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Nothing at all is mysterious about inflation; it is government intervention pure and simple. Why, then, do government leaders continue to inflate? And why do the printing presses go undetected by the general public? 
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181 Responses
The article combines a great idea (free banking) with a bad idea (the quantity theory of money). Voluntary trade will lead people to write IOU’s to each other, and those IOU’s will be used as money. Very few of those IOU’s will be payable instantly, or even with certainty, or backed by 100% reserves of metal. Nevertheless, people will value them in proportion to their belief that the issuer has enough assets to back them. Historically, governments have been the source of many of these IOU’s. They have traded as money, and people have valued them according to their estimate of the government’s assets and liabilities.
No matter who issues those IOU’s, they are not just printed and shoved into peoples’ hands. The issuer gets assets in exchange for the IOU’s, so the normal case is for the issuer’s assets to rise in step with the issue of money, and for the money to therefore hold its value. Inflation of the money supply, accompanied by an equal ‘inflation’ of the issuer’s assets, does not lead to price inflation.
So what should a good libertarian do? He should stop trying to prohibit fractional reserve banking, which is a purely voluntary exchange, and should recognize that the central bank is not a counterfeiter, and has as much right to issue paper money as anyone. The thing that a libertarian should oppose is laws that prevent private individuals and firms from issuing money of various forms, including paper money, checking account money, and credit card money.
Mike, you write “stop trying to prohibit fractional reserve banking, which is a purely voluntary exchange”. The consequence of this inflation is to give benefits to the recipients, at the expense of the rest. It is a transfer of wealth of the goods & services in the economy. Do you find this to your liking?
Mike Sproul is the Silas Barta of monetary issues: a one-note shit-for-brains who tries to hijack every thread with his obsessive nonsense. RBD has been refuted so many times in the last month here (partly by invoking Mises arguments from a hundred years ago) that to say it’s grown tiresome would be a grave understatement.
Allen Weingarten:
Fractional reserve banking causes no price inflation, and so causes no transfer of wealth. If a private bank issued money like a counterfeiter then it would cause price inflation. But when a bank issues a checking account dollar it gets equal-valued assets in exchange for that dollar, recognizes that dollar as its liability, and stands ready to use its assets to buy back that dollar. No counterfeiter does that.
The issue of those checking account dollars has the potential to increase the quantity of money, assuming that there is not an equal reflux of money to other banks, but the increase in the quantity of money is matched by an equal increase in the assets of the issuing bank, so the money holds its value. By analogy, IBM can issue a new share of stock for the going market price of $60. IBM’s assets will rise by $60 at the same time that the new share is issued, so the value of IBM stock will not change, even though there are, as quantity theorists say, more shares chasing the same amount of goods’.
Beefcake
RBD has been completely discredited as you point out, that Mike Sproul continues to offer such obviously invalid arguments in its favor has to be considered serious evidence of mental derangement. He deserves our pity, enough blows to the head and we too could be proponents of RBD.
Maybe the author should refresh his accounting class. The dollar’s value has gone down to 25 cents and the money supply has increased 1000 times. On the balance sheet, looks like we are better off today!
If there was no increase of the money supply over that time and productivity remained the same, that same dollar would be worth $10 today. And the only way that can happen is if wages would adjust down with the falling prices.
Everyone here is hung up on the value of the dollar. You should be looking at what you can earn and how much you can buy. Ask yourself if you can buy more today than you could 30 years ago. And if you can’t, then it is your fault as the money supply has increased 1000 times while value of the dollar has only dropped to 25 cents.
“Everyone here is hung up on the value of the dollar. You should be looking at what you can earn and how much you can buy. ”
i think this is true.
i am just wondering if a gold/silver regime would have produced a more stable – greater wealth generating economy?
and if there is any information indicating such.
ie. “This has given rise to claims that we live in the first sustained period of economic growth that has failed to offer a similarly sustained increase in real wages. Indeed, wages have declined in real terms by 2 percent in the last three years.”
http://mises.org/daily/2303
T. Ralph Kays,
“has to be considered serious evidence of mental derangement.”
As much as I hate reserve banking and would rather that we pay directly in gold or privately issued gold notes. As much as I am a libertarian and that I hate the propaganda spewed by Mike. I must come to his defense on your obvious Ad-Hominem.
Calling Mike a mentally ill or claiming that he demonstrate evidences of mental illness contributes nothing to the refutation of his claims on reserve banking.
It only goes on to show your lack of civics and your lack of debate skills.
And you know that mental illness has been grounds for incarceration without due process and grounds for the abolishment of habeas corpus.
You are clearly personally attacking Mike instead of his ideas. You are in a sense threatening his freedom and integrity.
Mike has committed no crime and he does not deserve to be called crazy.
I must say that you, Ralph, are dropping in my esteem and I hope that in the future you will refrain from making such gross ad hominems.
Mike, I don’t agree with your views on reserve banking and your personal issues against individual freedom.
But I will let nobody question your mental health.
T. Ralph Kays,
“has to be considered serious evidence of mental derangement.”
As much as I hate reserve banking and would rather that we pay directly in gold or privately issued gold notes. As much as I am a libertarian and that I hate the propaganda spewed by Mike. I must come to his defense on your obvious Ad-Hominem.
Calling Mike a mentally ill or claiming that he demonstrate evidences of mental illness contributes nothing to the refutation of his claims on reserve banking.
It only goes on to show your lack of civics and your lack of debate skills.
And you know that mental illness has been grounds for incarceration without due process and grounds for the abolishment of habeas corpus.
You are clearly personally attacking Mike instead of his ideas. You are in a sense threatening his freedom and integrity.
Mike has committed no crime and he does not deserve to be called crazy.
I must say that you, Ralph, are dropping in my esteem and I hope that in the future you will refrain from making such gross ad hominems.
Mike, I don’t agree with your views on reserve banking and your personal issues against individual freedom.
But I will let nobody question your mental health.
Mister Manjo
Don’t do me any favors, Mike Sproul has been convincingly and irrefutably shown to be wrong for the entire time I have been on this site. How many times do you think it is necessary to prove an idea wrong before it behooves you to move on? Why should any of us take Mike Sproul seriously any more, he has shown himself to be beyond the reach of reason. I invite you to spend the rest of your life dealing with his tired repetition of the same arguments over and over. Maybe you could do something helpful here and exchange phone numbers with Mike so that you could spend forever ‘discussing’ RBD with him, thus keeping him out of our hair.
As for your esteem of me, bite me.
Right on, T Ralph!
Mike Sproul has robotically posted the same two or three comments for about a month now. If he was willing to respond to the specific points raised against his doctrine, fine, no problem. But he simply regurgitates the same paragraphs over and over, and that’s not debate. He deserves to be treated scornfully.
Mike Sproul, you seem confused.
In your first post, the last paragraph has nothing to do with the previous ones. You start talking about pieces of paper called IOUs that are backed by some assets and that does make some sense. But then, you switch to defending fractional reserve banking and you end up countering your own argument.
You say: “But when a bank issues a checking account dollar it gets equal-valued assets in exchange for that dollar, recognizes that dollar as its liability, and stands ready to use its assets to buy back that dollar.”
Fine.
But FRB means precisely that the assets the bank has are a FRACTION (usually the arbitrary 1/10 these days) of what is needed to buy back the dollars it has emitted.
Maybe you’re too involved emotionally in your argument. Take a step back and re-analyze it.
Cosmin:
Fractional reserve banking means that RESERVES are a fraction of what is needed to buy back the dollars emitted. But if a bank has issued $100, it will hold $10 of reserves and $90 of other ASSETS (usually bonds). The bank has $100 (=10+90) of assets, which is enough to buy back the $100 of money emitted.
I have to defend Mike Sproul here. Not his ideas, of course.
If US banks had equal valued assets for the loans they made the banking crisis would be a myth. Mark to management would not be the current accounting standard.
But if it has 90$ worth of assets and has emitted 90$, what difference does it make if it emits 10 more dollars to itself to hold as reserve?
Why not emit 0 and have 0 reserves, or emit 90 more to itself in order to have reserves equal to what it has emitted outside?
Mike Sproul writes “Fractional reserve banking causes no price inflation, and so causes no transfer of wealth.” So when there is massive funds in circulation, the value of the dollar does not go down. Perhaps it is a coincidence that what cost a nickel in 1945 now costs a dollar?
Fred:
A bank’s assets can fall in value to the point where the bank is no longer able to buy back the money it issued. In that case the bank’s money falls in value in proportion to the fall in value of the assets.
Cosmin:
Banks don’t emit dollars to themselves to hold as reserves.
You should start by trying to see the confusion of assets and reserves that you committed here:
“But FRB means precisely that the assets the bank has are a FRACTION (usually the arbitrary 1/10 these days) of what is needed to buy back the dollars it has emitted.”
Mike, maybe the confusion is yours: “Fractional reserve banking means that RESERVES are a fraction of what is needed to buy back the dollars emitted. But if a bank has issued $100, it will hold $10 of reserves and $90 of other ASSETS (usually bonds). The bank has $100 (=10+90) of assets, which is enough to buy back the $100 of money emitted.”
If your bank has emitted 100$, the 10$ it holds are not “a fraction of what is needed to buy back the dollars emitted”. The 10$ are a fraction of the dollars emitted! How can they buy themselves back?
I have a purely practical experience of financial markets and an embarrassing lack of theoretical knowledge of Economics which for some reason I could never engage with, try as I might.
I have thought for several years that there is a qualititative difference between credit which is used to acquire existing productive assets, and the credit which is used for the circulation of goods and services and the creation of new productive assets. As far as I can see most schools of economics treat both classes of credit as being the same in effect.
Now Mr Spangler asks:
Why, then, do government leaders continue to inflate?
To which I must ask: “inflate what?”.
As far as I know, the recent bubble in asset prices now collapsing was inflated by private – not public – credit creation. This credit creation was initially by private banks, who were then able to outsource it to a shadow banking system of private investors through combinations of securitisation, credit derivatives and credit insurance.
While some argue that there were failures of regulation, others consider that regulation has no place in markets. Whataver the truth of that, I think it is difficult to argue that asset price inflation is caused by governments printing money, rather than the private sector doing so.
Retail price inflation is another issue, and in my opinion, retail price inflation is almost invariably the fault of governments running fiscal deficits, and borrowing to make up the difference, so that the government’s credit is not 100% backed by taxes.
The question then is, whether the inflation that results is caused by the government ‘printing money’ or simply destroying the basis of it.
Chris Cook,
You say: The question then is, whether the inflation that results is caused by the government ‘printing money’ or simply destroying the basis of it.
The government ‘printing money’ is what destroys the basis of the money.
One might as well ask: The question then is, whether the health problems that result are caused by the person’s horrible diet, inactivity, and 3 packs a day smoking habit, or simply the destruction of his immune system.
Allen Weingarten:
I assume you don’t mean to imply that the inflation since 1945 resulted from the fractional reserve operations of private banks. They were fractional then and they are fractional now, and the degree to which they expand the money supply has not changed much. You presumably blame the federal reserve for issuing more money, so that there is more money chasing the same amount of goods. I also blame the federal reserve, but I’d say that the Fed caused inflation by allowing its issue of money to increase faster than the fed’s assets.
Cosmin:
“The 10$ are a fraction of the dollars emitted! How can they buy themselves back?”
If a bank has issued 100 checking account dollars, against which it holds 10 paper dollars plus other assets (bonds, for example) worth $90, then the bank can sell its $90 bond for 90 of its own checking account dollars, which it retires. Then it can sell its 10 paper dollars for the remaining 10 checking account dollars, and retire them. That’s how a bank uses its assets (not just reserves) to buy back the money it has emitted.
Chris Cook,
Indeed, credit is created via the banking system; but to ignore the effect of open market operations on the creation of credit is simply absurd. If you were right, then the government would have no vested interest in monetary policy and the banking system–again, absurd. Massive credit creation, to the point where the supply of money far exceeds the demand for cash holdings, is made temporarily sustainable by central banks who have the power to create reserves at will for the parasitic private banks.
The rate of interest is continuously depressed to a point where the trade-off between consumption and investment is nonexistent in the short-run. Unfortunately, this distortion will be remedied in the long-run by self-correcting market forces.
Blaming regulation or seeking other ad-hoc explanations ultimately ignores the crux of the problem: the government interferes in the loanable funds market by suppressing the market rate of interest (to the cheers of clueless investors), creating asset bubbles, and ultimately laying the seeds of crises. When costs begin to rise, market actors will demand further suppression of the market rate of interest (through open market purchases), in order to remain profitable. If/when this does not occur, the market rate will rise towards the natural rate, leading to the crises (federal funds rate rose to 6% in 2007).
The investors cheer interest rate cuts, and criticize the FED for not lowering the rates when economic activity slows. This is because they are entirely ignorant of economic theory, and fail to realize (some don’t) that they’re cheering their own demise.
to chris cook:
prescribed bedtime reading
http://mises.org/books/moneyproduction.pdf
Mike, you’re saying if your bank has assets worth 90$, it can emit 90$, right? Even if it has no paper dollars.
And if it has 10 paper dollars, it can emit 10 more dollars. And if it has 20 paper dollars, I guess it can emit 20 more dollars.
So where’s the fractional reserve? Why bother with it at all?
inflation is a one of the very biggest problem for whole world not only a particular country
The problem with RBD is the concept of “backing” an what it means and implies.
If an asset “backs” a paper claim on that asset, this means the asset should only back that claim and take on no other functions at all. Otherwise concept of “backing” loses all its meaning and causal relation to the backed up paper.
For example, if a machine is used as an asset that is backing an IOU, for “backing” to mean anything the machine shouldn’t be used in other way. and locked up in a room somewhere. Only then the backing means something, because by “backing” it is implied that the paper represent the asset. If the paper represents the asset, the asset can not represent itself.
It is like a deed to a house. The house is the asset and the deed is the paper that is backed by the house and it is impossible for one person to own the deed and another to own the house.
But then we face dilemma. We have the backed paper which represents the asset, and asset itself lying there useless. So the instinct is of course to keep using the asset. But then “backing” loses all its meaning.
This is the eternal urge to have your cake and eat it too. In real terms it is impossible. But in the case of money, or nominal terms it is possible. It is called inflation.
In the past gold was chosen as money and it could be used as a backing to paper gold substitute. Because gold didn’t have much other use, unlike an asset like a producer good. But still gold was money and bankers couldn’t resist the urge to use them as money even though its only function was backing to the substitute.
A is either A or it isn’t A. There, a little Aristotle for you.
Mike Sproul, you write “I assume you don’t mean to imply that the inflation since 1945 resulted from the fractional reserve operations of private banks.”
If there is a given amount of money (including credit), and it is doubled, the value of each dollar has to be diminished. The goods & services are unchanged, so the doubled dollars cannot be exchanged for twice their number. For any commodity, increasing its amount reduces the value of each item.
So my answer is ‘Yes, inflation increased by the availability of extra money.’ Conversely, if the amount of money (including credit) were cut in half, each dollar would purchase more goods.
Cosmin:
“So where’s the fractional reserve? Why bother with it at all?”
The bank that holds 10 paper dollars and a bond worth $90 against 100 checking account dollars is operating on fractional RESERVES, not fractional ASSETS. The reserves are the paper dollars. The assets are the 10 paper dollars plus the $90 bond. No bank operates on fractional assets, but almost all banks operate on fractional reserves.
Karem Tibuk:
You can’t ride a claim to a horse, but you can trade with a claim to money. If each paper dollar is a claim to 1 square foot of land, there is no reason that the land can’t be farmed at the same time that paper claims to it circulate as money.
Allen Weingarten:
A bank gets 100 oz. of silver on deposit, and issues 100 paper receipts (dollars) in exchange. Each dollar is worth 1 oz. Then a farmer comes in wanting the bank to print another 100 dollars and lend it to him. He offers his farm (worth far more than 100 oz) as collateral, and hands the banker his IOU, promising 100 oz. plus interest in 1 year. The farmer’s IOU can be sold in the market for 100 oz.
The bank has 200 oz. of assets (100 oz silver plus the 100 oz. IOU) backing $200. Each dollar is still worth 1 oz., even though there are twice as many of them.
Mike,
your original post makes a lot of sense. I agree that fractional reserve banking is not a problem and that free banking is the ultimate solution.
I disagree that the Fed is not a counterfeiter. If “printing money” is not a problem, because the Fed gets assets in exchange, then why not allow everybody to print money?
Kerem Tibuk
Your last post is wonderful, never heard it explained so completely, concisely or correctly. Good job.
Mike, in your first post you said: “Voluntary trade will lead people to write IOU’s to each other, and those IOU’s will be used as money.” and “people will value them in proportion to their belief that the issuer has enough assets to back them.”
Are you now switching your argument to saying that they can’t in fact do that, unless they already have somebody else’s IOUs in value of 10% of the IOUs they want to issue?
That’s what puzzles me, because there’s no fractional reserve in your premise, but then you act like proving your premise proves the validity of fractional reserve banking.
Mike, you have assumed that every item of currency is redeemable, as though someone issued but a single IOU for his property. Yet fractional reserve banking, by definition, cannot redeem every dollar for property. It is as if a farmer gave out 5 IOU’s for his farm. Would you have any objection to his doing so, or do you not think that this constitutes inflation?
You write that “the Fed caused inflation by allowing its issue of money to increase faster than the fed’s assets.” We agree, except I maintain that the issue of credit (by fractional reserve) exceeds the money, which is why it is done. As Cosmin notes ‘FRB means precisely that the assets the bank has are a FRACTION…of what is needed to buy back the dollars it has emitted.’
Let’s say I open a bank. I have assets in the form of gold bars, in value of 1000$. Can I emit 1000$, or 10000$?
I assume fractional reserve banking means I can emit 10K. Isn’t that how it started in the middle ages? That’s why we talk about the extra 9000$ having no backing and being inflationary.
Here, my assets are my reserves.
But Mike seems to have a different definition of fractional reserve, where assets* are conjured up to back the extra dollars issued. Is it simply because these new assets* aren’t liquid money that you don’t consider them part of your reserves?
Maybe this scheme should be called “variable backing full reserve banking” instead.
