1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar
Source link: http://archive.mises.org/8194/taking-money-back/

Taking Money Back

June 13, 2008 by

To save our economy from destruction, wrote Murray Rothbard, and from the eventual holocaust of runaway inflation, we the people must take the money-supply function back from the government. Money is far too important to be left in the hands of bankers and of Establishment economists and financiers. To accomplish this goal, money must be returned to the market economy, with all monetary functions performed within the structure of the rights of private property and of the free-market economy.

FULL ARTICLE

{ 128 comments }

newson June 20, 2008 at 11:26 am

mike sproul says:
“Supply and demand curves are useless in this case, and if you remember your basic economics, you’l remember that supply and demand curves are always applied to commodities, not claims to those commodities.

but arbitrage means that the supply/demand curves fo the derivatives must be the same shape as the underlying, adjusted for the conversion/delivery costs. paper may trade at a premium to physical by way of convenience etc.

futures and share markets operate along supply/demand lines, with technical trading preoccupied with this element, and less on the fundamentals (backing, if you like).

Alex June 20, 2008 at 11:43 am

jp:

You said: “While I don’t think Mike has all the pieces in place it would seem hard for Austrians to ignore his points about the asset side of central and commercial banking, and how this determines the value of the money liabilities these banks have issued.”

The monetary base (the liabilities of the central bank) control the money supply, regardless of the degree of fractional reserve commercial banking. So, it is most important to focus on this base to understand how the government, through, a central bank causes increases in purchasing power and hence increases in prices. Again, to repeat my example above:

Wouldn’t I love to create a central bank of Alex, print up some Alex bonds, put them on the Alex central bank’s balance sheet and create an equal deposit account on the liability side, and then start spending this deposit. Of course no one would accept my cheques written on the central bank of Alex, but this is precisely what the government does with regard to central banking, and government cheques are accepted, because government money is legal tender.

Mike Sproul June 20, 2008 at 12:25 pm

All:

Sorry I’m going to fall even farther behind on blogging. Summer school is starting and I have young minds to corrupt with my real bills views.

Also, I’ll be busy setting up the central bank of Mike. I’m going to buy $100 worth of groceries from my local store and pay for them with 100 mike dollars, each of which has my signature, and my promise to deliver 100 green paper US dollars to the possessor on demand. The grocer will spend those mike dollars getting his car fixed at the local mechanic. The mechanic knows me, so he’ll accept them. The mechanic will use them to pay his plumber, who also knows me. The plumber will pay them to a bricklayer, who will pay them to a carpenter, etc. The carpenter happens to need $100 worth of economics tutoring, so he’ll pay me those mike dollars for the tutoring, at which point I’ll burn them. But you’ll notice I didn’t have to maintain physical convertibility of those mike dollars–I never paid any green dollars, but I didn’t defraud anyone either. In fact, I didn’t do anything any different from what the federal reserve does. I think I’ll print up another batch and use them to buy US government bonds!

jp June 20, 2008 at 1:28 pm

Fusgerm,
On second thought, it seems more to me that Austrians do consider a bank’s balance sheet. But they focus on the liability side, specifically the growth in money issued. They assume that the asset side is empty – ie. that liabilities are unbacked. The only item Austrians will admit to the asset side of the balance sheet is gold, maybe silver.

Mike Sproul talks about the asset side of the balance sheet a lot and he is willing to admit bonds and other financial assets, not just gold, onto the asset side. A favorite of his is houses. All these are collateral and show up on the bank’s asset side.

Austrian’s don’t like this since bonds are less real than gold and, being debt, can be created ad-infinitum. Therefore they maintain that bonds shouldn’t be granted entry to the asset side of the balance sheet. With an empty asset column, everytime a bank creates more money liabilities it seems to be doing so out of nothing ie. with out assets to back it up.

I think Mike does deal with the cashflow side of things. When there’s a cashflow problem ie. a bank can’t meet its convertability requirements, bank runs occur and that’s it for the bank. Unless it puts a halt on convertability.

fundamentalist June 20, 2008 at 1:32 pm

If a blip is a claim to 1 oz of silver, then why would it sell for 1.01 oz or .99 oz? Unless I miss something that could only happen under fractional banking in which the bank issued more blips (claims on silver) for ounces of silver than it had silver. In other words, the bank has just 100 oz of silver but issues 1,000 blips, each with a claim to one oz of silver. In that case, prices would rise to match the higher volume of blips and each blip would purchase fewer goods than before. So even though the bank claims it will redeem a blip for an ounce of silver, blips will buy less than an equivalent amount of silver. You mentioned that this would set up an arbitrage situation and you’re right. When people realize they have been defrauded, they rush to exchange blips for either silver or goods. If for silver, bank failures result; if for goods, hyperinflation results.

