The Wikipedia entry on the real-bills doctrine advances the controversial proposition that banks can increase the quantity of money without diminishing the purchasing power of each unit. I will refer to it as the Sproul doctrine. FULL ARTICLE by Robert Blumen
Source link: http://archive.mises.org/13990/the-michael-sproul-doctrine/
The Michael Sproul Doctrine
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This is truly sad. It’s bad enough that Mike Sproul infests the blog posts with his rubbish; was it really necessary to flatter his ego by putting his name front-and-center on the blog itself? What’s next, the Doctrine of Michael?
Let me add, what is objectionable about Sproul is not just the fallaciousness of his doctrine, but also the fact that he gives no indication that he even reads, much less understands, the criticisms directed toward the doctrine here.
The doctrine of michael? Here you go:
http://www.northstarcompass.org/nsc0003/stalweb.htm
Could have been worse, it could be called The Book of Sproul.
I think this blog post was made in order to clear up some confusion many Mises readers might have had about these concepts. I think that outweighs other concerns.
The accounting practices of both Sproul and Blumen leave a good deal to be desired. See http://www.csun.edu/~hceco008/realbillsintro.htm for Spoul’s, which appear to be much the same as Blumen’s.
Sproul reports that when the banker receives 100 oz. Ag it is correct to record it as an asset of the banker. Like wow, man. The banker’s commingling of his assets with those of the customer, whom I shall call Mr. Soandzo Tsilberbug, happened rather quickly.
But let’s think about that for just a moment. Tsilberbug has handed over 100 oz. Ag to the banker, who becomes legally responsible for safeguarding that silver. In other words, the 100 oz. silver is not an asset at all of the banker, but a liability of the banker. Now, he may have built a warehouse, bought a safe, some guns, and computers on which to run his accounting software. These are properly recorded as assets of the banker. But Tsilberbug’s property? Well, no. So the banker keeps his books in balance by making an entry of “-100 oz. Ag” in the owner’s equity section of his balance sheet.
The complications do not end there, of course. For example, Tsilberbug is no dummy, so he requests receipts totaling 100 oz Ag. Tsilberbug must also pay for the storage service provided by the banker. Let’s say that is 0.1 oz. Ag per month, and Tsilberbug aggrees that he will bring in an additional amount of silver every month to satisfy his obligations. In fact, on the day of deposit he has brought in enough extra silver to pay for the first six months’ of storage. If he doesn’t show up again by the first of the 7th month, he and the banker have agreed that the banker will deduct 0.1 oz Ag from banker’s liability to Tsilberbug.
More on this later, after I find out how Sproul handles a more detailed explanation along with a request, more polite than you could muster, I suspect, Beefcake the Mighty, for justification of his accounting practices.
Basically Sproul claims there is no law of supply and demand when it comes money.
Funny or sad? I can not decide.
Mike Sproul assumes that an IOU with a face value of $1 has a market value of $1. That IOU would most likely have a market value of $0.
And if Mike Sproul thinks that IOUs are always worth face value, then I’ll sell as many $1 IOUs as he wants for $0.50 worth of silver bullion each.
This should be the Wikipedia entry. Nice work, Mr. Blumen.
The quoted passages present an argument that the “value” or “worth” of a bank note is the same when the quantity of bank notes has changed. The conclusion is valid if “worth” is defined to mean the same thing as convertible.
If this isn’t bad enough, try explaining to him that the term “value” (when referring to coinage) is a description of the physical quantity of silver (or gold or whatever) contained in any given coin. Not its convertibility, and not its purchasing power.
“Value” is an entirely literal, objective, chemical, and scientific assessment of the physical properties of a coin. Its meaning as a term of comparison, referred to non-coin objects that are traded in market exchanges, is only secondary and metaphorical.
The “value” of a silver dollar is determined by a binary metric, which is defined in purely physical terms — its weight and purity, which together provide an assessment of the literal quantity of the number of molecules of the actual, chemical element of silver that is present.
“Regulating the value” of silver coins is a term that refers to the practice of defining weights and measures, and the chemical processes of alloys and measuring purity. That’s why the Coinage Clause in the Constitution is in the same paragraph as the power to define weights and measures.
Regulating the value of coinage only secondarily (and metaphorically) refers to the economics of trading silver in the marketplace.
And only after that does “value” have any meaning when applied to paper substitutes (notes, bonds, loans, etc.) that are denominated in terms of coinage.
Robert:
You might agree that if the bank had issued the extra $200 in exchange for 200 actual ounces of silver, then the bank would have $300 laying claim to 300 oz., and each dollar would have to be worth 1 oz. If the bank then traded that 200 oz of silver for an equal value of gold (or anything else), then I’d say that the value of each dollar would still be one ounce of silver. If one ounce of silver bought 1 loaf of bread at the grocery store before the issue of $200, then 1 ounce should still buy 1 loaf after the $200 was issued. Meanwhile, $1 will still buy 1 ounce of silver, so it will still buy 1 loaf.
What are you claiming? That the moment the bank trades its silver for gold, the price of a loaf of bread will rise to $3?
By the way: Quite a few of your objections might be answered in my latest paper: The Law of Reflux, which you can find by clicking my name above.
So a bank can issue $1,000,000,000,000,000,000,000 in exchange for IOUs with a total face value of $1,000,000,000,000,000,000,000, and that won’t affect the purchasing power of the $? Even if the person who got that money bought everything on the planet?
MIke,
“the moment the bank….” We can’t say anything about the timing of the movements in the purchasing power of money (PPM). In the short term we can’t even be sure of the direction. Mises has a discussion somewhere about how money demand may increase as fast as money supply, at the same rate, or in a hyperinflation, money demand decreases while money supply increases. To illustrate this point, suppose that an institution is printing bank notes and spending them into circulation. The moment the bank prints a new bank note does the PPM change everywhere? Not necessarily. The PPM changes over time as people make buying and selling decisions in order to maintain their real cash balances.
