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Our Financial House of Cards

March 25, 2008

Tags The FedGold StandardMonetary Theory


I am indebted to Professor William Barnett, II, of Loyola University, New Orleans. His recent internet postings on the mises@yahoogroups list made me aware of the fact that the capital requirements of banks under the Basel II Capital Accord, rather than official reserve requirements imposed by the Federal Reserve System, is all that has served to constrain the increase in the quantity of money in the United States in recent years. His comments also served to provide important insight into understanding the role of banks' capital requirements in explaining essential aspects of their recent behavior as well as their likely behavior in the weeks and months ahead.

[1] Sweep accounts are checking deposits that banks transfer into savings deposit accounts overnight, on weekends, and on holidays, in order to reduce their required reserves and thus be able to use any given amount of reserves to support a larger volume of checking deposits.

[2] Inasmuch as the accounts subsumed under this last head generally allow the writing only of a limited number of checks per month, and sometimes impose limits on the minimum dollar amount of the checks that may be written, they probably should not be counted as part of the money supply to their full extent. To precisely what extent they should be counted is an open question. Nevertheless, it may be that counting them to their full extent represents a lesser error than attempting to adjust them downward. This is because doing so makes allowance for the extent to which roughly $2.1 trillion of institutional money funds may also actually serve as money.

[3] The $800 billion of currency outside the banks is counted as part of the M1 money supply along with the checking deposit component of $625 billion previously referred to. Thus, at present, M1 is approximately $1.4 trillion.

[4] It should be realized that in the absence of any commitment of the Fed to buy gold at $12,700 per ounce, the market price of gold would almost certainly be radically lower. To the extent that additional gold could be purchased at lower prices, the possibility would exist of increasing gold reserves relative to outstanding checking deposits and currency and thus of ultimately having a 100-percent reserve at a price of gold less than $12,700 per ounce. Furthermore, it should be kept in mind that the Fed would need to proceed with great caution in purchasing additional gold. The danger to be avoided is that of initially drawing a disproportionate share of the world's gold to the United States, when it alone was in process of remonetizing gold. If the US economy became accustomed to such a large gold supply, and then, later on, if and when the rest of the world remonetized gold and drew much of that gold back out, the US would be in the position of experiencing first a virtual inflation in terms of gold and then a virtual deflation in terms of gold, the very kind of sequence of phenomena that a properly established 100-percent-reserve gold standard would permanently prevent.

[5] See above, the preceding note.

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