Mike Sproul,
” Voluntary trade will lead people to write IOU’s to each other, and those IOU’s will be used as money. ”
This statement of yours, which to me appears to form the basis of a lot of your conclusions, opens up a lot of questions. I thought I’ll try a few.
When you say IOU, the key missing word is “what?”. In other words, an IOU is meaningless unless it says “what” is owed. If it is money (which it invariably is), it cannot be money by itself but only a “money substitute”. A promise to pay money can never, by its basic nature, be money itself. If you say a certain sum of money is owed, what is the definition of that “money”? Just remember that to say that it is another paper of similar nature (a promise to pay, except at an even later date) is the hallmark of a Ponzi scheme.
Secondly, that voluntary exchanges of IOUs by a few people does not transform them from the status of “money substitutes” to money on account of what I have said above.
At the end of the day, all your conclusions depend on your definition of the concept “money”. If you define “money” as a medium of exchange, with the said exchange necessarily happening on a voluntary basis in a free market and with further exchange being the sole (with minor exceptions) purpose of obtaining the money, IOUs can never be money because at some level, they would never be accepted SOLELY for the purpose of further exchange but on the hope that on a specified day, they would be converted into something else that has already been accepted as money.
I am afraid that deep down, you are engaging in circular reasoning without realising it.
“When you say IOU, the key missing word is “what?”. In other words, an IOU is meaningless unless it says “what” is owed. If it is money (which it invariably is), it cannot be money by itself but only a “money substitute”. A promise to pay money can never, by its basic nature, be money itself.”
i thought that sproul had basically said it (a proper iou system, i guess) came down to what iou the was backed by and when it could be redeemed per contract stips.
the less clear the backing and the less it can be redeemed, the more the risk involved?
so the iou can operate as money…with different backing.
i am not sure if today that means much as far as an iou being backed by cash (money, iow)
that is if a 1500 dollar bill can be whipped up as quickly as an accounting entry can.
i guess to the extent that large scale economic calculation carried out by slowly pulling a lot of money metal out of the ground would differ from a combination of pulling a little metal out of the ground and printing a whole lot of paper saying that one has a lot of metal (if that actually happened) — there would possibly be different economic outcomes.
bad outcomes from ious i am not sure about.
scott t,
” i thought that sproul had basically said it (a proper iou system, i guess) came down to what iou the was backed by and when it could be redeemed per contract stips. ”
Sproul may have said it, but my point was that the moment it is an IOU, it can never be money. It is logic that denies it the position of “money”. When I asked the question “What do I owe you?”, the answer is a certain amount of money. Thus, to say that what is owed is more IOUs is a circular definition and the basis of a Ponzi scheme – paper for paper.
Secondly, what (in Sproul’s example, assets) backs the money substitute is a slightly misleading question because it assumes that the presence of backing gives it validity as money. It appears as some sort of reversal of cause and effect. The emergence of a commodity as money has to logically precede its being the “owed” part of an IOU that can serve as a money substitute.
Finally, you said “redeemed”. My question is “in what?”. Therein lies the circular reasoning involved in treating IOUs as money.
Once we stop treating IOUs as money but as fiduciary media unbacked by money, Mike Sproul’s problem is non-existent.
Curious:
“If “printing money” is not a problem, because the Fed gets assets in exchange, then why not allow everybody to print money?”
Everyone should be allowed to print money, and in fact, everyone is. I can take out a piece of paper, write “IOU $1″ on it, and there are a few people in my neighborhood who will give me a dollar’s worth of goods for it. They accept my IOU’s because they think I have enough assets to cover them. If I were richer and better known, my IOU’s could circulate more widely, and as long as my assets kept pace with my issue of IOU’s, they would hold their value.
Cosmin:
The IOU’s in my first post normally would have been issued on fractional reserve principles. A farmer who owns land worth 100 oz. of silver could issue up to one hundred 1 oz. IOU’s, even though he might have only 1 oz. or less of actual silver in his possession. His IOU’s are backed by his assets (land). His reserves (silver) might be a very small portion of his total assets.
“I have assets in the form of gold bars, in value of 1000$. Can I emit 1000$, or 10000$? I assume fractional reserve banking means I can emit 10K.”
You can emit only $1000 based on your $1000 of gold. The only way you would emit another $9000 is if a customer gave you $9000 of assets in exchange. You would then have $10000 in circulation, against which you hold $10000 in ASSETS–consisting of $1000 in RESERVES (gold) plus $9000 of of other assets. This is not my peculiar definition of fractional reserves. It is the definition used by every economics textbook on the market.
Allen Weingarten:
If a fractional reserve bank issues 100 checking account dollars, it will hold $100 worth of assets against that money. Perhaps $10 of those assets will be in the form of paper dollars, and the other $90 might be in the form of bonds, which can be sold on the market for $90. I keep saying fractional RESERVES, and you keep thinking fractional ASSETS. There are no fractional asset banks, only fractional reserve banks.
Bala:
An IOU can say something like “IOU 1 oz. of silver, payable during business hours, except during bank runs, when I reserve the right to delay payment by 30 days”. That IOU is the type of promise that banks normally make, and those promises are normally traded in the market at 1 oz. It is not necessary for a bank to hold 100% reserves in order for its money to have full value.
ok..if not money, then the iou, to the extent that they currently exist are still a ‘medium of exchange’.
if my dollar or check contins iou, somehow i can get goods with them.
previous sproul comments have specified redeemablility via contract stipulation…only mon thru fri in silver, ie.
so i dont see any circular reasoning.
i just want to know if the sproul basically describes what takes place now — with ious purchasing goods and are they more harmful than money purchasing goods on a large scale.
A farmer who owns land worth 100 oz. of silver could issue up to one hundred 1 oz. IOU’s, even though he might have only 1 oz. or less of actual silver in his possession. His IOU’s are backed by his assets (land).”
this seems like dishonesty or fraud.
you could issue 100 ious of a fraction of land-space whose total maket value is presently 100 oz of silver.
but the silver wouldnt exist for the iou.
i dont think any contract could make that so could it?
unless….??
“A farmer who owns land worth 100 oz. of silver could issue up to one hundred 1 oz. IOU’s, even though he might have only 1 oz. or less of actual silver in his possession. ”
is this pretty much what takes place now?
if it is, is it a bad thing?
Mike Sproul,
Firstly, I have no problem with IOUs backed by a specified amount of silver as long as the amount of silver that backs a unit of currency is in consonance with the definition of the currency in terms of silver…. Actually, the point here is that silver is already money. THAT is what makes this IOU a valid money substitute.
The same is not true when other arbitrary assets not yet accepted as “money are used to “back” an IOU. It is an IOU but not a money substitute or money. It can never be either.
” It is not necessary for a bank to hold 100% reserves in order for its money to have full value. ”
While your statement is true in the short run because only a bank that has established credibility through years, maybe even decades, of integrity can even get its money substitutes accepted, in the medium to long term, notes of different banks would trade at different discounts depending on how much they have pyramided notes and deposits on top of their reserves of specie. That it does not happen today is not because this principle is invalid but because government intervention on behalf of banks that pyramid thus has rendered it impossible for the principle to operate. My argument is based on the history of banking in the US in the 19th century as presented in Rothbard’s “The Mystery of Banking”.
Thus, your entire point still remains invalid. You need to stop using the term “money” as carelessly as you have been doing.
scott t,
” you could issue 100 ious of a fraction of land-space whose total maket value is presently 100 oz of silver. ”
Land as a form of money has been tried and has been a miserable failure because “land” suffers from a fatal flaw that prevents it from being money – it is not portable the way Gold and Silver are.
That apart, I have already addressed Mike Sproul’s silver backing example in my other post, so I see no point in repeating it.
” It is not necessary for a bank to hold 100% reserves in order for its money to have full (face?) value. ”
While your statement is true in the short run ….
could you substitute the word reserves with assets and call it the dollar…or mega-buck or something?
would that make a difference and is that what takes place now?
“A farmer who owns land worth 100 oz. of silver could issue up to one hundred 1 oz. IOU’s, even though he might have only 1 oz. or less of actual silver in his possession. His IOU’s are backed by his assets (land).”
this seems like dishonesty or fraud.
you could issue 100 ious of a fraction of land-space whose total maket value is presently 100 oz of silver.”
maybe land has.
since gold and silver are not currently money proper (so i have been told) and the paper dollar and deposit-dollar are the exchange media most prevalent (and taxed) does it make much of a difference if most circulating media (there was full, 100 percent standard-money backing for $42.7 billion of deposits, and no standard-money backing whatever for $6065.5 billion of deposits… http://mises.org/daily/3556 )
is unbacked by paper cash?
is it harmful in other words?
First, consider a person-to-person loan. Alice has a plow. She loans it to John. He promises to return it later, along with an interest payment. In case he is unable, he also promises an alternate payment of something he owns.
At this point, Alice has given up use of the plow, so won’t get any value from it during the loan. Later John will give her interest, to make up for this. During the loan, he will get the value of the plow, presumably more than the interest he’ll have to pay.
Now, consider a loan made by a bank that prints money. Alice has a plow. John goes to the bank to get a loan. The bank prints new money and gives it to him in exchange for his promise to repay it plus interest, and also his promise of something he owns if he is unable to pay. He then buys the plow from Alice.
At this point, Alice doesn’t have a plow, but she has money, so she can immediately buy something else of use, perhaps even another plow from someone else if she decides she shouldn’t have sold it. John has a plow to make use of. The bank has a promise from John.
Using a bank in this manner effectively separates the loan into two parts: the party that gives something up (Alice) and the one that gets paid interest (the bank). The party that gives something up actually gets split up further, if the money is spent. If Alice immediately buys something with the money, then someone else is giving something up in exchange for this money the bank just printed. So over the period of the loan, many people give things up, but for shorter periods than the entire loan.
There is a finite amount of resources available for the people to use. In the first situation of the person-to-person loan, Alice gave up some resources so that John could use them (in exchange for interest later). With the bank, the people giving up the resources don’t get any interest in return; the bank does.
For simplicity I’ve ignored the issue of the amount of money in circulation, as I think the interest issue alone is sufficiently problematic. BTW, it would be really nice if there were a more sane way of putting tables into replies on this blog.
scott t,
” since gold and silver are not currently money proper ”
That’s our real problem. Force (massive government intervention) and fraud (fractional reserve banking) have driven them out of circulation as money proper.
” the paper dollar and deposit-dollar are the exchange media most prevalent ”
We can fool ourselves and evade reality for only so long before reality gives us a tight slap in the face with a wet kipper. The fact that the paper-dollar and the deposit-dollar are not really money but fiduciary media but are being treated as money is the cause of all the trouble.
” does it make much of a difference if most circulating media ….. is unbacked by paper cash? ”
Actually, it does not make a difference how much paper cash backs the circulating media because the paper cash is itself not really “money”. You would have a slightly different set of problems (like hyperinflation and economic apocalypse similar to the collapse of the Roman empire) if the paper cash were to actually be present.
” is it harmful in other words? ”
You bet!!!
” could you substitute the word reserves with assets and call it the dollar…or mega-buck or something? ”
Call it whatever you want. It wouldn’t make a difference. The real thing to do is to stop treating the paper / deposit dollar as money.
At least, Austrians trying to engage others in discussions should first ensure that this point is understood and accepted. Otherwise, they risk getting engaged in specious debates of the kind that Mike Sproul and Joe Stoutenberg are getting them trapped in.
” would that make a difference and is that what takes place now? ”
It would at least help more people understand that the root of all our economic troubles is the undermining of the monetary system by Government and the (fraudulent) fractional reserve banking system.
“You would have a slightly different set of problems (like hyperinflation and economic apocalypse similar to the collapse of the Roman empire) if the paper cash were to actually be present.”
ok..this is what i dont understand. if there was a paper manifestion, a buck , in other words sitting in a vault somewhere for the claimed 6trillion or so of exchange media currently circulating…why would that be apoclypse?
” is it harmful in other words? ”
You bet!!!
how if ”
when prices are adjusted for inflation, Americans today spend ’40% less on clothes, 20% less on food, more than 50% less on appliances, about 25% less on owning and maintaining a car’than they did during the early 1970s.”
http://blog.mises.org/archives/010741.asp
im trying to see how the above linked info is harmful?
scott t,
” ok..this is what i dont understand. if there was a paper manifestion, a buck , in other words sitting in a vault somewhere for the claimed 6trillion or so of exchange media currently circulating…why would that be apoclypse? ”
If it sits in a vault….. I wonder if it will if we still have a Welfare State. It will be interesting to see how the Welfare State will finance its spending without inflating the money supply continuously. I also wonder what effect THAT will have on the stability of the value of the paper cash and the further effect that would have on economic calculation.
Secondly, it also depends on whether markets will be allowed to operate and people will be free to choose something other than paper emitted by government as money. This is critical to compare the link you provided to this situation because out there, people are free to choose to eat healthy food. I am not saying ban FRB. All I am saying is that the market should be free to decide what is money and how banks shall operate without intereference that is nothing but violation of property and contractual rights.
Mike Sproul, allow me to place the issue in historic perspective. An individual bank had a bank run, because it couldn’t redeem the claims of all of its clients to their money. So it had loaned out more than could be covered.
Then several banks collected their assets, so that if one had a run, it could be covered by the others. Still, when there was a simultaneous run on all, the claims of the clients could not be recovered.
Along comes the Fed, and covers all banks. Yet this does not change the fact that a run on all cannot be covered. (Nor is this accomplished by government insurance, where the FDIC could only cover a small percentage.)
In other words, the Fed was created so that the totality of banks could engage in more loans than it had assets to cover.
You write “I keep saying fractional RESERVES, and you keep thinking fractional ASSETS.†Thus you address the words that are used, but this in no way addresses the issue that *the money loaned by the fractional reserve system cannot be fully redeemed*. If it were, there would be no need for the Fed, since the banks would have all that they needed to cover any runs.
T. Ralph,
I know that Mike is wrong. I don’t agree with his posts.
Yet, I find your “mental illness” accusations against him to be very disgusting, uncivilized and unwarranted.
I suggest that you move on yourself and just ignore him. You’ve proven him wrong, there is no use to attack him personally.
Beefcake and Ralph Kays,
“But he simply regurgitates the same paragraphs over and over, and that’s not debate. He deserves to be treated scornfully.”
I agree, but he does not deserve to be accused of “mental illness”.
To try and use a fake pseudo-medical diagnosis to scorn somebody makes you guys even worse than Mike.
If Mike will not listen or respond to your refutations, just ignore him. After all he is ignoring you.
Mike Sproul,
“Everyone should be allowed to print money, and in fact, everyone is. I can take out a piece of paper, write “IOU $1″ on it, and there are a few people in my neighborhood who will give me a dollar’s worth of goods for it.”
This is just wrong. No one will accept my worthless bills (trust me I tried). Money emerges naturally through voluntary transaction–it’s not just paper with “IOU” written on it.
It saddens me that we’re forced to deal with such primitivism from all sides.
Or should that read, “everyone’s allowed to mine gold and convert it into coins and spend the coins’?
Bala,
Scott t.,
Shay,
Allen Weingarten,
Mister Manjo,
EIS
It’s a lot to expect people to digest the concepts of fractional reserve banking, backing, convertibility, real bills, the quantity theory, etc. in one thread, especially when mainstream economic theory gets it wrong and rejects the real bills/backing view in favor of the quantity theory. I started learning the quantity theory in 1976, taught it in my university courses from 1980 until 1988, and never heard or saw the words ‘real bills doctrine’ from any professor or textbook in all that time. I did, however, start to develop doubts about the quantity theory, especially how it implies that banking is tantamount to counterfeiting, how it uses tautological equations like MV=Py, and how it implies a free lunch for the issuer of money. I finally hit on a few key insights in 1989, and by 1994 I had organized my thoughts well enough to put them into a paper called “Backed Money, Fiat Money, and the Real Bills Doctrine”, which you can find my clicking my name above. You will also find my personal journal of random observations made between 1989 and 1994, which led me to accept the real bills view and reject the quantity theory.
Just this past Fall, UCLA did a video podcast of my macroeconomics principles course, available here:
http://www.oid.ucla.edu/webcasts/courses/2009-2010/2009fall/econ2-1
I expect that very few of you will be willing and able to digest it, but the lectures dated 10/6/09, 11/3/09, and 12/3/09 might be an easy way to learn the concepts underlying the real bills view. Of course it took me 18 years to work out the principles of the real bills doctrine, so I can’t expect others to learn it in a matter of hours. Most of you, of course, will ignore it or reject it. Some of you will try to refute it before you understand the most basic economic concepts, and a few of you will even post childish insults wile claiming to discredit it. That’s beyond my control. I can’t teach the unteachable. But I have at least posted the material for those with the intelligence and patience to understand it.
Mister Manjo,
I find your disgust for T. Ralph Kays and Beefcake’s tactics to be offensive, uncivilized, and unwarranted. The fact that you agree Mike should be scorned but simply don’t like the way they have decided to deliver their scorn only demonstrates that you are worse than they are. I suggest you ignore their posts as they have obviously ignored your pleas.
This is a satirical post btw. But, seriously, why perpetuate this not-so-merry-go-round? You’ve agreed that Mike should be scorned. There are many different flavors of scorn. How about you show us your favorite?
1- Good ‘mise-au-point’ Mike Sproul.
2- To try to understand it is also a good exercice to try to understand the economy at large, especially the monetary and banking system, but understand it doesn’t means to necessarily accept it.
3- What about this other theory, the ‘Mises theory’: for you, is it included in the quantity theory ? (You did not mentionned it.)
Mike,
to clarify:
If “printing money” by the Fed is not counterfeiting, because the Fed gets assets in exchange, then why not allow everybody to print the Fed’s (not their own) money?
They will get assets in exchange too, won’t they?
Mike Sproul taught monetary economics for 8 years and was apparently unaware of historical debates that any serious scholar should be informed about. His students should ask for their money back.
Gerry Flaychy:
Mises’ theory of money is built on the quantity theory. In most respects the two theories are identical.