In your example, I am assuming that you intend a background assumption that gold is in circulation as money. If monetary demand for gold balances increases and monetary demand for silver decreases, then that will move the gold:silver exchange rate, but let’s ignore that. Through these two assumptions I have made your example equivalent to “If the bank traded 200 oz of silver for 200 oz of silver”. Then there would be no change in the PPM.
As for the “or anything else” that is a different case. The difference is that the bank is now holding non-monetary goods against money. This is more of what I consider the classical real bills doctrine – that banks can “back” their money substitutes with non-money without changing the PPM. Suppose that the bank sells the silver in coin form to individuals who add it to their cash balances. Then the total supply of money has increased because the bank notes are still in someone’s cash balance and the silver coins that were held in reserve against the bank notes are in someone else’s cash balance. If you accept the real cash balance theory of the PPM, which I am pretty sure you do not, the PPM will adjust.
-Robert Blumen
Robert:
“Suppose that the bank sells the silver in coin form to individuals who add it to their cash balances.”
If the bank sold 100 oz of coined silver, it would have gotten something worth 100 oz. in exchange. Thus $100 of the bank’s paper money, previously backed by the 100 oz. of silver, is now backed by the stuff the bank bought. If the sale of the silver coins were to reduce the value of the bank’s dollars from 1 oz. to .99 oz, then the dollars would reflux to the bank in exchange for either 1 oz. of silver each, or other bank assets worth 1 oz. The value of each dollar either stays at 1 oz, or else it refluxes to the bank. The increase in the money supply that you spoke of does not happen.
The process that I think you are describing though I am not entirely sure is that there are limits to the extent that a bank can issue, which I agree with.
I think that the point where we disagree is that I do not see the issue of “backing” as determing the PPM. Money is money. What the banks have on their balance sheets matters for some purposes but it does not determine the PPM.
-Robert
Robert:
We probably agree about the issue of stock. No serious economist argues against the idea that the value of stock is determined by expected future earnings, or, broadly speaking, by the firm’s assets. They also don’t argue against the idea that while firms cannot issue unlimited amounts of stock, they can issue new shares to raise capital for new projects. A firm with promising new projects can offer new shares to the public for, say, $60/share. Every new share is offset by $60 of new cash, so the share price is unaffected. The $60 cash will soon be spent on the new project, and if it goes well the stock will rise, while if it goes badly the stock will fall. Finally, nobody argues that when a firm faces an unprofitable future, it will be unable to issue new shares. Instead, it will unwind its position, sell off its assets, and retire its shares. In short, the backing theory holds for stock, and stock also obeys the law of reflux.
I expect you would also agree that the backing theory and the law of reflux also apply to silver coins. The value of each coin is determined by its backing (which in this case is contained in the coin itself), independent of the quantity of silver that happens to have been stamped into coins. If there are too many coins, so that a 1 oz. coin can buy groceries worth only .99 oz., then people will melt the coins and sell the silver. That is, coins will automatically reflux to bullion. If there are too few coins, people will automatically stamp bullion into new coins. Reflux, reflux, reflux.
I might add that nobody seriously asks questions like “What if the quantity of silver coins doubled?”, or “What if the velocity of circulation of coins doubled?”
But now we come to paper money. I say that the same rules governing the value of any other kind of paper apply just as well to pieces of paper that happen to be traded frequently enough for people to call them money. You say that paper money, alone among all other kinds of paper that people use, is valued only because its quantity is limited and because people want to hold it.
I base most of my argument on arbitrage-type processes. I assume you’re familiar with it, but basically, if any piece of paper trades either above or below the value of the assets underlying it, then arbitrage will correct the mis-pricing. If a piece of paper trades for $90, while the underlier is worth $100, then arbitragers will go long in the paper and take delivery of the underlier, earning a profit of $10. If the piece of paper trades for $110, while the underlier is worth $100, then arbitragers will short the piece of paper and deliver the underlier, again making $10 profit.
When talking to finance professors, an arbitrage argument usually ends the discussion. But you seem to think that this process does not work for paper money, and that the value of money is determined not by arbitrage, but by “How many dollars are chasing goods”. For starters, you’ve already agreed that the value of stock is determined by assets per share. If new shares are issued, there will of course be “More shares chasing goods”, but nobody seriously thinks that would cause adequately-backed shares to lose value. Yet you apply that defective reasoning to paper money
Mike,
I’ve dealt with this in my article already, it’s in the last part of the article.
Prices are set by supply and demand. The “dollars chasing goods” is not some peculiar theory that I thought of, it is another way of saying supply on one side of the market is increasing. If that is the only change in a market the price in terms of the side where quantity is increasing will fall in relation to the good(s) on the other side of the market.
Arbitrage is not a distinct theory of how prices are formed, is the process by which the market prices converges to a level where supply and demand are equal. If supply and demand are not equal in a particular market that would create an opportunity for arbitrage. Arbitrage arguments do is how that the price will converge to the value that you would expect from supply and demand analysis.
What I understand from people in finance, they use the term arbitrage in a narrower sense – arbitraging in terms of money prices. For example, if you could buy the stock of a company at $10 per share while the company has $20 per share worth of assets, you would buy the company and sell the assets off. This example relies on the market to provide a money prices for the shares and the underlying assets.