Some confusion can be overcome by understanding that RBD doesn’t accept the subjective theory of value. RBD clings to the classical idea of intrinsic value: a blip or dollar has a fixed value determined by its backing. Most people debating the subject on this site follow the subjective theory of value.

Another confusion arises because Mike conflates the demand for loans with the demand for money, as many people do. They’re not the same. The demand for money is the demand to hold cash. The demand for loans is that demand by entrepreneurs to borrow money to invest. New money often enters the system via demand for loans.

With those definitions in mind, the supply of money depends upon the demand for loans, generally, which is tied to the interest rate, and the demand to hold cash. As the interest rate falls, demand for loans increase and the money supply increases. However, the demand for loans can fall flat when business confidence falls low enough. In that case, interest rates must fall dramatically in order to entice businessmen to borrow. In some extreme cases, banks can’t lower interest rates fast enough to catch the falling demand for loans. In those cases, the money supply falls.

So using Austrian definitions of value, money and loans, the supply of money is not unlimited, but slopes upward with the interest rate. In other words, banks are willing to make more loans at higher interest rates. The demand for loans slopes downward with respect to interest rates, but shifts up and down depending on business confidence. The mathematical version of the quantity theory makes it seems as if the supply of money could be unlimited, but the Austrian understanding of it shows that the supply is limited by demand to hold cash. As in the case of Germany in the 1920′s, and Zimbabwe today, when the supply of money is sufficiently high above the demand to hold cash, the money system collapses and people fall back on barter.

fundamentalist June 20, 2008 at 1:41 pm

fusgerm: “Mike Sproul isn’t really saying anything very radical. It’s simple book-keeping, basically this: 1. Money is the debt of a bank.”

Yes, that is how banks keep their books. If a bank loans out $10 is does simple double-entry book keeping. But it still doesn’t explain where the bank gets its liabilities, that is the money it loans out. A bank can have reserves of $100 and loan out $900 if it keeps 10% reserves. Where does that money come from? The banks books balance, but they don’t explain where the $900 came from. As de Soto explains in his book, it comes from thin air.

fusgerm June 20, 2008 at 5:19 pm

fundamentalist:
Rothbard called it “thin air”; Keynesians call gold a “barbarous relic”. That’s just name-calling on both sides. Anyone can create a promise out of thin air. Bills of exchange were created out of thin air, centuries ago. And then the market started to use those promises as money…

jp:
Yes, Sproul wants to admit financial assets on to his balance sheet, as backing for his demand-deposits. That works OK except in a liquidity crisis. But the problem is that a crisis is inevitable because the very act of granting loans out of promises instead of savings depresses interest rates and so gives rise to the Austrian business cycle.

Mike’s system would work OK if his money were redeemable. Then banking discipline – the need to prevent a run – would itself constrain credit expansion to very narrow bounds. That’s Mises’ “free banking” solution.

fundamentalist June 20, 2008 at 8:09 pm

fusgerm: “Bills of exchange were created out of thin air…”

Is that name calling, or are you trying to describe an actual fact? Fractional reserve banking allows banks to create money ex nihilo. How is that different from creating it out of thin air?

fusgerm: “Mike’s system would work OK if his money were redeemable. Then banking discipline – the need to prevent a run – would itself constrain credit expansion to very narrow bounds. That’s Mises’ “free banking” solution.”

Of course the free banking system described by Mises would work, but that’s not what Mike is suggesting. And it would work not for the reasons given by RBD or Mike, but for the reasons given by Mises, which are the opposite of RBD.

fusgerm June 21, 2008 at 8:24 am

Fundamentalist:

The expression “out of thin air” is far from neutral. It makes me think of a conjurer pulling a rabbit out of a hat. The connotation is that FRB is a cheap conjuring trick.

The term “ex nihilo” is not much better. It makes me think of an immense deity proclaiming “Fiat lux!”. The connotation is that man is trying to do what only God can do.