Curious:
The Fed is not a counterfeiter because it puts its name on the money it prints, recognizes that money as its liability, keeps assets against that money, and stands ready to use those assets to buy back the money it printed. A private person who does the same thing is not a counterfeiter, but if that private person printed “the Fed’s (not their own) money” then they would be a counterfeiter. They would not put their name on the money, would not recognize it as their liability, would not hold assets against that money, and would not use those assets to buy the money back.
scott t:
“this seems like dishonesty or fraud.you could issue 100 ious of a fraction of land-space whose total maket value is presently 100 oz of silver.but the silver wouldnt exist for the iou.i dont think any contract could make that so could it?”
It would be fraudulent to issue 101 IOU’s. Normally, the landowner could only issue something like 75 IOU’s against land worth 100 oz. The landowner could back those 75 IOU’s either by holding 75 oz of silver, or by holding land that can be sold in normal times for 100 oz, or even in bad times for 75 oz. People who accept those IOU’s will lose if the land falls below 75 oz., but that’s life, and people take their chances.
Shay:
No matter how many loans we imagine, the total value of IOU’s issued can’t exceed the value of the goods posted as collateral, and you can’t borrow twice against the same collateral. Land worth 100 oz. can only back 100 of those 1 oz. IOU’s.
Allen Weingarten:
A bank run happens when a bank that has issued 100 checking account dollars holds assets worth only 99 green paper dollars. This is consistent with the backing theory. If a central bank is created, then it can print one green paper dollar and give it to the private bank. This would end the run, but of course the central bank now has issued a dollar without getting assets of adequate value in exchange. This would reduce the central bank’s net worth, and if net worth were already zero, the value of the green paper dollars would fall.
Mike Sproul,
You are yet to answer me though you have answered the others. Hence, I think it is proper to ask you once again to answer me.
My main charge against you is that you are using the term money rather carelessly. I think you are wrong because you are considering that which is not money to be money.
Once you have committed an error at this basic level, it is of course possible to come up with any number of fanciful theories that seem to justify what you say.
Just to reiterate my point, “Money” is a medium of exchange that evolves out of market processes. By its very nature, it should be something people are already prepared to accept for the sake of its use value and which, on account of its ready acceptability for further exchange in the future, becomes so commonly and widely accepted that it becomes the medium of exchange that we call “money”.
Bits of paper with assets backing them DID NOT evolve this way, especially the modern Federal Reserve Dollar, the Bank of England Pound, etc. They first evolved piggy-backing on real “money” (defrauding a trusting populace) and then using the government to initiate massive force on the same populace to prevent them from bringing the fraudsters (the banks themseves) down when they (the populace) detected the fraud.
Today’s paper money is a product of fraud and force. It is hence ridiculous to consider it as “money”.
Bits of paper can only be “money substitutes” that stand for a fixed quantity of the “money” commodity. For this, they necessarily need to stand for a certain amount of a pre-chosen (by the market) “money” commodity.
IOUs cannot be money. Firstly, they were only (and always have been) only “money substitutes”. Secondly, when you talk of assets “backing” the paper, the assets themselves are not money. The money that is supposed to be “backing” the IOUs is (or could just as well be) nonexistent at the time of issue and at any point in time in the future. Therefore, the modern bits of paper that you call “money” are not even “money substitutes”.
I see no point in reading the links you have provided unless you address these issues. I think these are at the core of the debate and if you are unable or unprepared to grapple with them, there is no point in discussing anything else.
Bala:
For the sake of argument, let’s go ahead and define money your way, so that the only things that qualify as money are things that “people are already prepared to accept for the sake of its use value”. I take it you mean commodities like metal, salt, tobacco, cattle, etc.
Ordinary trade leads people to make promises to deliver so many units of commodity money. Ancient people scratched those promises (IOU’s) onto clay tablets, pieces of wood, and eventually paper. People began to use those IOU’s to buy groceries, and to “carelessly” refer to them as money. Sometimes those IOU’s were redeemable for commodity money on demand, and sometimes they were made redeemable at some unspecified future date. Eventually governments started issuing the same kind of IOU’s, sometimes redeemable on demand and sometimes not. But no matter who issued the IOU’s, people valued them in accordance with their opinion of the assets backing the IOU’s.
This thread started with the question of what causes price inflation. What causes non-commodity money to lose value? The quantity theory says that price inflation happens because the quantity of non-commodity money has increased. The backing theory, or real bills doctrine, says that if the quantity of non-commodity money increases, while at the same time the assets of the people who issued that non-commodity money increased in step, there will be no price inflation. On this view, inflation only happens when the issue of non-commodity money outruns the assets of the people who issued the money.
If you want to distinguish commodity money from non-commodity money that’s fine. But of course in general use the two things are lumped together,
Mike Sproul,
You are still wrong on every count and I am still left with no option but to reject EVERYTHING that you have said.
Firstly, you have not provided a justification to consider IOUs as “money” whereas when “backed” by “assets” that are not “money”, they are not even “money substitutes”.
Secondly, the “carelessness” I was referring to is not that of ordinary people who accepted IOUs in specific exchanges. It was the “carelessness” of economists (including yourself) who chose to ignore the fundamental definition of the concept “money”, applied it as per their own respective whims and fancies to anything they wished to apply them to and finally claim that they are legitimate because they are internally consistent.
” But no matter who issued the IOU’s, people valued them in accordance with their opinion of the assets backing the IOU’s. ”
Nonsense. When Gold and Silver were money (as they were till Government decided to use its full might to fight them), people accepted the IOUs as a promise to deliver a certain amount of Gold or Silver at some date in the future. The assets only gave the confidence that the borrower would be able to pay the Gold or Silver as committed. This confidence led people to accept the paper in place of Gold or Silver. It was a deferral of payment ant nothing more or less. The payment or the final settlement was always in Gold or Silver.
” Eventually governments started issuing the same kind of IOU’s, sometimes redeemable on demand and sometimes not. ”
Once again, nonsense. Bank notes were always a promise to redeem in a fixed amount of Gold or Silver. For instance, until FDR redefined it, $1 stood for 1/20.6 ounces of Gold. So, anyone promising to repay $1 agreed to provide 1/20.6 ounces of Gold on the due date. The same was true of the IOUs issued by Government.
The real problem was not government’s issuing IOU’s but forcing people to accept them at par and going on to outlaw Gold Clauses. What would happen to these silly pieces of paper in the absence of massive initiation of force and violation of rights by government is best exemplified by the history of the Continental.
” On this view, inflation only happens when the issue of non-commodity money outruns the assets of the people who issued the money. ”
Oh!!! If so, then why is there price inflation all over the world today? Where I live (in India), food prices are rising at something close to 18-20% per annum. Care to justify that?
To rephrase what I am saying, if, I repeat…. if I say that your theory is nonsense, I would be doing so because your are applying the term “money” to that which is not even a “money substitute”.
You have given enough acknowledgement that today’s paper money is not the product of a free market and that it is unsustainable in the absence of the massive government initiated force that was absolutely essential for its emergence in the first place.
To see why you are absolutely wrong, it will be helpful to ask yourself how many years… no, days your precious asset backed “money” will last against Gold or Silver on a free-market where Governments enforce contractual obligations and do not repeatedly suspend redemption or protect defaulting banks.
Your other points are not worth debating unless you address the core issue of the fatal flaw at the base of your entire flight of fancy… oops… theory.
Mike Sproul,
I missed this out.
” If you want to distinguish commodity money from non-commodity money that’s fine. But of course in general use the two things are lumped together, ”
Of course I am saying that this is the real issue. When you and I each use the word “money”, we mean different things. So, unless we agree on a common definition, our discussion is bound to be meaningless.
Just in case you still harbour any doubts, I am rejecting your (implied) definition of money as utter nonsense.
Thanks for the clarification Mike,
1. The Fed puts its name on the money it prints – true
2. recognizes that money as its liability – true
3. keeps assets against that money – true
4. and stands ready to use those assets to buy back the money it printed – false.
Returning to the issue of inflation, if everybody prints the Fed’s money, then why would it cause inflation?
The extra money wouldn’t be on the Fed’s balance sheet, but because the total amount of assets (Fed’s + others) would still equal the total amount of money (Fed’s + others), there would be no inflation.
Can you point the flaw in this line of thinking, as this leads to obviously absurd conclusion.
Firstly, you have not provided a justification to consider IOUs as “money”
does he have to?
if the ious function as ‘media of exchange’ why bother calling them money in a rothbard/mises/related sense?
tradable risk certificates, what ever.
do the ious cause economic hardship for many that what you say is money doensnt?
when discussing with sproul call what sproul call money sproul-money for clarification.
1. The Fed puts its name on the money it prints – true
2. recognizes that money as its liability – true
3. keeps assets against that money – true
4. and stands ready to use those assets to buy back the money it printed – false.
could you clarify point 4….what prompts the federal reserve to buy assets? why would a govt central bank need to?
scott t,
” does he have to? ”
He has to. No discussion is meaningful unless there is clarity on the terms being used and agreement on the appropriateness of the application of key terms to the entities under discussion.
” do the ious cause economic hardship for many that what you say is money doensnt? ”
Yes they do. Especially if force is used to drive real money out of the market and to coerce unwilling people into accepting the IOUs as money. That’s when it makes economic calculation impossible and creates recurring bubbles.
” when discussing with sproul call what sproul call money sproul-money for clarification. ”
I wouldn’t for the same reason that the incorrectly chosen label “fiat money” was soon conflated with the term money and enabled it to appear legimate. “Sproul-money” will soon magically transform into “money” in the middle of the discussion.
Therefore, I prefer to reject outright any attempt to give the IOU’s the label “money”.
ok. he seems to go to some lengths to describe how the ious would function – i would just try to omit or ignore the money term attached to function of the ious.
forwarding a discussion on the merit or detriment of the iou/rbd that i have seen discussed here that would make more sense to me.
does the curent us dollar (definition : the unit commonly employed in the United States in reckoning money values.) http://www.brainyquote.com/words/do/dollar156592.html
system operate in a way similar to what sproul describes??
Curious and scott t.
“4. and stands ready to use those assets to buy back the money it printed – false.”
Before 1933, the fed would buy back its dollars with either gold or bonds, at the customers’ option. In 1933, the fed stopped buying back its dollars with gold, (1971 for foreign governments) but it has always stood ready to buy back its dollars with its bonds, in what is usually called an open market sale of bonds. For example, the fed might have issued 100 green paper dollars, against which it holds $10 in gold and $90 of bonds. If the Fed sees that private banks’ reserves of green paper dollars are excessive, the Fed will normally sell (say) $20 worth of its bonds for 20 paper dollars, which it retires. Thus the fed soaks up the excess paper dollars without having to buy them back with gold.
“The extra money wouldn’t be on the Fed’s balance sheet, but because the total amount of assets (Fed’s + others) would still equal the total amount of money (Fed’s + others), there would be no inflation.”
If I print 10 green paper dollars, made to mimic genuine fed dollars, and if I don’t put my name on them, then those dollars will be the fed’s liability, not mine. I will spend the $10 I printed on groceries, and I will not stand ready to use those groceries to buy back those imitation dollars. Thus the fed’s liabilities will rise by $10, while the fed’s assets will be unchanged, so the fed’s dollars will lose some value.
On the other hand, if I print 10 paper dollars that clearly say “Mike Dollars” on them, and if I spend them on assets which I stand ready to use to buy back the Mike Dollars, then my liabilities rise by $10 and my assets rise by $10. The fed’s assets and liabilities are unaffected, so the fed’s dollars will hold their value, and so will the Mike Dollars.
scott t,
” does the curent us dollar (definition : the unit commonly employed in the United States in reckoning money values.) …… system operate in a way similar to what sproul describes?? ”
Based on my (obviously limited) knowledge, I think it does.
The link you provided actually gives the original definition of the dollar. Sadly, that has been rendered inoperable thanks to the dropping of the Gold Standard.
Mike Sproul,
” but it has always stood ready to buy back its dollars with its bonds, in what is usually called an open market sale of bonds. ”
Paper for paper.A new IOU redeems an old IOU. Wow!!! You couldn’t have been clearer. Here’s the Ponzi Scheme in its full glory. Thanks for the clarity.
Incidentally, could you please stop using the term money to refer to what isn’t money?
What’s really happening these days is close to Chartalism, although in actual history it usually didn’t start with the sequence government spends money, and only then can people pay taxes (occasionally it did start that way in colonial situations, but more in tandem, as in Madagascar).
Mike Sproul’s view, however, seems more akin to Circuitism, although he does admit that taxes do play a part in backing fiat money (all the while denying that it is fiat money). Hereabouts he is claiming that one round of IOUs rests stably on another, and that that is enough for it all to stay up in the air without resting on anything else. But see what that theory’s modelling difficulties indicate:-
What those models are genuinely telling us, of course, is that there really is nothing of value there in money of that sort, and the dynamicists’ counter is really only claiming – accurately but unhelpfully – that things don’t have to collapse straight away, that you really might be able to kite the cheques for a while, perhaps quite a while. But there really is nothing there unless the chain ends; it’s unsound and can collapse. If the chain ends in real assets it’s sound and just, while if it ends in taxes or similar it’s sound and unjust. Within the real assets category there are both the bullion standards and the genuine Real Bills Theory (as opposed to what Mike Sproul calls Real Bills Theory, in which he includes backing by IOUs, tax debts, etc.). The only thing wrong with genuine Real Bills Theory – a killer, albeit a slow one – is the picking winners problem: sometimes the backing turns out not to be valuable and self liquidating on the right time scale after all, so it leaks. This is a cumulative problem with it, so the difficulties are practical as well as philosophical.
But round here the biggest problem is the philosophical one of Mike Sproul insisting on changing the definitions to match the line he is trying to push.
Bala, Fed Notes are not IOUs.
If you go to a regional Fed bank and ask them to redeem your notes in bonds (or gold), they will not be obliged to redeem them, and they won’t redeem them, for the simple reason that they are not redeemable.
They could buy them by selling their bonds in the open market sale of bonds, but this is not redemption, this is just a market transaction like any other else. You may yourself sell your bonds in the market, it doesn’t means that you are redeeming Fed Notes in bonds !
Fed buys fed Notes, they don’t redeem them.
Mike,
that makes sense.
Now, if instead of groceries I print the Fed’s money and buy assets with them, the increase in Fed’s money is backed by assets, so the value of Fed’s money will not change.
So that should be OK, right?
When you say “stand ready”, when it is at the Fed’s choosing, that’s not really “standing ready” is it?
If I “stand ready” to throw you a life line not when you choose to, but when I choose to, am I really standing ready?
Would you morons kindly read what von Mises has written about RBD before posting here?
Thank you.
DITTO!
Curious:
If you in fact bought assets and stood ready to use them to buy back federal reserve dollars, then yes. But of course nobody in their right mind ever does such a thing, with good reason: The Fed would never trust you to stand behind the dollars you printed. You are free to issue Curious Dollars, each of which promises to deliver a fed dollar; but you should not be allowed to print imitation fed dollars that don’t have your name on them. I think the Americans that occupied Berlin after WWII made them mistake of giving currency printing plates to the occupying Russian forces. The Russians used them to extract, in a matter of weeks, several hundred million dollars worth of goods from Germany. When the Americans responded by refusing to honor the Russian bills, the Russians blockaded Berlin.
“standing ready” can mean many things, but if, for example, a bank issues 100 paper currency units, and that bank credibly declares that it will buy them back with assets worth 1 oz. of silver whenever their market value falls near or below 1 oz., then those currency units will trade in the market for 1 oz, even if people can’t redeem them for 1 oz. whenever they want.
Gerry Flaychy:
“Fed buys fed Notes, they don’t redeem them.”
Suppose the fed issued 10 paper dollars for 10 oz of silver, and then it issued another 90 paper dollars for bonds worth $90 (or equivalently, 90 oz). It could then sell the $90 bond for 90 of its own paper dollars and burn the dollars. Those 90 paper dollars were issued for bonds, and they were redeemed with bonds.
PM Lawrence:
“he does admit that taxes do play a part in backing fiat money (all the while denying that it is fiat money).”
Fiat money is money without backing. If it is backed by taxes receivable (i.e., by the government’s assets) then it is not fiat money. What I specifically say is that there is no such thing as fiat money. I’d invite anyone to name a single bank, central or otherwise, that has ever issued money without holding equal-valued assets against that money. In a recent blog, Nick Rowe admitted that he couldn’t name such a bank. Naturally, he didn’t change his mind.
“he is claiming that one round of IOUs rests stably on another, and that that is enough for it all to stay up in the air without resting on anything else.”
I say things like “a dollar bill is backed by a $1 bond, which is backed by $1 worth of taxes receivable, which is backed by a dollar’s worth of land”, but I do not say that the number of dollars can in any sense multiply beyond the value of the base assets. If the land at the bottom of the pile of IOU’s is worth 1 oz. of silver, then the dollars at the top of the pile can’t be worth more than 1 oz.
“Mike Sproul insisting on changing the definitions to match the line he is trying to push.”
I’ve always explicitly said that the traditional RBD says that money will hold its value as long as it is only issued for assets that are (1) adequate in value (2) productive, and (3) short term. My version, which I often call the backing theory, holds that only (1) is necessary, and the others are virtually irrelevant.
Bala:
Our views are different enough that it would take a long time, which I don’t have, to even begin to debate them.
Mike, If I have chickens in a barter economy and my neighbour has sheep, we establish an exchange rate of sheep to chicken. Are you saying we can’t devise a medium of exchange among ourselves based on the assets we have because we don’t have “reserves” of somebody else’s IOUs to satisfy a fractional reserve clause?
You split “assets” into 2 categories. Those that are reserves (because they’re liquid?), and those that are not. But they all back the dollars you issued.
The problem is, all the assets that back the dollars issued ARE reserves. That’s what backing means. When someone comes with your dollar IOUs and asks you to redeem them, you will give them either the gold from your “fractional reserve”, or the bonds forming the rest of your assets.
The problem with fractional reserve is that you trick consumer in thinking that the value of your dollars is based on the value of the assets comprising your fractional reserve. In truth, your other assets, whose value is less, have let you expand the pool of money while maintaining the illusion of their value being based on your “gold”.
Why is their value necessarily less? Simple: When someone who has acquired, let’s say 20% of the dollars you issued, wants you to redeem them, you will give him your “gold” and try to exchange more of your bonds for gold on the open market. However, since the demand for gold suddenly increased and the supply of bonds as well, you will have to pay more for that gold.
