I was reading a debate between two people who disagreed on whether fractional reserve banking was bad. I wanted to get to the root of why it is bad. Would it be correct to say it's only bad to the extent that it requires the central bank to print more money to meet redemption requests? For example, if I deposit $100 in a bank that lends $90 of it to someone who spends it on a product and the seller of the product then deposits the $90 in another bank, as long as I don't redeem my deposit before the loan is repaid, the central bank doesn't have to print money and lend it to my bank in order to repay me, right? Or is this an impossible situation because the loan cannot be repaid without some sort of monetary expansion in order for the borrower of the $90 to cover the interest that accrues on the principal? Thanks!
No, you need to go back to the origin of money. Money is the most widely exchangeable good. People accept gold as the medium of exchange because it is widely desired. Paper isn't. The current system treats money as backed by debt, which is to say future promises to repay in terms of... more paper money. So the current system is by no means analogous.
-Jon
I cannot be caged. I cannot be controlled. Understand this as you die, ever pathetic, ever fools.
Irenicus' Diaries.
Thanks,
Incidentally i have never understood what currency represents. If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me.
Perhaps i have misunderstood you, but if a 'non backed' bank note represents a future promise to repay with another 'non backed' bank note, then surely a bank note represents its own value, and not some particular underlying physical asset.
In the same way that a gold coin is 'non backed' in that it represents itself, and not some particular underlying asset.
Surely, in neither system can inflation occur via FRB alone, assuming of course, that in the case of the gold system that gold promisory notes, and gold receipts for the same bar of gold as well as the bar of gold itself are not in circulation simultanously. In the case of non-backed paper currency, this situation surely cannot arise, since the 'valuable' paper is traded directly and isn't represented for a second time in 'higher level receipt currency' in circulation (apart from say cheque book money that would bounce if the situation occured).
In neither system is there some underlying asset being represented more than once by the currency.
perhaps i should do more reading because I still remain confused and unconvinced.
confuse a cat: Incidentally i have never understood what currency represents. If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me.
Here is the advantage of gold as money over paper as money.
Right now, the price of gold is $920/ounce. If you offered to swap me 46 Federal Reserve Notes labeled '$20' for an ounce of gold, I'd say "fair trade", either way.
Two years from now, suppose the price of gold is $1500/ounce. If you then offered to swap me 75 Federal Reserve Notes labeled '$20' for an ounce of gold, I'd say "fair trade".
What happened? Did your gold magically become more valuable? Or, did someone print more pieces of paper, driving down their value?
As another example, suppose you offered to trade me 0.3 ounces of silver for a gallon of gasoline. Right now, that's pretty close to a fair trade. If you attempt the same trade two years from now, it will probably still be reasonable. Do you expect to be able to buy a gallon of gasoline for $5 two years from now?
Gold and silver keep their purchasing power over time, but pieces of paper do not. The people who print the pieces of paper like printing more of them and giving them to their friends. That's a pretty sweet scam they're running! However, you can't just print more gold and silver.
Money supply inflation is literally stealing the purchasing power out of your pocket and bank account. The nominal value of your money stays the same, but the amount of wealth it represents decreases.
I have my own blog at FSK's Guide to Reality. Let me know if you like it.
Really nice post. I'm constantly looking for ways to better explain inflation to people!
I'm hesitant to call it "money supply" inflation though. I usually say monetary inflation, but have been trying to put a stop to it. It is inflation, pure and simple. Peter Schiff debunks the notion of price inflation pretty convincingly in Crash Proof.
It's also counterfeit, which is illegal. It is illegal if you do it, if I do it, or if anyone else besides the government does it. Which if the act is wrong, how can it be right when done by government? That's illogical. A lot of people respond strongly to that point. Why does the government get to do what we would be jailed for doing ourselves?
I would make a great bureaucrat. Wanna see? Click here. It's fun.
liberty student:I'm hesitant to call it "money supply" inflation though.
Assuming the velocity of money is constant, money supply inflation and price inflation occur at the same rate. Due to asset bubbles, price inflation is not uniform.
If you want a true picture of inflation, look at commodities with relatively inelastic supply and demand, such as oil and gold. That's the reason energy is excluded from the CPI. The price of oil rises very nearly in lockstep with money supply inflation.
Most people remember that they used to pay $10 for a full tank of gasoline. They probably don't remember what a loaf of bread used to cost.
confuse a cat: Incidentally i have never understood what currency represents. If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me Perhaps i have misunderstood you, but if a 'non backed' bank note represents a future promise to repay with another 'non backed' bank note, then surely a bank note represents its own value, and not some particular underlying physical asset. [...]