Personally I prefer the more neutral expression “monetizing debt” or even Mises’ term “fiduciary media”. I do not recall Mises ever using the phrase “thin air” or “ex nihilo”. Nor did Mises condemn it on any grounds other than economic.

The term is also misleading. If a bank loans money into existence, it records the deposit as a liability and the loan as an asset. Only the balance sheet is affected. That is accurately described as debt-monetization. To say that a bank creates money out of thin air suggests rather that the liability is offset not by an asset but by an expense – e.g. that the bank prints money and uses it to pay wages. That’s probably what “thin air” would suggest to an accountant.

Yes, debt-monetization using discounted bills of exchange is a historical fact, developed by the market with no help or encouragement from central banks. I used the term “thin air” to show how inappropriate the term was.

Mike Sproul is an old rogue who hijacks threads to peddle his heresies. But his papers are well worth reading to anyone who seeks a better understanding of money. And although he believes in free banking for what we agree are the wrong reasons, he is at least a fellow believer in liberty.

Alex June 21, 2008 at 10:04 am

Mike Sproul:

I understand the demands of teaching, having been there, so don’t worry about answering if you don’t have time.

Anyway, you said: “Also, I’ll be busy setting up the central bank of Mike. I’m going to buy $100 worth of groceries from my local store and pay for them with 100 mike dollars, each of which has my signature, and my promise to deliver 100 green paper US dollars to the possessor on demand. The grocer will spend those mike dollars getting his car fixed at the local mechanic. The mechanic knows me, so he’ll accept them. The mechanic will use them to pay his plumber, who also knows me. The plumber will pay them to a bricklayer, who will pay them to a carpenter, etc. The carpenter happens to need $100 worth of economics tutoring, so he’ll pay me those mike dollars for the tutoring, at which point I’ll burn them. But you’ll notice I didn’t have to maintain physical convertibility of those mike dollars–I never paid any green dollars, but I didn’t defraud anyone either. In fact, I didn’t do anything any different from what the federal reserve does.”

You just engaged in a multi-step barter transaction, which is a heck of a lot different from what the Federal Reserve does. Ultimately, you redeemed your I.O.U.s buy giving tutoring services. The Federal Reserve does not redeem its I.O.U.s and never intends to. As I explained earlier, when the Fed engages in a short run monetary contraction, by, say, an open market sale of $100 of government bonds from its portfolio, at that point the Fed is redeeming $100 of its I.O.U.s. The simplest way to think of it is to have the public pay for these $100 bonds by currency. In this case, the Fed’s liability for currency outstanding falls by $100. The public now has a $100 bond which will pay interest and be redeemed. Note that this action also means that the government will have to raise taxes to finance the interest payments and bond redemption, whereas the government doesn’t as long as the bond is on the balance sheet of the Fed. But, as I say, such Fed open market sales of government bonds are, over time, swamped by Fed purchases of government bonds, and thus the Fed’s government bond portfolio grows, and grows. [In practice, of course, the $100 government bond sale by the Fed would see the Fed receive checks drawn on commercial banks and the Fed's liability that would be reduced would be commercial bank deposits rather than the Fed's currency liability.]

Mike Sproul June 21, 2008 at 11:14 am

Fusgerm:

I would have preferred “pioneer” to “old rogue” and “corrects monetary fallacies wherever he finds them” to “hijacks threads to peddle his heresies”, but at least you’re doing your part to correct the misuse of the “thin air” description of money.

Alex June 21, 2008 at 12:35 pm

Mike Sproul: The reason I focused solely on the Fed, rather than bringing in the commercial banks to money creation, is that everyone should agree that creating money out of “thin air” is certainly what the Fed engages in.

Alex June 21, 2008 at 12:36 pm

Correction: The Fed creates money out of hot air.

fundamentalist June 22, 2008 at 10:22 am

fusgerm: “If a bank loans money into existence, it records the deposit as a liability and the loan as an asset. Only the balance sheet is affected. That is accurately described as debt-monetization.”

Your linguistic gymnastics are impressive! But with FRB the fact of the matter remains that at point A in time, only the cash reserves of the bank existed as money, while at the later point B, 9 times as much money exists. Yes, modern accounting practices make it look legit. But someone has to answer the question, where did the extra money come from?