Thus, what good is it to say that your bonds back the money issued, if they lose their value as soon as the redeemability of your IOU money comes up?
“I’ve always explicitly said that the traditional RBD says that money will hold its value as long as it is only issued for assets that are (1) adequate in value (2) productive, and (3) short term. My version, which I often call the backing theory, holds that only (1) is necessary, and the others are virtually irrelevant.”
I don’t have a problem with this. I just don’t see how you jump to fractional reserve backing.
If there is money issued based on the value of certain assets, the market will decide the value of that money based on the current value of those assets AND their potential to rise or fall in value.
When you have another, more stable, asset fronting as a guarantee of value for your money you’re engaging in deception since only a fraction of the money you issued benefits from that asset’s stability.
FYI gentlemen,
The new world currency!
http://74.125.153.132/search?q=cache:TtY2TpKXC1QJ:www.examiner.com/x-32916-V
ancouver-Humanism-Examiner
Mike Sproul, if we take redeem in the specialized sense of ‘to pay off a promissory note’, it is not redeeming.
In this sense, it his the holder who has the choice to be paid or not in the promised thing, not the issuer.
Usually an issuer of a promissory note will not run after the holder of it to ask him to redeem the note, on the contrary, he will hope that that promissory note will never come back to him !
Mike Sproul,
” Our views are different enough that it would take a long time, which I don’t have, to even begin to debate them. ”
Ha Ha Ha!!! Good way to duck what is actually the root of the problem.
I don’t think this is a matter of “views” but of “definitions”, especially definitions of the basic subject of the study. The point is that your entire “argument” is based on false definitions and hence completely flawed.
Just bear in mind that “Logic” is a method. It operates on the GIGO principle. When you feed garbage as input, you get (maybe a different) garbage as output.
Mike,
“The Fed would never trust you to stand behind the dollars you printed”
What does it mean “stand behind”?
If I print the Fed’s money and exchange them for assets, then assets rise in step with the issue of money and according to your theory – no inflation, correct?
if “a bank issues 100 paper currency units, and that bank credibly declares that it will buy them back…”
That’s not the case with the Fed though, is it?
Mike Sproul wrote of my “[Mike Sproul] does admit that taxes do play a part in backing fiat money (all the while denying that it is fiat money)”, “Fiat money is money without backing. If it is backed by taxes receivable (i.e., by the government’s assets) then it is not fiat money. What I specifically say is that there is no such thing as fiat money. I’d invite anyone to name a single bank, central or otherwise, that has ever issued money without holding equal-valued assets against that money.”
What is this but denying that it is fiat money, based on changing the definition? He refuses to admit that fiat money is simply money resting on nothing other than the government’s say so – since he refuses to recognise that “you will pay taxes in this money” is part of that say so. He is defining out some fiat things and reclassifying them as separate backing.
Of my “[Mike Sproul] is claiming that one round of IOUs rests stably on another, and that that is enough for it all to stay up in the air without resting on anything else”, he wrote ‘I say things like “a dollar bill is backed by a $1 bond, which is backed by $1 worth of taxes receivable, which is backed by a dollar’s worth of land”, but I do not say that the number of dollars can in any sense multiply beyond the value of the base assets. If the land at the bottom of the pile of IOU’s is worth 1 oz. of silver, then the dollars at the top of the pile can’t be worth more than 1 oz.’
Sometimes he says things like that, but that is no refutation because he also writes things just like what I claimed he did, e.g. of my “Mike Sproul insisting on changing the definitions to match the line he is trying to push”, he wrote “I’ve always explicitly said that the traditional RBD says that money will hold its value as long as it is only issued for assets that are (1) adequate in value (2) productive, and (3) short term. My version, which I often call the backing theory, holds that only (1) is necessary, and the others are virtually irrelevant.”
But taking (1) on its own only provides value in a circular way, ultimately supporting nothing once the cheques stop being kited; it takes (2) to provide underlying support – to provide actual value that is not circular – and it takes (3) for that to happen before the cycle collapses as cheques stop being kited. When he claims that (1) on its own is enough, that is “claiming that one round of IOUs rests stably on another, and that that is enough for it all to stay up in the air without resting on anything else”; he simply didn’t look at “value” to see that that was what was going on in his scenario.
Over and above that, Mike Sproul omits the effect these distortions have, of bidding up prices. Granted, things worth a silver ounce note stay “worth” 1 ounce of silver at any given snapshot of time, but the competition – the crowding out of bullion by notes – means that more money units of either are needed to buy the same stuff than would have been needed without the added stock of notes. The total stock of currency at the top stays worth the same as the underpinnings at the bottom – but the value per unit goes down. About the only gain is a freeing up of bullion for foreign trade, a self limiting thing as there is less and less left to free up, and subject to the other problems of such mercantilist measures (some useful one off stuff can be achieved this way, though – at a hidden continuing price caused by eroding people’s capital; it is rare for the government to make a better use of its one off gain as capital for its own use, but it is possible).
Mike Sproul,
Austrians don’t use the equation of exchange, and aren’t mechanical quantity theorists. They use the Wicksellian indirect transition mechanism, but drop the alleged fixed relationship between changes in the interest rate and overall price level (replacing it with human action). Austrians (most Austrians) believe that “V” is entirely illusory; it doesn’t exist. You may already know this, but I just wanted to make that clear.
Cosmin:
A bank could hold 100 oz of silver against 100 paper dollars issued. Then reserves=assets. Depositors understand that the bank could be robbed, so each dollar only promises a probability of getting 1 oz. of silver. Depositors accept that risk because they know that carrying silver in their pockets is dangerous too. If that bank then proposes to lend 90 oz to a farmer who offers land worth 180 oz as collateral, depositors will see that the bank’s risk of robbery is reduced, the chance that the value of the farmer’s land will fall below 90 oz is low, and they will earn interest besides. So they accept the risk that sometimes the bank will delay in paying silver, or the farmer’s loan might go bad. There is no fraud in that, and where the $100 was previously backed by 100 oz in the vault, the same $100 is now backed by assets that can, with high probability, be sold for 100 oz.
This is not to say that the farmer’s loan can’t go bad, and that the bank might therefore be unable to honor its promise to pay 1 oz/$. But as long as the bank and its customers agree to it, there is nothing wrong with it.
Gerry Flaychy:
Whether you call it redeeming or not, dollars that are issued in exchange for bonds can be retired in exchange for bonds. Most customers would not care if their dollar is ultimately paid in 1 oz of silver, or in something that is worth 1 oz.
Curious:
“standing behind” = backing
“If I print the Fed’s money and exchange them for assets, then assets rise in step with the issue of money and according to your theory – no inflation, correct?”
Your assets rise, but it’s the fed’s assets that matter, and they don’t rise. If you gave your new assets to the fed, then the fed’s assets would rise in step with the issue of money, and there would be no inflation.
“That’s not the case with the Fed though, is it?”
The fed uses its bonds to buy back it’s dollars all the time. For example, every Christmas, the fed buys about $10B in bonds, thus adding $10B in cash to the public’s holdings. After Christmas, the fed will sell those bonds, get back its $10B in cash, and store them until next year.
PM Lawrence:
“fiat money is simply money resting on nothing other than the government’s say so”
The say-so is worthless without assets to back it up. You might just as well say that a checking account dollar at Wells Fargo is fiat money because it rests only on Wells Fargo’s say-so. If Wells Fargo had no assets to cover the dollars it issued, then its say-so would be worthless, and the same is true of the government.
“(1) on its own only provides value in a circular way, ultimately supporting nothing once the cheques stop being kited;”
There is no kiting. Banks don’t lend twice on the same collateral. If a bank has issued 100 checking account dollars on loan, that would only be because borrowers offered collateral worth at least $100 in exchange. And once the bank placed a lien on that collateral, it could not be used to take out another loan. If there are a trillion checking account dollars in the country, it means that a trillion dollars’ worth of stuff has been pledged to the banks that issued those dollars.
“the crowding out of bullion by notes – means that more money units of either are needed to buy the same stuff than would have been needed without the added stock of notes. ”
Correct. For example, in a world where significant amounts of silver are carried as coins, 1 oz of silver might buy 1 loaf of bread. If paper money replaces silver, the silver might fall to its ‘use value’ of .7 loaves. As that one-time displacement occurs, the backing theory will be incorrect, in the sense that the issue of paper money will cause the silver, and the paper that is pegged to the silver, to lose value. But once the silver has fallen to .7 loaves, further issues of paper will not reduce the demand for silver any further, and the backing theory will be fully correct. Additional issues of adequately backed paper will not cause the paper to be worth any less than 1 oz., and neither will it cause the oz to be worth less than .7 loaves.
“This is not to say that the farmer’s loan can’t go bad…”
Never mind the farmer’s loan. Even if it doesn’t go bad, why would people choose to use this money? It’s backed by assets that will drop in value as soon as someone tries to redeem his paper for silver.
It’s backed, only as long as you don’t redeem it. Why back it at all then?
In a sense, it’s just like using Monopoly money. I don’t see why people would use this money unless it was supported by the state and all alternatives disallowed.
Mike,
thanks for the explanation.
“The fed uses its bonds to buy back it’s dollars all the time.”
The assets (the bonds) backing the currency, are just promises to receive the currency itself.
So the currency is backed by itself or, put differently, it is not backed at all, is it?
Mike Sproul wrote of my “fiat money is simply money resting on nothing other than the government’s say so”, “The say-so is worthless without assets to back it up. You might just as well say that a checking account dollar at Wells Fargo is fiat money because it rests only on Wells Fargo’s say-so. If Wells Fargo had no assets to cover the dollars it issued, then its say-so would be worthless, and the same is true of the government.”
That first sentence is plain wrong. The government’s say so goes beyond telling us to pay taxes in its money to telling its own agents to mistreat us if we don’t. For that, it needs resources, not assets – and its resource base isn’t something independent but is carried by what the government extracts. The rest of the passage is the fallacy of irrelevant thesis.
Of my “(1) on its own only provides value in a circular way, ultimately supporting nothing once the cheques stop being kited…”, he wrote “There is no kiting. Banks don’t lend twice on the same collateral. If a bank has issued 100 checking account dollars on loan, that would only be because borrowers offered collateral worth at least $100 in exchange. And once the bank placed a lien on that collateral, it could not be used to take out another loan. If there are a trillion checking account dollars in the country, it means that a trillion dollars’ worth of stuff has been pledged to the banks that issued those dollars.”
That is more of the fallacy of irrelevant thesis – unless of course he simply doesn’t know what kiting cheques is: “Check [sic] kiting is the illegal act of taking advantage of the float to make use of non-existent funds in a checking or other bank account. It is commonly defined as writing a check from one bank knowingly with non-sufficient funds, then writing a check to another bank, also with non-sufficient funds, in order to cover the absence.”
Kiting cheques has nothing to do with issuing twice on the same collateral, it is when an issue is made on collateral that is itself an issue made on collateral that is itself… and so on.
Of my “the crowding out of bullion by notes – means that more money units of either are needed to buy the same stuff than would have been needed without the added stock of notes”, he wrote “Correct. For example, in a world where significant amounts of silver are carried as coins, 1 oz of silver might buy 1 loaf of bread. If paper money replaces silver, the silver might fall to its ‘use value’ of .7 loaves. As that one-time displacement occurs, the backing theory will be incorrect, in the sense that the issue of paper money will cause the silver, and the paper that is pegged to the silver, to lose value. But once the silver has fallen to .7 loaves, further issues of paper will not reduce the demand for silver any further, and the backing theory will be fully correct. Additional issues of adequately backed paper will not cause the paper to be worth any less than 1 oz., and neither will it cause the oz to be worth less than .7 loaves.”
Rubbish, or more precisely the fallacy of irrelevant thesis, because he has left out the rather important point I made that there is “a hidden continuing [emphasis added] price caused by eroding people’s capital”.
In case that wasn’t clear, I’ll spell it out. If there is a one off issue of notes, that does not simply mean that there was a one off break with the backing theory but that then it starts working again so there’s no problem. Even when there is only a one off issue of new currency (which is not the usual case), that causes a one off erosion of other people’s capital at the time – but that wealth transfer causes a continuing effect, since the capital stays gone unless and until something else happens to restore it. The fact that the boat ends up on an even keel again once everything settles does not mean it doesn’t end up lower.
We can see a hard and fast case of a one off depreciation with just such a continuing effect in the implementation of the Culture System by the Dutch to help them exploit the East Indies in a more intensive, sustained and increased way: ‘An ingenious device for increasing the Government profit was devised by General Van-der Bosch at the same time as he initiated the culture system. An enormous amount of copper coinage was manufactured in Holland, the intrinsic value being rather less than half the nominal value. This coinage was made a legal tender, and the cultivator was paid for his produce in this copper coin. Thus, as Mr. Money in his work Java; or, How to Manage a Colony, naively remarks:- “The loans, raised in Holland to start the system, produced an effect in Java equal to double their amount.”‘
I would like to add something to the discussion. While I am not an expert in the area, I have a bit of formal education in finance.
I think both sides use different views. Mike Sproul claims that if you interpret the government as a business, it has income and if the income is sufficient, that backs the value of their “products” (i.e. currency). From this point of view, there is no difference between the central bank-generated currency and any other product by private companies. It is possible for a company to have accounts payable in a sum that exceeds the assets of the company and their only backing being the ability of the company to generate revenue (e.g. accounts receivable). If a sudden fluctuation in one of these two areas appeared, the company can go bankrupt. Just like a fractional reserve bank can go out of business when there is a run. I have no problem with such an arrangement per se and see no relevant difference. A business can make estimates of future development and arrange their activities in a way to reach the desired risk level. Governments can, in theory, do the same.
However, the issue with central banking is that the currency is a legal tender, in other words, it is illegal to refuse the currency as a settlement of debt. Once the market value of this currency starts decreasing sufficiently (i.e. rising trends in CPI), this will motivate debtors to prefer this currency and drive other currencies out of the market. Also, since under a system with central bank and fiat currency a bank is practically prevented from going bankrupt, decreasing of reserves in fractional reserve banks is encouraged.
Therefore, in my opinion the problem with central banking isn’t fraud, but market distortion and promoting of irresponsible behaviour. If there were no legal tender laws, there would be no issue, noone would care about inflation and whether fiat money is fraud.
Peter Suda,
“I think both sides use different views. Mike Sproul claims that if you interpret the government as a business, it has income and if the income is sufficient, that backs the value of their “products” (i.e. currency). From this point of view, there is no difference between the central bank-generated currency and any other product by private companies. It is possible for a company to have accounts payable in a sum that exceeds the assets of the company and their only backing being the ability of the company to generate revenue (e.g. accounts receivable). If a sudden fluctuation in one of these two areas appeared, the company can go bankrupt. Just like a fractional reserve bank can go out of business when there is a run. I have no problem with such an arrangement per se and see no relevant difference. A business can make estimates of future development and arrange their activities in a way to reach the desired risk level. Governments can, in theory, do the same.”
The point is that all of his premises are entirely incorrect, making his argument fallacious. The silver which backed the notes was money, not the actual bills themselves. Paper bills have never, nor can they ever, become the media of exchange on their own–it requires compulsion, and some kind of link to a valuable commodity. This doesn’t include bonds whose market values can collapse at any moment (as soon as the FED slows down or stops buying them altogether, for example). I can’t buy a bunch of bonds, and then start handing out EIS bills–no one will accept them, period.
“Voluntary trade will lead people to write IOU’s to each other, and those IOU’s will be used as money.”
this was sprouls opening line….if he had said iou will be used as media of exchange would you people have written anything else??
are you using only a rothbardian/mises/austrian definition of money?
“Henry Hazlitt estimates that a dollar of today is worth less than 25 cents of a 1940 dollar, and certainly no one has to be told that a dollar continues to buy less and less….”
from the article…does this also mean that dollar(s) also buy less and less?
wages i am sure increased as well.
if the dollar of today as the article says is worth less than .25 were people making more than 4 times as many dollars??
if people are going to frrely exchange goods ious or money – does the iou system lead to greater imporvrishment all around than notes generated at whim?
Cosmin:
“Even if it doesn’t go bad, why would people choose to use this money? ”
People use it because its risks and inconveniences are often smaller than carrying silver around.
Curious:
“So the currency is backed by itself or, put differently, it is not backed at all, is it?”
That objection can be handled just by changing the denomination of the backing. Mexico might issue pesos, and back them largely with bonds denominated in pesos. Change to bonds denominated in dollars, and the problem is solved.
If a bank has issued 100 dollars, backed by 10 oz of silver plus $90 of bonds, (denominated in dollars), then let E=the exchange rate between dollars and silver (oz/$). The bank’s assets (10 oz plus $90 of bonds, worth E oz. each) must equal its liabilities (100 dollars, worth E oz. each). Thus 10+90E=100E, or E=1 oz/$. Dollars have been backed in part with other dollars. Not that it’s a great idea to do it. If the bank were robbed of 5 oz, then the equation becomes 5+90E=100E, or E=.5 oz./$. The lower the bank’s real reserves, the more vulnerable the bank is to this type of inflationary feedback, and the more volatile the value of the dollar.
PM Lawrence:
“For that, it needs resources, not assets ”
I’m sure the accounting profession would love to hear your explanation of how resources are not assets.
“Kiting cheques … is when an issue is made on collateral that is itself an issue made on collateral that is itself… and so on.”
All of which amounts to your attempt to say that banks lend twice on the same collateral, which they don’t.
“Even when there is only a one off issue of new currency (which is not the usual case), that causes a one off erosion of other people’s capital at the time”
This is Lloyd Mints’ Money’s Worth fallacy, which I explained in “Three False Critiques of the Real Bills Doctrine”. As long as the new currency is adequately backed, there is no rise in prices, no erosion of other peoples’ capital, and the process you refer to never gets off the ground.
Peter Surda:
You are right. The backing theory just says ASSETS=LIABILITIES, and money is the liability of the bank that issued it.
On legal tender laws: Yes, they are a form of theft, but they are also very nearly ineffective. The continental dollars of the American revolution, and the assignats of the French revolution, were both legal tender and both lost all value, in spite of enforcement that included mass murder. A government might declare that it will accept a paper dollar in lieu of 1 oz. of silver, and that can give the dollar value until the government runs out of assets. After that, all the declarations on earth won’t work.
