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?

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.

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.

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.

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”.

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.

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?

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.

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.

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.

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.

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.]

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.