You write that the bank “loans” money into existence. Doesn’t that require that the money not exist before the loan? And isn’t “not existing” the same thing as “nothing”? Maybe you have a different definition for “exists” than I do. If banks didn’t create money from nothing, ex nihilo, out of thin air, then banking would be nothing more than a transfer of money from one person to another, and it clearly isn’t that.

I’m afraid you get a rash from my terminology because it lays naked the reality of FRB.

TLWP Sam June 22, 2008 at 10:55 am

Egads fundamentalist! Is it turning into a circular argument? Apparently money comes from somewhere but where? Gold likewise is ‘out of thin air’ in that more gold simply inflates the existing supply. Did the gold miner ask people if they needed more gold? Who cares how much effort went in per ounce – more gold equals gold inflation. Perhaps the only difference is gold is an international currency whereas as most currency are national. Apparently the only around this is to say welll people are going to inflate the currency anyway (whatever it happens to be) so let’s use gold coins as the fortunes of gold mining are rather random relative to anything else yet.

Mike Sproul June 22, 2008 at 3:16 pm

Alex:

Some elaborations on the central bank of Mike:

I’ll start by printing up 100 mike dollars, on blue paper, each of which says “IOU 1 green paper US dollar anytime, except nights and weekends, and subject to a 1-day delay when daily demands for redemption exceed $10.”

I’ll spend tham at the grocer, who spends them at the mechanic, etc. I’ll keep 10 green paper US dollars on hand at all times to redeem them, and if there is a run, I’ll keep other assets (at least $90 worth) on hand that I can sell on one-day’s notice, either for green dollars or for blue (mike) dollars.
Then one day at the grocery store, I’ll offer the grocer 200 mike dollars in exchange for a US government bond that he’s been trying to sell for $200.
Eventually, I’ll stop paying out green dollars. I’ll only pay out $1 worth of my bonds for each mike dollar, if anyone asks. This will work fine, until the day that 200 mike dollars get redeemed at once, which would use up my bonds. If that day ever comes, then I will have to resume paying out green dollars, or else my mike dollars will lose value.
You might think I’ll make a profit because I earn interest on the bonds, while I don’t pay interest on the mike dollars. I doubt it. I think the cost of printing and handling will burn up my interest earnings. If they didn’t, I’d quickly find rivals who want to issue ralph dollars, joe dollars, etc, and they’d offer interest on their dollars, do I’d have to do the same.

Sometime before I die, I’ll have to square up with everyone, unless I sell my bank to someone else, who continues the same practice indefinitely. No doubt my descendents will have to listen to fundamentalist’s descendents, insisting that mike dollars are created out of thin air.

fundamentalist June 23, 2008 at 7:57 am

TLWP: “Gold likewise is ‘out of thin air’ in that more gold simply inflates the existing supply.”

Gold exists in the ground before the miners discover it. In fact, the production of gold is the result of someone’s savings, because someone had to save the money at some time that sustains the miners digging for the gold. The gold the discover and refine is the result of savings mixed with labor.

However, in FRB the new money literally comes out of nothing. Nothing was discovered. No labor or savings was required to produce it. You can have FRB with a gold standard. FRB under a gold standard started happening around 600 years ago in Italy. They didn’t even use paper money. The gold dealers would just add an entry to the account of a client. Because people trusted the gold merchants and used his books to settle accounts, the accounts acted like gold and produced the same effects as an increase in the supply of gold–price inflation, bank failures and recessions.

TLWP Sam June 23, 2008 at 8:41 am

I don’t care if gold is produced at a loss or suppose some rich nutter blows his fortune via extracting gold from seawater and floods world with new gold – gold is going to get hyperinflated, period. It’s akin to a collectors paradox of sorts: ‘the really valuable baseball cards were mass produced and boys of the era owned them yet only a few kept any let alone in mint condition hence these cards are valuable, but if the boys of times past had known about this and they all kept the cards, the cards wouldn’t be valuable now’. It would said when the Spanish Conquisadors sent gold back from South America those who first received the gold could spend at low prices before others caught on and the last to hear about the new gold suffered and so on. Gold got inflated and people had to adjust – ooops tough luck for some! As I said before, and what people have also said, gold is unlikely to be mass recovered any time too soon. There could be more sudden mass discovery sites, economic seawater extraction might become economically feasible, true space travel might happen, economic gold transmutation might be discovered and monkeys might fly out of my butt. People here have pointed out, time and time again, that money from paper sources, base metals and electronic could be hyperinflated on whim therefore precious metals coins make for the obvious option. I’m sure people here have also stated that gold, silver and platinum/palladium isn’t theoretically immune from the forces of hyperinflation but are very extremely unlikely without Star Trek-style technology. I just thought M. Sproul and fusgerm did make an interesting point about a type of open money being made via double-sided bookkeeping whereby the person get an asset and the issuer gets a liability therefore inflation might not occur as opposed to adhering to a precious metal standard and place faith there is neither finds nor losses (I wonder what happens when a ship carrying gold gets sunk on the way? Sudden losses? Deflation?).