EIS:
“Paper bills have never, nor can they ever, become the media of exchange on their own”
You’d have a hard time explaining that to people who commonly traded with paper bills of exchange and with various paper currencies issued under free banking situations. People have been writing IOU’s forever, and those IOU’s have traded person-to-person for nearly as long.
Thanks for the responses, they show me that I’m being understood. Now, allow me to conclude. I think some FRB opponents concentrate needlessly on trying to figure out what the fiat currency represents. In my opinion, it doesn’t matter. If we had free market on currencies and no legal tender laws, those fiat currencies would go out of use and noone would care.
scott t,
” if he had said iou will be used as media of exchange would you people have written anything else?? ”
Not exactly. I would have questioned the use of the words “medium” and “exchange”. That which is enforced by initiation of force cannot be called “exchange” and that which is used for a few transactions cannot be called a “medium” in general.
” are you using only a rothbardian/mises/austrian definition of money? ”
Am I wrong if I use one that makes complete sense? Am I wrong in not using one that does not make complete sense? In that case, which alternative definition of “money” should one even consider?
That apart, what other definition do you expect those who subscribe to the Austrian view to use? The Keynesian one? That money is what money does?
Mike Sproul,
So what is it in your mind that causes inflation in the sense of a general rise in the price level?
Mike Sproul,
” You’d have a hard time explaining that to people who commonly traded with paper bills of exchange and with various paper currencies issued under free banking situations. ”
From “commonly traded” to being a general “media of exchange” is indeed a huge jump and you need to justify it. Secondly, it’s not that difficult to explain the emergence of bank notes as “money substitutes” because they did not emerge “on their own” (That was indeed EIS’s main point which you are deliberately sidestepping) but did so piggy-backing on the prior acceptance of Gold/Silver as money proper. The paper was accepted not because it was acceptable but because it held out the promise of being redeemed in Gold/Silver or of being accepted in lieu of taxes (force exerted by government on behalf of the issuers of currency not backed by specie).
” People have been writing IOU’s forever, and those IOU’s have traded person-to-person for nearly as long. ”
This does not transform IOUs to the status of “medium of exchange”.
Mike:
Price inflation is caused by a loss of backing. So if a bank initially has 100 oz backing 100 currency units, and the bank then issues another 100 currency units for assets worth only 98 oz, then each dollar will then be worth 198/200=.99 oz.
Mike Sproul,
“Price inflation is caused by a loss of backing. So if a bank initially has 100 oz backing 100 currency units, and the bank then issues another 100 currency units for assets worth only 98 oz, then each dollar will then be worth 198/200=.99 oz.”
So the subjective valuations of individuals is entirely ignored–irrelevant.
Mike Sproul, you wrote of my “For that, it needs resources, not assets”, “I’m sure the accounting profession would love to hear your explanation of how resources are not assets”.
Leaving aside the sarcasm, accountants don’t need to be told, they already know. They define an asset as “a bundle of service potential”. The resources governments have, that they use in all this, are not bundles of that sort.
To make it clearer, suppose I had you in the same room as me and I decided to apply the mule system of education to you: beating you repeatedly over the head with a club, because first I have to get your attention. I would be using two resources, the club and my own strength, but only the club would be an asset.
True enough, governments do have “clubs” like jails, guns, etc. that they use in all this, but do you for one moment suppose that their value if they were sold off to redeem currency is anything like as much as the backing effect they produce by enforcing taxes, in conjunction with the bureaucracy etc. that form their other resources?
Of my “Kiting cheques … is when an issue is made on collateral that is itself an issue made on collateral that is itself… and so on”, you wrote “All of which amounts to your attempt to say that banks lend twice on the same collateral, which they don’t”.
That rejoinder is either a lie, if you know what you are talking about, or wilful ignorance, if you don’t. But whether you are a knave or a fool, it is wrong either way. Even if it were true that banks would then be lending twice on the same collateral (which it isn’t – they would be lending on no collateral), far from attempting to say that, I am attempting to deny it. Putting “amounts to” is substituting what you would like me to have asserted for what I actually did assert. The process you ascribe to me is not the process I describe, no matter that both would be the borrower getting something for nothing.
Of my “Even when there is only a one off issue of new currency (which is not the usual case), that causes a one off erosion of other people’s capital at the time”, you wrote ‘This is Lloyd Mints’ Money’s Worth fallacy, which I explained in “Three False Critiques of the Real Bills Doctrine”. As long as the new currency is adequately backed, there is no rise in prices, no erosion of other peoples’ capital, and the process you refer to never gets off the ground.’
Codswallop. I even gave a documented historical example of this happening. If for no other reason, this attempted refutation fails because the condition of that last sentence does not obtain during that one off issue of new currency (so I don’t need to explore that critique to know that its conclusions don’t apply here). You yourself admitted it:-
- “Correct. For example, in a world where significant amounts of silver are carried as coins, 1 oz of silver might buy 1 loaf of bread. If paper money replaces silver, the silver might fall to its ‘use value’ of .7 loaves.” That is a rise in price.
- “As that one-time displacement occurs, the backing theory will be incorrect, in the sense that the issue of paper money will cause the silver, and the paper that is pegged to the silver, to lose value.” See also your own later admission “Price inflation is caused by a loss of backing”. This one off rise in price is from a lack of backing.
EIS:
“So the subjective valuations of individuals is entirely ignored–irrelevant.”
If $100 are backed by 99 oz. worth of assets, then smart people will subjectively value each dollar at .99 oz. People who are not so smart will value them at 1 oz or .98 oz, and they will tend to lose money to those who value them at .99 oz.
PM Lawrence:
“governments do have “clubs” like jails, guns, etc. that they use in all this, but do you for one moment suppose that their value if they were sold off to redeem currency is anything like as much as the backing effect they produce by enforcing taxes”
The jails, guns, etc, might be salable for a few dollars. The government’s ability to use them to extract taxes is worth a few billion dollars. When I speak of the government’s assets I mean the billions, not the smaller number.
“Kiting cheques … is when an issue is made on collateral that is itself an issue made on collateral that is itself… and so on”
Suppose my only asset is a house worth $100,000. If you were to try to describe a process akin to your “collateral on collateral” story, you should be able to come up with a way for me, or a group of co-conspirators, to borrow $500,000 or so against nothing more than that house. If you can tell me where the bankers are who will go along with your process, I’ll send them more customers than they can handle.
Your historical example is either a case of the cultivator being robbed by a legal tender law, or a token currency that is worth more than its intrinsic value–hardly an exceptional occurrence. Codswallop indeed.
“This one off rise in price is from a lack of backing.”
If the backing was inadequate to the new issue of money then of course there would be inflation. But Mints claimed (and I suppose you would agree) that the new money would cause inflation even if it were adequately backed.
“the bank then issues another 100 currency units for assets worth only 98 oz…
is that a loss of backing or is it issuing false (unbacked) currency?
or if they issued 100 currency units each worth .98oz??
or are they the same?
wouldnt the note have to indicate something different?
well…some people trade things and sometimes they use dollars.
some people profit by using the dollar (the bill and its variants) and it gets exchanged for things?
what do you call the dollar then..albeit forced on some people for some tihngs?
i suppose the amount and circulation to some extent can be measured and can be used to some degree for economic clauculation…and some may like the dollar?
what would you call it (the current dollar ) then?
from what i have read at mises sites ,if its true — i wouldnt consider the current dollar a money from a free-market perspctive.
i would call it a fiat currency…fiat meaning ‘by decree’ from the armed govt and ‘currency’ is attatching some type of national character to the ‘exchange media’.
i do believe that the dollar is exchanged for goods and doesnt serve much other purpose…except for some mexican guy i saw make origami rings with them…some tourist spots have penny flatteners.
the coin, paper and digital expressions of the dollar i dont fully understand and cant define. which is why i dont completely trust it as an optimal ‘money.’
i am mainly trying to determine if the monetary-inflation (the frb/fed combination) spoken of in the article leads to price-inflation that specifically outpaces wage-increases for the better part of the population.
or does capitalism despite govt interventions in some way overcome the ills and disease money-inflation and leave the masses better off anyway?
Mike,
“That objection can be handled just by changing the denomination of the backing.”
What are you talking about? We are discussing the current Fed system.
The Fed is only exchanging dollars for debt (more dollars). Your claim that this “backing” gives dollar its value doesn’t make sense.
What am I missing?
Curious:
The fact that dollars are redeemable for things that are themselves denominated in dollars disguises the fact that dollars are backed by real assets. If a bank issued $100, backed by 100 oz., then the backing is obvious. If 90 oz were then sold for bonds worth $90, the value of the backing would still be the same, but the fact that the bank now has dollars backing other dollars makes it look like the dollar has no actual backing. But the simple act of selling the $90 of bonds for real assets worth 90 oz. would make it clear that real backing was there all along.
“If 90 oz were then sold for bonds worth $90, the value of the backing would still be the same, …”
i guess. unless value extends beyond what a single price exchange is.
i dont know if that process extended over a large complex economy would bring about harmful inflation though.
Mike,
what oz are you talking about?
You can trade dollars to the Fed in exchange for a Treasury security. That security will turn into dollars at maturity.
Can you trade your dollars to the Fed for something else?
Thus dollars are “backed” by dollars only and I don’t see how that can give the dollar any value. Therefore the value of the dollar must come from something else.
Curious,
” Therefore the value of the dollar must come from something else. ”
Good point. I can see clearly that it comes from the gun in the hands of government.
I suspect you’re right Bala.
Curious:
When the $90 bond matures, the bank will take it to the government agency that issued it. If the bank owes $90 in taxes, then the bond and the taxes due are both canceled. The bonds is not just paid off with more dollars. If the bank owes no taxes, the government will buy back the bond for $90 in green paper dollars, which it will eventually collect as taxes due from someone else. When those dollars are collected as taxes they can be retired, or what is more likely, returned to circulation. There will always be a float of paper dollars that have not yet been redeemed, but as long as the government has adequate assets (like taxes receivable), every paper dollar issued can be retired at par.
In colonial times, paper money was issued with the explicit promise that it would be retired when collected as taxes. Thus paper money was backed by taxes receivable. In modern times, paper money is backed by the government’s bonds, which are in turn backed by taxes receivable. We’ve just added a step to the backing process, that’s all.
Mike Sproul,
” In colonial times, paper money was issued with the explicit promise that it would be retired when collected as taxes. ”
Tax collected in…? Gold or more paper of similar nature? That should tell you that paper came up solely by piggy-backing on the prior acceptability of Gold as money.
” In modern times, paper money is backed by the government’s bonds, which are in turn backed by taxes receivable. We’ve just added a step to the backing process, that’s all. ”
No. You (Please don’t say “we”. That makes me feel like I am party to a brazen act of embezzlement) have shifted the final transfer that constitutes “retirement” from payment of Gold/Silver to issue of fresh paper. You have transformed a legitimate process into a Ponzi Scheme.
“In a US government bond, it is a debt on top of existing debt where the US government exchanges with the Federal Reserve a US government bond in exchange for fiat currency in the denomination value of the bond.”
http://en.wikipedia.org/wiki/Government_bond
(the above wiki claims the information is not sourced or cited…seems odd for a rather commonly discussed subject)
“The fact that dollars are redeemable for things that are themselves denominated in dollars disguises the fact that dollars are backed by real assets. If a bank issued $100, backed by 100 oz., then the backing is obvious. If 90 oz were then sold for bonds worth $90, the value of the backing would still be the same, but the fact that the bank now has dollars backing other dollars makes it look like the dollar has no actual backing. But the simple act of selling the $90 of bonds for real assets worth 90 oz. would make it clear that real backing was there all along.”
sproul seems to go between oz assets and $…i still dont know what he means by $.
if the above linked wiki info is true, can somone in something other than sproul-ish if it is at odds with what the sproul says?
i assume the bond is ‘a promise to take taxes’ for a specific govt item (a navy shipyard for instance)…does the fed just quickly print up the money faster than it takes to get the taxes from the peoplez..to make teh shipyard faster and then the peoplez just pay back the fed…then canceling the paid in dollars?
or is there someting else that would truly make the federal reserve harmfully inflationary…the ill and disease that it has been called at lrc and mises??
Mike,
I agree that taxes are part of what gives the dollar its value (as Bala said: “it’s the gun…”).
You said: “…every paper dollar issued can be retired at par.”
At par to what?
Mike Sproul, you wrote of my ‘governments do have “clubs” like jails, guns, etc. that they use in all this, but do you for one moment suppose that their value if they were sold off to redeem currency is anything like as much as the backing effect they produce by enforcing taxes?’ “The jails, guns, etc, might be salable for a few dollars. The government’s ability to use them to extract taxes is worth a few billion dollars. When I speak of the government’s assets I mean the billions, not the smaller number.”
Of course you do mean that – but those are organised as resources, not bundled up as assets. They could be reorganised that way (but see below), but as things stand they are not assets.
If the government’s resource base were reorganised that way, say by switching land tax for a system of seize-and-lease-back under which taxes on land it did not own became rents on land it did own (after seizing it), it just moves the wrinkle in the carpet around. Certainly, after that, land taxes “backed” by forcible resources would become returns on land as an asset – only, just as with a one off issue of new currency that balances out afterwards, there is a problem at the transition that has continuing effects. The seizing needs a book entry (say, against bad will, or bad credits the government doesn’t intend to pay), and doing it on paper and in the real world is an exercise of that resource base. Ultimately, reorganising a non-asset revenue base into an asset revenue base involves using a non-asset resource base, and the book entries reflect that it happens! This even happens when the trick is done more subtly, not seizing land but buying it with… new issues of money. That is, that creates accurate book entries when, and only when, the government’s role as landlord is value adding as compared with not buying land with new funds like that – and in a short enough term to increase the supply of purchaseable “stuff” around enough to mop up the new money bidding for goods along with existing money. Usually, less than fair price is paid and less than good use of the land is made, and in any case the assets are long term, so you get the leakage problems of genuine Real Bills Theory that I outlined before.
Of my “Kiting cheques … is when an issue is made on collateral that is itself an issue made on collateral that is itself… and so on”, you wrote ‘Suppose my only asset is a house worth $100,000. If you were to try to describe a process akin to your “collateral on collateral” story, you should be able to come up with a way for me, or a group of co-conspirators, to borrow $500,000 or so against nothing more than that house. If you can tell me where the bankers are who will go along with your process, I’ll send them more customers than they can handle.’
But, since the two are not the same thing (see earlier replies), but rather the kiting cheques style thing is different from the double borrowing thing, it’s mere digression and deviation to ask for an example of double borrowing on a house as an illustration of kiting cheques – a ploy you have tried unsuccessfully before.
You then wrote “Your historical example is either a case of the cultivator being robbed by a legal tender law, or a token currency that is worth more than its intrinsic value–hardly an exceptional occurrence. Codswallop indeed.”
Of course it is “either a case of the cultivator being robbed by a legal tender law, or a token currency that is worth more than its intrinsic value”. That was the whole point – to illustrate with a historical case that that is just precisely what happens when unbacked issues are made. Far from being codswallop, the very fact that it is no exceptional occurrence shows it is a real and present defect of that approach, arising from the continuing and enduring effects (from other people’s loss of capital) of even a one off wealth transfer (towards the money issuer).
And then you wrote “If the backing was inadequate to the new issue of money then of course there would be inflation. But Mints claimed (and I suppose you would agree) that the new money would cause inflation even if it were adequately backed.”
Neither he nor I would claim the latter – if it were adequately backed; rather, the process you describe – as you already admitted, in the parts I quoted in earlier replies – would produce inflation, which is ample demonstration that it does not provide adequate backing. For you to argue as you do is to beg the question, to assume the very thing you are asserting, about the backing of your process being adequate.
Later, you wrote “The fact that dollars are redeemable for things that are themselves denominated in dollars disguises the fact that dollars are backed by real assets. If a bank issued $100, backed by 100 oz., then the backing is obvious. If 90 oz were then sold for bonds worth $90, the value of the backing would still be the same, but the fact that the bank now has dollars backing other dollars makes it look like the dollar has no actual backing. But the simple act of selling the $90 of bonds for real assets worth 90 oz. would make it clear that real backing was there all along.”
Take that apart slowly and carefully and you will see which cup the pea is under – and which it isn’t:-
- “If a bank issued $100, backed by 100 oz., then the backing is obvious”. Yes – if.
- “If 90 oz were then sold for bonds worth $90, the value of the backing would still be the same…”. Yes – if. Here, if they really are worth that, based on there really being backing that does that.
- “…but the fact that the bank now has dollars backing other dollars makes it look like the dollar has no actual backing”. Hold it, where did that “dollars backing other dollars” come from? We were talking about dollars backed by bonds backed by something adequate. We (you) shouldn’t beg the question of what is or is not adequate. The actual fact is, the bank now has dollars backed by bonds denominated in dollars (spread out over time, too), not backed by dollars. Ultimately, this would work – but if and only if the chain closed properly, with some productive enterprise at the far end of the chain turning out real stuff to mop up the dollars issued at the near end (see the reminder about genuine Real Bills Theory and leakage issues earlier – and remember, the only way the leakage doesn’t happen is if the government carries out enterprises better than those who would otherwise have had the capital it siphoned off).
- “But the simple act of selling the $90 of bonds for real assets worth 90 oz. would make it clear that real backing was there all along”. No; that is looking for the pea under the wrong cup. It was the bond issuer doing the selling, not the bank, and the mere fact that he got 90 ounces for the bonds doesn’t mean that there was real backing all along (it might have been far less, and the bank might not have got fair value – unless it plans on the value of money falling to keep what it gets back the same in dollar numbers as the bonds describe, thus almost literally passing the buck). Rather, right after the sale the bond issuer has backing (the 90 ounces), but that’s merely instantaneously. There’s no way of knowing, just from the description of the bonds, that there’s matching “stuff” behind it as at any of its due dates.
Later on still, you wrote “When the $90 bond matures, the bank will take it to the government agency that issued it. If the bank owes $90 in taxes, then the bond and the taxes due are both canceled. The bonds is [sic] not just paid off with more dollars… There will always be a float of paper dollars that have not yet been redeemed, but as long as the government has adequate assets (like taxes receivable), every paper dollar issued can be retired at par… In colonial times… paper money was backed by taxes receivable. In modern times, paper money is backed by the government’s bonds, which are in turn backed by taxes receivable. We’ve just added a step to the backing process, that’s all.”