These type of finance arbitrage arguments are useful for drawing conclusions about the prices of securities priced in terms of money because they rely on the money prices of the securities and the assets. You can use these type of arguments in a monetary economy to establish that a particular price is out of line with the rest of the money price system. But you can’t use an arbitrage in terms of money prices to establish anything about the purchasing power of money itself because these arguments presume the existence of money that has some purchasing power on the market already. When you get to money itself, you have reached the end of the line. You can’t make an argument about the liquidation value of money into money because that is always 1.0.
To establish the PPM requires that we go back to basic supply and demand analysis. We can call this arbitrage arguments the more general sense, but not in the way that finance professors use it. if the PPM is “too high” relative to your cash balance, you can “arbitrage” by spending some money to acquire goods.
If you look at fiduciary media as a sort of derivative or security then you can make arguments about their liquidation value If the banking system has 100oz of silver and 200oz of cash liabilities (notes and demand deposits), then the bank note or deposit should trade at 0.50 relative to the metal. That is what arbitrage arguments show.
This arbitrage process does happen but it takes time. The entire justification of FRB is to maintain the convertibility ratio between bank liabilities and metal 1.0 while having less than 1.0 ounces of metal backing per unit. Fractional reserve banking from the bank’s standpoint depends on the uncovered money substitutes being taken at face value rather than liquidation value. If bank liabilities immediately traded down to their coverage ratios then a) no one would use them as money and b) fractional reserve banking wouldn’t work from the bank’s standpoint.
The Austrian analysis of this process (ABCT) is that eventually notes reach parity with coverage but it takes time, and usually the bank notes converge to their coverage ratios through the default of part of the banking system, in which some portion of the supply of bank liabilities get written down to zero.
What I understood you to be saying on wikipedia is that that the banking system can issue 200 bank notes against 100 of silver without the purchasing power of a bank note changing. As discussed above, there are situations where banks can for some time maintain the convertibility ratio at 1.0 (for example if there are not very many demands for redemption of liabilities in terms of metal). But the convertibility ratio offered by a bank is only one price in the entire economy. When I am talking about the purchasing power of a bank note, I mean against goods generally. That one price is a “false price” — it is out of line with the entire rest of the price system.
The purchasing power of money generally against all other goods than silver is going to reflect the quantity of bank notes – 200 — not the quantity of metal because if no one bothers to redeem their bank notes, then the convertibility ratio is not playing a role in the decisions of individuals concerning the size of their cash balances. In that case, bank notes are money and the money supply is 200 units.
So in summary we have three scenarios
-Robert
Robert:
“But you can’t use an arbitrage in terms of money prices to establish anything about the purchasing power of money itself because these arguments presume the existence of money that has some purchasing power on the market already.”
All I’ve presumed is that some good, silver, trades on the market for certain quantities of apples, oranges, bread, etc. I didn’t make any claims about how silver’s price was determined, but obviously it was by supply and demand. What I have said is that if there is some slip of paper that says “IOU 1 oz. of silver”, and if that slip was issued by some reliable person whose assets are sufficient to redeem that slip for either 1 oz., or else for 1 oz. worth of apples, oranges, etc., then that slip will trade in the market for 1 oz. When I talk about arbitrage, I’m talking about what happens if that slip starts trading for 1.1 oz. or .9 oz. In either case, arbitrage will drive the slip back to a value of 1 oz. Meanwhile, the price of silver relative to apples and oranges might be stable or changing, but that does not change the fact that the slip continues to trade for 1 oz.
“The entire justification of FRB is to maintain the convertibility ratio between bank liabilities and metal 1.0 while having less than 1.0 ounces of metal backing per unit. Fractional reserve banking from the bank’s standpoint depends on the uncovered money substitutes being taken at face value rather than liquidation value.”
We agree that if the bank has 1 oz. backing $1, then $1=1 oz. We agree that if the bank has 1 oz. backing $2, then $1=.5 oz. Are you saying that if the bank has 1 oz. of silver, plus an amount of apples that currently sells on the market for 1 oz. or more, then $1=.5 oz.? Would you say that even if the bank is willing and able, at any time, to sell those apples for 1 oz. and redeem both dollars for 1 oz. each? Or alternatively, to hand over 1 oz. worth of apples for each of its dollars? What if the bank’s apples are worth millions of ounces? Would you still say that the dollars can’t be worth more than .5 oz., on the grounds that only the 1 oz. of silver matters, and the million oz. worth of apples doesn’t count?
“there are situations where banks can for some time maintain the convertibility ratio at 1.0 (for example if there are not very many demands for redemption of liabilities in terms of metal). But the convertibility ratio offered by a bank is only one price in the entire economy. When I am talking about the purchasing power of a bank note, I mean against goods generally. That one price is a “false price” — it is out of line with the entire rest of the price system.”
Convertibility at 1.0 does not depend on customers refraining from cashing in all at once. It depends on the bank having assets worth enough to buy back each of its notes for either 1 oz. or else for other stuff with a market value of 1 oz. A bank that has 50 oz. worth of stuff backing $100 can’t maintain convertibility at 1 oz./$, even briefly, since customers will arbitrage against it. They will bring in the first 50 dollars, get 50 oz. worth of stuff, and the last $50 will be worthless.
Now if that bank has 100 oz. worth of various assets backing $100, then each dollar will trade for 1 oz both at the bank and in the economy at large. So whatever silver is worth out in the world, that’s what the dollar is worth too. That’s not a case of false prices.
Mike, I think the main problem here is that you consider “debt” as “stuff”. A bank making a loan, does not receive any kind of “stuff” in return. It only gets an obligation to repay the loan in the future – which is no “real” asset in my book. Sometimes a loan cannot be repaid and the collateral lost its value in the meantime (that’s what happen in the sub-prime mess of few months ago). Even if banks gave loans only to those with loads of assets and an impeccable record, we are talking about future here – nobody has the absolute certainty of any future event. People fail their obligations with banks all the time – bother to ask the director of your local bank, you might learn surprising facts.