jp June 23, 2008 at 10:45 am

“Gold exists in the ground before the miners discover it. In fact, the production of gold is the result of someone’s savings, because someone had to save the money at some time that sustains the miners digging for the gold. The gold the discover and refine is the result of savings mixed with labor….However, in FRB the new money literally comes out of nothing.”

A bullion vault that stores gold on behalf of clients without lending it out prints the client a certificate. This certificate circulates as money. Didn’t the vault owner create the certificate out of thin air too? It took him almost no time or effort, just a few strokes of his pen. Isn’t this a case of new money coming from nothing, no savings and no labour required, just like FRB?

TLWP Sam June 23, 2008 at 9:35 pm

Interesting point jp.

P.M.Lawrence June 24, 2008 at 12:13 am

In JP’s scenario, gold is withdrawn from circulation as certificates are issued and released as those are withdrawn, all in step, so no money is created or destroyed using thin air.

When Spanish bullion arrived there was indeed a range of inflationary effects (mostly from the silver as it was the main monetary medium in those days), but it wasn’t hyperinflation. Money didn’t lose its ability to transmit price signals, but people with resources tied to nominal values lost out and a few other things happened that mattered because of cumulative effects. Broadly, Spain lost infrastructure and countries like Poland and Turkey at the end of the transaction chain exported commodities for depreciating money, while middleman countries like England and Holland gained capital investments and infrastructure.

TLWP Sam June 24, 2008 at 1:11 am

But wasn’t that M. Sproul and fusgerm were implying? That there should be a liability created along with the asset. Just as it would be to say for the gold coin & certificate – if the issuer treated the gold certificate as money and the coin as money then the issuer would have gained an asset and issued an asset therefore the system would break if the issuer collected the gold coins and turned around and spent them too. If the banker was being genuine in saying that the paper money is an asset and the gold coin is a liability to the issuer then things should be okay. But still money has to initially come from ‘somewhere’. The issue is can new money be genuinely created in step as not to be inflationary as M. Sproul implies or does money have to be something like gold and hope the new gold will always be a trickle and cause virtually negligible effect?

Mike Sproul June 24, 2008 at 10:46 am

I think everyone agrees that coining bullion into gold coins does not affect the value of gold or of coins. If excess coins are minted, people will just melt them into bullion. The Law of the Reflux assures that excess coins will reflux to bullion. Of course it’s better still if people trade with 100% reserve gold certificates, since they are handier than gold for exchange. Now, of course, people could use bushels of wheat as money too, and if a bushel were stamped into a (very large) wheat coin, then that wheat coin could, in principle, circulate side-by-side with gold, with excess wheat coins refuxing to the wheat market. In this case, 100% reserve wheat certificates would also be a great improvement over the wheat coins. Again, there should be no price effects from the issue of these wheat coins Now make just one change: Let the wheat certificates be denominated in gold. Now part of the certificates are backed by gold, and part are backed by wheat. We have changed to fractional reserves just by changing the denomination of some of the certificates. If you believe that this system is no more inflationary that the gold and wheat certificates circulating side-by-side, then call yourself a real bills’er. If you think that the mere change of denomination would cause inflation, call yourself a quantity theorist.

jp June 24, 2008 at 10:57 am

PM:
I was trying to point out that Fundamentalist’s critique of FRB as being based on “thin air” can be turned against good old fashioned gold warehouse banks that issued receipts to depositors. After all, these receipts come from “thin air”, didn’t require savings or sweat or labor on the part of the issuer, etc.

That leaves Fundamentalist uncomfortably criticizing money certificates (ie 100% backed warehouse receipts), something Mises would have frowned on. Looking through the past comments Mike Sproul called him on that several times.