No, you have not simply added a step, you have added a new link on the end of a chain that used to be broken at the end, so now it is broken in the middle where it is less clear. Those “taxes receivable” are only ever assets after… drum roll… a fiat process creating them ab nihilo. The actual backing – I’m not denying that it works, just that it is no result of free exchange but of fraud and/or force, stealing – is the enforcement resource base, not any free standing assets with an existence of their own; it’s that enforcement that puts them on the governments books as taxes receivable or however they like to call it.
Bluntly, the other posters have got you and the gaps in your theories sussed.
RBD
At the heart of RBD is the assertion that if credit expansion is backed by adequate collateral for the new loans, then the money, or money substitutes, thus created have real value, and therefore will not cause inflation or lead to the business cycle as described in ABCT. The money, or money substitutes, have value because the collateral used to guarantee the loans has value.
Some of the less sophisticated proponents of RBD assert that when the new money, or money substitutes, are created then an equivalent value assett is also created, namely the loan itself, which can be traded at the push of a button. That loans are traded this way is irrelevant however; the critical point is, was a new assett actually created? When a loan is made, say on a home, the homeowner gives up part of their claim to the property in exchange for present money, the loan represents the claim they surrendered to the bank. Instead of a new assett coming into being, what has actually happened is that an existing assett has been divided between two entities. To argue otherwise would amount to asserting the right of homeowners to take out a loan on their home and still be able to use the equity thus encumbered as they please. They could sell it and pocket the money, they could take out as many loans as they wanted against that same equity, there would be no limit to their claim to the collateral. That is clearly not the case.
RBD proponents are offended when it is claimed that the credit expansion that occurs under their system results in “money being created out of thin air”. People who make this claim point to the fact that after the credit expansion occurs the only new assets (please see previous paragraph) are the new money or money substitutes. RBD hinges on the claim that the value of the collateral creates the value of the money, or money substitutes, that come into existence with the credit expansion.
Their are two basic divisions in the discussion of value, there is the objective theory of value and the subjective theory of value. The objective theory of value asserts that objects have intrinsic value apart from the opinions of humans and that it should be possible to measure objectively this ‘value’. There are many different schools of objective value theory, even though not one of them has ever successfully been able to measure ‘value’. The subjective theory of value, the one at the core of Austrian economics, holds that value is determined differently by every individual and that no object has an intrinsic ‘value’ apart from the opinions of individuals.
RBD proponents must explain their assertion that the value of the money, or money substitutes, created under their system derives from the value of the collateral behind the loans, using one of these two basic philosophies of ‘value’. If they choose the objective theory of value they should be able to define the value of the collateral without reference to money, after all, the value of the money comes from the collateral, it is a derivative of the value of the collateral. They should also be able to explain what constant unit of measure is appropriate to ‘value’.
More often RBD proponents follow somewhat of a subjective theory of value, but there is a serious problem with this approach. They use the term ‘value’ extensively, but, when pressed, they admit that what they really mean is the money price of the collateral behind the credit expansion that creates the new money, or money substitutes. So the ‘value’ that establishes the ‘value’ of the money, or money substitutes, is in fact the money price of the collateral. But the money price of the collateral would depend entirely on the ‘value’ of the money, and the ‘value’ (or money price) of the collateral is what establishes the ‘value’ of the money. It is an endless circular argument.
What one is left with is the Austrian explanation of prices and their function in the free market. The ‘value’ of money, or money substitutes, adjust, along with every other item in the market, in order to clear the market. Clearly the abundance of any item in this world will be reflected in its ‘value’, including money.
“At par” means at the same value for which it was issued, or in other words for stuff worth 1 oz. of silver.
Think of it this way: A landowner collects rent of 50 oz./year. If the market interest rate is 5%, that makes his land worth 1000 oz. (=50/.05). He can buy groceries by writing “IOU 1 oz”, and declaring that he will accept his own IOU’s (‘dollars’) for rent. In theory he could issue up to $1000 in paper IOU’s ( though in practice the limit of peoples’ trust would be more like $400). But if he wrote 1000 IOU’s his T-account would show assets of 1000 oz rents receivable (or equivalently, land worth 1000 oz.) and liabilities of 1000 oz. (or $1000).
Replace “landowner” with “government” and “rents receivable” with “taxes receivable”, and you have a reasonable description of how modern paper dollars are issued. You might also see how people could mistakenly believe that the landowner’s dollars are unbacked, since they might never be redeemed for actual silver.
The landowner could then buy another 2000 oz. worth of land by writing a bond worth 2000 oz. His new rents would pay the interest on the bond.
Finally, he could designate a room in his house as his central bank. From that room, he could issue another $300 and use them to buy back 300 oz. of his own bonds. He could either keep a separate set of books where his central bank’s asset is the 300 oz bond and its liability is $300 (equivalent to 300 oz) , or he could cancel his own 300 oz bond, just replacing the bond with $300.
Every dollar he issued is ultimately backed by land, (which is to say, by rents) and as long as each new dollar is issued in exchange for equal-valued assets, there is no price inflation. I suppose you could say it’s the gun that lets him keep the land, but how he got the land is beside the point.
“We were talking about dollars backed by bonds backed by something adequate. We (you) shouldn’t beg the question of what is or is not adequate. The actual fact is, the bank now has dollars backed by bonds denominated in dollars (spread out over time, too), not backed by dollars. Ultimately, this would work – but if and only if….”
ill ask the question…what is not adequate?
…dollars backed by bonds denominated in dollars backed by…..raw materials/capital goods/labor ready to be put to some govt use by people who were voted into office?
“The actual backing – I’m not denying that it works, just that it is no result of free exchange but of fraud and/or force….”
well…a few people did vote.
but has the process not worked?
i dont know if because many didnt go jump off of cliffs if it works or not.
” when prices are adjusted for inflation, Americans today spend ’40% less on clothes, 20% less on food, more than 50% less on appliances, about 25% less on owning and maintaining a car’than they did during the early 1970s.” if true?
http://blog.mises.org/archives/010741.asp
if the above price info above is true it sounds as if the process (if that what really happens) works.
does the process not work as well data-wise as another process, ie gold/silver, 100% reserves?
what is advocated for in the texts at mises.org?
In theory he could
in song there are purple people eaters
does the current fed/frb system work in a way similar to what is called rbd?
is the inflation harmful?
Mike,
thanks for the discussion.
You make no sense anymore.
“They use the term ‘value’ extensively, but, when pressed, they admit that what they really mean is the money price of the collateral behind the credit expansion that creates the new money, or money substitutes. So the ‘value’ that establishes the ‘value’ of the money, or money substitutes, is in fact the money price of the collateral. But the money price of the collateral would depend entirely on the ‘value’ of the money, and the ‘value’ (or money price) of the collateral is what establishes the ‘value’ of the money.”
i had asked this before i thought.
if a farmer purchased some farmland with 10oz of silver and he farms awhile and then prints up 10 paper money-subs of each ‘worth’ 1oz of silver
are they (in theory) now backed by his farm which originally cost 10oz of silver?
is that what the sproul and others are claiming with the mentioned backing theory?
print – call a previous purchased asset the backing-spend – repeat???
is this similar to what takes place now?
Mike Sproul,
” A landowner collects rent of 50 oz./year…….he will accept his own IOU’s (‘dollars’) for rent. ”
Ahhh!!! You are getting there finally.
The difference between this and government issuing paper money is not the type of asset (land vs tax receipts) but the fact that the VALUE…. that means the land owned by the land owner ….. existed prior to the issue of the paper. The value gained by the utilisation of the land was valued by the person accepting the IOUs as sufficient compensation for the goods he was supplying to the land owner.
So, here is the exchange described.
Land-owner gets to consume the gorceries – Supplier of groceries gets to use the land
In simple terms, this would be called BARTER, get it? It is a product being exchanged for a service, the only special feature being that service is to be delivered over a period of time while the product is to be delivered right up front.
When government similarly issues paper, could you please tell me what the supplier of groceries gets? I am unable to see anything other than the business end of the gun and the threat to pull the trigger if he refuses to accept the IOU.
” Replace “landowner” with “government” and “rents receivable” with “taxes receivable”, ”
Only a completely confused person would make this replacement without squirming in his seat. Rents are voluntary and are paid for a genuine service provided while taxes are extracted at gun point for no service other than not pulling the trigger. They are NOT equivalent, get it?
In any case, if all ‘money’ is likewise issued on the promise of redemption through tax receipts which are themselves the same ‘money’, how is the paper not backing itself? How is this not circular?
” Every dollar he issued is ultimately backed by land ”
It is not backed by land but by the faith in the honesty and integrity of the land-owner. In fact, it is backed by nothing because it is part of a barter arrangement. The faith in the honesty and integrity of the land-owner are required for the supplier of groceries to trust that he will indeed provide the service as promised.
” I suppose you could say it’s the gun that lets him keep the land, but how he got the land is beside the point. ”
Like all things that really matter, this too is besides the point…..
scott t,
” print – call a previous purchased asset the backing-spend – repeat???
is this similar to what takes place now? ”
Spot on!!
Mike Sproul, you wrote ‘Think of it this way: A landowner collects rent of 50 oz./year. If the market interest rate is 5%, that makes his land worth 1000 oz. (=50/.05). He can buy groceries by writing “IOU 1 oz”, and declaring that he will accept his own IOU’s (‘dollars’) for rent. In theory he could issue up to $1000 in paper IOU’s ( though in practice the limit of peoples’ trust would be more like $400). But if he wrote 1000 IOU’s his T-account would show assets of 1000 oz rents receivable (or equivalently, land worth 1000 oz.) and liabilities of 1000 oz. (or $1000).’
This is leaving out the time value. He would be getting a gain from issuing dollar tokens in the present that people would be paying back to him later. Even if he retired them then, until then he would have had the use of the capital gained by his issuing dollar tokens. E.g., as when you wrote “The landowner could then buy another 2000 oz. worth of land by writing a bond worth 2000 oz. His new rents would pay the interest on the bond” – that is what would happen, what would be going on underneath.
Then you wrote “Every dollar he issued is ultimately backed by land, (which is to say, by rents) and as long as each new dollar is issued in exchange for equal-valued assets, there is no price inflation. I suppose you could say it’s the gun that lets him keep the land, but how he got the land is beside the point”.
Beep, no. We already covered this, and you admitted there was a one off inflation. That happens and persists while there is an overhang of new money along with the old money (unless the genuine Real Bills Theory criteria of making new stuff in step to match new money apply – and, with land, the time scale issues mean they definitely don’t). If the new issues aren’t retired, the overhang of that persists, there is a continuing existence of the original capital transfer to the issuer, and price levels stay at the one off raised level while the issuer gets a return on the capital gain indefinitely; that is, unless and until he uses it up. Even if he retires the overhang he gets to keep the product of the capital while he had it, and if he repeats the trick to get yet more capital it isn’t even a one off wealth transfer.
Over and above that, how he got the land is not beside the point, because if he got it by force or fraud the overall accounting effect over time is the same as if he levied a land tax throughout. It’s just that the accounting funny business would be moved to the point where the land acquisition was recognised in the accounts, so if you didn’t look at it over time but only looked at later periods, none of the funny business would show up in the accounts for those periods.
But you have been told all this already.
Scott T, you asked of my “We were talking about dollars backed by bonds backed by something adequate. We (you) shouldn’t beg the question of what is or is not adequate. The actual fact is, the bank now has dollars backed by bonds denominated in dollars (spread out over time, too), not backed by dollars. Ultimately, this would work – but if and only if….”, “ill [sic] ask the question…what is not adequate? …dollars backed by bonds denominated in dollars backed by…..raw materials/capital goods/labor ready to be put to some govt use by people who were voted into office?”
No, look again. I’m pointing out that Mike Sproul isn’t using a false pattern of reasoning just there, he himself is dodging past the issue of spelling out what makes adequate backing. He’s been trying to trick me into denying this part, probably so he can go “Aha! But there’s no flaw here!”. There isn’t a flaw there, he’s just misdirecting away from where the flaws really are. Certainly making new money on a kiting cheques basis isn’t adequate, and certainly using tax revenues as backing supports money – but at lower (i.e. inadequate) levels unless taxes are raised to match, which simply makes the taking from other people clearer.
Then you wrote of my “The actual backing – I’m not denying that it works, just that it is no result of free exchange but of fraud and/or force….”, “well…a few people did vote. but has the process not worked? i dont know if because many didnt go jump off of cliffs if it works or not.”
It works in the same sense as bag men collecting money for gangsters works. They really do get something out of it – i.e., it works.
@Bala:
> Rents are voluntary and are paid for a genuine
> service provided while taxes are extracted at gun
> point for no service other than not pulling the trigger.
Of course, from ethical point of view, there is a difference. But from the point of view of utility / risk analysis / price volatility, i.e. financial point of view, there is no difference.
From consumer perspective, all government-supplied services have some value, even though they are paid for by coercion and under certain circumstances competition is prohibited. Sure, the value is typically crap and couldn’t stand to competition. But the value itself isn’t “fraud”.
In my humble opinion, it is pointless to muse about the “real value” of the money, fiat or commodity-backed. Value is subjective. It might be true that fiat money encourages inflation more than commodity-backed money, and the market price of the latter is less volatile. But “real value” versus fraud? I don’t think so.
Peter Surda,
” In my humble opinion, it is pointless to muse about the “real value” of the money, fiat or commodity-backed. Value is subjective. ”
I beg to differ. It is not pointless. Mike Sproul’s claim is that the ‘money’ gets its value from the assets that back it. I am just showing that claim is nonsensical and that the only ‘value’ comes from the business end of the gun wielded by government. Once that is done, all his other arguments have no meaning at all. They would all be plain verbal and mathematicsl gymnastics.
Bala,
I think we misunderstand each other. I agree that “the gun” is influencing the value. But the problem is the aspect of force rather than backing by revenue instead of assets. Still, this is an ethical, rather than financial, issue. From financial point there is no qualitative difference.
Peter Surda,
” I think we misunderstand each other. ”
Rather, I think our objectives are different. I am just trying to show that Mike Sproul is talking rot because he is not talking of money while all the while claiming to talk of money. My objective is to try and stop the flow of nonsense as quickly as possible.
1) As to the “point of the gun” argument: Peter Surda has given a completely satisfactory answer. Whether the landowner is a good guy or bad guy, whether he got the land by theft, purchase, inheritance, or as a gift from God, the land is his asset, and if it is worth 1000 oz of silver, he can issue up to $1000 against it. The same is true if ‘landowner’ becomes ‘government’.
2) Resources vs. assets: The land is a resource, and it is an asset. If no money has been issued against it, then the landowner’s assets are 1000 oz, and the liability side of his balance sheet would show a net worth of 1000 oz. If he issues $400, his liabilities rise by 400 oz (=$400) and his net worth falls by 400 oz. His wealth is not affected, and neither is anyone else’s.
3) If the monetary use of silver had caused silver to sell at a premium, and if the $400 displaces 400 oz. from circulation, then the 400 oz. will be melted. That is, it will reflux to bullion. This will cause the value of silver to fall, and the backing theory will be wrong over this range. (As a historical matter, this would have happened so slowly as to be virtually undetectable.) Once silver is no longer used as money, further issues of dollars will not affect the value of silver. Neither will it change the fact that $1 buys 1 oz.
4) As new dollars are issued by the landowner or anyone else, the issuer will normally get assets worth 1 oz. in exchange, and each dollar will still be worth 1 oz. If the issuer gets assets worth less than 1 oz, the issuer’s money will lose value. If the issuer gets assets worth more than 1 oz then either the issuer gets a profit, or his dollars rise in value (assuming they had previously fallen below 1 oz.).
5) The value of dollars is not preserved by the fact that new goods are eventually produced. The value is preserved by the fact that existing assets are pledged as backing for the dollars.
6) Counterfeiters create money out of thin air. They cause price inflation. Banks do neither.
7) There is normally no “gain from issuing dollar tokens in the present that people would be paying back to him later.” This is easiest to see if the tokens (dollars) are costless to issue. Competition from issuers of rival dollars will force the issuer to pay interest on his dollars, so that he earns zero economic profit. If the dollars are costly to issue, then the interest paid by the issuer will be reduced by an amount equal to the cost of issue.
one more time
RBD
At the heart of RBD is the assertion that if credit expansion is backed by adequate collateral for the new loans, then the money, or money substitutes, thus created have real value, and therefore will not cause inflation or lead to the business cycle as described in ABCT. The money, or money substitutes, have value because the collateral used to guarantee the loans has value.
Some of the less sophisticated proponents of RBD assert that when the new money, or money substitutes, are created then an equivalent value assett is also created, namely the loan itself, which can be traded at the push of a button. That loans are traded this way is irrelevant however; the critical point is, was a new assett actually created? When a loan is made, say on a home, the homeowner gives up part of their claim to the property in exchange for present money, the loan represents the claim they surrendered to the bank. Instead of a new assett coming into being, what has actually happened is that an existing assett has been divided between two entities. To argue otherwise would amount to asserting the right of homeowners to take out a loan on their home and still be able to use the equity thus encumbered as they please. They could sell it and pocket the money, they could take out as many loans as they wanted against that same equity, there would be no limit to their claim to the collateral. That is clearly not the case.
RBD proponents are offended when it is claimed that the credit expansion that occurs under their system results in “money being created out of thin air”. People who make this claim point to the fact that after the credit expansion occurs the only new assets (please see previous paragraph) are the new money or money substitutes. RBD hinges on the claim that the value of the collateral creates the value of the money, or money substitutes, that come into existence with the credit expansion.
Their are two basic divisions in the discussion of value, there is the objective theory of value and the subjective theory of value. The objective theory of value asserts that objects have intrinsic value apart from the opinions of humans and that it should be possible to measure objectively this ‘value’. There are many different schools of objective value theory, even though not one of them has ever successfully been able to measure ‘value’. The subjective theory of value, the one at the core of Austrian economics, holds that value is determined differently by every individual and that no object has an intrinsic ‘value’ apart from the opinions of individuals.