You should understand that when a bank issues fiat currency, the banker is taking two separate bets about future events. First, he hopes the guy will repay the loan. Second – and this is the reassuring part – he’s almost sure someone will bail him out in case of a bank run. Bankers cannot be sure, of course – that’s why they charge loan with interests. Theoretically speaking, 100% of certainty (that is, they guy will surely repay the loan) would mean 0% of interest, plus a small margin for profit. And 0% of certainty (that is, the guy will surely fail to repay the loan) would be equivalent to 100% of interest rate, plus a small margin for profit. Real life is somewhere between those two extremes. And a bank is being profitable as long as their math guys make accurate risk assessments.
Concluding, your theory is based on unrealistic assumptions. It would only be correct in a world where each and every future debt gets systematically settled, with absolute certainty. But, in such an “ideal” world, banks would not exist – since nobody would need to pay for their services. But in such a world also future events would be somehow already known by everybody, with a whole lot of bizarre consequences…
Andre:
I buy a house for $500,000, even though I know that in the future it could be destroyed by fire, flood, earthquake, etc., or I might lose it through some defect in the title. If not for all that uncertainty I would have paid more, so the $500,000 reflects my best guess about the likely services I will get from the house, balanced against the risks.
Years later, I want to borrow $500,000 from a bank. No sane banker will lend me $500,000 on the security of a $500,000 house. He knows that if the house drops to $499,000, I can default and he’ll lose $1000. The banker might, however, lend me $400,000. This gives him a high probability that I will repay. Of course, there’s a small chance the house will fall to $399,000, in which case the banker will potentially lose $1000, but the bank is willing to take that chance in exchange for the profit he expects on the loan.
Conclusion: debt=stuff.
More parlor games. Don’t even try to coherently defend your position, just throw out some irrelevant examples.
Conclusion: Mike Sproul = idiot.
“When I talk about arbitrage, I’m talking about what happens if that slip starts trading for 1.1 oz. or .9 oz. In either case, arbitrage will drive the slip back to a value of 1 oz. Meanwhile, the price of silver relative to apples and oranges might be stable or changing, but that does not change the fact that the slip continues to trade for 1 oz.”
This is a rather clear (by Sproul’s standards) admission that Sproul is NOT talking about money in these discussions.
There isn’t anything different between this plan and the current fractional reserve system. The paper currency and low-grade metal alloy coins with arbitrary “values” stamped on them are only being replaced by silver. The fact that banks are still able to engage in promises for repayment beyond what is actually held still remains constant.
So, while a $1 silver coin (if defined by the 1792 coinage act at 371.25 grains of silver as Dollar is a unit of constant measurement) if the banking system still retains its 10% reserve ratio requirement, the grocery store would demand $10 in silver promissory bank notes for the same loaf of bread when they would accept just a single $1 silver coin. The price premium when using promissory notes will change based on reserve requirements.
The problem is further unavoidable as modern banking is performed nearly exclusively electronically. Little of the money we use is in physical form. 10% of your paycheck from the California State University, Northridge would have any actual silver backing it. The other 90% is based on hope (and possibly some change) that it will be there when you ask for a pile of coins.
Other problems come in your definition of “value”. Your counterbalance to this is that the bank accepts collateral equal to the “value” of the loan. Value is a subjective proposition. Banks did this exact same thing with every home loan in the country, but it clearly didn’t seem to solve the problem. The house was collateral of equal “value” of the loan. Again, the same situation would happen under your system as you do little more than exchange Federal Reserve Note for 371.25 grains of silver and mirror exactly how banking functions today.
Your plan confuses value with spot liquidation potential. Value is a subjective judgement. For instance, I recently purchased PC parts for self-assembly. I purchased a 6 core Intel Gulftown processor, two Nvidia Geforce 480 GTX graphics cards, 12GB of RAM, and a 240GB Vertex2 SSD for storage. I plowed $3,600 into this computer system. I spent this kind of money because I enjoy amateur 3D pre-rendering (think Pixar) and high-end computer video games. I could use this as collateral for a $3,600 loan.
Now, lets assume 6 months go by and I default on my loan. The bank comes to collect on my computer system to make good on your paycheck. Since you unlikely do anything on a computer beyond light activities such as word processing, e-mail, and surfing the web, you wouldn’t consider the PC that was collected from me in lieu of the $3,600 in silver coins a fair trade. To you, a home PC is probably only worth around $700 (I’m making this up for convenience sake, don’t bother telling me what you’d pay for a PC, it doesn’t matter). Would you accept this PC you value at $700 for your $3,600 in withdrawls? You could also tell me the bank will sell the PC. But PC component pricing, even at the extreme high end, rapidly drops. In the 4 months I’ve owned this system, the price on the componets have dropped $400. The $3,600 loan I secured with this PC that was, at the time of the loan, valued at $3,600 is now only able to be sold for $3,200. The bank is now unable to provide $400 in silver coins to accomodate your $3,600 withdraw request.
Substitute my PC example for anything. Car, house, boat, purebreed dog, whatever. The mechanics remain the same.
Who knows what else the bank accepted as collateral for the loan. All this system does (apart from being pretty much identical to how it is now) is create the same cumbersome system a barter economy would have, undermining the advancement to a medium of exchange economy.
You can’t fix the exchange price between two commodities on the market. Money is just a commodity. If a bank presents a $1 note, it must be backed with 371.25 grains of silver, not something else. That something else will fluctuate and will, except by pure coincidence, never be “worth” that Dollar value on the certificate. The only way the bank can be honest about what my PC is worth is if I give them the PC and they present to me a piece of paper that has the system’s specifications written on it. I then need to find someone who would accept this paper, who would then return to the bank to pick up the PC. I could just bypass the bank and go on Craigslist if I wanted to do that.