Incidentally i have never understood what currency represents. If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me
Perhaps i have misunderstood you, but if a 'non backed' bank note represents a future promise to repay with another 'non backed' bank note, then surely a bank note represents its own value, and not some particular underlying physical asset. [...]
Money always has value independent of its function as money. There will always be plenty of people in the world that want gold just to have it (for jewelery or whatever). That, combined with the fact that gold is durable, fungible, divisible, and portable made gold highly remarketable. This meant that even if you didn't want gold for yourself just to have it, you know that it wouldn't be too hard to find someone who did. This is what made gold serve well as money. Consider that cigarettes have served as money in prisons even for people who did not smoke. Same principle at work. Cigarettes, salt, spices, silver, Persian rugs, tea, sea shells, feathers, etc. have all been highly remarketable goods that have served as money.
Federal Reserve Magic Tokens (FRMTs) are 'backed' by the fact that you need them to pay your taxes. That is, everyone needs to come up with them at tax time. If you don't come up with them, the government will take your stuff away and throw you in jail. This makes FRMTs very remarketable. Without this threat of force by the government, FRMTs would be completely worthless. And indeed, history is littered with fiat currencies that have become worthless. All this stuff about money being backed by debt is an attempt to obscure the true purpose of fiat currency, which is to allow the banks and the government to extract wealth from the economy without the political inconvenience of taxing people directly for it.
confuse a cat: Surely, in neither system can inflation occur via FRB alone, assuming of course, that in the case of the gold system that gold promisory notes, and gold receipts for the same bar of gold as well as the bar of gold itself are not in circulation simultanously. In the case of non-backed paper currency, this situation surely cannot arise, since the 'valuable' paper is traded directly and isn't represented for a second time in 'higher level receipt currency' in circulation (apart from say cheque book money that would bounce if the situation occured). [...]
[...]
Fractional-reserve banking is about allowing a bank to treat debt that it is owed as if it were money that it could spend now. You are correct in that in some weird sense the 'value' of the paper in the case of fiat currency doesn't really derive its value from the debt it supposedly represents because that debt is nothing but more paper.
The true purpose of the accounting system behind fractional-reserve banking is to cartelize the banks. Since FRMTs are created out of nothing, any one bank could in theory create as many of them as it wanted. But this would immediately destroy their value. The purpose of the banking regulations is to allow all banks to create FRMTs as long as they all simultaneously do so at the same controlled rate—a rate that in theory won't completely destroy the economy.
For what it's worth, it's impossible to really understand banking until you entertain the possibility that it is the single biggest criminal activity on earth, because that's exactly what it is: http://mises.org/story/3010
Perhaps i have misunderstood you, but if a 'non backed' bank note represents a future promise to repay with another 'non backed' bank note, then surely a bank note represents its own value, and not some particular underlying physical asset. In the same way that a gold coin is 'non backed' in that it represents itself, and not some particular underlying asset.
Alright, and why would anyone accept pieces of paper for payment, as opposed to actual production? You see, if people actually valued the pieces of paper highly, as is the case with gold, you'd be correct. However, the way the currency arose, the paper money was originally backed by gold, until this link was severed. It was only by government force that the paper could remain in use as money. Money that can be printed at will, that has no real value other than that garnered by the imposition of government force, is disanalogous to a good that is widely desired, is difficult to produce and has value independent of the use of any force. That is the asymmetry between paper money (as it currently exists) and gold qua money.
I've accepted worthless pieces of paper all my life. I never questioned for 32 years whether notes really represented anything, yet it didn't stop me valuing this paper and desiring it more than gold for which i have no use. To me my money is just information about my spending power and nothing more. Of course, if the entire population woke up tomorrow and decided they were no longer going to accept my paper money, for example because they all decided paper money in reality was intrinsically worthless paper and not worth trading, then equally my notes would no longer have any value to me and i'd look for another medium of exchange they desired. But this potential problem with paper currency, albeit unlikely, equally applies with a gold currency i might use.
If money was 'written on' an intrinsically useful medium with real value to industry, say silicon, then surely the money supply would shrink due to consumption of the medium by industry and the price of silicon would also inflate due to its use as coinage? In the past wasn't gold currency really used in the same way as 'non backed' paper currency with the main difference being that its harder for the government central bank to expand the gold supply? (which they still can do, albeit to a finite extent by maipulating reserves in the usual manner). I can see that paper money requires trust in both bankers and the government not to debase the currency and that people don't trust government or bankers or fractional reserve banking. But issuing currency in gold in order to be assured of a fixed money supply is surely going from the information age and returning to the middle ages. Surely the important thing is restoring public confidence in the current financial system. Not returning to gold.