RBD proponents must explain their assertion that the value of the money, or money substitutes, created under their system derives from the value of the collateral behind the loans, using one of these two basic philosophies of ‘value’. If they choose the objective theory of value they should be able to define the value of the collateral without reference to money, after all, the value of the money comes from the collateral, it is a derivative of the value of the collateral. They should also be able to explain what constant unit of measure is appropriate to ‘value’.
More often RBD proponents follow somewhat of a subjective theory of value, but there is a serious problem with this approach. They use the term ‘value’ extensively, but, when pressed, they admit that what they really mean is the money price of the collateral behind the credit expansion that creates the new money, or money substitutes. So the ‘value’ that establishes the ‘value’ of the money, or money substitutes, is in fact the money price of the collateral. But the money price of the collateral would depend entirely on the ‘value’ of the money, and the ‘value’ (or money price) of the collateral is what establishes the ‘value’ of the money. It is an endless circular argument.
What one is left with is the Austrian explanation of prices and their function in the free market. The ‘value’ of money, or money substitutes, adjust, along with every other item in the market, in order to clear the market. Clearly the abundance of any item in this world will be reflected in its ‘value’, including money.
Mike Sproul,
” and if it is worth 1000 oz of silver, he can issue up to $1000 against it. ”
This statement is plain dumb. Absent force, people need to be convinced of the issuer’s integrity for them to accept the notes at face value. In the absence of established integrity, the notes would either not get accepted at all or would not get accepted as the equivalent of $1000. They would trade at a discount.
Looks like you want to discount all the “human” aspects (like choice) involved in the determination of value and deal only with the mathematical ones. That’s why I insist that you are speaking nonsense.
You remind me of the Smith.
” and if it is worth 1000 oz of silver, he can issue up to $1000 against it. ” a $ being what exactly?
This statement is plain dumb.”
i believe in previous posts the sproul has said “if….”
and also “if a contract….” which are clearly market imperatives.
would money ignorance, foster what the sproul describes as a rbd-ish system, lead to large scale calculation errors more so than a market paradigm of gold/silver/commodity money – 100 percent backed with true-credit issuance and collateral backing many loans???
i dont know.
i am still trying to figure out what exactly takes place with the fed/frb/dollar system that occurs now…and if it is an ‘in spite of’ scenario where with what laissez-faire exists does it make up for govts money manipulation.
Great points as always, T Ralph.
This should be checked out:
http://www.fee.org/pdf/books/Free_Market_and_Its_Enemies_The.pdf
RBD proponents (and other confused parties):Â please read Lecture 8, esp. p. 65-66.
Beefcake
Thanks and happy new year! I will check it out.
Beefcake the Mighty,
I have only read 1 page of Lecture 8, but I already know that that is precisely the reference that supports what I am trying to drive home to the Smith. Thanks a ton. I’ll download the lecture series right now.
Mike Sproul,
This is the first line in your first comment on this thread.
” The article combines a great idea (free banking) with a bad idea (the quantity theory of money). ”
And you apply the Quantity Theory of …….. Money to that which is not Money, find that the Quantity Theory does not seem to explain what you want it to but which it cannot explain for the obvious reason cited above and then conclude that the Quantity Theory is a bad idea. The wonders of your “logic” seem to know no bounds.
Bala, glad you like it.
As a side note, some Austrian free-bankers (who share some beliefs with RBD, despite denials) have appealed to some statements made in Lecture 6 to support their claims that Mises, even in his later thought, was a monetary equilibrium theorist. They conveniently remain silent on Lecture 8 (where BTW he repeats statements made even in his earlier writings eg Theory of Money and Credit),
Beefcake
Thanks for the link, it is a great read. I am putting it on my kids reading list. There are far too many people reading just a bit of Mises or Rothbard and then spouting off with their half-baked ideas. Sound bites don’t illuminate anything in economics, and partial understanding of austrian theory often does more harm than complete ignorance.
T Ralph, totally agreed. Too much stuff gets hashed out here that has already been resolved in standard works.
Beefcake
Re-inventing the wheel over and over gets pretty tiresome. Sometimes it feels like this site is more of a venue for hacks and crackpots then a representation of austro-libertarian thought. I can’t help feeling that there are a lot of knowledgable individuals on this site who just sit back and watch while some nut job runs roughshod over a well meaning novice student of austrian theory without bothering to help out. We only hear from that group when we get too extreme with our fucking language.
Looks like Mike Sproul left. Since he was kind of alone, I’ll try to supplement. I have not followed the argumentation thoroughly, so will try to present my ideas instead of Mike’s.
I agree that fractional reserve banking, fiat money and legal tender laws increase inflation, and consider ABCT (mismatch between market interest rate and central bank interest rate leading to malinvestment, bubbles and busts) to be true. However, I still claim that the difference between asset-backed and revenue-backed IOUs is financially less significant than the Austrians typically present, and no IOUs have objective value. The core of the problem is legal tender laws rather than type of backing. Company shares are similar to fiat money in this respect (revenue-backed IOUs). Yes, their market value is more volatile. Yes, the market value of goods that have universally desired uses and not much supply fluctuations (e.g. gold) is more steady. But still, their only “value” is what the interplay of demand and supply indicates (i.e. market price). Although there is of course a connection between the features of the backing and their market price, they don’t have any intrinsic “value”. Even asset-backing is no guarantee for any “value”. The assets can be damaged or stolen. Or more abundant substitutes can be discovered. To talk about the “real” money value as being derived from backing is in my opinion kind of silly. To me it kind of looks like the labour theory of value.
Peter
The labor theory of value is an ‘objective theory of value’ and is completely discredited. The austrian subjective theory of value says that there is no way to establish the value of anything, there are only prices, and these should never be confused as being a measure of value. You confuse what is meant by ‘backing’, backing should only be used to refer to the money that is promised in exchange for a money substitute, whether that be a commodity money or not. (some foreign currencies are backed by US dollars for instance) The correct use of backing does not guarantee ‘value’, it is a guarantee to redeem money substitutes for a defined amount of money, and nothing else. There is no promise that the money provided will have any value, that is entirely a function of the free market.
The Real Bills Doctrine is based on a false premise, and is just a dressed up version of fractional reserve banking. I will repeat a previous post about this here:
RBD
At the heart of RBD is the assertion that if credit expansion is backed by adequate collateral for the new loans, then the money, or money substitutes, thus created have real value, and therefore will not cause inflation or lead to the business cycle as described in ABCT. The money, or money substitutes, have value because the collateral used to guarantee the loans has value.
Some of the less sophisticated proponents of RBD assert that when the new money, or money substitutes, are created then an equivalent value assett is also created, namely the loan itself, which can be traded at the push of a button. That loans are traded this way is irrelevant however; the critical point is, was a new assett actually created? When a loan is made, say on a home, the homeowner gives up part of their claim to the property in exchange for present money, the loan represents the claim they surrendered to the bank. Instead of a new assett coming into being, what has actually happened is that an existing assett has been divided between two entities. To argue otherwise would amount to asserting the right of homeowners to take out a loan on their home and still be able to use the equity thus encumbered as they please. They could sell it and pocket the money, they could take out as many loans as they wanted against that same equity, there would be no limit to their claim to the collateral. That is clearly not the case.
RBD proponents are offended when it is claimed that the credit expansion that occurs under their system results in “money being created out of thin air”. People who make this claim point to the fact that after the credit expansion occurs the only new assets (please see previous paragraph) are the new money or money substitutes. RBD hinges on the claim that the value of the collateral creates the value of the money, or money substitutes, that come into existence with the credit expansion.
Their are two basic divisions in the discussion of value, there is the objective theory of value and the subjective theory of value. The objective theory of value asserts that objects have intrinsic value apart from the opinions of humans and that it should be possible to measure objectively this ‘value’. There are many different schools of objective value theory, even though not one of them has ever successfully been able to measure ‘value’. The subjective theory of value, the one at the core of Austrian economics, holds that value is determined differently by every individual and that no object has an intrinsic ‘value’ apart from the opinions of individuals.
RBD proponents must explain their assertion that the value of the money, or money substitutes, created under their system derives from the value of the collateral behind the loans, using one of these two basic philosophies of ‘value’. If they choose the objective theory of value they should be able to define the value of the collateral without reference to money, after all, the value of the money comes from the collateral, it is a derivative of the value of the collateral. They should also be able to explain what constant unit of measure is appropriate to ‘value’.
More often RBD proponents follow somewhat of a subjective theory of value, but there is a serious problem with this approach. They use the term ‘value’ extensively, but, when pressed, they admit that what they really mean is the money price of the collateral behind the credit expansion that creates the new money, or money substitutes. So the ‘value’ that establishes the ‘value’ of the money, or money substitutes, is in fact the money price of the collateral. But the money price of the collateral would depend entirely on the ‘value’ of the money, and the ‘value’ (or money price) of the collateral is what establishes the ‘value’ of the money. It is an endless circular argument.
What one is left with is the Austrian explanation of prices and their function in the free market. The ‘value’ of money, or money substitutes, adjust, along with every other item in the market, in order to clear the market. Clearly the abundance of any item in this world will be reflected in its ‘value’, including money.
Peter Surda:
Consider those landowner IOU’s (dollars) I brought up a few posts back. You could point to the fact that the landowner gets 50 oz/yr in rents, and say that dollars issued by the landowner are revenue-backed. Or you could point to the fact that the land is worth 1000 oz and say they are asset-backed. The value of the IOU’s, and the landowner’s ability to issue them and maintain their value at 1 oz/$ is the same in either case.
It’s important to recognize that these IOU’s are not fiat money. They are backed by the landowner’s assets. Quantity theorists (including Austrians) claim that fiat money can have value in spite of having NO backing at all. They claim that it is only necessary to limit the supply of pieces of paper, and that limited supply, coupled with peoples’ demand for a medium of exchange, will give them value. The flaw in this argument is that the issuer gets a free lunch, which attracts rival issuers. This reduces the demand for the original fiat money, with no stable solution short of zero value. That’s a simple reason why fiat money is no more real than phlogiston, ether, and caloric.
The backing theory says things like “$1 is worth 1 oz of silver.” It makes no claims about what silver is worth, so the theory of value does not really describe what is going on. The value of the dollar is determined by much simpler factors, namely the public’s estimate of the probability that their dollar really is redeemable by the issuer for 1 oz of silver, or other goods worth 1 oz.
The thing that confuses people is the concept of redeemability. Those landowner dollars were redeemable in rent payment, and it’s possible that no dollar would ever be redeemed for an actual oz. of silver. This gives the dollar the false appearance of being unbacked, when in fact it is simply not directly redeemable for silver, just as the modern US dollar is not directly redeemable for gold.
If, in a silver system, I go to the bank to redeem its promissory notes, it is because I want silver, not ” something that is worth 1 oz”, like, for example, a loan contract worth 1 oz of silver, or else.
Moreover, ” most customers”, and probably all of them, ” would care”.
It is the samething nowadays. When I go to my bank to redeem my account-money in cash (fed notes), say $1 000, I want fed notes, not ” something worth”$1 000, like a loan contract worth $1 000 !
Hurrah Gerry! great post!
Mike Sproul,
” The flaw in this argument is that the issuer gets a free lunch, which attracts rival issuers. ”
The flaw in your “argument” is that there cannot be any rival issuers when the issuer (read government) is wielding a gun and is ready to eliminate any rival issuers. So, it is possible (and indeed, it does happen) that there can be a monopoly emitter of unbacked paper. Hence, please stop the flow of nonsense immediately.
Are you aware that in the US, counterfeiting is punishable by death?
Gerry Flaychy:
When a call option specifies that the bearer is entitled to buy 1 share of IBM stock from the writer for $50, it is actually fairly uncommon for that call to be redeemed for IBM stock, since it is easier for the writer to simply buy it back from the bearer for its market price. Similarly, it is often easier for for a bank to redeem its dollars by buying them back with a dollar’s worth of goods or securities, rather than paying out actual green paper dollars.
@T. Ralph Kays:
I agree with you in that RBD (which I’m not familiar with so I’m taking your definition) is incorrect. I am not a RBD proponent.
Thanks for clarifying that the backing issue is not about value. That however only eliminates part of my objection. However, even if you have asset-backed IOUs, there is still no 100% guarantee you’ll be able to redeem them, if the assets are damaged or stolen. It is also not a problem that revenue-backing means a less specific identity of the collateral. This is a quantitative, not a qualitative issue. Even with gold-backed notes, you can’t redeem them for specific gold, just “a” gold.
@Mike Sproul:
> Quantity theorists (including Austrians) claim
> that fiat money can have value in spite of having
> NO backing at all.
I am not sure your interpretation of the Austrian money theory is correct, it only explains part of the theory (as I understand it).
> They claim that it is only
> necessary to limit the supply of pieces of paper,
> and that limited supply, coupled with peoples’
> demand for a medium of exchange, will give
> them value.
Again, I think this is only a partial interpretation.
> The flaw in this argument is that the issuer gets
> a free lunch, which attracts rival issuers.
Bala already answered: this doesn’t happen because of legal tender laws. Absent these, truly fiat money (neither asset- nor revenue-backed) would indeed have zero market value.
Peter
Your responses to Mike Sproul are correct, he seriously misrepresents austrian theory.
I don’t think you and I really have much of a disagreement at this point, just some different definitions possibly. Mike Sproul trots out various financial instruments and claims that they are money, when they clearly aren’t. IOUs are not money, they are loan documents. That a market arises where they can be traded easily is no different than any other specialized market for trading specific types of goods. Collateral is not what you seem to be claiming it is. Collateral provides security for a loan, nothing more, it is not in any sense backing.
When you say: “It is also not a problem that revenue-backing means a less specific identity of the collateral.” I really don’t understand what you mean, and I am pretty sure that is not my point.
Backing a currency means nothing more than promising to exchange it for a specific amount of something else. When credit expansion results in the creation of money, or money substitutes, the collateral behind the loans is not backing, it is only security for the loan. The banks do not own the collateral and cannot give it to the holders of the money, or money substitutes, at will. This is where Mike Sproul gets tricky though, he says it doesn’t matter because the collateral will make the loan an attractive asset that can be used to raise the money necessary to honor the claim. As far as that goes and within limits it is true. It is his claim that this is not fractional reserve banking with all its flaws, and specifically his claim that this type of credit expansion does not affect the value of the money, or in other words cause inflation, nor lead to the business cycle that is wrong.
He claims that having more money chasing the same amount of goods will have no affect on the value of the money, in other words, prices won’t change; AS LONG AS the extra money was created by someone who already has enough assets. He is saying that the supply of money relative to the goods available will have no relationship to prices if the money is issued by someone who has enough assets.
Nowadays, what individual commercial banks are issuing is account-money, not bank notes, or dollars, or green paper dollars, still less fed notes. Even the central bank issued account-money.
Thus a commercial bank cannot buy back its dollars for the simple reason that they don’t have dollars !
Concerning the account-money, it is redeemed in base money ” i.e.” fed notes, and also coins, when the depositors ask for it ” i.e.” when they redeem their account-money.
Banks don’t rather give back goods or securities to those depositors !
So what are you talking about in the above quotation ?
Gerry Flaychy,
” So what are you talking about in the above quotation ? ”
You still think he knows what he is talking of? You should click on the links he has provided. You will really split your sides laughing at the kind of rubbish he has put up. What’s even funnier is that he really believes in it.
Peter Surda:
“I am not sure your interpretation of the Austrian money theory is correct, it only explains part of the theory (as I understand it).”
Mises did say that credit money has always originated in a suspension of convertibility, so he gave backing that much credit, but he makes it clear that once convertibility is suspended, money gets its value from supply and demand, not backing. For example:
(From Mises, Theory of Money and Credit, part II, ch. 8)
“How could it come about that the government bonds, bearing interest at five percent, could be valued less highly than the non-interest-bearing currency notes? This could not possibly be attributed, say, to the fact that people hoped that the currency notes would be converted into gold before the bonds were redeemed. There was no suggestion of such an expectation. Quite another circumstance decided the matter.
The currency notes were common media of exchange—they were money—and consequently, besides the value that they possessed as claims against the state, they also had a value as money.”
You’ll find the same idea in Hayek, Rothbard, etc.
As for mainstream textbooks, they say without exception that paper dollars get their value solely from supply and demand (e.g., Mankiw, 3/e, p. 353). I don’t know of a textbook that even mentions backing, except occasionally to explode the “myth” that backing can give value to pieces of paper money. This goes back to Ricardo, Thornton, Hume, Locke, and earlier.
As for legal tender laws, I’ll mention three problems:
1) Money crosses borders easily.
2) The Assignats, Continentals, etc, lost all their value, in spite of legal tender laws that were enforced by every means including mass murder.
3) Private issue of checking account dollars, credit card dollars, etc. would reduce the demand for the legal tender dollars, and reduce their value, with no stable solution short of zero value
Gerry Flaychy:
Modern private banks issue checking account dollars. A bank can buy back one of its checking account dollars with a green paper dollar, with a bond, or even by selling some of its furniture for some of its checking account dollars.
” he makes it clear that once convertibility is suspended, money gets its value from supply and demand, not backing.”
is this process different than when 1oz if gold/silver is less expensive to get out of the ground than 1oz in your hand?
Mike Sproul,
” Private issue of checking account dollars, credit card dollars, etc. would reduce the demand for the legal tender dollars, and reduce their value, with no stable solution short of zero value ”
They do! Ha Ha Ha!!! Why do you think $1 today is worth less than 5% of what $1 was worth in 1913? You prove everything we say and then claim to have disproved it. Your argumentation is really interesting. Thanks for the laughs.
This is kind of odd, because I partially agree with Mike Sproul and partially with the Austrians.
Mike’s objection is precisely why I have reservations with some aspects of Austrian theory. On one hand, I don’t see a difference between money and IOUs. I also don’t see a financial difference between asset-backed and revenue-backed IOUs. On the other hand, I agree that if an IOU is only revenue-backed, that creates inflation (ABCT). Does that make any sense?
Regarding legal tender laws:
> Money crosses borders easily.
I am not sure I understand this. Legal tender laws require people to accept the currency as debt settlement (there are other requirements, e.g. using it in accounting but they have smaller effect now in the time of computers). It does not mean that you can’t use other currencies. However, due to a similar effect as in Gresham’s law, they are crowded out of circulation (as debtors prefer it). You can see a similar effect in reverse in countries that have high inflation: foreign currency pushes the local one out of circulation (as creditors refuse to accept it).