Ultimately, Mr. Sproul, your concept is identical to the banking system today. Calling it “asset based” doesn’t change the underlying mechanics. Changing the identity of the Federal Reserve paper note to a pile of silver doesn’t change the underlying mechanics. It will still function the same and it will still suffer from the same frequency and magnitude of crashes as it does now.
“There isn’t anything different between this plan and the current fractional reserve system.”
EXACTLY! This was my first impression when I read about RBD years ago.
This article cold have been a LOT shorter.
Not to mention that central banks don’t loan out money (out of thin air) without collateral of equal “value” as it is. They already follow the RBD. No inflation you say!
“So long as money is only issued for assets of sufficient value, the money will maintain its value no matter how much is issued.”
Inexpicable and yet, in its own contradictory way, defensible.
It says nothing, because it can be contorted into anything the author wishes it to mean.
Right. How does the bank know it has assets of sufficient value to back its new notes?
The example from the article presents a plausible case for GM at $60.
I don’t buy that, either. It works for GM, and small numbers of shares, but if Sproul is suggesting that Mom&Pop, Inc., with a market cap of $100k, could decide to issue a few million dollars worth of new shares and it would make no difference to the value of the company, he’s smokin’ the wacky weed. If they could put the money to productive use, it could be “neutral”…or cause their share price to increase, more likely [which would presumably be the point of issuing the shares in the first place!]; but if they’re just sitting on a pile of cash afterwards…no!
Money is the medium of exchange.
If a bank issues 100 $1 silver certificates accepted as money, there is no increase in the supply of money if it also has accepted 100 ounces of silver on deposit because it has removed the same amount of money (actual silver) from circulation as it has added.
However, if it has accepted a non-money asset on deposit, even MMF checks, there has been an increase in the supply of money (the medium of exchange), at least until it cashes the MMF checks for a real money and holds it on deposit.
Regards, Don
Mike’s Real Bills Doctrine denies the very foundation of economics: subjective valuation, marginal value, and final utility. Instead he holds to the ancient intrinsic value theory of the mid 19th century.
Robert:
You said: “This doctrine could be valid only in a world where new goods materialized in response to the issue of money.”
So you agree that if the new $200 was issued into a world where the needs of business had just increased by $200, then prices won’t be affected. Where do you stand on the question of the assets the issuing bank got in return? I say that if the $200 was issued to a farmer who offered land worth 200 oz. of silver in exchange, then the bank would have 100 oz of silver, plus land worth 200 oz., as backing for $300 of money, so each note will remain worth 1 oz., or in turn, 1 loaf of bread.
What if the bank issued the $200 in exchange for nothing, helicopter-drop-style? I say there would now be 100 oz of silver backing $300, so the dollar would fall to 1/3 oz. even though the needs of business had increased by $200. You seem to be saying that the helicopter drop would not affect prices in this case. A pretty tough claim to defend, I’d say, since the dollars would be vulnerable to all kinds of arbitrage strategies.
Here’s one area where you seem to misunderstand the backing theory: Let’s suppose there has been no increase in the needs of business, and yet the bank somehow issued the new $200 in exchange for 200 oz. worth of the farmer’s land. I say that the extra $200 will reflux to the bank and not circulate. You seem to think that I claim that the money will somehow force itself into circulation, chase goods, and triple prices. It won’t. That’s why it’s important to understand the Law of Reflux.
“$200 in exchange for 200 oz. worth of the farmer’s land”
And how does the bank know how much “200 oz. worth” of the farmer’s land is? Are land values constant with respect to time, space, and person? What happens when the farmer stops paying his mortgage? Does that reduce the backing of the notes? What happens when people only want to pay 100 oz. for the land?
This line clearly explains Mike Sprouls motivation in pushing his RBD theories. “So you agree that if the new $200 was issued into a world where the needs of business had just increased by $200, then prices won’t be affected.” Ignore for the moment that he has equated actual new goods with the undefined entity “needs of business”. What is most important to Mike Sproul is exactly that, the “needs of business”, and what business needs more than anything else in Mike Sprouls opinion is the right to steal from people by way of fractional reserve banking. All of his obtuse and twisted rationalizations are directed towards justifying this theft in the name of “the needs of business”. Certainly is true that crime does in fact pay, as long as you can get the government to legalize it first.
Yours Truly, the heretic Sy Akhplart
Was that farmer’s land priced during a bumper crop period or a period with a crop shortage? Is he a corn farmer that borrowed $200 against $200 of land during a period of Ethanol subsidy and then during the course of the loan, the subidy was eliminated, thus dropping the land values. Does the farmer have to put up additional land to make up for this decrease in land value or is the bank, and its customers, expected to just eat the loss?
How about the flip side? The farmer placed $200 of apple orchards as collateral during a period of low crop market values and in subsequent years a major drought in China wiped out half the orchard output. Since China grows 1/3 of the world’s apples, the supply was just cut by 1/6 and since trees don’t grow all that quickly, the world’s existing apple orchards just got more valuable. Does the farmer get a remittance for the land that is now worth more than at the period of the loan or does the bank get to enjoy a profit should the farmer default?
That’s the bank’s problem. A bank that lends $200 against collateral worth 200 oz. is on thin ice, so nobody trusts them. A normal bank will issue $200 to a farmer only if the farm offered as collateral is worth 300 oz. or so. Even then there is a risk that the farm might fall in value to 199 oz, in which case the bank is insolvent. That’s the chance the bank and its customers knowingly take.
It’s not the banks problems, the money in circulation backed by that land, if the land devalued, is now worth less and as such, merchants demand more of it in response.