I agree with Fusgerm on this. It would be interesting to hear a critique of FRB that avoids phrases like “out of thin air” and “money out of nothing”.

Joe Stoutenburg June 24, 2008 at 11:34 am

You can call me a real bills’er to the extent that I accept that money may be backed by anything that people are willing to allow (including gold, real estate and financial assets representing claims to real assets). I have a number of remaining doubts and criticisms.

1) I’m not completely convinced that our banking system is backed by real assets. I’m starting to drift toward being able to accept that government bonds are claims on real assets. If I accept that, I will still object to our monetary system on the grounds that the assets backing the money was posted coercively. It remains a wealth transfer as the quantity theorists claim but not for quite the reasons that they offer.

1a) It is worth conceding that there is no wealth transfer if collateral is voluntarily posted.

2) Because the market for bank collateral is hardly a free market (being composed primarily of claims on tax collections), I highly doubt that the value of the collateral is well reflected. If I’m not mistaken, you have conceded that inflation may occur if the monetary backing is proven to not be worth what it had been thought. (Am I correct?) It seems to me that there is not necessarily inflation as long as the collateral has value and that the money is used to purchase new products. You seem to come off as saying that inflation can not happen under RBD.

2a) In any case, if you concede that inflation can and has occured in our monetary system, you’ll make some headway. If you don’t, then you and I remain apart in opinion.

3) From your explanations, I fail to see the necessity for the Federal Reserve under a free market RBD monetary system. It seems that its primary purpose is to monetize government bonds. Because those bonds represent promises to steal, I can still find no reason to support the Fed’s continued existence.

Joe Stoutenburg June 24, 2008 at 12:10 pm

A few other comments came to mind (I’ve been writing this off and on during the morning).

4) I still find fault with your insistence against inflation in RBD. Relatively speaking, given the same amount of goods, prices will be higher when there are more dollars offered against those goods. The problem I think, may be that some people tend to reverse causality. They say that the new money caused inflation. In a free market RBD money system, it is demand that brings the new money into existence.

To illustrate, borrowing under a gold standard would require you to locate someone who already owned gold and offer to pay interest for the use of the money. In this arrangement, collateral may or may not be required depending upon the level of security desired by the lender. If the pool of goods increases faster than the supply of gold entering the money system, prices will tend to go down.

Rather than borrowing existing money, you might instead offer property as collateral to back new money. In this arrangement, the posting of collateral is vital in order to keep the bank solvent. It’s unclear to me whether inflation would result generally though it clearly could occur in the markets toward which the new money was directed.

5) Though I may accept the legitimacy of free market RBD (as contrasted to the system currently imposed), I still would not advocate a system without a predictable money supply. It seems like RBD claims that what constitutes money may continually change. And while money may indeed need to change from time to time, I don’t see the value of encouraging it to change continually. It seems that this kind of institution would only encourage fraud in the banking system as bankers attempted to introduce more and more questionable collateral to back their money.

P.M.Lawrence June 24, 2008 at 8:43 pm

TLWP Sam wrote “But wasn’t that M. Sproul and fusgerm were implying? That there should be a liability created along with the asset. Just as it would be to say for the gold coin & certificate – if the issuer treated the gold certificate as money and the coin as money then the issuer would have gained an asset and issued an asset therefore the system would break if the issuer collected the gold coins and turned around and spent them too. If the banker was being genuine in saying that the paper money is an asset and the gold coin is a liability to the issuer then things should be okay. But still money has to initially come from ‘somewhere’. The issue is can new money be genuinely created in step as not to be inflationary as M. Sproul implies or does money have to be something like gold and hope the new gold will always be a trickle and cause virtually negligible effect?”

The whole point of a bullion standard or similar is that it keeps the issuers honest. Of course an all wise and all good government could indeed arrange for “new money [to] be genuinely created in step as not to be inflationary” (although that still gives them a windfall “inflation tax” from eating up the deflation of a growing economy, one that a wise and good government would invest or use to pay off debt rather than simply spend). But to state that is to highlight the importance of keeping them honest; the issue is not as you supposed whether an honest lot can do the right thing but what keeps the real lot honest in the first place. In this sense, bullion is just a real bill backing that it is a lot easier to keep honest.