Also, as i asked before, surely the problem with fraudulent banking where receipts are counterfeited can only occur with respect to 'backed' currency where potentially both receipts of an underlying asset and the underlying asset itself can float in circulation simultaneously. Clearly this cannot occur with direct gold trading, but how can this fraudulent duplication occur with non-backed paper money? any paper notes deposited at a bank are removed from circulation and can no longer be spent by the depositor. When he deposits his notes he doesn't get a receipt apart from a number written into his account. To spend the money written into his account, the borrower must first return the money (hopefully with interest). If this wasn't the case and FRB really did create money, why would bank runs occur in the first place? Banks could just lend money to each other indefinitely to create as much money as needed....
Thanks for reading agian, CAC.
confuse a cat:I've accepted worthless pieces of paper all my life.
You're entirely missing the point. People don't use pieces of paper instead of gold because pieces of paper are a better monetary system.
People use pieces of paper instead of gold because State violence prevents them from using other forms of money. Consider what happened to E-Gold and the Liberty Dollar.
It's one thing to say "everyone got together and voluntarily decided to use paper instead of gold as money". It's another thing to say "a handful of people use violence to force everyone else to use paper as money".
For any monetary system based on pieces of paper, the people who print the paper will print more and give them to themselves. Historically, every fiat currency has ended in hyperinflation for this reason.
I never said you aren't free to use pieces of paper as money if you want to. I said that I shouldn't be prevented from using other forms of money. You're a fool/slave for using unbacked pieces of paper as money.
confuse a cat: I've accepted worthless pieces of paper all my life. I never questioned for 32 years whether notes really represented anything, yet it didn't stop me valuing this paper and desiring it more than gold for which i have no use. To me my money is just information about my spending power and nothing more.
I've accepted worthless pieces of paper all my life. I never questioned for 32 years whether notes really represented anything, yet it didn't stop me valuing this paper and desiring it more than gold for which i have no use. To me my money is just information about my spending power and nothing more.
But the fact that other people accept them from you for payment of things clearly means they aren't worthless. Money is not merely a matter of social convention. There are people who want you to think that. There are people who want you to think that a sound and efficient and modern monetary system is about trustworthy bankers and political leaders. But as I tried to explain, Federal Reserve Magic Tokens are, in a very real and concrete sense, 'stay-out-of-jail' tokens. They are not at all "worthless." They merely derive their value from the business end of government guns.
confuse a cat: Of course, if the entire population woke up tomorrow and decided they were no longer going to accept my paper money, for example because they all decided paper money in reality was intrinsically worthless paper and not worth trading, then equally my notes would no longer have any value to me and i'd look for another medium of exchange they desired. But this potential problem with paper currency, albeit unlikely, equally applies with a gold currency i might use.
Of course, if the entire population woke up tomorrow and decided they were no longer going to accept my paper money, for example because they all decided paper money in reality was intrinsically worthless paper and not worth trading, then equally my notes would no longer have any value to me and i'd look for another medium of exchange they desired. But this potential problem with paper currency, albeit unlikely, equally applies with a gold currency i might use.
It is not at all unlikely that you could wake up tomorrow and find that people no longer accepted your paper money. It happens all the time. It's happening now. The dollar has lost almost half its value in the last five years. And there are reasons to think that it will only get worse. Gold, on the other hand, has always had value in the marketplace.
confuse a cat: [...] I can see that paper money requires trust in both bankers and the government not to debase the currency and that people don't trust government or bankers or fractional reserve banking. But issuing currency in gold in order to be assured of a fixed money supply is surely going from the information age and returning to the middle ages. Surely the important thing is restoring public confidence in the current financial system. Not returning to gold. [...]
[...] I can see that paper money requires trust in both bankers and the government not to debase the currency and that people don't trust government or bankers or fractional reserve banking. But issuing currency in gold in order to be assured of a fixed money supply is surely going from the information age and returning to the middle ages. Surely the important thing is restoring public confidence in the current financial system. Not returning to gold.
You seem to think that gold was money because the government declared it to be money. Gold was used as money because it had properties that made it particularly well-suited for use as money. And this is the real issue. Students of the Austrian School might sound like they're advocating gold as money. They're not. What they're realy advocating is that the government not be allowed to force people to use any one particular thing as money. They don't care at all if people use silver or copper or hemp script as money so long as they do so voluntarily. Most Austrians are pretty convinced that a free market will naturally settle on gold as money, but they are not at all arguing that "we" (in the political sense) should use gold as money.
Also, bankers and the governmnet always debase the currency when they have the chance. That's the very reason they force people to use bank notes as money in the first place.