That’s the problem when you attempt to back a currency demnominated in a specific commodity with a different commodity. The price between the two fluctuates. If the economic system’s stock of money is made up of a mishmash of different assets beyond silver bullion, the value of that currency in relation to silver bullion will continually fluctuate. Over time, the currency will inflate as the stock of assets backing that currency will inevitably devalue over time compared to the silver bullion. Banks backing assets with automobiles, commercial buildings, homes, etc, will see a depreciating asset stock but a fixed obligation in silver that the bank cannot liquidate the assets to cover.
So, what would merchants do in response? Continually raise prices in relation to this asset-backed currency to counter-balance this constant depreciation of the asset stock the banknotes are representing.
This is called inflation, which is supposed to not happen under the proposed system.
“Robert:
You said: “This doctrine could be valid only in a world where new goods materialized in response to the issue of money.”
So you agree that if the new $200 was issued into a world where the needs of business had just increased by $200, then prices won’t be affected. ”
This is classic Mike Sproul. Robert Blumen speaks of a (imaginary) world where new goods materialize in response to money issue, Sproul believes he is talking about the “needs” of business. Either Sproul is too mentally impaired to grasp what other people are saying, or he is just too slimy to engage in honest debate.
Mike,
Putting my 2 cents in :
“You seem to think that I claim that the money will somehow force itself into circulation, chase goods, and triple prices. It won’t. That’s why it’s important to understand the Law of Reflux.”
Why does a business need money that it doesn’t put into circulation, broadly defined? Even if the money comes back to the bank, the supply of money has been increased in the intermediate time interval.
It doesn’t matter what the farmer’s land is worth because taking it internal to the bank hasn’t reduced the outstanding supply of the medium of exchange.
Regards, Don
Don:
The farmer wants to borrow $200 to buy a tractor. He hands his IOU to the bank, promising to pay 220 oz of silver to the bank in 1 year. That IOU is worth 200 oz. today, assuming an interest rate of 10%. The tractor seller receives the $200 and deposits it in the same bank that issued it, or maybe the tractor seller buys the 200 oz. IOU from the bank as an investment. Either way, the $200 immediately refluxes to the bank, and is not spent again. The rest of the dollars in circulation might be spent 100 times/year, so there has been only a temporary $200 blip in the money supply.
Now, why did the farmer borrow from the bank instead of from someone else, or even directly from the tractor seller? One answer is that there was a temporary blip in the needs of business, so a blip of new money had to be issued to cover it. Had there been no such blip, the farmer could have bought the tractor directly from the tractor seller with his IOU.
I don’t know what you mean by “taking it internal to the bank”.
Mike,
“…The tractor seller receives the $200 and deposits it in the same bank that issued it,…”
In the simplest case, this deposit is to a checking account. In which case it counts as part of the money supply.
The only thing that matters about the farmer’s land is that its control by the bank does not withdraw any money (medium of exchange) from the economy, so the money issued by the bank is not offset.
Regards, Don
Don:
If the money issued by the bank is not offset by the bank’s withdrawal of money from circulation, then money will be withdrawn from circulation by someone else. Think of an economy that uses only silver coins, but which also holds a stock of silver spoons, forks, and bullion. Silver can be coined at any time, but nobody will bother to coin it unless more coins are needed. Conversely, if the economy has too many coins, they will be melted and reflux to bullion. Paper and credit money works the same way. People issue it when it is needed, and it refluxes to them when it is not needed.
Mike,
I would count bullion as money, especially as it can be coined at will, but anyway.
As far as the spoons, etc. go, silver will tend to move back and forth between the monetary and non-monetary uses depending on the relative value of silver in each application and the transaction costs.
BTW, the whole idea of covering a money issue is like starting to read a book in the middle. In the beginning, a new bank building is empty. If covered money is to be issued, then the silver must come from somewhere. Unless the bank building has been erected on top of a silver mine, it must withdraw its silver from the economy. This is why issuing covered money doesn’t increase the money supply, because it has been pre-offset.
Regards, Don
“….unless more coins are needed”
Please define the use of “needed” in this sentance.
This line clearly explains Mike Sproul’s motivation in pushing his RBD theories.
“So you agree that if the new $200 was issued into a world where the needs of
business had just increased by $200, then prices won’t be affected.” Ignore for
the moment that he has equated actual new goods with the undefined entity “needs
of business”. What is most important to Mike Sproul is exactly that, the “needs
of business”, and what business needs more than anything else in Mike Sprouls
opinion is the right to steal from people by way of fractional reserve banking.
All of his obtuse and twisted rationalizations are directed towards justifying
this theft in the name of “the needs of business”. Certainly is true that crime
does in fact pay, as long as you can get the government to legalize it first.
Yours Truly, the heretic Sy
Akhplart
Right, what the hell does it mean for the needs of business to “increase by $200″? It really makes no sense at all. I don’t think Sproul even qualifies as a crank; lunatic is more like it.
This “needs of business” comment is based on the false idea that as real wealth (stuff) increases, that the money supply needs to increase proportionately with the new production.
The problem seems to be with those that can’t understand ratios.
As new stuff is created (but money supply remains constant), the ratio of money : stuff would change. Each unit of money would eventually be able to purchase more of the stuff. There would be a period of time for this adjustment, and nobody can predict exactly how it turns out, but it’s likely that if the amount of stuff doubled, then prices would drop in half.
This is simply Rothbard/Mises proposition that there need be no change in the quantity of money. Remember, money is NOT used up in trade. So, we don’t need more of it just because there’s more stuff to buy. We simply use less money to buy each unit of stuff as prices drop.
No I reject the needs of trade doctrine.
I don’t see the backing or non-backing of the bank as determing the PPM. The example you give of the bank buying land is the same example that I used in my article. For the reasons that I give in my article I don’t see the backing of the bank or non-backing as determining the PPM.
As long as the money substitutes issued by the bank are credible as money, they add to the money supply. [MS] “You seem to think that I claim that the money will somehow force itself into circulation”. [RB] My view, which is the Mises/Rothbard cash balance view is that there is no such thing as money being in circulation. All money is at all times in someone’s cash balance. The PPM results from money demand, which is demand for cash balances and demand for goods in money terms. However, money demand and money supply are not unrelated. As the money supply increases, money demand must increase as well, if people are to maintain the same real cash balances.
-Robert Blumen
FFS. Congratulations Mr. Murphy, you’ve just given Mike Sproul enough motivation to keep him peddling his sophistry into perpetuity.
I’m really disgusted with the personal attacks and caricatures of Mike Sproul people use on this discussion. Why is his doctrine something to be belittled and over-simplified, rather than calmly refuted? All these do is make me more interested in studying what he’s saying, because it tells me that those criticizing it don’t have anything of substance to argue with.
I’m guessing you like banging your head against brick walls.
Robert Blumen’s rebuttal is not calm? It’s personal? It relies on caricature?
Where do you see these things happening?
With other commenters?
Some of us have been discussing these things in these comments with Dr Sproul literally for years. His modus operandi is generally to go round and round and round, without addressing (much less rebutting) specific points. It’s a parlor game with him. His premises keep shifting, reasonable questions are not answered directly, the terms of words change their meaning, and the same irrelevant points get repeated over and over as though they are substantive and on point.
I love discussing topics with people who disagree with me. That’s how I corrected every major error in my thinking I have ever encountered. I would love to correct even more of them, whatever they may be, but I can’t identify my errors until I or someone else discovers them with sound reasoning. Until that happens, I have to conclude that I am correct, as we all do.
I see you ignored 2/3 of my posts above (I admit, the first one was a cheap joke).
Sorry, I wasn’t claiming that every message or the blog posting had attacks, just that there were several in this thread. I don’t know about others, but a discussion with several personal attacks on someone mixed in is not enjoyable to read, even if many of the posts don’t contain any attacks. It was this that prompted me to comment on it. J. Murray, I appreciate your posts in this thread and others. Phinn, thank you for your response, and summing up the problems you’ve had with Mike Sproul’s responses.
No; I don’t have a desire to read many messages of people putting other people down so meanly. It brings me down, no matter who is being put down, and makes me have little desire to read these blogs. I come here to read about and discuss economics, not for name-calling. If you’re annoyed at dealing with Mike Sproul, then say that. It doesn’t require putting people down to describe the experiences you’ve had or the lack of productive discussion with him. That is informative to others who may want to avoid a similar experience.
The truly sad thing is, that there *are* genuine Real Bills, of course not those peddled by Mike. Because of all the noise the signal has little chance to get through. Shall we try?
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Ok, so how money comes into being? And when there is some money in use, what selects the amount of it? Why, Mises answers that one for us: when need arises, people choose originaly non-monetary things, suited for indirect exchange better than anything else available to them. He spelled out neccessary conditions for good money candidates: durability, divisibility, scarcity, initially in use for non-monetary purposes. This normally brings up gold and silver, but e.g. in prison it can select cigarettes.
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Now there are these little pieces of paper, called invoices. After delivering goods, merchant is left with a signed piece of paper, clearly stating who and when will deliver real money as his part of the
deall. How much is such paper worth? Well, $0 if the counterparty is a fraud, but almost face value if the other side is any good and the payment date is near.
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It comes almost as an insult when *Austrian* economists dismiss suggestions about monetary use of invoices, just because they are made of paper. So what? The only real economists on the planet should know better about limits to their own power. They should know they are too weak to dictate what will and will not be selected as means of exchange (money). Talking here about a special kind of privately issued credit, which is able to provide valuable short-term flexibility and has built-in self-liquidation feature, they should give invoices a chance.
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I mean, bust Mr.Sproul for what it is worth, I’ve had my share of “discussions” too. Just please note there is a real historic thing called Real Bills.
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On the other hand, if the opinion is all the Real Bills are bad, and e.g. those from the works of prof. Fekete are similar nonsense as the ones debunked here, I’d be interested to hear why. Recalling the invoice example mentioned above, I would be glad to learn about what issues with them being used as means of exchange can be uncovered by mises.org readers.
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Austrians don’t reject paper. What Austrians reject is a legal tender. If I, a vendor, should not want to accept that paper invoice as trade, I should not be forced by some outside agency to accept it under threat of legal action. Should both parties accept the invoice, either with a risk discount or at face value, it’s perfectly acceptable.
Where Austrians distrust paper is if it is unbacked by any asset (Federal Reserve Note) and expected to be treated as if it was no different than the commodity the bill represents, or written in vagueries ($20 worth of land).
The Real Bills system presented by Mr. Sproul falls under the vagueries aspect that Austrians distrust. Trading away $200 in bills for $200 “worth” of some item that isn’t the commodity in the exact weight and value (metallurgically speaking) of the unit of currency is a recipe for disaster.
There are three levels of pricing with subsequently decreasing reliability between them.
First one is the sale price. This is the only reliable measure of value, even though it only applies to the parties involved in the transaction.
Second one is the market price. This one is an estimation using a large number of prior and recent transactions. The actual selling price will become more and more unreliable the further away temporally the snapshot market price becomes.
The third and final is the appraised price. This is just some individual’s “gut check” on what it will sell for. This is what is used when historic transactions are either too few to generate a market price or so far in the past that attempting to use history is functionally worthless.