Mike Sproul wrote “I think everyone agrees that coining bullion into gold coins does not affect the value of gold or of coins”. Well, no. There is always seigneurage, corresponding to the real and actual growth that is released by having a monetary medium, that would be held back by the lack of it. In the very beginning days of a cash economy this can be quite large (think Midas or Croesus of Lydia), but in a mature economy it averages a small percentage. This is the “somewhere” that money comes from that TLWP Sam asked about in “But still money has to initially come from ‘somewhere’” – it’s a match to the accumulated seigneurage, and with any real medium like bullion a lot happened when it first got monetised. From our point of view, it’s simply brought forward from some earlier stage.

“Now, of course, people could use bushels of wheat as money too, and if a bushel were stamped into a (very large) wheat coin, then that wheat coin could, in principle, circulate side-by-side with gold, with excess wheat coins refuxing to the wheat market. In this case, 100% reserve wheat certificates would also be a great improvement over the wheat coins. Again, there should be no price effects from the issue of these wheat coins Now make just one change: Let the wheat certificates be denominated in gold. Now part of the certificates are backed by gold, and part are backed by wheat. We have changed to fractional reserves just by changing the denomination of some of the certificates. If you believe that this system is no more inflationary that the gold and wheat certificates circulating side-by-side, then call yourself a real bills’er. If you think that the mere change of denomination would cause inflation, call yourself a quantity theorist.”

This is leaving out a whole load of stuff, from carrying cost and risk. There is a contingent liability that’s not being reckoned up. Everything is plain sailing until one day the cupboard is bare because some disaster has hit the granaries, e.g. a mouse plague. Then you find your loss realised in the form of inflation.

JP wrote ‘PM: I was trying to point out that Fundamentalist’s critique of FRB as being based on “thin air” can be turned against good old fashioned gold warehouse banks that issued receipts to depositors. After all, these receipts come from “thin air”, didn’t require savings or sweat or labor on the part of the issuer, etc.’

But, they did require the gold to be lodged. That’s the point; it’s not whether the issuer had to make a sound backing but whether someone had to.

‘I agree with Fusgerm on this. It would be interesting to hear a critique of FRB that avoids phrases like “out of thin air” and “money out of nothing”.’ Easy – it’s whether the real bills are real that makes the problem. The difficulty is like a roulette system that says “bet red when it’s about to come up red and black otherwise”. It’s not whether the trick works but whether you can do the trick. In the early days of an attempt at real bills it usually does work, partly because the underlying value hasn’t yet hit serious problems, partly because you aren’t yet loading it too hard, and partly because you can ride out minor problems by growing the overhang a bit more – all of which leaves more exposure later. In one sense all a bullion system is doing is insisting on a real backing of very high quality so as to minimise these risks, but it still can’t abolish them (think what happened to the value of bullion money in cities under siege). But real bills are a standing temptation for getting in too far and having bills that are not real while kidding yourself that they are (subprime, anyone?). Someone in that position can ask quite seriously what is wrong with his real bills theory and still not get it that his problem is that they aren’t real, and that he was always going to get into that bind sooner or later on some day of reckoning. The difficulty with the theory isn’t in the reasoning but in the premises – which are often near enough true to begin with to get you into trouble later, like a motorcycle with enough power to get you up to dangerous speed but not enough to accelerate out of a dangerous situation once one comes up. This pretty much answers Joe Stoutenburg by confirming his early suspicions, too.

Joe Stoutenburg June 24, 2008 at 9:57 pm

The more I follow this discussion, the more I am reminded of the subjective nature of exchange. As long as exchange is voluntary, lovers of liberty should have no objection (though they may criticize some actions as unwise). Thus, I can give qualified approval of a voluntary banking system of RBD and object to the very existence of government bonds (since they are ultimately backed by theft).

Still, I believe that it is prudent to remember that not all people are forth-coming in exchanges. And the more wealth involved in transactions, the more fraud will be attracted. For this reason, we would be wise to keep our bankers on a tight leash. While there may be nothing intrinsically wrong with RBD, I wonder whether fraud may possibly be kept at bay. Heck, it might be a hard enough task to assure that banks have enough gold in the vault under a 100% gold standard. Are we to expect that the public (especially the current economic illiterate public) can really assure that the backing is real on uncountable numbers of IOUs?

Comments on this entry are closed.

Previous post:

Next post: