and thus cause a bigger panic as people think they cant get money back. Actually this isnt quite as much a problem as it used to be as mortgage books can now be sold (so instead of calling in thousand of mortgages (which obviouslyl causes problems for these people) they can sell the mortgage so the borrower keeps the loan but now had a new lender)
Do reserve requirements apply once the loan has been made?
Example:
A bank has sufficient reserves to make a loan. After the loan is made,
reserves drop below that level. Is the bank legally required to
call in the loan? Or does this just mean the bank can't make
an additional loan until reserves are up?
>>> because banks have thousands of loans going out and in at any point, they would rarely have to call one in for this reason. Also banks can bid for deposits and hence reserves on the interbank market if they are short and indeed this is the process that pushes up interest rates when reserve ratios are raised
Suppose y2k causes massive withdrawals of cash, for fear ATM's
wont work. How will this affect anything? It won't increase inflation
or currency velocity because people aren't going to be putting
the cash into circulation any sooner. (unless there's a fear of
hyperinflation and retreat into real goods.)
>>> your right here, the fact that people hold cash isn't a problem in itself, as long as they dont withdraw more than the banks can supply at that given point. Of course banks may decide to have more of their assets in cash at yr 2000 incase this happens.
I may be missing something obvious here. Don't be afraid to
use the word "dummy" in your reply, because I will undoubtedly
respond with "Oh, yeah, what a dummy!"
>>> of all subjects in economics this is probably the most complex !
In a message dated 10/27/97 8:37:50 PM PST, you write:
<< Theonomy-L submission from DShaw38254@aol.com
Dougie Shaw replies w/ a question to J. Ross Justice:
(1) How to you propose handling the transition from 2% to 100% banking
which
involves a contraction of the money supply by a factor of 50 ! i.e. mega
depression
===================================
My *short* answer is:
I propose handling that transition by immediately implementing Paul's
directive of... "let him who steals, steal no more."
1) Get the government out of the money business altogether. (I.e. take
away their private monopoly central bank "money tree.")
> Agreed
2) Let there be a free market in money!
>agreed
3) Let Federal Reserve Notes (i.e. U.S. dollars) "float" against any and
every other kind of money. Let those who have faith in THAT Fed-Gov
fiat money continue to exercise that faith & freedom.
> agreed
> No probs but none of that avoids the 50 times contraction of the money that actually exists as people change to the new money
> and by the way a free market in money a la Hayek doesn't necessarily imply zero money supply growth (but your 100% system like mine would)
Virtually every economics text I have read explicitly says that inflation is
a form of a tax. And that is true. FIAT money inflation quietly takes
purchasing power away from some classes of people and gives that
purchasing power to others. That is theft.
> agreed
===============================================
Dougie says:
(2) By 100% banking, is the primary issue for you that if everyone in a
given day came into the bank that they could receive their money back,
on demand.
==========
Yes, Dougie, that is what 100% reserve banking means. But please
be sure to note that a longer term deposit like a Certificate of Deposit can
not be redeemed until the maturation date of the certificate.
Dougie continues:
(3) There are 2 quite separate ethical issues here: the first is growth of
the money supply which is theft from one person to another and which
my system would stop.
================
Commodity style *monetary inflation* (like precious metals from a local
mine) increases the quantity of scarce goods and/or services to a
community... by definition. That is godly wealth creation.
Fiat money style *monetary inflation* only increases the quantity of
money units and does not increase the quantity of goods and/or services
to the community. (Economically, the effect upon a society of fiat money
expansion by the banking system or by a counterfeiter is exactly the
same. Counterfeiters do not create wealth. They only transfer it from
one group of people to another.)
>> its an interesting idea that the growth of the supply of money is not a problem if it is caused by an influx of gold from the mines. This is on the basis that money is a capital good like any other which people pay for in order to help them exchange value with others. Yet an influx of silver into Spain from Peru ( for example) has exactly the same effect as the fed reducing reserve ratios. In other words those holding the "old" money find that it is able to buy less because those with access to the new spend it first driving up prices. This is a transfer of resources from one to the other. The only difference is that is involves more effort to dif gold out of mines than for the fed to have a meeting.
It also has the usual effects on investment i.e. new money coming in makes certain investments look good when they are not and when the money stops coming in there is a crash.
I see the problem in that its difficult to see someone engaging in mining as doing something wrong. However what I think this highlights is that commodity money is not very suitable as money precisely BECAUSE it can be increased by doing something that is not in itself unethical or illegal but yet can bring down the value of everyone elses money. MIning other goods doesn't do that .
Money denominated in currency ,for example, dollars or pounds ( even when they aren't legal tender and there is no central bank) can be kept entirely constant unlike commodity money and so form a better type of money.>>
Therefore (contra Milton Friedman) a little, steady fiat monetary inflation is
not a good thing nor a beneficial thing. It is an unrighteous and
economically unproductive thing!
> absolutely, about the same time I got your first post I also got one from a guy who believed that money supply should go up with GDP (a la Friedman). Arguments against this idea would be useful though I'vegot quite a lot already, theres room for more >
=