Real Bills, or any other non-primary commodity alternate using a measurement of a specific alternate commodity will only be good for one specific individual at one specific moment in time. Change either one and the “value” no longer matches with what was deposited to match the paper note being issued.
Real Bills is, in essence, price fixing. At no point in history has a fiat-set price ever done an economic system any good. All it does is promote gaming and jockeying to get a profit at the expense of the other party. We saw quite a bit of it when the United States attempted to force a bimetallic system using both gold and silver as legal tender and hard-fixing both a specific weight in silver and gold as the defined Dollar where. Like in a world where an inch is legally defined as both the length from the middle of your thumb to the base of the thumb and the tip of the thumb to the base of the thumb, people played with the distortions between the value of the two metals. Everyone paid off debts with the undervalued Dollar (let’s say Silver) and demanded payment be received in the overvalued Dollar (Gold). Banks went bust as customers demanded their deposits in silver be remitted in gold. Basically, attempting to set the price between the two instead of choosing only one metal to be called the Dollar and allowing the other to be traded on a weight basis caused chaos.
The same would happen if we allowed a bank to produce a note denominated in $50,000 in exchange for an acre of land. Such a system would be inherently biased toward one party or another. If the customer can exchange anything he pleases, he would exchange a good or commodity that rapidly devalued. I would offer computer hardware as the collateral when taking out loans. I could purchase $3,000 in computer hardware, take out a $3,000 loan, and after failing to pay back the loan, the now devalued PC, which I still got to enjoy, is offered up in exchange for the currency. I got a free PC rental out of the deal.
If it is flipped the other direction, and only physical land can be offered, the bias will typically work in favor of the bank as the owner is expected to offer up an appreciating asset in exchange for a non-appreciating bank note. This would create incentives for banking institutions to offer teaser rate loans and other types of lending activity that we’ve seen over the past few years up to land owners, hoping some would default so they could profit off an appreciating asset.
Real Bills is a bad idea because of the ability for banks to administer notes redeemable in silver coins for other assets and act as if they’re permanent equivalents. Nothing is ever permanently valued in the same proportion to some other commodity on the market.
Hey, another fun discussion about RBD–this could be good, if you don’t mind running around in pointless circles or untying Gordian knots.
Ireland,
Money is THE medium of exchange, not a means of exchange.
You must be so confident in the acceptability of money to a stranger in exchange for an unknown item in an uncertain future that you will hold money for that purpose.
Regards, Don
Mr. Blumen has everything in his article, but I think it would clarify things to emphasize marginal utility. Marginal utility, in my dumbed down world, means that the value of anything will fall as the supply increases. So, more money means that money will become less valuable. Consequently, prices will rise unless something else happens to off set the loss of value. For example, a free market economy increasing the available goods and services will, again because of marginal utility, add value to money (increase purchasing power), which would tend to make prices fall generally (other things being equal). May I add that calling something a law does not make it true.
Wikipedia is useless. If you look at any “discuss” page, you will discover that all decision-making is in the hands of bullied teenage rejects. With all the stuff they keep cutting out due to narcissism and infighting, there are so many other Web sites with loads more information on a topic.
Save yourself the aggravation and keep Mises.org the most “notable” and “verifiable” source for Austrian economics, rather than putting your trust in economists without a high school diploma.
Mike Sproul is the Roman Polanski of monetary economics.
I guess banks could *try* something like what Mike_Sproul has proposed, but in competition with a bank that has a full silver reserve, I’ll take the latter.
A Sproul bank promises that my dollars will be redeemable for, *at most* the value of 1 oz. of silver each, and less if the loans don’t quite work out. If its non-silver assets become worth less than silver, tough luck.
A full-reserve bank promises that my dollars will be redeemable for *exactly* the value of 1 oz. of silver.
Hm, I think I’ll go with the full reserve, and let the other loons debase their dollars by trying to scramble to sell a loan for 200 oz of silver when most actual silver is locked up in the full reserve banks…
Silas:
The 100% reserve bank promises at most 1 oz., unless the bank is robbed. The bank also charges storage fees.
The fractional reserve bank promises at most 1 oz., unless the bank is robbed, and unless the bank’s assets (including the paid-in capital of the bank’s owners) falls below the value of the money the bank has issued. The bank also pays interest instead of charging storage fees.
Over the course of centuries, fractional reserve banking won.
Fractional reserves “won” because they were dictated as a de-facto system by the governing authority. Without entities like a Central Bank and government bank insurance, fractional reserve banks would lose and lose badly. All it would take is one bank run and all you would have left are full reserve banks. I would prefer paying for storage instead of renting back credit that the current system works under. I don’t own the contents of my bank account, the bank does. Paying a fee on something I own is better than giving up all my cash-based holdings and getting a promise on something I don’t.
In several centuries of fractional reserve banking, there has been at least one bank run. It (they) did not leave us with full reserve banks, even before there was such a thing as deposit insurance and central banks (which I oppose, by the way).
The BRD has been the philosophy of the Fed since its inception.
“The BRD has been the philosophy of the Fed since its inception.”
If not its philosophy, definitely its policy.
No inflation here!
Robert:
“[E]conomists all recognize that if GM stock is currently selling for $60 per share, then GM can issue 1 new share, sell it for $60, and there will be no change in the price of GM shares, since assets will have risen exactly in step with the number of shares issued.”
This would imply the if GM did a 2 for 1 stock split, that the price of GM would remain at $60? (As opposed to starting up the next trading day a $30. If this were not the case it would create an arbitrage situation – people would buy 1 share at $60 before the split and then sell 2 shares at $60 the morning after the split and make a risk free profit of $60.)
Please explain.
Thanks,
Walt
BTW – another good article.
TANSTAAFL
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