> The Assignats, Continentals, etc, lost all their
> value, in spite of legal tender laws that were
> enforced by every means including mass murder.
This does not negate my claim. See previous paragraph. If the negative effects of the inflation rate of the local currency outweigh the threat of retribution, the local currency will stop circulating.
> Private issue of checking account dollars, credit
> card dollars, etc. would reduce the demand for
> the legal tender dollars, and reduce their value,
> with no stable solution short of zero value
I believe this is actually correct. They reduce demand and lead to inflation.
I have never heard of a modern bank buying back one of its checking account money.
I have a checking account and I don’t understand why ‘my’ bank would want to buy back my checking account money.
On the contrary, banks do all they can to make us deposit as much money as possible into checking accounts, and to make us use account-money instead of base money.
And even if for a mysterious reason the bank would want to buy back my checking account money, the bank cannot buy it if I don’t want to sell it, still less for furniture !
So what are you talking about ? What do you mean exactly ?
Peter Surda:
“I also don’t see a financial difference between asset-backed and revenue-backed IOUs. On the other hand, I agree that if an IOU is only revenue-backed, that creates inflation (ABCT). Does that make any sense?”
Nope. No sense at all. Think of IBM stock. Even the most die-hard quantity theorists agree that if IBM shares initially sell for $60, then IBM can issue 1 more share, sell it for $60 of new assets, and the share price will not change because IBM’s assets would have risen in step with it’s issue of shares. IBM might have previously had 100 shares laying claim to assets worth $6000 (hence share price=6000/100=60). Now they have 101 shares laying claim to assets worth $6060, so share price is 6060/101=$60.
Now suppose that $60 ‘asset’ was a bond that will yield revenue of $3/year forever. At a market rate of interest of 5%, the present value of this perpetual revenue stream is $60. We’ve just gone from saying that the extra share of IBM was ‘asset-backed’ to saying it is ‘revenue backed’, but it makes no difference to the share price. The issue of the extra share does not reduce IBM’s share price in either case. The same is true of money.
“> Money crosses borders easily.”
Countries can be small, weak, and close together. Currencies compete. If the supply/demand view of money were correct, then as one currency loses value, people will demand it less, and it will lose more value, which reduces demand more, etc. On this view the dollar should have driven the peso out of circulation long ago. But the backing view says this won’t happen, because the peso is valued according to its backing.
If modern paper money has value because of supply and demand, and not because of backing, then why do central banks always hold assets? There should be some bank somewhere that holds no assets against the money it issues. There never has been such a bank.
“> Private issue of checking account dollars”
If you say it causes inflation, then banking is equivalent to counterfeiting, and widespread banking should have reduced the value of the dollar to zero long ago. But if the green paper dollar is backed by stuff worth 1 oz. of silver, then no amount of checking account dollars will affect the value of the green paper dollar. You don’t get the absurd result that banks are like counterfeiters.
Gerry Flaychy:
Change the words “buy back” to “redeem” and you might see it more clearly.
Mike:
In your example of IBM shares, the nominal value of the share is unchanged by the switch, but the total amount of money (and derivatives) issued by both companies is different (ceteris paribus). Same amount of assets in economy but more money in circulation equals inflation.
Peter
One of the problems with Mike Sprouls argument is his use of words like ‘value’ and ‘worth’. For example he says: “But if the green paper dollar is backed by stuff worth 1 oz. of silver,…”. What does he mean by this? The dollar he refers to is not backed by the 1 ounce of silver, he says so, it is backed by the “stuff”, which he claims is “worth” 1 ounce of silver. One confusion here is that the dollar really would be “worth” 1 ounce of silver if it were reliably redeemable directly for 1 ounce of silver. In that case its actual value could change just as the value of 1 ounce of silver can change. But what does he mean when he says the “stuff” is worth 1 ounce of silver? He doesn’t mean that someone is guaranteeing to always exchange the “stuff” for 1 ounce of silver either. He means the current silver price of the “stuff” is 1 ounce. The point he wants you to ignore is that the silver price of the stuff is based on the supply and demand for silver and “stuff”. But somehow he insists that this does not result in the dollars based on this system being subject to supply and demand. At this point he is actually postulating that a subjective value system of supply and demand can establish an objective value for dollars. Everything on the market is subject to the effects of supply and demand, there is no such thing as an objectively determined value, not even for dollars.
Peter:
Start by comparing two views of IBM’s issue of 1 new share.
(a) The backing view says that it doesn’t affect the share price, since IBM’s assets move in step with the quantity of shares.
(b) The quantity view ignores the new assets and says that the quantity of shares has increased by 1%, therefore the share price will fall by 1%.
View (b) is indefensible. View (a) is subject to minor qualifications, like questions about whether IBM is able to utilize the new $60 effectively. But any finance professor will tell you that view (a) is pretty much correct, while (b) is plain wrong.
The quantity theory applies view (b) to money and says that it does not matter that the assets of a money-issuer normally move in step with the issue of money. The simple fact that the quantity of money increases by 1% will cause about 1% inflation regardless of issuers’ assets. That’s a view that I find indefensible, and yet it is, regrettably, the mainstream view. It is advocated by everyone from Austrians to Keynesians and worse.
Now, about your ‘ceteris paribus’: You always have to ask why new shares of IBM are issued, and you always have to ask why new money is issued. The new share of IBM is only issued because IBM and its investors “want” the share. That is, because IBM believes it can put the extra $60 to good use, and the investors believe it too. Now this doesn’t rule out bad behavior. IBM might just want the $60 so its managers can blow it on candy. The backing view just says that this will make IBM shares fall in value by 1%.
So now ask why a new dollar gets issued. A common reason would be that it’s the Christmas shopping season, and people have use for more money. So a shopper goes to his bank and borrows 100 checking account dollars. The only way that bank would issue those dollars is that they believe that the shopper will repay the $100 plus interest, and one way for the shopper to reassure the bank is to offer a $100 lien on his house.
So the new dollars get issued, and not only do the bank’s assets rise in step, but the new dollars are only issued to satisfy an increase in money demand, so even a quantity theorist would say that no inflation will result.
@Mike Sproul
Both a and b in your examples are incorrect. Austrian theory (as I understand it) doesn’t say that the market price of a share as expressed in dollars falls (eventually it probably would, but that’s irrelevant). That would be what other economists call “price inflation” as opposed to “monetary inflation”.
I made a couple of tables to demonstrate the financial situation of the IBM share example: http://shurdeek.shurdix.org/tmp/money.pdf
There are 4 entities in the economy: some manufacturer, IBM, bond issuer and IBM shareholders, and 3 situations (before the issue of extra share, after issuing it as an asset-backed IOU, and after issuing it as revenue-backed IOU). On the very right side you see the sums for the whole economy. I put zero into most cells, it might not actually be zero in reality, but putting there some other number might be confusing.
You see that in all three cases the amount of assets in the whole economy is the same. In the first two, all IOUs are asset-backed. In the last one, some are only revenue-backed. Now, you will observe that the sum of the nominal values of all circulating IOUs is higher in the last one than in the second one. The bond issuer has introduced debt, or leverage, into circulation. This is per definition monetary inflation.
Now I need to turn again, agree with Mike and disagree with the Austrians. Monetary inflation does not necessarily mean anything bad or fraudulent or lead to price inflation, as long as the actual revenue backing the IOUs is sufficient. Now, back to ABCT. On a free market, this is kept in check by the free choice of currency, risk of going bankrupt, and the interest rate reflecting the intersection of supply and demand. Legal tender laws as market regulation, central bank as the lender of last resort and the determinant of the interest rate all disrupt this process and lead to bubbles and busts.
@T. Ralph Kays:
I am afraid on this one I have to agree with Mike. From the point of view of the creditor, there is no qualitative difference between asset-backed and revenue-backed IOU or even if the legitimacy of the revenue. You might prefer asset-backed IOUs and that’s fine. But that does not completely eliminate the risk of non-refundability or give the IOU an objective value.
Peter
So what? I never argued that point. His economics is wrong because he thinks there is a way to create money that is not subject to the effects of supply and demand, in other words an objectively determined value.
Peter
“Monetary inflation does not necessarily mean anything bad or fraudulent or lead to price inflation, as long as the actual revenue backing the IOUs is sufficient.”
This is a completely false statement. Smart banking practises in the form of having good security for loans made has nothing to do with the fact that the money supply has changed by these processes. You and Mike are both postulating a form of money that is somehow outside the effects of supply and demand. Gold coins cannot avoid the effects of supply and demand, how does this magical money you and Mike are talking about do it? If the money you and Mike are talking about exists outside of the effects of supply and demand then you should be able to explain its value WITHOUT reference to things that are subject to supply and demand.
As I stated before:
Notes and demand deposits are contractual labels that can only be assumed by 100% Reserve Banks. Fractional Reserve Banks issuing fractional “notes and demand deposits” should label them as “promises of payment with at least x% of reserves.â€
Promises of payment would carry a discount to true Notes and Demand Deposits (100% Reserve) = they would not be fungible.
Why I would accept a “promise†of a thing instead of the actual thing? Why would I deposit my physical coins in a fractional reserve bank receiving fractional reserve notes instead of receiving true 100% notes or deposits?
So, in a complete honest Free Banking, good money would drive bad money.
Of course people could be accepting “promises†(fractional reserve notes or demand deposits) instead of true notes or demand deposits, but not at same face value.
“His economics is wrong because he thinks there is a way to create money that is not subject to the effects of supply and demand, …..”
i guess. i understand the sproul to say in a basic way
1. print money — 2. print money claiming a ‘worth’ of a previously money-purchased asset, it can be anything — 3. if the printed ‘worth’ was wrong, so be it…the notes lose value.
if this is incorrect let me know.
i guess you mean by objective value a note that says redeeem for 1oz. of silver will always be for 1oz of silver …even though the 1oz.of silver possibly can decline in value as well.
i am not sure however if what the sproul describes, carried out on a large economy wide basis is harmful or the disease and ill that i have seen inflation described as on mises sites.
RBD explained!
It seems that Oberon, the king of the fairies, is so impressed with good banking practises that he rewards those who protect their credit expansion by obtaining adequate collateral. This reward consists of sending forth hordes of little fairies who sprinkle magic dust on all of the new money created this way, which protects this money (but not other money created in evil ways) from the influence of the law of supply and demand!
Account-money is redeemable in fed notes not in bond nor in furniture, and it is on the depositor demand, and also it is obligatory for the bank to redeem in fed notes and for the same amount: the bank doesn’t have the choice.
To buy back something means that it is the seller of this thing who wants to have it back. He cannot simply demand it, like in the depositor case above, to get it back.
The buyer is not obliged to sell the thing back, and if he accepts, he can ask the price he wants: he is not obliged to sell it back for the same amount paid. He has the choice.
And, as the ‘buyer’ that we are speaking of here is a depositor, it doesn’t makes much sense, if any. A depositor doesn’t buy back the fed notes he has deposited some time before, he doesn’t have to, he just redeem them.
Thus, contrary to what you said, modern private banks don’t redeem checking account dollars: depositors do; banks don’t even buy them back.
Peter:
The issue of more shares, or more money, is what Austrians call monetary inflation. But as long as those shares, or those money units, have adequate backing we do not see what Austrians call price inflation.
Start by thinking of a pure barter economy where all goods have a market price at which they trade against other goods. Now if, instead of trading with salt, cows, etc., people start trading with IOU’s that reliably promise to deliver salt or cows, then relative prices don’t change. The number of IOU’s rises (monetary inflation) but there is no price inflation.
A farmer who owns cows can easily issue IOU’s promising a cow, but people will also trust him to issue an IOU promising salt. He might not have any salt, but as long as he has enough cows, people will accept his salt IOU’s. There is still more monetary inflation, but no price inflation. All goods still have the same relative prices, and an IOU that reliably promises 1 pound of salt will still be worth 1 pound of salt, even if it’s backed by cows. Note that the total value of all the IOU’s issued is limited by the total value of goods that exist. The IOU’s don’t just multiply without limit.
Peter
When the fellow who has no salt to back his salt IOU goes into the market to buy the salt he needs won’t that be an increased demand for salt? Won’t that change the price of salt? How can relative prices stay the same if this guy is out in the marketplace trying to cover his IOUs by buying things he didn’t have when he issued the IOUs? In this barter society does this guy withdraw from circulation enough cows to buy salt to cover his salt IOUs? If he doesn’t then aren’t the cows still trading on the market in which case the IOUs do increase the money supply and cause inflation. What gets really confusing is when Mike Sproul stops misrepresenting RBD and admits that the property he proposes backs the money doesn’t even belong to the issuer of the money, it is collateral only, not backing.
Peter
Look carefully at Mike Sprouls pure barter economy and his introduction of IOUs to this economy. As I pointed out earlier, if all of the goods that previously were trading in this market are still trading and a new item, the 1 pound salt IOU, is added it will clearly affect a change in relative prices, inflation if you will. But what if the guy who issues the salt IOU, lets call him Mike, withdraws enough cow from the market to trade for sufficient salt to redeem the IOU at current prices. It doesn’t matter if he directly sets aside cow, or if the cow is off the market because it was pledged as collateral to Mike. The IOU trades as if it were salt because Mike is widely seen as being honest. The effect of the IOU is to temporarily depress the value of salt, after all there is now more ‘salt’ on the market. Withdrawing the cow from the market will increase the value of cow, after all supply has decreased. Now prices of cow in terms of salt has increased, and conversely the cow price of salt has decreased. Now lets assume someone redeems the IOU, so Mike goes to the salt dealer, lets call him Peter, with the amount of cow that was set aside at the OLD prices to buy salt. But now the value of salt has been depressed and the value of cow has risen. Mike recieves far more salt for his set aside cow than he needs to retire the IOU. Now the IOU is gone, we are back to the original trading situation and the original ‘prices’ will re-establish themselves. Now when Peter goes to buy salt to replace what he sold to Mike he will find that the cow he got from Mike will buy only part of what he sold to Mike. Mike has whatever he traded for the IOU and the person who redeemed it has the promised salt, but also Mike has the extra salt and Peter has less salt, and this has resulted from nothing but Mikes creation, out of thin air, of an IOU.
This process if continued will continue to enrich Mike and impoverish Peter, giving Mike more and more assets on which to base more IOUs, accelerating the process.
Of course that is Mikes true purpose in pushing RBD, he likes the idea of stealing from people.
As I stated far above, I’m not an expert in banking, I am merely trying to understand and to clarify (to myself) the Austrian approach. I have been trying to comprehend the Austrian approach for a while and have trouble following the conclusions of parts of the Austrian monetary theory.
@Mike Sproul:
> The issue of more shares, or more money, is what
> Austrians call monetary inflation. But as long as
> those shares, or those money units, have adequate
> backing we do not see what Austrians call price
> inflation.
Surprisingly, I have no issue with this argument. I agree with you. Maybe we might disagree on what “adequate backing” means.
@Austrians:
Neither money nor gold have “objective value”, and indeed the value is determined by supply and demand.
I agree that it should be clear to the creditor whether the IOU he obtains is asset-backed or revenue-backed and if they claim something that is contrary to the financial situation (e.g. 100% immediate redeemability while the reserves are below 100%), this means fraud. But apart from that, there is no issue. Notes with fractional redeemability wouldn’t have a market price directly proportionate to the reserve ratio, rather also to the estimated risk of default.
Even if you have asset-backed IOUs (e.g. gold deposits), there is still no guarantee for redeemability. The gold could get stolen and then the notes would be worthless. Also, the market value of gold could decline, which also decreases the market price of the notes. Just like if you have a revenue-backed IOU and the debtor fails to get sufficient revenue, the market value of that IOU falls. It is also normal for a business to have a negative equity. There is a non-zero risk in all cases, and in all cases the market price can fluctuate.
Imagine the extreme case, if replicators were invented (like in Star Trek). That would make all the matter equivalent. A ton of gold would have the same market price as a ton of sand. The market for gold and gold-backed IOUs would collapse and from this perspective there would be a massive price inflation.
In my opinion, the “asset-backed IOU theorists” insist that the expected future revenues should only be reflected in the interest rate and not in the money base.
I don’t see a reason for this strict separation. Of course, if there is mismatch, it means trouble. But asset-based IOUs are also affected by this phenomenon, as demonstrated above. Furthermore, free market would keep this in check and allow you to refuse IOUs which carry higher risk than you prefer.
“But apart from that, there is no issue. Notes with fractional redeemability wouldn’t have a market price directly proportionate to the reserve ratio, rather also to the estimated risk of default.
Even if you have asset-backed IOUs (e.g. gold deposits), there is still no guarantee for redeemability.”
unless the issue is one of forcibly mandating the fractional-backed note – also even if no force is used does the mechanism lend itself to greater economic miscalculation than the previoulsy referred to objective-value note.
for insntance, unless gold theft really took place on a regular basis from depositors (unlikely) they would at least know that the note did definitly have a corresponding amount of gold sitting somewhere – and would this operate better for long term economic calculation thaen fractional-note soup.
has that ever shown itself to be the case historically?
Shares? Shares of what?
I would be very curious to see a quotation confirming that.
Mises and the meaning of inflation.
http://mises.org/books/Theory_Money_Credit/Part2_Ch13.aspx#_ednref11 (7 Excursus)
“…that is not offset by a corresponding increase in the need for money…”
isnt a need for money met by exchangeing a good for it?
is a need for money different than a need for any other good?
“…so that a fall in the objective exchange value of money must occur.”
does this really matter?
i have seen inflation called a disease and ill at mises and lrc.
if there are more weaker moneys around instead of fewer moneys that are stronger…is there much of a difference?
if there are more weaker moneys around instead of fewer moneys that are stronger…is there much of a difference?
now that i review this…historically has this just not happend all at once? benefitting a few and harming many?
until….
“when prices are adjusted for inflation, Americans today spend ’40% less on clothes, 20% less on food, more than 50% less on appliances, about 25% less on owning and maintaining a car’than they did during the early 1970s.”
http://blog.mises.org/archives/010741.asp
or do the first receivers still remain better off?